Europe a deadly concern too, says Montek Singh

Leading credit rating agency Standard & Poors downgraded United States to AA+ from AAA on Saturday amidst fears of a global financial crisis. In an exclusive interview to CNBC-TV18, Deputy Chairman of the Planning Commission Montek Singh Ahluwalia said that this move was not surprising. According to him, global markets are equally worried about the Eurozone.

The slowdown in the developed world will hurt global growth. But, the market reaction in Asia is not too severe he said. He goes on to add that the fall in commodity prices will aid Indian markets.

Below is an edited transcript of his interview.

Q: How big a global event is this in your eyes, because the market reaction has been quite severe across the world today?

A: I am aware of the market reaction, but I wouldnt call it severe. I mean its about 2% decline in most Asian markets including ours and the event that you refer to which is the S&P downgrade is not a surprise. Markets knew that the US fiscal position was getting very difficult. The key issue is the correction of the US fiscal deficit. I think what matters is what the world thinks, what the US thinks is going to be the strategy over the next several years. So in some sense, the S&P downgrade looks like a judgment that the US in incapable to rectify the problem over the next several years. I dont think thats fair. While its true that right now they maybe in a political situation where its very difficult for them to give signals, I am not sure that the markets believe that there will be no corrective steps taken whatsoever.

Having said that let me say that a downgrade which is the first time since 1917 is a very significant event. It does draw attention of a lot of people to a problem that earlier was very little in the pages of the financial press and therefore you are seeing the market getting a little upset. I would have expected that would have happen because whenever you have a negative signal there are forces in the market that will amplify it.

I think its also true that the problem is not just the US. What markets are wondering is that if the US has this problem, what is the situation in the Euro Zone. I think if you project in the consequences of this event, it would be a very different situation if the whole world was in good shape and US was in deep trouble. Actually what you got is all the industrialized economies whether its Japan, Europe, United States have problem and we have known that and the global growth pattern has been one in which its been known that growth in industrialized countries is going to be a bit weak. This is just forcing people’s attention and hopefully it will make policymakers aware that you cannot ignore this for too long and thats the key point.

Q: How severe do you think these growth concerns are though because post the downgrade many parallels have been drawn between the situations in the US economy versus what Japan has live through in many year and as we know both economies have different impact on global growth. How severe do you think this growth concern is from our markets point of view?

A: As I said even earlier, the assessment of the global economy was that growth in industrialized countries is going to be anemic with lots of uncertainties. It looks now as if unless some very positive developments occur it looks as if the earlier growth forecast will be shaded up maybe by 0.25 or maybe by 0.5% I dont know. So from that point of view, the world from the industrialized countries perspective looks a bit weaker than it did six months ago.

In any case the perception of developing countries was that there is a lot of economic fundamentals pushing for much higher growth in the developing countries, but we definitely get adversely affected if the rest of the world slows down. Maybe the only positive impact of a slowing down in the industrialized countries is that commodity prices wont be under pressure. So on one hand, we are likely to see less rapid growth in potential export market, on the other hand oil and commodity prices will weaken and you have to look at the net effect.

Generally my feeling is that anything that unsettles the global economy has negative effects on everybody. So it is in our interest to make sure that the world sees this as a problem. I think the top leadership, the G20 and everybody else should be giving a sort of a concerted common appreciation of the problem and a signal that they are watching and that corrective steps are being taken; thats the best that governments can do.

Q: How do you think global investors will approach this and I am not talking about just near-term stock market investors but the broader class of global investors? Do you think this event might make them leery of countries which have fairly significant current account deficits and are running fiscal deficits which are beyond their comfort levels like India?

A: I think its certainly true that a focus on fiscal deficits abroad will translate into a much more careful scrutiny of fiscal deficits in all countries. Yes, I think people will be more interested in looking at our fiscal deficit to see whether we run into similar problems. But I would like to emphasize that they wont be looking at what the fiscal deficit is now, they will be look at the trajectory of the fiscal deficit.

I think the real problem in United States is that its not so much the fiscal deficit, its the perception that social security payments in the next ten years are going to make the deficit out of control. The issue they will be looking at is what our trajectory is going to be like. I think we have to emphasize the fact that we have a plan to bring our fiscal deficit under control.

Secondly, our growth rate justifies a higher fiscal deficit. The fiscal deficit that you can sustain consistent with debt to GDP coming down is higher if growth is 8% than if it is 2%. So the most important thing for India is to look at its fiscal deficit in terms of what the growth rate is likely to be. This year we may not get more than about 8.2%; in the 12th plan we hope to get at least 9%. People should make a judgement on what the debt situation is going to be based on a reasonable medium-term growth rate. I think that reasonable medium-term growth rate would be definitely higher than 8.5%. So put that together with some of the items on our agenda in terms of tax reforms, things like the GST coming in hopefully within a year or so. I dont think the Indian fiscal situation then will look bad, but I think people will be watching whether we are on that trajectory.

I think thats going to be the signal everywhere that fiscal deficits are going to become a more important part of the assessment of economic prospects. But fiscal deficits viewed in a dynamic context, not just what the deficit is in one year but what its going to do to the debt to GDP ratio over the next five years, over the next seven years.

Q: The last time we spoke at length about the action taken by the Reserve Bank of India. Would you say in the last fortnight the turf has changed considerably and any further action on rates maybe extremely detrimental to growth?

A: As I said I never like to speculate because it reduces the RBIs room for maneuver. But I do think that the situation has changed in the sense that the global environment is different; there will be a lot of under heating of the global economy which is currently likely to take place. We need to look at what the transmission to inflation through commodity prices is going to be and of course there is always the issue of what is agricultural production in the current year. So RBI has should in any case the next time around have looked at all these things. I am quite sure they will be doing that right now.

Q: Last we spoke and I asked you whether you think that Indian growth could slip as close to 7% or somewhere in that vicinity. You said its out of question but given the kind of sluggishness we are seeing in global growth do you think its possible that we get nowhere close to 8.2% that the Prime Ministers economic advisory council is laying out for this year?

A: Any growth forecast has a margin of error. I dont know what the Prime Ministers economic advisory council had in mind; people should be projecting a sort of 10% probability either way. So there is a downside to 8.2% but equally there could be an upside. I think from the growth point of view in India, the most important question is what is going to be the impact of all this on investment in the course of this year. We have only got one quarter of the year pretty much done. I think there is a good chance that on things like infrastructure investment many of the impediments that people thought about as problems will be taken care off in the next couple of months or so.

So I would rule out a 7% outcome for the year because for that to happen there will have to be a much bigger collapse of demand. But whether it can be a little bit below 8.2? I dont think we should rule that out at all. The important thing, at least in the Planning Commission, is that we dont put much emphasis on our ability to forecast the next quarter. We are focusing on medium-term and this is what investors should look at, if someone is investing in India, he is investing for the next 20 years or so. I am talking about Greenfield and FDI type of investors. Those investors would be well advised to think that this is an economy that has all the potential to grow at 8.5% per year at least and if they look around in the rest of the world, other than China, they are not going to find too many countries that are in that position. So I feel that long-term if we convey the impression of fiscal control, I think investors should find India one of the best bets to invest in and I do hope they will read that message.

Q: Any fear on the impact for the currency because of the global event we have lived through this last week because that in-turn also impacts investor sentiment and there is a degree of vulnerability today in Asian currencies?

A: I think currency markets will be a little bit in turmoil, but what happens to the currency in the next week is not what investors are looking at; they will be looking at whether currency markets are going to be well managed. Any sort of temporary movements in the currency in a world of flexible exchange rate, thats what you expect. As a matter of fact, most investors should take greater comfort at the fact that the system of management of the exchange rate is such that the exchange rate reflects market pressures. I dont expect to see any massive deterioration at the exchange rate at all but we are running a flexible exchange rate so it will show movements little bit here and little bit there.