Kaushik Basu, the outgoing chief economic advisor to finance minister, speaks on economic growth, inflation, interest rates and politics in an exclusive interview to Gautam Chikermane. Gautam Chikermane:
The world's biggest story is that the world's second-fastest growing economy, India, is already the third-fastest. What has gone wrong?Kaushik Basu:
One legitimate way to view your question is that while there has been a slowdown, rank-wise India has, nevertheless, remained roughly where it was. If you look at growth in quarterly terms, the fall is from roughly 10% to 5%, which is steep and alarming. If you looked at this in monthly terms, the fluctuation would be even greater. But the right way to look at growth is to take longer run averages, such as annual growth. This has gone down from 8.4% to 6.5% in recent times, which is disappointing but not alarming. What is important to stress is that in relative terms we are roughly in same place. India is the second-fastest in the BRICS cluster, third-fastest in G20. So, rank-wise, India remains much the same. I agree we could have done better if we had managed to push through a couple of reforms, but policy is not made in a political vacuum. Also, we do injustice to ourselves if we don't recognise that the global slowdown is impacting all nations and India cannot be an exception. Brazil was a vibrant, buoyant economy. Last quarter, when India's growth is down to 5.3% which we are lamenting, Brazil is down to 0.7%. So, globally, our ranking remains pretty much the same. India's fundamentals are robust. With a couple of strategic policy moves, we can position ourselves so that, once the global economy revives, we are able to race ahead.
Gautam Chikermane: Everyone is talking about the impact of global slowdown on India in abstract terms. Can you quantify its contribution?
Kaushik Basu: Of the three contributors to the slowdown, two domestic and one global, the global is by far the most dominant. Our growth rate last year, even if we had got our domestic policies right, would have been, I guess, no more than 0.3 or 0.4 percentage points higher than what we achieved. The entire world is slowing down and we can't go totally against the grain.
Gautam Chikermane: That's it, just 0.4 percentage points?
Kaushik Basu: Let me clarify that these numbers are not formal estimates based on econometric modeling, but something to give you a rough sense of magnitudes. With that in mind, an additional 0.4 percentage point growth in one year is not negligible; so I am not discounting the domestic factors.
Gautam Chikermane: What are the two domestic factors for the slowdown?
Kaushik Basu: The first is demand contraction that we deliberately implemented in order to control inflation. The second is the slowdown in reforms which we non-deliberately achieved.
Gautam Chikermane: The government is blaming everyone but itself for the slowdown. But it took all the credit for higher growth rates.
Kaushik Basu: It's human that when good things happen we take the responsibility and when it is not so good, we look harder to locate external causes. But there is some validity in our analysis. The current slowdown is caused in large measure by the Eurozone crisis. It is arguable that every country in the world, with the possible exception of North Korea, is being adversely impacted by the global slowdown.
Gautam Chikermane: Was it because of greater global liquidity?
Kaushik Basu: Yes, but there is something else. Ever since the reforms of the early 1990s, there has a shift in the thinking of the Indian people. Our analysis and thought have become more sophisticated and this is facilitating better policymaking and, in turn, higher growth. We must never discount the power of collective beliefs and collective thinking.
Gautam Chikermane: Like multipliers of earlier reforms that began in NDA times? Like roads?
Kaushik Basu: There were small reforms from early 1980s and you can almost see growth picking up in step. In 1980s, our growth was 5.2%. We had broken out of the trap of 3.5%. It gathered steam and in 1994, it jumped further to 7%. Each round of reform brings fresh capital that can have long-run benefits lasting decades. The other unwitting contributors to growth were India's emphasis on higher education --- engineering, sciences, finance, technology --- which for a long time meant that we were creating unemployed youngsters. Suddenly, when the global demand fell into place, starting with Silicon Valley, India was perfectly positioned to take advantage of this. So, we can take credit for creating the human capital but have to thank global changes for the creation of demand for that capital. And now there is enough endogenous demand as well.
Gautam Chikermane: Do you agree with the assertion that global speculative capital has been looking for new packages of exotic investments and the coinage of BRICS or the India-China growth story was mere packaging?
Kaushik Basu: Packaging unfortunately matters, from cricket to international investment directions. If you think of the BRICS cluster, it's not a natural cluster in any sense. The countries belong to different regions and have very different strengths. It's not like we are all oil producing countries or have any other common linkages.
Gautam Chikermane: It was a statistical creation…
Kaushik Basu: …it was an arbitrary creation. But, having made the creation, it has come to gain traction as a group. Even global investors think in terms of whether or not to put money in BRICS. It has become a category of global thought. We are now even thinking of a possible BRICS-led development bank.
Gautam Chikermane: How do you view Indonesia replacing India in BRICS? It is definitely ahead in terms of per capita income, a strong measure.
Kaushik Basu: Per capita income is not quite the right view. If you go by that, then India should not be in any of these groupings. After all, in per capita terms, we are still a poor country. We are the poorest in G20, poorest in BRICS cluster. When you think of these groupings you are also thinking of a nation's global presence, its intellectual prowess, and India's importance on these counts are not in any dispute. Indonesia is doing very well, especially over the last three to four years. Indonesia is one of the finest-performing countries, according to the comparative rating index, CRIS, that we prepare at the Ministry of Finance.
But if you look at global importance and if you look at the last 15-20 years stretch, India has done consistently well. India being in BRICS is just right. And India and Indonesia being in G20 cluster, despite India being poor in terms of per capita income, is also right.
I can tell you from my own experience with G20, India gets the kind of importance that is completely on par with the industrialised countries. So, in G20 we have a voice, which is surprising given our per capita income. Part of this, of course, is to do with the fact that we are a talkative nation. We contribute through our verbosity. But it goes beyond that.
Gautam Chikermane: Growth has to mean a decent per capita income. You may say you are a $2 trillion economy but it means nothing as long as we have 850 million people living on less than $2 a day. Do you think we are headed towards becoming a middle income country and if so, by when?
Kaushik Basu: I completely agree, the income earned by individuals is fundamental. And even more than that, the per capita income of the bottom segment of population is what we should focus on while crafting policy. So, just the average per capita income rising in the country, which is happening in India and very rapidly, that in itself is good but not good enough. We must learn to evaluate a nation in terms of how its poorest segment fares. At least for me that is the fundamental focus of policymaking.
Gautam Chikermane: How do you do that?
Kaushik Basu: In one of my academic works, I developed the notion of judging the country by its bottom quintile. In India, while per capital income is rising very fast, there are large tracts of poor people. But the good news is that poverty is declining. The two distribution variables that we look at are inequality and poverty. In India inequality is rising but poverty is falling. All statistics show that the conditions of the poor are improving. But the top end income is increasing so much more rapidly that inequality is rising. I wish there were less inequality in India and the world.
Gautam Chikermane: So, how do you devise the right policies under such extreme circumstance?
Kaushik Basu: It is easy to make policy blunders, whereby you end up helping no one. For instance, some people argue that we should massively tax the corporate sector and divert that money to the poor. Trying to do this in today's world will mean that you will soon see the best companies and skilled human beings leaving the country and then there would be no wealth being generated to be diverted to the poor. And the poor will lose out. So diverting money and resources to the poor, I believe, should be our target, but trying to do that foolishly will mean that you will drive out the rich and hurt the poor.
Gautam Chikermane: And countries across the world are competing for that capital and skill.
Kaushik Basu: Right. In today's globalised world there are severe limits to what a single country can do. Here is another example that illustrates this well. Take the 30 years of Communist rule in West Bengal. In terms of the broad intention of trying to reach out to the poor and benefit them, they were right. But they made a big mistake. They didn't realise that it's a fairly globalised world and even within India capital can move from one region to another. Try to take draconian moves to help the poor, you will end up hurting them because capital and industry will move out. This was the fatal flaw that the Bengal government made.
Gautam Chikermane: Singur, for example?
Kaushik Basu: Yes, Singur is a classic example of capital moving, in this case within India.
Gautam Chikermane: So, what do we need to do to get growth back in the short term?
In the short term we need a couple of bold reforms which may not be the deepest of reforms but which will energise the country and encourage private players to begin to invest.
Gautam Chikermane: Like FDI in retail?
Kaushik Basu: FDI in retail is just one instrument to modernise the retail sector. India's retail sector is primitive and has vast scope for expansion. You will not only improve the sector in terms of what consumers or farmers are getting but also activate the real estate sector, open up export channels, through which our products will go out to the world. This can have a big effect and is something that's doable.
Gautam Chikermane: Any other short term measure?
Kaushik Basu: The Land Acquisition Bill is another reform which would create scope for industries to expand. You don't have to do very much, just three or four things over the next six months and you will reenergise the sentiment. In the medium term, there are deeper changes that are called for. India still has a slow-moving administration and bureaucratic costs are extremely high. We know this from cross-country studies done by World Bank. We are one of the worst performers in the world. This cannot corrected overnight. But I feel this should be in the frontline of our medium-term plans.
Gautam Chikermane: Over the past three years, inflation has only been going up and staying up. All effects, like base effect or any statistically-manipulable effect, are over and we are holding on to very high prices that hurt the poor the most as they move down the food chain. What's going on? Why are we not able to control inflation, particularly food inflation?
Kaushik Basu: First the facts. Inflation in early 2009 had gone down. By late 2009 inflation was up. By early 2010, food inflation had crossed 20%. After that it came down quite a bit. But it's a fluctuating decrease. Food inflation is now around 10%. In managing inflation, you have to understand that this is one area where it is not the lack of intention on part of politicians or RBI that causes it. Inflation is a partially-understood discipline.
Gautam Chikermane: What does "partially-understood" mean?
Kaushik Basu: Recently, I had long meeting with Australian policy makers at Canberra. Australia use to be like us, inflating at 15-16%. It has now gone down to 2% or less. How did it happen? While it is evident that Australia has put in an impressive amount of talent into its economic policymaking, I don't think anybody fully understands what led to this amazing success. Unlike other variables, inflation is not something that any politician wants. It hurts their electoral prospects. So it's a genuinely-difficult policy problem.
Gautam Chikermane: How do you fix it?
Kaushik Basu: There are some blunt instruments which you can use which will have big, dampening effect on growth but can bring down inflation. But we don't know the consensus on how much of dampening of growth is acceptable to bring down inflation. Also, we must remember that a growth slowdown will come with increasing unemployment. Let me point out that when we consider the historical record of inflation around the world, India does not come out poorly. Our central bank has an impressive track record of policymaking.
Gautam Chikermane: And failing!
Kaushik Basu: Failing is the wrong word because inflation comes from multiple sources, many that are beyond the control of government or the RBI.
Gautam Chikermane: That's alarming.
Kaushik Basu: Maybe, but it is fact. And denying facts is not a good way to proceed. I'll give you two examples. In a globalised world money being created in country X flows into country Y with an ease that was never there before. Earlier, RBI controlled our liquidity, US Fed controlled US liquidity, BOJ controlled Japan's liquidity. But in today's world, the US Fed generating liquidity comes flooding into other markets, including India's. So our liquidity is not fully within our control. Secondly, when we go for financial inclusion, we enable poor people who used to hold their money and keep it under the pillow, to put it in the banking system or mutual funds. This is good and we should do it. But it also means creating money supply because money that was effectively withdrawn from the system is injected back into it. So, even if RBI and the government did nothing else but ordinary people start putting their money in the bank, this will create an upward pressure on prices because the effective supply of money in the economy would go up.
Gautam Chikermane: This leads me to a question that addresses the growth-inflation mix. Are we happy with 4% inflation and 5% GDP growth or is it better we go for 10% inflation and 11% GDP growth?
Kaushik Basu: My answer is easy. We should go for 10% inflation and 11% GDP growth. After all, 11% GDP growth is real growth; so people are every year better off by 11%. If this is equitably distributed across the population, then it is fine even if it means that we have to tolerate a higher inflation. South Korea, which took off in huge way during 1970s, was inflating at around 20% per annum. But it was also producing more in leaps and bounds. So it was vibrant economy with large inflation. We should not aim for that, but if we have to live with a little higher inflation to get greater growth, I would go for that rather than holding back people in poverty just to keep inflation down.
Gautam Chikermane: But we seem to be moving towards the previous option, that we temper growth to control inflation. Or worse, we temper growth but inflation stays high and we move to stagflation. I think we are falling in an intellectual-policy trap.
Kaushik Basu: I disagree with that. A 6.5% GDP growth, with even 10% inflation is not stagflation. This is real growth taking place. Nominal growth is occurring at around 17% and inflation is eroding only a part of that. But we are still growing at 6.5% in real terms after you remove the inflation. That is not stagflation.
Gautam Chikermane: Is this view of high growth and high inflation the general political view?
Kaushik Basu: I can't say so because the general political view is often quite chaotic. But if everybody thought clearly, they would all agree with me. Whether everyone has that clarity of thought I don't know.
Gautam Chikermane: Let's come to the question that links growth and inflation: interest rates. This is the third leg so to speak --- low growth, high inflation and high interest rates. I believe, RBI has to slash its rates. It doesn't have to cut rates by 25 or 50 basis points but slash them by 2.5 percentage points. That could kick start the economy during these times of policy paralysis. Do you agree?
Kaushik Basu: I may not agree with you on slashing rates but I may point towards the direction which is similar. This is a very deep question, an intellectual problem and has to be dealt with correctly. This is one of the disputed areas within economics, where the best professionals will have diversity of opinions, which is not the case with every topic economic policy. Economists agree on a variety of things but this topic is an open intellectual matter.
Gautam Chikermane: What is your view?
Kaushik Basu: I believe that high interest rates in today's globalised world tend to have a bigger impact in holding back growth than in curbing inflation. So, to that extent, it is not the most effective instrument. This used to be an effective instrument in older days when the world was not globalised. And, therefore, my inclination is to go in the direction of lower interest rates to stimulate growth, even though I would not do it as sharply as you're suggesting. Some of our inflation today is supply driven, so if can get growth up and more goods come into the economy, this may ironically have a dampening effect on inflation.
Gautam Chikermane: It will also create jobs.
Kaushik Basu: I agree.
Gautam Chikermane: So, why isn't RBI cutting rates?
Kaushik Basu: There is a whole body of thought that the interest rate tightening is the right way of inflation control. I am aware that what I am suggesting is a contrarian view and I am fully aware that there is no clinching answer to this problem. The RBI does an impressive amount of research and it has a solid record of responsible policymaking. Lowering interest rate is an out-of-the-box action. And RBI has to worry that if it's going to do something out-of-the-box, like lowering interest rates during high inflation, and it backfires, it will have to take the criticism. So on balance RBI is going along with what is the standard safe option.
Gautam Chikermane: If you were RBI governor, would you cut rates today?
Kaushik Basu: If that happened, I would have far more access to research than I have now. So answering this question in advance is a hazard, like cutting interest rates in the middle of an inflation. But, on balance, my answer is yes. I would risk the hazard and cut rates.
Gautam Chikermane: How do you relate to this: despite high interest rates, inflation has not come down? Global commodity prices or food prices that hit their highs in 2010, have nothing to do with RBI's interest rate policy and will continue to move the way they are.
Kaushik Basu: I am agreeing with you on the direction of interest rates. The thing I'm not agreeing with is treating this as a no-brainer. Take the extreme example. You suck money supply out of the Indian system, basically drain the body of economy of blood, inflation will collapse --- no matter what happens to international prices. Crude prices can go through the roof, Indians won't have the money to buy. So you can play this deadly game of just draining money supply. Just because global prices are rising it's not a fait accompli that our prices will rise. In my view, the right direction to go at this point of time when our growth is slowing down sharply and inflation is gently slowing down is to lower interest rates, and help get the growth back up. But to treat this as the obvious policy is to do intellectual injustice to a deep and admittedly difficult policy matter.
Gautam Chikermane: Globalisation seems to be a common problem for India on all three fronts --- growth, inflation and interest rate. Is India so globalised that whatever it does on the policy front, it will have little or no impact?
Kaushik Basu: I will not put it that strongly but its true your instruments of policy begin to get blunted in a globalised world. There are various things that you can do in closed economy, but not in a globalised economy. On a variety of policies your power gets weakened. If you want to redistribute income massively, you can do that in a closed economy, not in a globalised one.
Gautam Chikermane: That gives ammunition to its detractors to say that let's stop globalisation.
Kaushik Basu: I don't go along with that at all because the reason for our relative prosperity compared to 20 years ago is because of globalisation. To jettison globalisation because it has some negative side effects would, in my opinion, be utterly wrong.
Gautam Chikermane: So, would it be fair to conclude that sovereign power is falling with every step a country takes towards globalisation?
Kaushik Basu: Absolutely. The political power of the sovereign goes down with every move towards globalisation. And also, your power to do things in other countries increases. Economics has become an instrument of global political and even military strategy. I don't know if this is good or bad but I am sure that for any nation to fail to recognise this would be a folly.
Gautam Chikermane: So, maybe the governance structures of the past now need to break down and be replaced by new ones?
Kaushik Basu: We need more effective global governance systems. We already have WTO guidelines for trade and ILO for global labour policy. But we also need fiscal policy, monetary policy coordination. This immediately raises questions about global democracy. I have written a lot on this. It's a very difficult juncture for the world but the fact is that the world has globalised in terms of economics but it has not globalised in terms of politics and this is creating a kind of tension which we've never seen before.
Gautam Chikermane: Finance is very easy to move, people aren't. So, India's strength in terms of labour faces issues like citizenships but for capital it is a seamless flow into India.
Kaushik Basu: Sure. Some right-wing groups in industrialised nations will argue for a complete free flow of capital between nations, since capital is a factor of production. But if you ask them about labour movement across nations, they will either run away without answering or give you a convoluted no for an answer.
Gautam Chikermane: Let's now move to the more exciting parts of political economy --- the role of politics. Is the politics of India getting in the way of economics?
Kaushik Basu: Politics does get in the way of economics in the same way that gravity gets in the way of flying. It is a part of life and we have to accept it.
Gautam Chikermane: Is it more accentuated today in India?
Kaushik Basu: Yes it is. Till India's vibrant democracy settles down --- we are still a young democracy finding our feet --- popular opinions will have a huge restraining effect on what kind of policy is possible. As the popular opinion and thinking improves it will begin to have positive effect on policies. And here we all have collective responsibility --- the media, ordinary citizens, schools, colleges, everyone. We need to have people thinking more clearly and less emotively on matters of economic policy.
Gautam Chikermane: What does that mean?
Kaushik Basu: I mean, it cannot be that you look at a policy, think of your immediate interest, give no further thought to the future and begin to campaign on one side. If you do that in a democracy, politicians will respond and give you what you ask for. And a lot of the time what you are wanting, as your immediate demand, will do more harm than good in the long run. That is happening in India. There is a chorus of demand that picks up, which is based on very little thought. It's a democracy, so the politician sees where the demand is and what he needs to do to become more popular with the electorate. The ultimate director of policy in a democracy is the electorate. So, enriching the thinking of the electorate is crucial. I do worry that in India we are not doing enough on this front and this is having an adverse effect on how we design policies.
Gautam Chikermane: If that were indeed the case, then FDI in retail, which is very good for farmers --- and farmers know it --- should have sailed through. Why is being blocked?
Kaushik Basu: When this was first proposed, almost a year ago, farm opinion had not been mobilised enough. So, if you look at the immediate reaction, the general opinion was against it. Again, it was knee-jerk reaction. Opening up FDI would mean international MNCs will come in. And you can see the flaw in human thinking. People would ask me, do you think multinational companies are coming to help India? To me, that's not even a question to ask. Of course, they are not coming to help us, they are coming here for their own profits. And many people, as soon as they see X making a profit, they feel everybody else will lose out. We don't realise that in the economic world there are many non-zero sum games. One person's profit can be another person's profit as well.
Gautam Chikermane: Certainly, allowing MNCs a free run is bad policy.
Kaushik Basu: Of course, you have to have regulations and competition law in place. If an MNC becomes a monopoly, consumers will not gain from their entry in the market. But India is sophisticated enough today to be able to handle MNCs so that they earn profits and our workers, farmers and consumers also benefit.
Gautam Chikermane: In this case, not only is the farmer a huge vote bank --- won't call it a lobby because the lobby is only of a small number of large farmers and a small number of middlemen --- consumers are a large vote bank as well. And politicians are saying goodbye farmers, goodbye consumers and hello middlemen, hello large farmers. Isn't this a contradiction?
Kaushik Basu: I see no contradiction. When this was first brought up, consumer opinion was MNCs will come in and we will be hurt, farmer's opinion was not vocal enough. Now I am getting letters from farmers, and farm lobbies impatient for this policy. From the experience of China and Indonesia, we know that consumers and farmers can be better off by this. Middlemen will feel the pressures in the beginning but the retail sector is likely to grow so much that in the end even they will be better off.
Gautam Chikermane: Are our politicians listening to these voices?
Kaushik Basu: I expect change on this particular front. I feel opinion is changing. I see farmers are actually writing in and expressing their view on this. I hope political opinion will change but I should warn you that I'm not very good at political forecasting.
Gautam Chikermane: The constant example that is cited is Walmart and its employment conditions, its contractors. But are we going to decide India's FDI in retail policy based on Walmart?
Kaushik Basu: Some concern on this is exactly right. We need to have effective antitrust laws and zoning laws in place. Left completely to themselves, MNCs will become monopolies. You need regulations to put curbs on that. So, when you are letting in Walmart, you should try to bring Carrefour and Tesco to create competition. We also need to build zoning laws within the cities such that small suppliers have lots of space, so they can compete. You can't give these MNCs totally free reign --- this is very important to stress. But we had made a sophisticated plan on how to keep them competitive. Even though an MNC will come for its own profit, it can be used to generate welfare for the people. A fast-flowing river's intention is not to give you electricity but simply to get to the sea. But if you build a dam intelligently, it can convert that the river's movement into electricity from which we all can benefit.