Y V Reddy: The rise of Asia - implications for the global economy
Memorial lecture by Dr Y V Reddy, Governor of the Reserve Bank of India, on the occasion
of the 40th anniversary celebrations of the Bank of Mauritius, Mauritius, 3 December 2007.
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The Honourable Vice-President of Mauritius, Honourable Ministers, Respected Governor
Rundheersing Bheenick, Mr. Googoolye, Dr. Khadaroo, Directors of the Board of the Bank of
Mauritius and distinguished friends.
It is a great honour and privilege to be invited to deliver a Memorial Lecture on the occasion
of the 40th Anniversary Celebrations of the Bank of Mauritius. The invitation is yet another
demonstration of not only the close ties between India and Mauritius but also between the
two central banks, which have a mutually beneficial and very special relationship. I am
personally grateful to Governor Bheenick for giving me the opportunity to be here with you.
The Honourable Prime Minister, Dr. Navinchandra Ramgoolam, in his address on August 24,
2007, to commemorate the 40th anniversary celebrations of the Bank of Mauritius, paid rich
tributes to the Bank. He specifically referred to the effort and dedication that have gone into
making the Bank "a successful and well respected institution". I would amplify that the Bank
has become a globally well respected institution and we, in the Reserve Bank, have got great
trust and confidence in our counterpart in Mauritius.
The Bank for International Settlements, Basel, Switzerland, (BIS) in its Review 99/2007,
carried Governor Bheenick's address on the same occasion on August 24, 2007 which is
titled "Escaping the fate of Dodo". It is a brilliant exposition of not only the evolution and the
successful adaptation of the Bank of Mauritius to the changing circumstances, but also on
the theory and practice of central banking. On the tasks ahead, Governor Bheenick
"this Central Bank needs to achieve this transition from being the Bank of
mentioned that
Mauritius to being the Bank for Mauritians; the Bank of the people. We must make the sound
financial choices for every family, the easy choices". We, in the Reserve Bank of India, have
recently set ourselves similar mandate. Let me formally congratulate the Bank of Mauritius
on its successful journey into the 41st year and wish it all the best in its pursuit of the goals of
growth, stability and, above all, service to common persons.
The theme for today's lecture is "The Rise of Asia - Implications for the Global Economy". I
want to approach the subject with considerable humility. My first trip to Mauritius was in
1997, in connection with the Commonwealth Finance Ministers' Conference. From here, I
was scheduled to proceed to Hong Kong for attending the IMF / World Bank Annual
Conference. However, I chose to cancel my trip to Hong Kong and, instead, returned to
Mumbai since the financial markets in India indicated some sort of unease. It was about that
time that the full blown Asian Crisis erupted. For months and years thereafter, we deliberated
on the unfortunate developments in the Asian economies and the consequent difficulties, as
well as the need for reforms. On my second trip to Mauritius, after ten years, now we are not
merely celebrating the success of the Asian economies but also contemplating on how they
may contribute to the global growth and stability. It has been a remarkable turnaround for the
Asian region, and no one could have predicted this outcome, ten, or even five, years ago.
Second, could anyone have anticipated turbulence in financial markets that would emanate
from the advanced economies like the United States and more particularly from a global
financial centre?
Third, how many could envisage a situation where the largest financial intermediaries,
especially global banks, which are highly rated for their risk management capabilities, would
suddenly lose full confidence in the liquidity position of each other and thus become reluctant
to deal with each other? Consequently, some central banks have, perhaps justifiably,
pumped in huge liquidity into the system on extra-ordinary liberal terms.
Fourth, in a related event, in a leading global financial centre, the government had to take
initiatives to support a bank when there was a run on the bank - an approach that was
seldom on the drawing boards of governments, in recent years.
In brief, the need for humility arises because recent history has shown that we do not know
enough to predict economic outlook for nations, or the global economy, with any reasonable
degree of certainty. Moreover, the current global economic environment is particularly
uncertain, making such predictive exercises very tentative.
In this background, let me present a few perceptions about the Asian economies in the global
context. At the outset, we should recognise that Asia is a large region with several countries
and economies that are of varying size and nature, which are at different stages of
integration with the global economy and also with each other. Hence, what is attempted here
is a set of very broad generalisations.
The growing importance of Asia in the global economy is well-documented and hence a brief
recall should suffice. Asia can boast of three of the ten largest economies in the world -
these are Japan, China and India. In 1980, Asia accounted for 19 per cent of the global
Gross Domestic Product (GDP) in Purchasing Power Parity (PPP) terms. Today, Asia
accounts for over 36 per cent and by the year 2020, it is expected to reach over 45 per cent.
Currently, Asia contributes close to 50 per cent of world growth in PPP terms. Asia's share in
the global trade is increasing rapidly and trade within Asia is also increasing in an impressive
fashion. The Asian economies are more open to each other now, than ever before.
However, while the size of the national GDP, in comparison with those of others, is very
important, the levels of per capita GDP in each nation, in PPP terms, is also somewhat
relevant. As per Maddison's projections, the per capita GDP of China will be about one-fourth
of that of the US in the year 2030, though the GDP of China is expected to surpass that of
the US within the next twenty five years. This broadly reflects the position of most of the
Asian economies vis-à-vis the advanced economies. In brief, therefore, there is merit in
combining justifiable enthusiasm for a rising Asia with a dose of humility, which is warranted
by the long journey ahead.
The impressive growth in Asia has benefited the global economy in several ways, though
some issues have emerged. First, by producing highly competitive goods and services, Asia
has helped enlarge the range of goods available and enhance their quality. As a
consequence, world over, billions of consumers, as a group, have benefited from the growth
of Asia. This process helped central bankers, globally, in containing inflation and inflationary
expectations. In view of the vast reserves of labour force that will be available in Asia for
several decades to come, and the strides made in the field of technology, many expect the
process to continue, perhaps not necessarily with the same intensity.
Second, many commodity producing countries, especially in Africa and Latin America, have
benefited through better terms of trade and increased export earnings, as well as increased
economic activity, by catering to the rising demand from Asia. Thus, Asia supplemented the
US in providing impetus for global growth. As Asia is expected to continue the growth
momentum, the positive impact is expected to persist.
Third, rapid growth of large economies in Asia may continue to generate significant
opportunities for expanding the markets for other economies, especially the neighbouring
economies, and these could certainly include tourism and financial products also.
Fourth, a few advanced economies tended to experience some discomfort in the rise of Asia
since competitive forces put pressure on wages of some categories of workers, though, as
consumers, the general populace benefited from the process.
Fifth, there are additions to demand for energy due to rapidly growing Asia and, according to
some, thus impacting oil prices. In terms of the existing levels of energy consumption, Asia is
still a minor player in the overall energy market. Further, many attribute the rising oil prices to
financialisation of commodities and speculation. No doubt, over the medium to long term,
there is scope for improving efficiency in the use of energy in Asia. The energy economy of
the world and the rise of Asia may continue to interact in a dynamic setting in future also.
Sixth, the economic growth in Asia has resulted in an unprecedented number, in millions, of
people moving out of poverty levels every year thus generating demand for food items,
including cereals and milk. The structural increase in demand for food on account of Asia
may continue for several years. While demand for food is relatively inelastic, the supply side
is often influenced by several factors, including political economy considerations. The
problem is accentuated by the uncertainties in the global climatic conditions and increasing
financialisation of trade in these commodities.
Finally, the monetary authorities are facing very complex challenges, since traditionally oil
prices were treated as "shocks" and food prices are also treated as some sort of a "shock". It
is now realised by the monetary authorities, in advanced economies also, that food prices
have significant impact on inflation-expectations, which are vital for the conduct of monetary
policy. In developing economies, the problem is more acute since the weight for food prices
in price indices is large.
Way forward, all of us recognise the growing importance of Asia in an inter-dependant world.
Hence, Asia needs to be conscious of the challenges to public policy and the international
community would also gain by being supportive of policies that benefit Asia and the global
economy over the medium term to longer term. Such collaborative and mutually reinforcing
policies are critical for growth and stability in all regions.
Let me recount a few important challenges in Asia. First, two-thirds of the world's desperately
poor live in Asia. According to the Asian Development Bank (ADB), 620 million people within
the region are still living on less than one US dollar per day and if we raise the limit to two US
dollars per day, the number would be more than a billion. Hence, a policy of inclusive growth
becomes critical and, indeed, essential.
Second, the share of Asia in billionaires and high networth individuals (HNIs), relative to
other regions, is growing disproportionately, which could flag concerns regarding
maintenance of social and political stability. The consequences of growing regional
inequalities are being felt in several Asian economies. There is evidence of several policy
initiatives in this regard also.
Third, the urban population in Asia may double by the year 2030 relative to the year 2000. By
2030, Asia will have about 2.7 billion urban people, while all other regions in the world will
have a combined urban population of about 2.3 billion. This will result in large demands on
urban infrastructure. At the same time, due to globalisation and growth experiences, the
urban residents will be more demanding in regard to quality of urban infrastructure and
services. Hence, public-private participation, cutting across national boundaries, may
become significant.
Fourth, the demographic trends in Asia over the next 50 years are expected to be reflective
of the past 50 years for developed countries, with significant divergence among the various
Asian economies. The expected increase in old age dependency during 2000 to 2025, and
further on to 2050, may increase fiscal pressures. However, countries such as India and
Indonesia are expected to reap benefits of demographic dividend over a longer period
ahead, than the other Asian economies, perhaps for another 25 years. Reaping benefits of
demographic dividend is dependent upon enhancing quality of health conditions, imparting
better skills and improving public infrastructure so as to take advantage of globalisation. In
the absence of appropriate public-policy initiatives, what could be a demographic dividend
could turn out to be a demographic problem.
Finally, the global community has to address the issue of adequacy of voice and
representation to a rising Asia in the current international financial architecture. In other
words, governance structures and arrangements need to reflect the new realities of a rapidly
growing Asia, in the interests of all stake holders.
An issue of contemporary importance is the possible interaction between recent events in
global financial markets and Asia. As of now, all relevant aspects of financial markets and
institutions are yet to be fully transparent. There a feeling that full normalcy is yet to be
restored in the global financial markets. The impact on the real economy in the USA is yet to
be fully felt and a possible slow down in that economy is not ruled out. While neither financial
contagion nor slow down in the US economy is ruled out, the global consensus, as of now, is
that global growth will be robust as anticipated, but with heightened uncertainties. At this
stage, therefore, we can make only a few very broad observations on the likely impact of
global financial conditions on Asia.
The economic reforms in the real sector have improved the overall productivity and resilience
in Asia. The macro economic conditions in Asia, as a whole, are significantly stronger and
conducive to overall stability relative to the past. The financial systems in most countries,
both markets and institutions, are far more efficient and resilient than before. The external
sector has been strengthened and considerable reserves provide cushions to withstand
financial contagion. In fact, it is felt by many, that Asia's reserves can help smoothen the
process of unwinding of global imbalances that appears to be underway through, what has
"falling with a parachute"
been described as scenario. Overall, the economies in Asia seem
to be reasonably equipped to withstand, to some extent, heightened volatilities in most of the
financial markets.
The possible impact of adverse developments, if they happen, on the real sector is, however,
less clear. While some hold that any slow down in the US will impact Asia adversely, since
Asia's exports to the US are large, others hold that some "de-coupling" has occurred in view
of the growing intra-Asia regional trade. It is also argued that intra-regional trade in Asia is
linked to exports to the US. A more plausible scenario would be that slow down in the US, if it
takes place, would, to some extent, dampen the growth in Asian economies, but to the extent
there has been some elements of decoupling, which may be country specific also, the impact
may be moderated. In other words, it will be unrealistic to hold that Asia can substitute for the
US as the major engine of global growth at this stage. Hence, heightened vigilance among
Asian central banks appears to be common.
We, in India, are monitoring (a) the process of restoration of full normalcy in global financial
markets; (b) the evolving financial contagion; and (c) the possible spill-over to the real sector
after accounting for the possible extent of "decoupling". The major reason for extraordinary
vigilance by the Reserve Bank of India, at this juncture, is what I would describe as
simultaneous volatilities in several globally significant markets, namely, money, credit and
currency markets; asset prices; and commodity prices, especially oil and food items. The
current phenomenon of simultaneous volatilities should be viewed in the context of possible
repositioning of the world's dominant reserve currency, involving significant wealth, income
and terms of trade effects.
Ladies and gentlemen, let me now turn to the Indian economy in greater detail. Before
independence, during the first five decades of the 20th century (1900-01 to 1946-47), the
annual average growth performance of the Indian economy was very low, averaging 0.9 per
cent per annum. Since the beginning of the planned development process, in the early
1950s, the GDP growth displayed a self-accelerating tendency reaching a level of around 6.0
per cent in the 1990s. Two exceptions during this phase were the dipping of the growth rate
in the 1970s to 2.9 per cent and during the crisis year of 1991-921 when the growth was as
low as 1.4 per cent.
In the new millennium, the GDP growth rate has accelerated further averaging 6.9 per cent
during the seven-year period 2000-01 to 2006-07, while the growth rate in the last four years
(2003-04 to 2006-07) averaged 8.6 per cent. In 2005-06 and 2006-07, it has grown still
higher at 9.0 per cent and 9.4 per cent, respectively. During this phase too, in one year
during 2002-03, the growth rate dipped to 3.8 per cent due to drought conditions in several
parts of the country leading to significant fall in agricultural production.
The strengthening of economic activity in the recent years has been supported by persistent
increase in gross domestic investment rates from 24.3 per cent of GDP in 2000-01 to 33.8
per cent in 2005-06 and domestic saving rate from 23.7 per cent in 2000-01 to 32.4 per cent
during 2005-06. It is important to note that over 90 per cent of investment during this period
was financed by domestic savings.
In tandem with acceleration in the rate of investment in the economy, there has been
evidence of a pickup in productivity and efficiency of capital use. Some of the recent studies
relating to India have indicated an increase in total factor productivity (TFP) in recent years.
While growth rate has picked up in the new millennium, the inflation rate has moderated to
still lower levels ensuring price stability. Since 2000-01, the annual inflation rate, as
measured by Wholesale Price Index, has averaged below 5 per cent despite the recent oil
price shock.
Fiscal management in the country has significantly improved with the combined fiscal deficit
of Centre and States declining from 9.5 per cent of GDP in 2000-01 to 6.4 per cent in
200607. However, combined public debt of the Centre and the States, as proportion of GDP,
remains high at over 70 per cent.
India's external sector has become resilient with the current account deficit being maintained
at very modest levels after a few years of marginal surplus during 2001-02 to 2003-04. The
value of both exports and imports, in US dollar terms, has tripled by 2006-07 relative to
200001, and the current account deficit remained modest at 1.1 per cent of GDP, or below, for
four out of the seven years, while there was a surplus in the remaining years. On account of
strong capital flows, there have been accretions to foreign exchange reserves, which, at US
$ 271.2 billion as on November 16, 2007 are currently higher than the external debt (US$
165.4 billion at end-June 2007).
For monetary policy purposes, the Reserve Bank, in its Annual Policy Statement of April
2007, placed the real GDP growth for the current year, 2007-08, at around 8.5 per cent,
assuming no further escalation in international crude prices and barring domestic or external
shocks.
The policy preference for the period ahead is strongly in favour of price stability and
wellanchored inflation expectations with the endeavour being to contain inflation close to 5.0 per
cent in 2007-08. In recognition of India's evolving integration with the global economy and
societal preferences in this regard, the resolve, going forward, would be to condition
expectations in the range of 4.0-4.5 per cent so that an inflation rate of around 3.0 per cent
becomes a medium-term objective, consistent with India's broader integration into the global
economy.
The Indian economy is confronted with some major challenges in the medium term. First,
though about 60 per cent of the Indian population is still dependent on agriculture, its share
in the GDP has been declining steadily over the years and now accounts for less than 20 per
cent of the GDP. Enhanced growth of the agricultural sector is, therefore, vital for ensuring
food security, poverty alleviation, price stability, overall inclusive growth and sustainability of
growth of the economy. Second, absence of modern infrastructure and shortage of skilled
manpower are the most critical barriers to the growth. It is, hence, imperative to augment the
existing infrastructure facilities, particularly roads, ports and power, to provide the enabling
environment for industry to prosper. Third, in order to reap the benefits of the demographic
dividend, substantial expansion and reforms in the education sector would be needed on an
urgent basis. Fourth, reprioritisation of expenditures towards social sectors along with higher
capital outlays is required to promote fiscal discipline without restricting operational efficiency
of the Government. Fiscal empowerment would allow higher capital outlays and boost
infrastructure and social sector spending with beneficial impact on domestic productivity,
growth and employment. It is, thus, necessary to emphasise the criticality of quality of fiscal
adjustment. Finally, to meet the growing credit demand and sustain high economic growth,
banks need to widen their deposit base. Banks need to bring more and more financially
excluded people within their fold, which would help the low-income households and
strengthen financial deepening.
I have already alluded to some of the quantitative positive aspects of the Indian economy,
such as savings-investment balances, and price stability, just a while ago. Now, I will narrate
some of the prominent non-quantifiable strengths which are expected to help in facing the
challenges mentioned above. First, it is endowed with a vast pool of science and technology
graduates and millions of people who are familiar with English language. Second, familiarity
with multiple languages makes adaptation better to multi-cultural situations, making it easier
for the Indian manpower to fit into international systems smoothly. Third, being the largest
democracy of the world and the existence of a free press provide some insurance against
excesses and make Governments more accountable than otherwise. Fourth, the
empowerment of women in the recent years has helped them to defend their rights and
helped to gain greater self-esteem and control over their own personal lives and social
relationships. Fifth, despite the coalition cabinets and periodic elections, the political climate
is characterized by political system stability. Sixth, considerable "demographic dividend" can
be realised by putting in place prerequisites such as skill-up-gradation and sound
governance. Finally, in terms of business environment, a fast emerging very broad-based
growing entrepreneurial class, with a penchant for innovation and imbued with
professionalism, is seeking to become globally competitive.
However, to ensure continued successful performance of the economy, it is generally
recognised that all stakeholders need to strengthen State capacity and enable it to perform
its core functions more effectively and equitably.
Referring to the long-term economic outlook for emerging market economies, in general, and
for India, in particular, Mr. Jean-Claude Trichet, President, European Central Bank, said in
the Tenth L K Jha Memorial Lecture on November 26, 2007 that "..it suffices to recall how
significant India's weight in the world economy was two millennia ago, when the Middle
Kingdoms were ruling in India and the Roman empire was ruling in Europe and North Africa.
At that time, India was by far the world's largest economic power, accounting alone for about
a third of world output. Moreover, at par with China, it subsequently remained the largest
economy in the world for several centuries, until the eve of the industrial revolution. Seen
from this long-run perspective, the rapidly growing importance of India in today's world
economy seems to be a return to normality."
Concluding remarks
Governor Bheenick made a brilliant exposition of achievements, policies and challenges for
Mauritius in a presentation at the BIS/African Governors' Conference in Cape Town a few
weeks ago. I am, therefore, convinced of a bright future for Mauritians and the Bank of
Mauritius, in particular, under his leadership. There are some telling aspects of the Mauritian
economy and public policy of Mauritius that appear to be worthy of note by the other
countries, especially economies in Asia that we are speaking about, including of course,
India. I will allude to some of these aspects now, which we in Asia will be well advised to take
note of and imbibe.
The November 2007 issue of the journal "African Business" carries an Index on African
Governance 2007 and, as per the final score, Mauritius occupies the number one position in
Africa. Mauritius is also ranked first in the latest global African Competitiveness Index of the
World Bank and the International Finance Corporation. My personal observations show that
many of us, in Asia, could study and learn from the public policies in Mauritius relating to high
coverage and quality of primary education, efficient delivery of health services and protection
of environment. Yes, we have a lot to learn from each other and there are many areas in
which we can cooperate. The two central banks will, I am sure, strengthen the traditional ties.
We will carry forward a continuous dialogue to strengthen cooperation between the Bank of
Mauritius and the Reserve Bank of India.
As a reciprocal gesture, let me extend an open and standing invitation to Governor Bheenick
to visit India soon and, in addition, participate in the celebrations of 75th Anniversary of the
Reserve Bank, which is due soon in a couple of years from now.
Thank you all, ladies and gentlemen.