Ashok Dasgupta

Planning Commission Deputy Chairman Montek Singh Ahluwalia left early on Monday for London for the preparatory sherpa meeting ahead of the G-20 summit of Heads of State on April 2, which is to be attended by Prime Minister Manmohan Singh.

In an exclusive interview with The Hindu prior to his departure, Mr Ahluwalia spoke at length on issues pertaining to the global financial crisis, the steps that need to be taken to combat the resultant slowdown and India's expectations from the summit.

Q: What is the backdrop of the G20 London summit?

A: The summit is taking place at a time when there is global crisis of extraordinary magnitude, the worst in 60 years. I think all the leaders understand that the summit’s aim is to look at the global economic situation, to review what has been achieved in the areas identified in November last year when they met in Washington and, may be, to give some messages on what should be done in future.

Q: What is India’s expectation from the summit?

A: Obviously, we are interested in all the different elements of the global crisis which needs a global response. India is one of the 20 countries which represent about 70 per cent of the world GDP and we hope the summit comes out with a global message which meets our expectations. We need a revival of the global economy, we need the financial system in industrialised countries to get fixed as soon as possible, without which it is difficult to envisage a revival of confidence. We think that the global community needs to take some special measures to make sure that the developing countries are helped at a time when a crisis that was not of their making is having a very severe effect on them.

The whole shrinkage of private capital flows from emerging markets is massive, something like US$ 700 billion. Obviously, this will have an adverse effect on growth of many developing countries and I think that this withdrawal of capital has occurred not because of anything that has gone wrong in developing countries but because the financial systems in the industrialised countries malfunctioned. So the global community needs to take corrective steps so that some revival of capital flows takes place till the multilateral institutions step in. There is also the larger issue of financial architecture. We need to make sure that in a globally integrated world where a crisis in one part of the system can affect the whole world, we should have a global governance framework that can anticipate such crises and then take corrective action.

Q: From the Indian perspective, what should be the ingredients of these special measures?

A: First of all, it is very important that a coordinated effort is made by all major economies, including India, to take steps to de-lever the crisis. Since this is a period when governments have to actively intervene, it is our view that both monetary and fiscal policy should be actively used to restore growth momentum. On our own front, we would certainly tell the assembled leaders that we are doing what is necessary. We have had a major relaxation of monetary policy, we have had a major fiscal stimulus, we have tried to make sure that the more vulnerable sections of our population get an adequate flow of support through the NREG programme and we would like to see the rest of the world also take steps to stimulate their economies.

Secondly, I think it is very important that the global economies remain open. We are very concerned that there are protectionist noises being made and I want to emphasise that we must distinguish between a protectionist noise and actual protectionist action. The fact is that a protectionist noise actually gets converted into action unless there is a strong political leadership. When the leaders met in Washington in November, they had said that we must have a ‘standstill’ agreement -- in the absence of an agreement on the Doha Round -- that we will not increase protectionism. Actually, every country has taken some action but, by and large, the protectionist actions taken have been minor.

But protectionist pressures are rising and we are very concerned, for example, over financial protectionism. We support the fact that industrialised countries are trying to save their banking system. So when the banking sector has problems, we have to recapitalise banks. But some governments have said that one of the conditions of recapitalising is that they will preferentially increase domestic lending. This is protectionist. As a result, trade finance has dried up as banks are focusing on their own home turf. This hurts developing countries because if they have an incentive not to lend to trade, then I think trade will decline. So we are opposed to that.

Then finally, I think in the area of multilateral institutions, we can increase the flow of resources to developing countries through institutions like the IMF and the World Bank. Fortunately, India has no intention of going to the IMF as our reserves are very ample. But for developing countries as a whole, it’s very important that the IMF is adequately financed. The present position is that the IMF’s total resources are $ 250 billion, which is exactly equal to India’s foreign exchange reserves. Now how can the IMF solve the problems of the world if its resources are equal to only India’s reserves? On the one hand it tells you that India is very adequately protected, but it also certainly tells you that the IMF is not adequately funded. So we want more of that.

Q: What about funding of regional development banks?

A: We are very keen that regional development banks should increase their lending at this time when countries are experiencing a withdrawal of private capital. I think the multilateral institutions should step in, may be temporarily, to offset this outflow. The ADB, for example, has a long-standing demand to increase its capital by 200 per cent in order to support higher levels of lending. India is very keen to do that. So are the Japanese and other countries in Asia are in favour of it and we have to see whether we can get endorsement by the summit. So I think on all these fronts, we need to find ways of finding more resources.

The US Treasury Secretary had said that the IMF needs an additional $ 500 billion, which is almost a trebling of its resources. That is more or less our estimate also. In Davos in January this year, when an official spokesman of the IMF said that they needed a doubling from $ 250 billion to $ 500 billion, we said that IMF needed a trebling of resources to $ 750 billion. One of the issues that comes up is that how does it get these resources. Do you just borrow them in an ad hoc manner which is a temporary solution or do you increase the IMF quota. And if you increase the IMF quota, how do you rebalance the voting share, because you could follow a rule or a formula for the additional quota which is different from the existing share and that would help to rebalance. We think that should be done so that the emerging market countries which have gained in their position in the global markets have their economic strength reflected in their voting share.

Q: But what about a greater voice for developing countries?

A: We have been arguing for a greater voice for developing countries in most of the fora where critical decisions are made. One of the key issues in the financial crisis is -- what are going to be the supervisory and regulatory rules imposed on the financial system of the world to make it less vulnerable to crisis. The international regulatory forum for banking supervision is the Basel Committee and there is the Financial Stability Forum (FSF) which brings the different groups together.

In the past, India has not been a member of these and we had argued that the group should be broad-based. There is already success in that because the FSF has been expanded and the countries in the G20, which were earlier not a part of the forum, have been made members. There are two groups, the BRIC countries have been brought in on the same level as the G7 in terms of number of seats. The non-BRIC G20 countries have been brought in a second tier. Similarly, the Basel Committee has also been expanded and India is now included. I think these are important systemic changes which democratise the system.

At the Finance Ministers’ meeting, it was agreed that the heads of both the World Bank and the IMF should no longer be a closed selection process in which there is some informal understanding that the World Bank head will be an American and the IMF head will be a European. Rather it should be an open competitive system. Obviously, the bigger countries will have a larger say because they have a larger voting power, but the process will be open and all the countries will vote for their preferred candidate.

Q: What about the differences in perception on the corrective steps required? The US is banking more on fiscal stimulus packages but the European countries want stricter financial regulation…What is India’s stand in this regard?

A: India’s position on this is very clear. First of all, these are two separate issues. There is the issue of what you do with the global economy today and the issue of how do you regulate the financial system so that these kinds of problems do not happen in future. We are quite clear that we need to act on both fronts. We need to do something to take care of the global situation today, but we also need to change the system of regulation and improve it.

I think there is a lot of agreement among different countries that the perimeter of regulation should be expanded. We should cut out regulatory arbitrage. Shadow banks which were doing the same thing as banks, particularly in the United States and also in Europe, should be subjected to similar regulation. Otherwise, you are basically legitimising an area for non-regulatory activity by institutions that become very large. This is not a very serious problem at all in India because the non-banking sector is still very small. But in the US, the non-banking sector is as big as the banking sector.

As you know, we have ourselves internally been very cautious, but we are certainly in favour of more effective international regulation and particularly for systemically important institutions which operate across borders because it is these institutions that can transmit contagion from one part of the world to another part of the world. I don’t think the Americans dispute that either. You may occasionally have differences over how much regulation, but even the Europeans say they want more regulation but regulation should not kill innovation. The Europeans perhaps want tighter regulation on hedge funds; the Americans feel that the problem was not because of hedge funds, it was because of leveraging and the leveraging was done by regulated institutions. So they are more in favour of registering hedge funds and getting more information, but these are matters of detail.

There is complete agreement that we need stricter regulation as the present system of regulation and supervision has been shown to be inadequate. I do not think that the US has any different view. We need a better system, but what that better system is going to be has already been fixed by the leaders and it will go back to the regulators, Basel Committee and others. It’s the regulators that will then determine as to what is the global standard that we should aim at. Now one good development is that we are part of that system because we are now represented. It is not as if some G7 regulator will come up with a solution and we have to implement it. We are part of finding the global consensus.

Even when the global consensus is determined, regulation will be national. National regulatory authorities will be looking at the global standards while allowing their own regulation as global regulation. In the case of systemically important institutions which operate across borders, there is, I think, agreement that we should have some sort of system of a college of supervisors.

Q: How is this system of college of supervisors likely to function?

A: Typically, let me say that you have a banking institution which is also doing investment banking activity and some part of it is also doing insurance activity. In the home country, the college of supervisors should include the regulators of these three segments. Across countries, the college of supervisors should include supervisors in the host countries where this entity has a significant presence. So this will be a completely new idea because up to now we have not had supervision by a college including international representation.

Q: Will this college have statutory powers to point out where a country is going wrong?

A: I don’t think it will have global statutory powers. Each regulator will control what an institution does in its own country. But being part of the college, it will become a part of the supervision of that institution by others. So hopefully, by being a member of this organisation you will have a better sense of the possible problems. An Indian member of the supervisory college cannot stop the institution from doing something somewhere else. But based on what they learn, they can stop it from doing whatever they are doing in India. So in that sense, they don’t have a global regulator.

Sometime ago, there was an impression that some people would like to have a global regulator. I don’t think that is possible as it is actually not practical. Today, I don’t think there is any country actually arguing for a global regulator. They want national regulation but they want the standards to be made globally more acceptable and national standards to be aligned and cooperation among supervisors. Now that’s quite a big change from the past and very significant for forward development.

Q: Everyone knows that the reckless behaviour of US financial institutions that led to the current global crisis. Do you think that the London summit can work out a mechanism to correct the situation and ensure that it does not happen again?

A: A lot of what you said relates to where you put the blame on the crisis. Now that’s an important issue and I don’t want to go into it. I don’t think the leaders are going into this meeting on the blame-game point of view. But they are going into the meeting saying that look, whatever happened is pretty bad and how do we stop it from happening in future.

The key answer to that is a better system of financial supervision and regulation and two, the IMF as a global monitoring body interacting with the Financial Stability Forum with the responsibility of becoming an early warning system to be able to spot difficulties. Now there is a lot of scepticism about whether the IMF can actually do that job and it is a very difficult job. Everybody is agreed to improve the regulation and in addition to that, we need an international institution which specialises in trying to see whether the dangers to stability are mounting.

Historically, the IMF has tended to be viewed as having a lot of clout when it is dealing with countries that have to borrow from it and having no clout at all when it is dealing with countries that don’t have to borrow from it. .

Q: During the East Asian meltdown, the IMF had no inkling of what was going on? So can it be trusted in a wider global crisis?

A: That's true, but let me put it this way. In trying to build an international financial architecture, you are engaged in a really creative act in trying to set up systems that will strengthen themselves over time. There’s nothing you can do in three days from now that will be a guarantee. One can be very cynical and point out that what’s the use of this agreement which is saying things it does not mean anything in practice. Now some of what they are saying is very substantive. Like for example, we will expand the perimeters of regulation, we will set up a college of supervisors, we will set up global standards.

They are also saying that we will set up the IMF as an international organisation charged with studying problems of vulnerability and financial instability and being an early warning system.

It's true that in the past, the IMF has not done a good job. But let me say that it is a very difficult job to do. But all said and done, there is a lot of scepticism and there is a feeling that the IMF has actually not been very effective in being able to raise issues of stability when the problems rests with industrialised countries. They have been quite willing to identify problems in developing countries but even there, there are many instances where they missed signs of these problems. Now, can you overcome this? We have to see. Obviously, no one is saying they are confident that the IMF can do it. But what they are saying is that if it has to be done, it must be given to the IMF and then find and work out why it is finding it difficult and how we can strengthen them. They must become more self critical and I think peer review also very important.

Countries must realise that the current crisis is serious. And that does not mean only the emerging market countries. If the problem emerges in any of the major blocs of the world – whether it is the US, Europe or Japan – we can see that in a world of global integration it can badly affect the other blocs. It’s not that the bad effect is only on the developing countries. I think they have seen that it is in their interest to try and spot when there are problems.

Q: When compared to the fiscal stimulus packages announced by the US and China, do you think that the packages announced by India are good enough to combat the slowdown?

A: That's a very important question. There is a misunderstanding on the extent of stimulus in India. That is because if you define the fiscal stimulus to be the extent to which the fiscal deficit is allowed to worsen. India’s fiscal stimulus is very substantial. The IMF itself has documented that it is over three percentage points of the GDP. The problem is that some of that happened not because of what we call fiscal stimulus but because of other increases in expenditure that occurred during the course of the year. Some of them may have occurred even before the crisis. But nevertheless, the bottom-line is that while new expenditures took place, we did not try to cut other expenditures.

Actually, as a conscious management decision, we lived with a higher fiscal deficit. I think the fiscal stimulus was not just what was announced in December 2008 and January this year. If fiscal stimulus is (measured) by how much the fiscal deficit widens, to that extent the fact that you gave a Pay Commission increase but didn’t try to offset it by higher taxes or cutting other expenditure is a fiscal stimulus. Even the fact that your revenues turned out to be less that what was expected is a kind of automatic stabiliser leading to a fiscal stimulus.

So I think India’s fiscal stimulus is actually not small. In fact, many people think that India does not have fiscal space and, therefore, the fiscal deficit has been allowed to widen too much. India’s fiscal policy thus cannot be criticised on both counts. You cannot say your fiscal stimulus is too small and simultaneously say that your fiscal deficit is too large. In my view, the fiscal stimulus is not too small because it must be looked at in totality.

Now we come to the question whether we are being irresponsible by allowing the fiscal deficit to increase as much as we have. The answer is no. And the reason for that is we are facing a massive shock of demand because of the shrinkage of exports and financial disruptions which is affecting investment activity. Now if you face such a shock of demand in a world where exports are not going to increase, you have a choice. You can either let the multiplier effect work and get a depressed level of output or you can offset this loss of demand by injecting new demand which will general feedback through a multiplier. That is what we have done.

The only argument one could make is have we done the fiscal deficit increase in the best possible way. Some people might say that by not allowing the oil price to rise in the first half of the year when oil prices shot up, that itself contributed to a big fiscal deficit. Some others might say that is not the best way of doing it, you should have raised oil prices and done the fiscal stimulus in the form of infrastructure spending. But there is no doubt that in the short run, by allowing the gap on the oil front to widen, you are actually doing a fiscal stimulus. And then you have to consider whether we have allowed the fiscal deficit to become too large. I don’t think so, given the nature of the global shock.

Q: China has questioned the status of the US dollar as the world reserve currency. What is India’s view on that?

A: I have seen the article published by the Governor of the Bank of China wherein he raised the issue that an international reserve currency has to observe certain kinds of discipline which, in his view, the US dollar is not in a position to meet and therefore is not a suitable international currency any longer. He suggested that we should rely on the SDR (special drawing rights). I think the issue of what is the most stable form of having a reserve currency is a very real issue. So the problem he is addressing is a legitimate problem. It is true that potentially, the dollar is not the only reserve currency. There is the Euro, there is the Japanese Yen, but the way it has worked, the dollar has been seen by most people and most countries at a dominant position. As far as the SDR is concerned, there are two separate issues. India’s view is that we should have an expansion of the SDR and that it can play a useful role by being expanded, including therefore, by encouraging people to hold their reserves in the form of SDRs.

But you know, at the practical level, there is inadequate consensus to allow that to happen because the SDR is a very restrictive form of currency. The IMF’s ability to control it is very restrictive. For example, if we are to move to an SDR-based system, we will have to redefine the rules. Today, it is extremely difficult to expand the SDR as we need an 85 per cent majority and what is more, if you have to contract it, you would still need an 85 per cent majority. Keynes had said that when we move to a globally integrated world, the IMF should be able to create a global currency.

The SDR is only a very small step towards that. So as practical matter, the only choice we have is to let the SDR’s role expand and let the IMF push in new SDRs which will give everybody a little bit of liquidity. India is definitely in favour of that and we have argued in the discussions leading up to the G20 that there is a case for a significant fresh issue of SDRs.

Q: Did the Washington summit play down the culpability of the US and Europe?

A: You know, I think to talk about culpability, international summits are not the place where you discuss these issues. Another way of focusing is that the Washington Summit did not come to an analysis of what caused the crisis, except in very general terms. The US did own up to the crisis but there was no clear understanding of what caused the crisis.

I think today there is a better understanding and a lot more recognition that there was a regulatory failure. Remember, that monetary policy and controls and things like that, both in Britain and in the US, is not in the hands of the political leadership. They are in the hands of politically-appointed regulators. Today there is a perception that these regulatory authorities failed and had they acted more prudentially, this crisis would not have occurred or whatever happened would have been less damaging.

Q: The current crisis is giving rise to protectionism. Do you think it is a short-term reaction?

A: There is no doubt that the rise of protectionism will create problems for all members of the world economy, including us, and we often make the point that at least as developing countries there is a lot of doubt and suspicion about the fairness of the global economic system. We have been very successful, I think, in opening up our economy and showing people that opening up the economy to the world gives you many opportunities and while here and there it might cause problems, the opportunities it opens up are worth those problems.

Now if as a result of protectionism, those new opportunities begin to disappear or even to be reduced, it will reduce the support for globalisation. And it is not that this will actually help the countries that practise it. They know from their own history that the Great Depression was greatly exacerbated by their resort to protectionism. One of the biggest disasters of 1930 was that industrialised countries resorted to protectionism amongst themselves and sent the world trade into a tailspin. I think it is a no-brainer that we must avoid repeating the mistake of history. I think they know that and they say it. So I think we need to strengthen the resolve to fight against protectionism. You know, here the leadership has to come from countries that have more stake in the global economy which is the industrialised countries. We hope that they will show that leadership and stand firm, explain to their own public that these sort of knee-jerk reactions are not in the interest of their own economy, quite apart from the fact that they will hurt us. And, of course, when they hurt us there will be a danger of retaliation which we cannot control.

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