Raghuram Rajan: Impact of Chinese slowdown on SAARC region and policy options
Central bank: rbi | Type: speech | Date: 2016-05-26

## Raghuram Rajan: Impact of Chinese slowdown on SAARC region and policy optionsInaugural

talk

by

Dr

Raghuram

Rajan,

Governor

of

the

Reserve

Bank

of

India,

at SAARCFINANCE Governors' Symposium, Mumbai, 26 May 2016.*

*

*It is indeed a pleasure to be here this morning.

Let me welcome our guests of honour from the seven other SAARC countries; especially Mr. Arjun Mahendran in his capacity as the present SAARCFINANCE Chair as also Mr.

Fazle

Kabir,

the

Bangladesh

Bank

Governor

and

Mr. Dasho

Penjore,

Governor

Royal

Monetary

Authority

of

Bhutan

who

will

be

attending

the SAARCFINANCE event for the first time.

I welcome our distinguished guests, including our invitees from the IMF and the BIS.SAARC 1 , as a regional bloc was set up in 1985 with the aim of promoting the welfare of the people

of

South

Asia,

to

accelerate

regional

economic

growth,

strengthen

collective

selfreliance

and

contribute

to

mutual

trust,

understanding

and

appreciation

of

one

another's problems in the region.

Since then, our nations have come a long way.

They share a common goal of sustainable economic development, and face several similar developmental challenges.

In terms of GDP based on purchasing power parity (PPP), SAARC's share in the globe has increased rapidly from 4.0 per cent in 1980 to 9.0 per cent currently.

However, SAARC nations also make up 24 per cent of total world population.

We do need more growth, and do need to do more to support each other in this quest.

Intra-regional trade accounts for a measly 5 per cent 2

compared to 66 per cent within EU.However, today, I will not be talking of SAARC alone but the challenges SAARC faces in the context

of

globalization.

The

world

has

become

increasingly

interdependent,

with

the strengthening

of

economic

and

financial

linkages

within

geographic

regions

and

across but at the same time exposed economies to spillovers from disturbances in one part of the geography to another.Amid such growing vulnerabilities and imbalances, SAARC region shows continued resilience in the face of turbulent international markets, maintaining its spot as the fastest-growing region in the world.

Average growth in the region has outstripped the average growth of emerging market and developing economies (EMDEs) throughout the post-crisis period.

The outlook for the region has also improved as a result of significant disinflation in the region during 201416.

However, within the region, growth trends have diverged temporally and spatially.Moreover, the region is now facing newer challenges arising from uncertainties in other parts of the world.

Possible moves by the US Fed, a potential rebound of oil prices, possible Brexit, geopolitical risks in the Middle East and volatility in financial markets due to risk-on or risk-off sentiment are some of the possibilities we have to anticipate.

However, when we decided the theme of this conference, a common uncertainty that confronted us was the possible sharp slowdown of the Chinese economy.

To my mind, this still remains a significant risk for the global economy and our region, though Chinese policymakers have a record of over three decades of astute policy making, which suggests they may significantly mitigate the potential downsides.

Therefore, in the rest of this discussion, I will focus on the impact of the Chinese slowdown on SAARC region.

I will also address potential policy responses, drawing specifically on India's policy actions.1 Afghanistan, Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan and Sri Lanka.2 UN Commodity Trade Statistics Database, 2014.BIS central bankers' speechesOver the past two decades, China has emerged as a powerhouse of global production.

China eclipsed the United States in 2013 to become the world's largest trading nation.

As per WTO data, China was the world's largest exporter and second largest importer in 2014 accounting for 12.4% and 10.3% share, respectively.

The United States accounted for 8.6% of the world's exports and 12.7% of the world's imports.

So it is clear that a slowdown in China will affect the global economy, including the SAARC region.

The sharp contraction in China's imports over the

past

year,

has

already

led

to

spillovers

through

the

trade,

confidence,

tourism

and remittance channels.

SAARC nations have not been able to avert its impact.

More negative externalities could follow as Chinese economy adjusts to a more sustainable path.Not only has China had to rein in production as a result of weak post-crisis industrial country demand, it has also suffered from weak aggregate demand of its own, as it shifts from an investment-

and

export-led

growth

model

to

a

consumption-led

model.

Combined

with

the previous bouts of leveraged expansion, China now has a number of sectors that suffer from the twin ailments of overcapacity and high leverage.

Bad loans in the banking system are likely to grow over current levels - stressed loans are estimated to be around 5.5% of the bank loan book today.

In addition, there may be serious weaknesses in the shadow banking system, which could feed back to banks.

Clearly, cleaning up the financial system will be a challenging but necessary task.Work at the IMF suggests that a 1-percent permanent negative shock to China GDP caused by one-off 1-percentage decline in its real GDP growth will knock off 0.23 percentage points from global growth in the short-run 3 .

A key question is whether we in SAARC region are at significantly more risk than others.

The answer probably is no because none of us is primarily commodity exporter to China, but it cannot be an unqualified one.

Trade could be impacted due to second round effects - we export to those who traditionally export to China and have thus slowed down - and due to similarity in trade patterns with China - we compete with those who now have excess production capacity.On the financial side, exposure to China is large for the Asia-Pacific banks, especially for banks from Hong Kong, Singapore and Australia and much less for banks from our region.

However, some of our countries, though not India, have significant borrowing from Chinese banks, and these borrowings could become costlier if Chinese banks turn inwards.

Moreover, financial market losses in China can heighten the risk premia that industrial country investors will charge for investing in our region, and the result could be capital outflows of the kind that were seen last August and early this year.Chinese growth will depend not just on its policies, but on growth elsewhere in the world.

There appears to be a general consensus that global growth has been too slow for too long.

The IMF downgraded its outlook for global growth in 2016 and 2017 by 0.2 and 0.1 percentage points, respectively.

It is true that downside risks and uncertainties to the global outlook are large in the backdrop of event risks I have alluded to.

However, a more careful look at the data suggests some care in jumping to the conclusion that growth has been slow.

Global growth has averaged 3.5 per cent since 1980 and, in fact, if we take out the credit boom supported average growth of

4.5

per

cent

during

the

period

2000-2007

that

led

to

global

financial

crisis,

the

global average falls to 3.2 per cent.

The fact is that after the small contraction in 2009, global growth has averaged 3.8 per cent during 2010-15 and is still expected to be 3.2 per cent in 2016.What this means is that growth in period before the financial crisis was perhaps goosed up by borrowing, and the post financial crisis period is not so bad in comparison, especially if we account

for

the

deleveraging

that

has

taken

place

in

industrial

countries.

Of

course,

the question of why underlying industrial country growth has slowed in recent years is still being debated, and the answer probably lies in the hard-to-understand effects of population ageing3 Cashin, Paul, Kamiar Mohadess and Mehdi Raissi (2016), 'China's Slowdown and Global Financial Market Volatility: Is World Growth Losing Out?' IMF Working Paper, No. WP/16/63, March.and productivity slowdown.

While stronger global growth may be just around the corner, as the IMF has anticipated every year in the last few years, it may yet be some time in coming.

It might

therefore

be

optimistic

to

expect

that

China

will

be

lifted

by

global

tides,

and

it

will probably have to undertake the needed policy adjustment without the tailwind of global growth.What should SAARC countries be doing?

While growth in India, Bangladesh and Bhutan is still quite good, overall we are confronted with a difficult combination of relatively slow domestic demand growth since 2013 and a difficult global environment.

Portfolio flows have turned more volatile in this period.

Let me explain what India has been doing in the face of these global uncertainties.First, there is no substitute for good policy.

India has outlined and adhered to a path of fiscal consolidation

to

reduce

the

fiscal

deficit

that

had

widened

dramatically

following

the

postfinancial

crisis

stimulus.

It

has

contained

inflation

through

a

combination

of

better

food management, a new inflation framework and calibrated monetary policies, and of course the good luck of lower energy prices.

The resulting demand management has resulted in a lower current account deficit, down from 4.8 percent in 2012-13 to about 1 percent in 2015-16.

We have also embarked on a cleanup of bad debts in the banking system so as to free bank balance sheets to support growth.In addition, the government has embarked on ambitious structural reforms to revive growth, including significant efforts

in

the

agricultural

sector to

boost productivity

through

irrigation, insurance, and access to markets, a strong push to deregulate business, especially for startups, important efforts to improve the governance of public sector banks and to resolve distress in power distribution companies, and an immense effort to expand financial services to the excluded through the provision of bank accounts and of direct benefit transfers.

While the eyes of the world have been on the much anticipated Goods and Services Tax reform, a number of other significant reforms have taken place, including the recent passage of the new Bankruptcy bill,

which

is

likely

to

speed

the

resolution

of

distress

tremendously.

With

the

benefit

of hindsight, I am sure we will see the cleaning up of the process of allocating public resources like spectrum and mines, as well as the process of appointing critical personnel such as public sector bank chiefs, as one of the most effective reforms undertaken by the government.

This is significantly increasing transparency in our system.A second element of our defense is being careful about foreign borrowing, especially at the very short term.

So we have expanded limits for foreign portfolio investment into government debt in

a

very

measured

way,

even

though

considerable

pressure

has been

put

on

us

by foreign investors to create more room.

We have required any new debt investment to be in debt over 3 years in residual maturity.

We have also reformulated our rules on foreign bank borrowing to ensure that domestic entities without foreign earnings either borrow in rupees or really long term.

We are trying to create an offshore rupee corporate 'masala' bond market.

Finally, a strong liberalization of FDI regulations, coupled with the government's active efforts to attract foreign investors, have resulted in record FDI inflows last financial year.We

also

are

careful

in

moderating

periods

of

extreme

volatility

in

the

currency

through exchange intervention.

This is more of an art than a science, and we are extremely careful not to try and target any particular rate.

Instead, we let the market adjust as needed, intervening only when we are convinced the movement is excessive.

As a result, despite running a current account deficit, the currency has been relatively stable even in extreme risk-off periods.

Based on our macroeconomic situation, we also intend to expand or contract what can be taken out annually by households - this will be a macro-prudential instrument.The fourth element of our defense is foreign exchange reserves.

We have about $ 360 billion, plus

forward

positions

to

offset

possible

forward

liabilities.

We

also

see

merit

in

pooling reserves, and have a Contingent Reserve Agreement with BRICS countries, and a currency swap arrangement with SAARC countries.

I am glad to say that this SAARC facility has been of use to some of you.We are very conscious of the role the Indian economy plays in influencing growth in other SAARC economies.

To avoid any negative externalities, we have kept the objective of securing and preserving macro-stability at the top of our agenda.

The ongoing disinflation, aided by our new monetary policy framework, and the resultant outcome of relative exchange rate stability compared with other emerging market peers, have hopefully served as a public good in this region.

We have contributed to strengthening the safety nets in the region.

We look forward to a strengthening Indian economy as recent structural reforms take hold, and hope that some of this growth will spillover to your economies.

In turn, we hope to be benefited as your economies pick up.

Together, we can hopefully be an island of relative stability and co-operation in this turbulent world.Thank you.

I look forward to fruitful deliberations at the rest of the symposium.