Raghuram Rajan: Impact of Chinese slowdown on SAARC region and
policy options
Inaugural 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.
SAARC1, 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 cent2 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
regions. Globalization has brought several economic gains and improved consumer welfare,
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 2014-
16. 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.
Over 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-run3. 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 ageing
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.