The International Monetary Fund chief economist-designate Raghuram Rajan feels big deficits -- whether India's fiscal deficit or the United States' current account deficit -- are not sustainable in the long term.
He also says part of the adjustment of the global imbalance will come through the value of the dollar and a part from increases in consumption.
Extracts from an exclusive interview with Tamal Bandyopadhyay and Manas Chakravarty:
Are you against all sort of protectionism?
I don't want to make such a sweeping statement. But I think, in general, protectionism is bad.
For one, it does not do what people advocate to do -- which is creating breathing space for an industry to grow and become more competitive. It actually creates space for an industry to stay stagnant and also it creates the forces that eventually demand more protection.
As industries become stagnant they cannot compete and they lobby for more protection and actually protection breeds more protection.
The idea to have protection when the industry is at an infant stage and then remove it later on simply does not happen.
Would you not consider the east Asian model to be different in this case?
I don't deny the fact that there are some countries which have grown under a sort of protectionist environment and luckily opened up at the right time so that the industries that were protected domestically eventually went out and expanded. . .
My sense is that it requires a whole fortuitous set of circumstances. From the Indian experience, think about the automobile industry under protection. We always thought that if we open up now Ambassador would get wiped out.
Finally, when we opened up Ambassador did get wiped out and for sometime there was no company producing genuine Indian cars other than Maruti ,which is essentially a foreign collaboration.
But over time, the ancillary industry built up and then an Indian firm Tata Motors came up with a car which beat the foreign firms on their own turf. You got that because of competition.
Without making any sweeping statement, let me say, in general, not having protection tends to be better than having protection.
Are you against capital controls?
One has to be very careful about imposing capital controls. I think those countries which have a very under-developed financial system may not be able to sustain -- especially if there are rigidities in that system like controlled interest rates etc, if you allow capital flows to come in.
If you already have a distorted system, the capital flows may distort the system even more.
Does that apply to India?
I am less sure about India. While systems are getting to a reasonable situation, I do think that if we want to take full advantage -- I mean the upside; the capital flows without the downside -- we need to fix some of the aspects of the infrastructure like we need a solid bankruptcy law which is clear cut, quick and transparent.
If we don't have that, the creditors will always be wary that they are going to be left holding the bag if there is a crisis. We also need to improve the accounting systems and need to reduce the administered interest rates to rock bottom as they create distortions.
All these things have to happen. I think I must say that there are people who say let's wait till the system is in place before we open capital flows.
The problem with that reasoning is that often the capital flows themselves cause an improvement in the system which would not happen otherwise.
So, you can't wait till things become perfect. Instead, you should have a stage-wise process of opening up. You don't need to open up immediately but open up in a deliberate and pre-determined fashion so that people have the room to anticipate and change in anticipation of the opening up.
Does that mean that the Reserve Bank and the finance ministry are on the right path?
I think broadly they are in the right direction. One would like to see more speed. Here I am talking as an Indian and not as a future chief economist of the IMF. Second, it will be really good if we see a roadmap.
In that roadmap it also must indicate reduction of the government control over the public sector banks.
This does not necessarily mean privatisation but the reduction in government control otherwise the government will continue to interfere in the areas of credit, etc.
Are there powerful disincentives in public sector banking?
I think there are distortions of various kinds, both positive and negative towards the public sector banks.
Interest rates have come down but not for every corporate. How do you react to that?
One of the problems in India is the huge fiscal deficit and the question is how much is that crowding out private credit. I do not think that we have a clear cut answer. In the long run, if you have such a huge fiscal deficit, eventually, it start crowding out private credit.
It does that in more ways than the traditional thinking that it is absorbing part of the savings and therefore pushing up the interest rates for private sector.
When banks find there is a "safe alternative" they are less prone to take risks in investment and so you get the spectre of banks investing in safe papers.
You can keep saying that there is no credit demand but if you improve the infrastructure and the laws governing collection, those creditors would become credit worthy. When there is a safe lending avenue, there is no incentive to go out and improve that. You need an internal push to this.
We have priority sector lending to offer weaker sections of society access to credit.
The question is: Is that access going to the people who needed credit the most or is that credit being directed in ways less than appropriate.
So, when banks are forced to lend, the political factors work. You give loans to my brother-in-law because I am the local MP and that comes under priority sector lending.
I think that it will be better to make these loans on the basis of commercial judgement. If you really want to help certain sections, offer a direct subsidy. Instead of forcing banks willy-nilly to lend to certain segments regardless of their credit-worthiness, give them subsidy directly.
The loan losses for these directed credit is pretty substantial and that hurts the whole system.
You have mentioned that markets have to be regulated. But when the whole system is globalised and there is no global regulator, won't the firms go to less regulated places and take advantage of regulatory arbitrage?
The assumption that less regulation is always better for firms is not quite right. Why do so many firms list on New York Stock Exchange?
Because the NYSE has a set a rules and regulations on corporate governance, disclosure obligations, so on and so forth.
So the firms will always go to the least regulated markets in some God-forsaken place is not correct. There are always benefits from being regulated. But over-regulation is not good.
In India we have a plethora of regulators. Should the country opt for a super-regulator on the FSA (Fiscal Services Administration) model?
That point is debatable. I don't think we have a good sense of which system works better. It is not clear-cut that one is superior to the other. With the growth of new markets, we are getting a little haphazard formation of regulators.
It makes sense to go back and rethink whether we have the right set of regulators for everything.
The choice may not be between a super-regulator and multiple regulators. We need to see whether the entities are being regulated by the right kind of regulators.
What is your view on the current global imbalance? One the hand, some countries have huge current account deficit while a few others are piling forex reserves?
It is not sustainable. If you have a country which is running a huge current account deficit, at some point people will stop holding assets of that country. It could take 15-20 years but that's going to happen at some point.
Also I think that developing countries are in some sense running a surplus. Eventually given the state of development they should be running a deficit as they should be investing more.
This change has to take place. It has to take place for another reason which is population is growing older in developed countries.
So, they should be investing in developed countries and when they grow old, these investments should pay dividends.
That should be the pattern. It has to be flows from north to south rather than south to north.
The imbalance has to correct itself. There is also some north-north imbalance and south-south imbalance but the north-south imbalance has to correct itself at some point.
Do you see several bubbles all over the place waiting to be burst?
I think that these big deficits -- whether India's fiscal deficit or United States' current account deficit -- are sustainable for some time.
We keep thinking that because they have been sustainable for so long, they will continue to be sustainable in the future. But the laws of economics at some point have to start ticking in.
So, what happens at that juncture? It is better that there is a convergence rather than an abrupt shock.
Do you expect this bubble to get deflated through the value of the dollar?
I don't want to use the word bubble. Part of the adjustment of the imbalance has to come through the value of the dollar and part has to come from increases in consumption from the countries that are exporting tremendous amounts.
Once their currency goes up clearly consumption will increase. Some of it may come from increase in investment from those countries and capital goods flowing the other way, thus correcting the trade imbalances.
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