I.
Growth Trends I am happy to observe the continued healthy expansion of world
GDP and that the International Monetary Fund (IMF) is projecting only a marginal
slowdown from 5.1 per cent in 2006 to 4.9 per cent in 2007. It is important to
note, however, that some other forecasters are not so sanguine. The global economy
has maintained its pace of growth in the first half of 2006. Although growth rates
recorded in most of the advanced as well as emerging economies have exceeded their
earlier projections, the US does appear to be slowing down in the face of headwinds
from a cooling housing market. Expansion has continued in the euro area, which
along with a sustained recovery in the Japanese economy bodes well for world growth
prospects. China and India have continued to grow at an accelerated pace and the
rest of Asia has also maintained its growth momentum. China and India certainly
will continue to exhibit healthy growth next year. The IMF projects that China
is expected to grow at 10 per cent in 2006 as well as in 2007, while the growth
projection for India has been placed at 8.3 per cent for 2006 and 7.3 per cent
in 20071 (Table 1). Considering these developments, the projections by the
IMF for the world economy at 5.1 per cent in 2006 and 4.9 per cent in 2007 may
not be over optimistic, barring a really severe US slowdown. During 2007, a slowdown,
which is expected in most advanced economies, will be partly * Presentation
by Dr. Rakesh Mohan, Deputy Governor, Reserve Bank of India in the Meeting of
G20 Finance and Central Bank Deputies held in Sydney, Australia during October
13-15, 2006. Assistance of Rajiv Ranjan in preparing this address is gratefully
acknowledged. 1 We may note that official Indian GDP growth estimates have
been revised to 9.0 per cent for 2005-06 and the Reserve Bank has projected growth
to be in the range of 8.5 – 9.0 per cent for 2006-07. offset by continued
strong growth in major emerging markets, particularly in Asia. However, it would
depend on how far growth in emerging economies is autonomous of the US growth
prospects. Softer demand in economies such as the U.S., Japan and Germany will
drive the slowdown as the tightening of economic policy begins to materialise,
though indications from Japan and Germany suggest a continuing recovery. However,
emerging Asia is still considered to be the fastest growing region of the world,
which would prop up the global economy in 2007. So far high oil prices have
had a limited impact on economic growth as demand rather than supply has been
the major driver of price rises. International oil prices have, however, eased
in recent months possibly on account of a series of positive supply side developments
before picking up again more recently. If further sustained increase in prices
prevails2 , it may aggravate the growth
Table 1: Growth Projections
by IMF for Major | Regions
and Countries | Region/
Country | 2005 | Projections | Projections |
| | for
2006 | for 2007 |
World | 4.9 | 5.1 | 4.9 |
Advanced economies | 2.6 | 3.1 | 2.7 |
US | 3.2 | 3.4 | 2.9 |
Euro area | 1.3 | 2.4 | 2.0 |
Emerging Asia | 8.5 | 8.5 | 8.2 |
Middle East | 5.5 | 5.7 | 5.8 |
Africa | 5.4 | 5.4 | 5.9 |
Western Hemisphere | 4.3 | 4.8 | 4.2 |
Australia | 2.5 | 3.1 | 3.5 |
China | 10.2 | 10.0 | 10.0 |
Japan | 2.6 | 2.7 | 2.1 |
India | 8.5 | 8.3 | 7.3 |
Source: World Economic Outlook,
September 2006. | 2 The mild winter in the US and Europe
2006-07 has subsequently contributed to the cooling of oil prices for the present. concerns
for 2007 as the consequences could be much worse this time round. In the face
of heightened uncertainties with regard to slowdown in growth in advanced economies
like the US, coupled with inflation concerns, policy makers are finding it increasingly
difficult to gauge appropriate policy responses for supporting growth while fighting
off renewed bouts of rising inflation at the same time. II. Risks to the Global
Economy As a central banker, I have to admit that nothing worries us more than
collective impression of no risks on the horizon. As Mr. Mervyn King is reported
to have said, when asked what do central bank Governors do in their bi-monthly
meetings in Basel: “we get together to worry together”. Accordingly,
I was also disturbed in the last IMF Article IV Mission to India that found little
to worry about! Then, what are the worries at the present juncture? As almost
all commentators would list, let me reiterate the common concerns. 1.
Continuing Uncertainties Related to Oil Prices The issue of rising oil prices
has been a source of concern for policy makers for some years. The reasons of
rising oil prices are of course multiple including limited spare capacity, geo-political
uncertainties, and the like. In contrast, others believe that the price of oil
is almost entirely speculative, and that the increase in price is due to oil speculation
extending into the long term. They argue that speculators foresee increasing demand,
decreasing supply, or both, leading to a long term increase in the price
of oil. Uncertainties with regard to rising oil prices leave the countries particularly
the biggest consumer like US and China highly vulnerable to any supply disruption
and/or ratcheting up of prices. During the first eight months of 2006, the average
petroleum spot prices has surged by 16 per cent. It appears that price increases
since 2003 have had some dampening effect on demand but continued buoyancy in
most of the major countries, especially China and US has prevented a fall in overall
consumption (IMF, 2006). Since the issue of elevated international oil prices
has been discussed and analysed a lot over the time, I would like to conclude
by highlighting four points, two negative and two positive. (a) The overall
demand supply situation remains tight and is expected to remain so over the next
few years. Hence, a high level of international oil prices may continue and any
small disturbances will lead to high volatility and uncertainty. (b) If there
is a world GDP slow down, it could affect developing country oil importers very
adversely. (c) There seems to be further scope of improving the oil use efficiency
by enhancing productivity, and the US can go a long way in improving the oil economy.
(d) Use of oil resources by the oil exporters, if put in real investment, could
stimulate the world economy. 2. Possibility of Inflationary Pressures The
global economy proved remarkably resilient to the sharp rise in energy and metal
prices till early 2006. This is perhaps partly attributable to the fact that overall
pass through has not yet materialised across many countries to greater globalisation
and competition in product markets, increase in energy efficiency, lower oil-GDP
ratio and lower raw material intensity in production process (lower share in value
added). However, in recent months, headline inflation in many of the major advanced
economies and emerging economies has been above central bank comfort zones3 on
account of rising oil prices but there are now signs of increases in core inflation
as well. Major central banks have reacted to upside risks to inflation (Table
2). Energy prices and more recently certain non-oil commodities like metals have
been a major source of build up of inflation pressures in most of the economies.
During the first eight months of 2006, in the US, the consumer price index (CPI-U)
rose at a 4.6 per cent seasonally adjusted annual rate (SAAR). This compares with
an increase of 3.4 per cent for all of 2005. The index for energy, which rose
17.1 per cent in 2005, advanced at a 22.3 per cent SAAR in the first eight months
of 2006. Despite the fact that the world economy has coped remarkably well with
sharp rises in energy and metal prices the following four factors indicate a worrisome
picture: (i) The overall monetary overhang of prolonged monetary accommodation
in the US/Europe/Japan should, in principle, bare its ugly inflationary effects
at some point. 3 As oil prices have fallen from their $70+ peaks, headline
inflation has also tended to moderate in developed countries.
Table 2: Increase
in Policy Rates in 2006 -Select Economies | Country | Policy
Rates | Latest Policy
Rates (%) | Change | No.
of Hikes in 2006 | 1 | 2 | 3 | 4 | 5 |
Australia | Cash Rate | 6.0
(August 2) | 25 bps | 2
times | Canada | Overnight
Rate | 4.25 (May 24) | 25
bps | 4 times | Euro
area | Interest Rate on Main Ref. Operations | 3.25
(October 5) | 25 bps | 4
times | Japan | Uncollateralized
Overnight call rate | 0.25 (July 14) | 25
bps | 1 time | UK
| Repo Rate | 4.75
(August 3) | 25 bps | 1
time | US | Federal
Funds Rate | 5.25 (June 29) | 25
bps | 4 times | Switzerland
| Target Range for 3 month LIBOR | 1.25
to 2.25 (Sept. 14) | 25 bps | 2
times | Norway | Sight
Deposit Rate | 3.0 (August 16) | 25bps | 3
times | Sweden | Repo
rate | 2.5 (August 30) | 25
bps | 4 times | Hungary
| Central Bank Base Rate | 7.75
(Sept. 26) | 50 bps | 4
times | South Africa | Repo
Rate | 8.0 (August 3) | 50
bps | 2 times | Chile
| Monetary Policy Rate | 5.25
(July 13) | 25 bps | 3
times | Korea | Uncollateralized
Overnight Rate | 4.5 (August 10) | 25
bps | 3 times | Israel
| Interest Rate | 5.5
(July 24) | 25 bps | 4
times | Thailand | 14-day
repurchase rate | 5.0 (June 7) | 25
bps | 4 times | Turkey
| (i) CBRT Borrowing Rate | 17.5
(July 20) | 25 bps | 3
times | | (ii)
CBRT Lending Rate | 22.5 (July 20) | 25
bps | 4 times | (ii)
The sustained high oil and metals price would also be expected to pass through
gradually. (iii) Increasing levels of capacity utilisation may also constrain
further expansion of global output unless new investment kicks in. (iv) Increasing
food prices, particularly in developing countries is another concern in the global
context. In short, there are risks that continued high inflation may seep in
to high inflation expectations and higher wage demands leading to cost push pressures
in the US. Further supply concerns in the oil market may aggravate such inflation
concerns and as mentioned earlier posing the challenge of growth-trade off for
the central banks. The emerging scenario with regard to inflationary concerns
would depend on how equipped we are as monetary authorities and fiscal authorities
to manage these incipient risks. It would hinge upon (i) how far can monetary
tightening go without impacting GDP growth, and (ii) how far rising interest rates
could impact new investment. 3. Cooling of Housing Markets in the US The
US housing market has already shown signs of cooling down and the US Chair can
perhaps inform us more on this issue. Any abrupt cooling of housing market in
US is likely to weigh down US consumption and thus its growth prospects, which
in turn, would have adverse spillover effects on major trading partners like China
and other emerging economies. The US economy is decelerating moderately and this
trend is expected to roll over well into 2007 as growth is likely to moderate
at 2.9 per cent, driven primarily by an expected sharp slowdown in household expenditure
and more modest business investment. By some measures, prices of existing homes
have leveled off in nominal terms, house sales have fallen, and inventory/sales
ratios have risen sharply. Residential investment has already subtracted
about 0.5 percentage point from second quarter US GDP growth, more than many observers
expected. How much this slowdown will affect consumption is unclear. According
to Ben Bernanke, the Fed Chairman, “the decline in US residential construction
would subtract “about one percentage point” from growth in the second
half of this year and “probably something going into next year as well”.
The ultimate determining factors in this context would be (i) how far the housing
market correction will last, (ii) what would be the magnitude of its impact on
the rest of the sectors, and (iii) how other sectors like equity, non-resident
construction sectors behave in the period ahead. Importantly, a “substantial
correction” in the US housing market is going on but so far it has not had
a big effect on the rest of the economy and has yet to translate into significantly
lower consumption. To date there is little evidence that this correction in the
housing market has had any significant adverse spillover effects on other parts
of the economy. The production of construction supplies has decelerated, but in
general, surplus resources available in the residential market appear to have
been largely absorbed in nonresidential building or elsewhere. The cooling of
housing market may erode household expenditure by dampening the wealth effect
but trends in equity market, growth in wages and oil prices would also be important
determinants of US consumer spending. Therefore, the ultimate outcome would hinge
upon the confluence of these factors. It may be noted that both the housing and
equity boom have been important drivers of growth in recent years. Furthermore,
there has been substantial off-setting strength in other sectors, including non-residential
construction and we may witness a soft landing. 4. Abrupt Adjustment to Global
Imbalances The build-up of global macroeconomic imbalances poses a serious
threat for the global economy as the US current account deficit continues to widen
as does the Chinese surplus (Table 3). In the US, the current account deficit
widened to 6.4 per cent of GDP in 2005 and 6.6 per cent in the second quarter
of 2006. The budget and current account deficits need to be seen in a more holistic
perspective as fiscal shortfalls, especially with the economy nearing full employment,
intensify the need for foreign capital. The greatest threat to the US fiscal position
over the long-term comes from unsustainable growth in entitlement programs such
as Social Security, Medicare. The US Budget for FY 2007 carried some proposals
for savings and reforms to mandatory spending programs. How far these measures
would contribute towards halving of the budget deficit by 2008 and thus leading
to narrowing of US current account deficit is yet to be seen. The important
question in this regard is – do we need coordinated structural action or
will the market mechanism work? Although alternative scenarios are widely discussed
yet it is difficult to be decisive with regard to the final solution. While the
correction can be envisaged through joint policy action across different regions
for moving towards a more orderly adjustment but consensus on such correcting
policies
Table 3 : Global Current
Account Balances | (In
Billion US $) | | Average | 2002 | 2003 | 2004 | 2005 | Per
cent of | | 1991-2001 | | | | | GDP
(2005) | United States | -178 | -475 | -520 | -668 | -805 | -6.4 |
Euro area* | 13 | 39 | 32 | 74 | -16 | -0.2 |
Germany | -21 | 41 | 46 | 102 | 115 | 4.1 |
Spain | -12 | -23 | -32 | -55 | -83 | -7.4 |
Japan | 105 | 112 | 137 | 171 | 168 | 3.7 |
Other Advanced Industrial economies | -3 | 34 | 55 | 48 | 44 | 0.8 |
China | 14 | 35 | 46 | 69 | 161 | 7.2 |
Other emerging Asia | 15 | 92 | 120 | 115 | 82 | 2.6 |
Latin America | -49 | -16 | 7 | 18 | 30 | 1.2 |
Central and Eastern Europe | -13 | -24 | -37 | -59 | -65 | -5.4 |
Oil-exporting economies | 5 | 87 | 143 | 239 | 417 | 9.6 |
Norway | 9 | 24 | 29 | 35 | 49 | 16.7 |
Russia | 12 | 29 | 35 | 59 | 84 | 11.0 |
Saudi Arabia | -6 | 12 | 28 | 52 | 91 | 29.5 |
Oil -importing economies | -101 | -239 | -210 | -304 | -515 | -1.3 |
Advanced | -67 | -328 | -338 | -431 | -683 | -2.2 |
Emerging | -34 | 89 | 128 | 127 | 168 | 1.8 |
* : Sum of the balances of individual euro
area economies. Source: BIS Annual Report 2006. |
across policy makers may be an issue. In this regard, the IMF is conducting
its first multilateral consultations, involving the U.S., the Euro area, Japan,
China and Saudi Arabia to assess how joint efforts by key countries can contribute
to reducing global imbalances while maintaining healthy growth. In an alternative
scenario, adjustment could be automatic through the market mechanism but the crucial
issue is whether it will be in an orderly fashion or otherwise. It is, however,
clear that emerging Asian economies along with the oil exporting countries would
have a greater stake in the adjustment process. The concern, therefore, warrants
a better understanding of policy issues so that appropriate and timely policy
actions can be taken in such a manner that adjustments can take place in an orderly
fashion. I have expressed my apprehensions regarding the efficacy of the exchange
rate adjustment mechanism in various fora. There seems to be some moderation
in exchange rate pass through due to the lower share of manufacturing in GDP and
the globalisation of production. Hence the effect of exchange rate adjustments
on consumption and other behaviour appears to be muted. Policy actions which can
work toward an orderly adjustment could be: - A rapid fiscal consolidation
to raise the savings rate in the US;
- Greater exchange rate flexibility
in emerging Asia which has been financing the twin deficits of the US;
- Additional
spending by oil exporting countries from the Middle-East;
- Structural reforms
in Japan and the Euro area to boost growth and domestic demand through increasing
labor market flexibility and competition;
- Promotion of efficient
absorption of higher oil revenues in oil exporting countries with strong macroeconomic
policies.
5. Risk of GDP Slowdown Sustained growth in the global
economy in recent years has absorbed spare capacity and led to some emerging signs
of inflationary pressures. Output gaps seem to be closing in the advanced countries
and narrowing in emerging market economies. Such a scenario makes the potential
growth prospects of the world economy more uncertain with the underlying risk
of growing inflationary pressures in the years ahead. This suggests that there
is need for new investment to create further capacity or that aggregate demand
would have to be managed within the present limits of productive capacity. Business
sentiment, which seems to have picked up globally, may bode well for a further
strengthening of corporate investment. However, given the present scenario marked
with uncertainties with regard to growth and also the global economy operating
near the potential level of output, policy makers are likely to face challenges
of an optimum policy mix of monetary and fiscal policy. Central banks of major
economies like the US are facing the paradox of an expected slowdown along with
the possibility of incipient high inflationary pressures. While on one hand, inflationary
pressures force central banks to have a tightened monetary policy stance, the
expectation of a slowdown in major economies warrant an expansionary monetary
policy. The question now is whether fiscal policy can provide any cushion. Since
these countries are also facing fiscal strain in the form of high current
account deficits and fiscal deficits, there may not be any further headroom for
expansionary fiscal policy. Therefore, in the short to medium run one cannot expect
much expansion in the global production capacity out of public expenditure at
least. Given the limited existing spare capacity and fiscal challenges for most
of the countries, policy makers will have to manage aggregate demand through an
optimal policy mix so as to maintain a balance between growth and price stability
which of course would depend on country-specific circumstances. 6. Growing
Protectionism A major offshoot of the global slowdown and disorderly adjustment
to global imbalances could be the intensification of a protectionist wave across
the major advanced countries. The OECD has estimated the gains at nearly US$ 100
billion in terms of increased economic activity and hence prosperity –that
could be obtained from full tariff liberalisation for industrial and agricultural
goods. The benefits from liberalising trade in services – the fastest growing
sector of the world economy - could be five times higher, at around US$ 500 billion.
Thus, these ongoing developments, not entirely mutually exclusive, pose some threat
to the growth prospects in the advanced economies. 7. Food Prices Rising
food prices are another emerging challenge for the global economy in general,
and developing economies in particular. The Food and Agriculture Organisation
(FAO) projects an increase of over 2 per cent in the world food import bill
in 2006 compared to 2005. Given the higher share of imports of food and feed,
developing countries’ import bill is expected to grow by 3.5 per cent, while
that of low-income food-deficit countries is forecast to increase by nearly 7
per cent (FAO, 2006). The food price index rose 11 per cent between January–July
2006 (IMF, 2006). Unfavorable weather conditions early this year reduced grain
production significantly, while demand continued at record highs, drawing down
already low global stocks. Countries like Australia are facing drought conditions
while the agriculture sector in India has remained stagnant. It is difficult to
ascertain whether rising food price cycle is a temporary phenomenon? If such a
trend in food prices continues, it poses threats not only in the form of further
inflation, but would also have serious equity implications internationally. To
the extent that food has a larger weight in the consumption basket in developing
countries, similar sectoral price increases would result in higher measured inflation
in developing countries. Attributing the rising food grain prices partly to
crop based fuel production, Lester Brown of the Earth Policy Institute warns that
for the 2 billion poorest people in the world, many of whom spend half or more
of their income on food, rising grain prices can quickly become life threatening.
The broader risk is that rising food prices could spread poverty and overall instability
in low-income countries that import foodgrain. This instability could in turn
disrupt global economic progress (Brown, 2006). Furthermore, it is unclear how
long the current upswing in world prices will persist? In short, global
risks can be enumerated both in terms of demand side as well as supply side concerns.
Whether it is negative demand shocks triggered by the sharper slowdown in US housing
market or supply side shock in terms of fall in productivity and productive capacity
in advanced countries leading to inflationary concerns, it has become a formidable
challenge for central banks to decide on lead and lags of their policy actions.
These uncertainties not only warrant better coordination between national government
and central banks within a country but across the countries. III. Global Macroeconomic
Prospects and India In recent years, India’s stake in the global economy
has increased as its share in world GDP has increased from 4.3 per cent in 1990
to about 6.2 per cent in 2005. The Indian economy has been growing at an average
annual growth rate of nearly 6 per cent since the 1980s, and at over 8 per cent
during the last three years, which is likely to be exceeded this year. A Draft
Approach Paper to the Eleventh Five Year Plan (2007-08 to 2011-12) suggests that
the economy can grow between 8 and 9 per cent per year (Government of India, 2006)4.
India has also shown considerable resilience during the recent years and avoided
adverse contagion impact of several shocks. As regards the price situation, it
may be noted that pre-emptive monetary actions by the Reserve Bank in the form
of hike in policy rates in recent period helped in stabilising inflation expectations 4
The approach paper released in November 2006 has indicated an average growth rate
of 9 per cent over the Eleventh Five Year Plan period. in the face of rising
international oil prices and domestic demand. Inflation movements in 2006-07 have
been driven largely by primary food articles prices. The impact of mineral oils,
which have been the major driver of inflation over the past two years, petered
out by early September 2006 on the back of base effects. Headline inflation remained
within the indicative trajectory although underlying inflationary pressures continued5
. As far as India’s growth prospects in the face of global slowdown are
concerned, it is important to note that the Indian economy is largely domestic
demand driven and is likely to remain resilient on account of its inherent strengths
even if a growth slowdown occurs in rest of the world. We are in fact in the world
of a positive sum game mainly because of increasing trend in saving and investment.
Increase in the domestic saving rate is contributed by a significant turn around
in public sector saving and the sustained high profitability of the corporate
sector. Assuming the trend continues in the coming years, one can imagine that
the Indian economy may achieve higher growth in GDP and per capita GDP. Given
the reform initiatives envisaged under the Fiscal Responsibility and Budget Management
(FRBM) Act, we expect the public savings to improve further. One important
point needs to be mentioned that India’s services sector, especially the
sub-sectors that have been 5 Inflation has since exceeded the indicative
range of 5 to 5.5 per cent and the RBI has taken further measures to withdraw
monetary accommodation, along with prudential measures to restructure credit growth
in certain sectors. showing robust growth (e.g., business and financial
services, retail and construction) for the last few years, need lower capital
intensity than the manufacturing sector. This preserves the current pattern of
growth and therefore, India may not need or achieve the kind of investment rate
that the East Asian countries needed to finance their rapid growth driven by manufacturing
sector. It is not merely the difference between the rates of saving but it is
the composition of saving that seems to be more striking. In all the East Asian
countries as well as in the US, the corporate saving exceeds household saving
by a magnitude of 10 per cent (Korea) to nearly 400 per cent in case of Philippines,
while for India the reverse is the case. As far as impact of global growth
slowdown on the Indian external sector is concerned, it is important to note that
not only Indian growth process is more domestically driven but our export basket
composition is quite diversified. Our trade deficit on goods accounts is partly
financed by the surplus on invisible account particularly remittances and software.
However, one unstated worry is that if the trade deficit gets widened in the medium
term in the range of 6 to 7 per cent, it may lead to concerns relating to domestic
employment prospects. In the event of a global slowdown and a sharper fall
in US growth, there may be some adverse impact on software exports and remittances
flows to India (Table 4). However, over a period of one and a half decades, the
share of the top 10 trading partners in India’s total trade has decreased
from 65 per cent in 1990-91 to 46.2 per cent in 2005-06 indicating growing trade
Table 4 : Current
Account of Balance of Payments (Net) | (US
$ Million) | Item | | 2000-01 | 2001-02 | 2002-03 | 2003-04 | 2004-05
(R) | 2005-06 (PR) | Apr.-Sept.
2005-06 (P) | I. | Merchandise | | -12,460 | -11,574 | -10,690 | -13,718 | -33,702 | -51,841 | -35,141 |
II. | Invisibles | | 9,794 | 14,974 | 17,035 | 27,801 | 31,232 | 42,655 | 23,458 |
| Services | | 1,692 | 3,324 | 3,643 | 10,144 | 15,426 | 23,881 | 14,298 |
| Of which: Software
Services | 5,750 | 6,884 | 8,863 | 12,324 | 16,900 | 22,262 | 12,085 |
Total Current Account (I+II) | -2,666 | 3,400 | 6,345 | 14,083 | -2,470 | -9,186 | -11,683 |
P : Provisional. R : Revised. PR : Partially
Revised. Source: RBI, Handbook of Statistics on the Indian
Economy 2005-06 and Monthly Bulletin. | relations and wider
diversification across countries. In this context, it may however, be noted that,
till recently, the US had a much higher weight in India’s global trade,
which is now being supplemented by China and the East-Asian economies (Table 5).
Table 5: Trends in
Direction of Trade | (%
Share in Total Trade) | | | 1991- | 1996- | 2001- | 2005- |
| | 95 | 2000 | 05 | 06 |
| | | | | |
I. | OECD
countries | 56.1 | 52.6 | 42.9 | 37.6 |
| A. EU | 27.7 | 26.0 | 20.6 | 18.2 |
| 1. Germany | 7.5 | 5.8 | 3.8 | 3.8 |
| 2. U.K. | 6.3 | 5.8 | 4.7 | 3.7 |
| B. North America | 15.2 | 15.0 | 13.2 | 11.0 |
| 1. Canada | 1.1 | 1.1 | 1.1 | 0.8 |
| 2. U.S.A. | 14.1 | 13.9 | 12.2 | 10.2 |
| C. Asia and Ocenia: | 10.0 | 8.0 | 5.4 | 4.9 |
| of which | | | | |
| 1. Australia | 2.1 | 2.2 | 1.9 | 2.3 |
| 2. Japan | 7.6 | 5.6 | 3.3 | 2.5 |
II. | OPEC | 15.0 | 17.1 | 9.6 | 10.7 |
III. | Eastern
Europe | 6.1 | 3.1 | 2.2 | 2.3 |
| 1. Russia | 4.6 | 2.1 | 1.2 | 1.1 |
IV. | Developing
countries: | 21.7 | 26.7 | 28.8 | 31.3 |
| of which | | | | |
| A. Asia | 17.4 | 20.3 | 22.2 | 24.8 |
| 1. China, People’s | | | | |
| Republic of | 0.9 | 2.0 | 4.2 | 7.1 |
| 2. Hong Kong | 2.7 | 3.2 | 3.2 | 2.7 |
| 3. South Korea | 1.6 | 2.0 | 2.0 | 2.5 |
| 4. Malaysia | 1.4 | 2.3 | 1.9 | 1.4 |
| 5. Singapore | 3.0 | 2.7 | 2.7 | 3.6 |
| 6. Thailand | 0.9 | 0.9 | 1.0 | 0.9 |
| B. Africa | 2.9 | 4.8 | 4.6 | 4.2 |
| C. Latin American | | | | |
| countries | 1.5 | 1.6 | 2.0 | 2.2 |
Source: Handbook of Statistics
on the Indian Economy 2005-06. | Indian trade has grown
faster with these countries than its overall trade growth. Emerging Asian economies
accounted for a significant share of around 25 per cent in India’s total
exports in 2005-06 (16.0 per cent in 1999-2000) and 23.0 per cent of total India’s
imports (16.2 per cent in 1999-2000). China has emerged the second major export
destination for India after the US. It has now become the largest source of imports
for India, surpassing the US. A similar trend was noticeable vis-à-vis
the ASEAN-5 (Singapore, Thailand, Malaysia, Indonesia and the Philippines) but
way ahead there is vast scope for expanded trade with these countries. In view
of this diversified destination and source of India’s foreign trade, it
is unlikely that global slowdown would have any significant impact of trade.
Moreover, the export basket of India has become increasingly diversified with
certain sectors such as automobiles, pharmaceuticals, textiles, etc., and emerging
as driving factor. For example, steel production in India is now among the lowest
cost in the world. Pharmaceutical and biotech firms are likewise very competitive
internationally. It is important to realise that the traditional face of Indian
business has changed dramatically in the last few years. Indian firms are
no longer only seekers of foreign technology or producer of staple goods or providers
of low-end services. Indian corporate sector have recorded better bottom-line
growth with higher sales in recent quarters. Their engagement with the world has
acquired new dimensions. Indian firms are increasingly carrying out their own
R&D. India has an impressive record when it comes to investment abroad and
acquiring brands by its companies. Indian firms are acquiring manufacturing firms
abroad to leverage comparative advantage of foreign locations, using synergies
between the parent company and the company under acquisition and having production
facilities near the major markets. Our patent law is compatible with the best
countries in the world. The Indian capital market have been exhibiting buoyancy
as resources raised by the Indian corporates through public offerings, private
placements and euro issues increased significant. The secondary market registered
sharp gains during 2005-06 and continued to surge during the early part of 2006-07
with the benchmark indices recording all time high levels. This trend has continued
in the current financial year as domestic stock markets recorded gains during
the July-September period offsetting almost all the losses suffered in the meltdown
in May-June. Large investments by foreign institutional investors (FIIs) and domestic
mutual funds on the back of robust macroeconomic fundamentals, congenial investment
climate and strong corporate profitability buoyed the stock markets. In the
context of impact of slowdown in the US economy which may have adverse impact
on the global economy, it may also happen that in search of low cost, outsourcing
from the US and other parts of the globe to India may get boost and compensate
any adverse effect which may be in terms of slowdown in software exports or remittances.
As in recent years, we have witnessed the coming of age of the Indian IT multinationals,
with the traditionally India-centric, indigenous players beginning to build noticeable
presence in other locations - through cross-border acquisitions, onshore contract
wins and organic growth in other low-cost locations. This has been complemented
by global majors continuing to significantly improve their offshore delivery capabilities
- predominantly in India, vindicating the success of the global delivery model
and highlighting India’s increasingly important role in the new world IT
order. With Indian firms exporting services ranging from call centers to medical
diagnostics to tutoring, India’s position of strength in information technology
is well known. India‘s Information Technology Enabled Services/Business
Process Outsourcing (ITES-BPO) industry has demonstrated its sustained cost advantage
and fundamental competitiveness. Around 30 per cent annual growth in India’s
IT and ITES exports since the mid-1990s reflects the maturity of the Indian service
capabilities in meeting the needs of a global customer base and the importance
accorded to India as a global sourcing destination. According to NASSCOM (2006),
IT software and services exports were US$ 23.4 billion in 2005-06. The large investments
of the Government in establishing high quality institutions like the Indian Institutes
of Technology (IITs), Indian Institutes of Management (IIMs) and other publicly
funded engineering and technical institutions form the human resource backbone
of India’s IT and ITES revolution. There had been apprehension in several
quarters that with the turn in the interest rate cycle after reaching the minimum
of 1 per cent, would lead to slowdown in capital flows towards emerging market
economies. Moreover, a moderate degree of correlation has been observed in global
growth and net private capital flows in emerging market economies in recent years
(Chart 1). Any slowdown may have a concomitant impact on the capital flows to
emerging economies. However, the events in the last 2-3 years have shown that
India has emerged as a major destination of foreign investment, especially portfolio
investments even in this tightening cycle. Furthermore, the trend in foreign capital
flows in India would also depend on the trend in interest rate differential between
India vis-à-vis other countries mainly source countries. It may happen
that with the decrease in Fed rate as is expected in US, emerging markets like
India may continue to attract private investors from abroad. 
The
World Investment Report 2005 has ranked India as the second most attractive investment
destination among transnational corporations (UNCTAD, 2005). This is also evident
from a recently released survey by ATKearney which, in terms of FDI Confidence
Index, has placed India at the second place after China. Their Survey based on
opinions of CEOs and CFOs of the world‘s largest 1000 firms finds that investors‘
enthusiasm for investment in China and India is an all time high and India seems
to be on the cusp of FDI take off (ATKearney, 2005). Although foreign investment
in India has gone up in the past two decades, it has remained well below the foreign
investment in countries like China. India ranks as one of the three largest emerging
markets in terms of economic size and stock-market capitalisation. Foreigners
have invested in more than 1,000 Indian companies which is a record for any country
outside the US. Likewise, India is more attractive than ever to global retailers
and has topped the 2006 global retail development index of ATKearney as buoyant
and sustained growth is likely to support retail industry estimated at US$
325 billion and expected to grow by 13 per cent in the current year (ATKearney,
2006). A recent study by Economist Intelligence Unit (EIU), released in March
2006 projects that emerging markets, China and India in particular, will take
a greater slice of the world economy. It also projects that propelled by fast
growth in China and India, Asia will increase its slice of world GDP from 35 per
cent in 2005 to 43 per cent in 2020. Thus, given the inherent strength of the
Indian economy and the interest that we see among the global investors combined
with the fact that emerging Asia could continue to drive the global economy, we
do not see any major change in the attitude of foreign investors in the wake of
slowdown in the global economy. Another advantage we see would help us to withstand
any global slowdown is the demographic profile of India which bodes well for prospects
of growth. India has the world’s youngest and fastest growing working-age
population. India is entering the second stage of the demographic cycle and over
the next half-century, a significant increase in both savings rate and share of
working age population is expected. In 2020, the average Indian will be only 29
years old, compared with 37 in China and the US, 45 in West Europe and 48 in Japan
(Chandrasekhar and Ghosh, 2006). Given our emphasis on human resource development
in terms of producing a large number of engineers, technologists, doctors etc.,
it is expected that a large and young population of India would have high labour
productivity along with lower need for social security and health related expenditures, which
in turn, could power the growth process of not only India, but would increasingly
meet the growing need of other industrialised countries. India, being one of the
youngest countries in the world could use its large and growing labour to its
advantage in terms of better growth by making efforts towards human capital formation.
Given the ongoing buoyancy in the Indian economy and the related need to increase
improve infrastructure, there are ample opportunities for both local and international
investors. The financial sector in India has witnessed advancements in terms
of stability, health and depth. The strength of India’s financial sector
could help us to withstand any stress in the balance sheet of the banks due to
global slowdown. India has a mature banking and financial system with a network
of 84 scheduled commercial banks, 102 Regional Rural Banks and over 68,000 bank
branches. India has also made significant progress in financial liberalisation
since the institution of financial sector reforms in 1992 and this has been recognised
internationally. India has also made significant progress in financial liberalisation
since the institution of financial sector reforms in 1992 and this has been recognised
internationally. Among emerging economies, India appears to be the most financially
solvent. IV. Concluding Observations Growth performance of the world economy
has remained satisfactory so far under the relatively benign world environment
and concerns with regard to inflation have been well managed by the central
banks with calibrated policy responses. However, risks with regard to inflation
continue to pose a challenge to monetary and macroeconomic management. In this
context, supply side trends in oil, metals and food would be particularly important
for the global price situation. It is still unclear how far the upward trend in
food prices, which is relatively recent, would continue. At the same time, there
are also concerns regarding the rising inflation pressures as the expansion matures
in the face of narrowing output gaps across the major growth driving economies,
may lead to a cyclical global slowdown as central banks may have to resort to
further monetary tightening to contain inflationary pressures. Furthermore,
it is yet to be tested how far growth in Europe and Asia is really self-sustained.
Although domestic demand in the euro area, and especially corporate spending,
strengthened progressively in the first half of 2006 and the recovery also seems
to have reached the labour market, private consumption growth might still be fragile;
especially the impact on consumer spending of the planned fiscal tightening in
Germany and Italy in 2007 remains uncertain. Another risk to be accounted for
is the sharp expansion in China, largely based on excessive fixed investment not
subject to market discipline, represents a major challenge. Similarly, as rightly
mentioned in the IMF background paper, a global slowdown would aggravate the challenges
faced by fiscal policy to ensure sustainable fiscal position particularly in the
US and some of the European countries. All these risks reinforcing each other
have imparted considerable uncertainty to the global growth prospects and also
have made decision making for the policy makers a challenging task. References:
ATKearney (2005), FDI Confidence Index, Global Business Policy Council 2005, Volume
8, A.T.Kearney, Inc. USA. ATKearney (2006), Emerging Market
Priorities for Global Retailers, The 2006 Global Retail Development
Index, A.T.Kearney, Inc. USA. Brown, L.R. (2006), “Supermarkets and Service
Stations Now Competing for Grain”, Earth Policy Institute, July 2006.
Chandrasekhar, C.P and Ghosh, Jayati (2006), “India’s potential `demographic
dividend”, Macroscan, Business Line, January 6, 2006. Economic Intelligence
Unit, Foresight 2020, Economic, Industry and Corporate Trends, Study sponsored
by CISCO Systems, The Economist, March 2006. Food and Agriculture Organisation
of the United Nations, Food Outlook, June 2006. Government of India (2006),
“Towards Faster and More Inclusive Growth: An Approach Paper to the 11th
Five Year Plan”, Draft Paper by Planning Commission, June 14, 2006. International
Monetary Fund (2006), World Economic Outlook, September 2006. NASSCOM (2006),
Indian IT Industry: Fact Sheet. United Nations Conference on Trade and Development
(2005), The World Investment Report, 2005: Transnational Corporations and the
Internationalisation of R&D, United Nations: New York and Geneva, 2005.
* Presentation by Dr. Rakesh Mohan, Deputy Governor, Reserve Bank of India
in the Meeting of G20 Finance and Central Bank Deputies held in Sydney, Australia
during October 13-15, 2006. |