What will be the impact of the S&P downgrade? Should it be taken seriously? Will the markets shrug it off after a while?
It is significant for the reason that somebody said, “The emperor is without any clothes.” It is not the substance itself, but the fact that somebody could dare to say it. If you look at their statement, you can always say that for the fisc, the US being a country with a reserve currency, technically it is not necessary that they ever have to default — unless you reach an extreme position. The only way you can default is if you stop printing the dollar. And they can always print the dollar because the downsides here are lesser than the default on debt. They also have not brought out any new facts. People can certainly question their track record in the past; can question the numbers as some have done. Basically, the significance is that somebody could say it — that it is something less than triple A. Analysis-wise, I would say that this is partly a wake-up call for the US and partly for the rest of the world. It was a wake up call for the US to focus on the fisc, or the people will get emboldened to question you. When you are a big power, if somebody is emboldened to question you, that itself is the beginning of a sign of weakness. For an economic power this is really significant. The rating represents an assessment that economic recovery has been very weak. That is most significant for us. There also, it is actually a realisation that the growth was not recovering. The real sector was not recovering. The recovery was fragile, incipient. Financial markets had not recognised the truth of the weakness of recovery. What this S&P rating has done is to make people recognise the reality. It is different from 2008. Interestingly it has disclosed the possible weakness, but it has also brought into focus the inherent strengths. If it implied that people will go somewhere else, we saw people go back to the dollar. Whether it is because there is no alternative, in effect the dollar has been the dominant reserve currency for the immediate future, has been re-established. When we are discussing the dollar, we are forgetting something. You have to look at the fiscal side as well as the external sector. We are looking at it narrowly — only at the deficit. We can keep that under control and it can still be fiscally active. It depends on from whom we are collecting taxes and for whom we are spending. Everybody knows corporates are cash-rich. So therefore, analytically, you have to make the point that just because there is deficit, it doesn't mean you can't be fiscally active. Similarly, with regard to the supply of and demand for the dollar, we are focussing on the reserve currency and the treasury because that is the benchmark — but that is for financial market transactions. If you go behind this and look at the economic strength, then you must look at the external assets and liabilities of the country. Imagine the external assets of the US — these are owned by large corporates — including the corporates operating in China that are owned by them. They have a strong national private assets position. As for their liabilities — it is the US Government which has this debt. Of course, I agree that the household debt is leveraged but in the aggregate, the corporate sector has significant external assets. When you look at the aggregate position, it is this strength that you can draw upon.
Then there is the relative position — ultimately when you are allocating global capital or even global confidence as between different countries or currencies it is not the absolute position that matters but the relative position. You may say that the confidence in dollar has come down. But has the confidence in the euro come down? Yes. Has the confidence in yen come down? Yes. Except the Chinese renminbi which may show some strength, the others are nowhere near. The gap between the dominant currency and the others that are competing is, to start with, big, and it is not narrowing at all. When you look at the downgrade and its implications there is no reality which has come to light. But it is a wake-up call for everyone.
Isn't this somewhat similar to what happened in 2008?
In 2008 what happened was even more interesting. There was the Chiang Mai Initiative where many countries of the Asean region, China, Japan and South Korea could draw from their common pool of reserves. Initially it was a bilateral arrangement before the multilateral arrangements were put in place. But, interestingly, the countries didn't use it at that time. Korea and Singapore wanted liquidity when the crisis hit in 2008. And what do they do? They go to the very country which is the origin of the crisis. They went to the Federal Reserve of New York. They had the money. At that point of time, it was not how much you borrowed — it was about the US showing confidence in Korea and Singapore.
What are your views on debt ceilings for government on the lines of what we have seen in the US? Are they practical?
If you are neutral, there are two aspects you must consider. The first is ideological and the second is contextual. If you have no ideology, take the borrowing issue. It is not a problem as long as you can use the money in a productive way. So if you have debt ceiling, in effect you are saying that even if you have a productive opportunity, you should not borrow. You can have a low debt ceiling but high consumption expenditure or a high debt ceiling and investment expenditure and use it in a productive manner. Second, if public debt is to be funded by savings, then the level of savings is very important.
If you look at the question contextually, once you believe that fiscal policy is an instrument and having accepted that there are now countercyclical regulatory policies, monetary policies, why not have countercyclical fiscal policies too?
Then that should provide for debt ceiling to go up or down depending on the cycle and, therefore, ceilings can sometimes be a problem. In any case, will you have a ceiling, if there is a war? Will that not be breached then? The argument now is that if you can do it for a military war, why not for an economic war? Therefore, my point is that a ceiling is like a self-commitment. You are saying that normally you will not exceed the limit except for exceptional circumstances. If you introduce this ‘exceptional circumstances' then it becomes executive privilege to decide what is exceptional circumstances. So the commitment is diluted. So, if you want commitment then let it be passed by law and if you want to change it, then do it through the due process of law. In the US, the problem arose because there is no political consensus for change of debt ceiling. The whole debate now is about the quality of fisc and the multiplier effect. In terms of investment, we have to see what is the type of investment that is being made? When we look at our ‘fiscal stimulus' it was pre-committed expenditure which had the effect of a fiscal stimulus. My point is that the quality of our fiscal stimulus relative to that of many other emerging market economies was poor. The only way out is through growth.
Doesn't the Fiscal Responsibility and Budget Management (FRBM) Act itself impose the necessary discipline?
Earlier we had automatic monetisation, which meant that we print money as the government wants. But that also means that you suppress the money in the non-government sector. That is why you have CRR/SLR, and so on. Second is the cost at which you are funding. If you fund at concessional cost, then there is a problem because you are distorting the market. Then the private placement by government that is taken by the RBI also injects uncertainty. What we did earlier was that we transformed all these things before the FRBM itself. We addressed the amount issue through the Rangarajan agreement followed by my agreement. The cost issue was also changed slowly and moved to a market-oriented structure. And, thirdly, we also stopped private placement in practice. One of the things I would like to say is that it is not necessary to jump into legalising all these practices.
Will the US dollar be dethroned as the reserve currency anytime soon? Is your argument against a single currency being a reserve currency or is it that the US dollar should not be the reserve currency?
That depends on whom you ask… My point is that if you are saying the dollar as a reserve currency is a current problem and if it is considered inevitable that its unique position cannot or should not continue, then the debate must start now — are we saying that it should be replaced by another currency? And if so, which currency? In a globally integrated economy and with a global financial system you cannot succeed unless you have something other than a single country currency. Otherwise, how are you going to be better off by substituting the dollar with the euro or yen or Chinese renminbi? Because the same weaknesses will be there also. Whenever there is a convergence between the country's interest and global interest there will be no problem. But whenever there is a divergence, there will be a lot of problems. China is just saying that US dollar as reserve currency should change. But does it mean that it should change so that China can replace the US dollar? It is in the interest of the global community to start asking these questions now. Implicitly and subconsciously you are saying that for the world there is no alternative to the single currency system — because of the externalities of what is called network and social effect. If six people out of ten start using it, then everybody starts using it. The other four cannot but start using it.
So where will this head? Do you see any solution for this problem soon?
As I see it, there are two ways of looking at the issue — one is incomplete globalisation and the other is premature globalisation. One can say there is incomplete globalisation.
For instance, in the US there is a single financial authority, a single currency or single centralised fiscal authority, so even if some of their state governments have a problem they can adjust because there is closer economic integration and a central fiscal authority. The more you integrate, there will be no economic imbalance. There are current account deficits and capital flows — but there is no impact because they are integrated. The other is premature globalisation meaning we have allowed financial globalisation. Finance can move without other factors moving freely. You have allowed movement of goods and capital but not movement of people. So you have let some sectors globalise but not others. That is why I call it incomplete and premature globalisation. How do we resolve this? If you accept the position that it is incomplete globalisation, then you must allow more globalisation. Europe is finding it difficult with all the political problems. And if you think there is premature globalisation then you have to go the other way and say that in whichever area there is premature globalisation you'll have to roll back some measures. In the ultimate analysis, as Merwyn King of Bank of England said, “Banks are global in life and national in death!” When they are alive and happy, they are everywhere; but when you are in trouble, you go back to your government. If you say people look to the country, and it is the country which is the ultimate risk bearer, then you have to look at the powers of the sovereign. What are its powers? The power to tax; the power to spend; the power to regulate and the power to allocate resources. All four powers have been diluted — partly by technology; essentially by ideology and thirdly by deregulated, liberalised financial markets. You have to face this reality. You have to empower national public policy and create space for it.
HBL
