Duvvuri Subbarao: G 20 and India
Text of the 46th A D Shroff Memorial Lecture by Dr Duvvuri Subbarao, Governor of the
Reserve Bank of India, at the Indian Merchants' Chamber, Mumbai, 20 November 2012.
* * *
My sincere thanks to the Forum of Free Enterprise and Shri Minoo Shroff for inviting me to deliver the A.D. Shroff
Memorial Lecture. It is an honour to which I attach a lot of value.
A.D. Shroff
Even as he had no privileged background, A.D. Shroff rose to become one of the country's
most eminent and respected professionals in the financial world of his time. From the Board
of Tata Sons, where he was the financial adviser, he went on to become the chairman of
New India Assurance and then of Bank of India prior to these institutions being nationalized.
At a time when Nehruvian socialist ideology dominated economic thinking, the development
paradigm was shaped by the Feldman-Mahalanobis model and the public sector was at the
commanding heights of the economy, Shroff had the courage of conviction to argue for an
increased role for the private sector in a market economy. It was these intellectual
foundations that inspired the Bombay Plan of 1944 of which Shroff was one of the
co-authors.
The Reserve Bank recognized Shroff's expertise and innovative thinking early on when, in
1953, it set up a committee under his chairmanship to examine how the flow of finance to the
private sector could be enlarged. The Shroff Committee recommendations played a key role
in defining the basis for institution building in the financial sector - ICICI and at a later date
IDBI, were set up as development financial institutions, a deposit insurance corporation in the
shape of DICGC came in the early sixties and the Committee's suggestion of setting up unit
trusts as vehicles to channelize small savings into investments provided the basis for the
later day UTI.
The Shroff Committee recommendations were seminal and have been acknowledged.
Perhaps less known is the fact that A.D. Shroff was the deputy governor that the Reserve
Bank never had. Sir Osborne Smith, the first Governor of the Reserve Bank of India (RBI),
asked for him as the deputy governor of RBI in 1936 but the proposal was vetoed by the
British government which felt that Shroff was too close to the Congress Party. It is ironic that
this perceived "Congress Economist" went on to be regarded as one of the most virulent
critics of the Congress Government's economic policies during the second and third plan
periods.
Clearly a man ahead of his time, A.D. Shroff understood the importance of private investment
in nation building in a liberalized, market driven environment. Like every great idea awaiting
its time, the liberalization that he so fervently advocated had not fully arrived in the country till
the early nineties - a quarter century after he passed away.
The economic liberalization that we started in the nineties has meant India integrating with
the rest of the world, a process that is still work in progress. Over the last ten years, India's
two way trade flows as a proportion of GDP have doubled; our two way current and capital
flows as a proportion of GDP have more than doubled. The experience of the global financial
crisis and now the Eurozone crisis has taught us that even as we benefit from integration,
because of that very integration, we become vulnerable to global shocks.
India's embrace of globalization and the remarkable transition the economy went through
after the economic reforms of the 1990s are an eloquent testimony to eminent thinkers with
foresight and conviction like A.D. Shroff. I can think of no better way of honouring the
memory of a visionary like him than talking about India's enlarged stake and growing role in
global economic policy making. In particular, I will focus on the G 20 and India's interests in
this very vital international forum.
G 20
The G 20, as all of you know, has been in the forefront of battling the financial crises - the
global financial crisis of 2008/09 and the Eurozone crisis since 2010 - that have taken a
devastating toll on global growth and welfare. Indeed when the history of this crisis is written,
the London G 20 Summit in April 2009 will be acknowledged as the clear turning point when
world leaders showed extraordinary determination and unity. Sure, there were differences,
but they were debated and discussed, and compromises were made so as to reach the final
goal - of ending the crisis. This resulted in an agreed package of measures having both
domestic and international components but all of them to be implemented in coordination,
and indeed in synchronization where necessary. The entire range of crisis response
measures - accommodative monetary stance, fiscal stimulus, debt and deposit guarantees,
capital injection, asset purchases, currency swaps, keeping markets open - all derived in
varying degrees from the G 20 package.
Five years on the crisis is still with us; only its epicenter and the main actors have changed.
During these five years, the world has also become privy to the differences on some vital
issues within the G 20 membership. Understandably therefore, there are concerns and
apprehensions that the vaunted unity and sense of purpose that the G 20 showed earlier on
are dissipating.
My own view is that these differences should not be exaggerated. After all, in a world
comprising nation states, there is no natural constituency for the global economy. There are
bound to be differences when the agenda is so broad and country level compulsions are
seen to be clashing with global interests. What is important is that we are able to resolve
these differences with the realization that in a globalizing world, no country can be an
"island". What happens anywhere affects economies everywhere. Global financial stability is
a global public good, and there can be no more an effective forum than the G 20 to steer the
world towards globally optimal solutions.
Having set that context, I will now address the following questions:
(i) What is the G 20 and how does it function?
(ii) Why is the G 20 important?
(iii) What have been/are the main issues on the G 20 agenda and India's concerns
regarding them?
(iv) What are the future challenges for the G 20?
What is the G 20?
The G 20 is an informal club with 19 member countries and the European Union which
together represent 90 per cent of global GDP, 80 per cent of global trade and two-thirds of
the global population.
Contrary to popular belief, the G 20 is not a new international grouping triggered by the
global financial crisis. It was, in fact, triggered by an earlier crisis, the Asian crisis of 1997.
Although, it has been meeting regularly since 1997, it acquired a higher profile and credibility
in the aftermath of the global financial crisis during which time it was elevated from a Finance
Ministers' forum to a Leaders' forum.
The chair of the G 20 rotates every year from country to country. The chair country takes the
lead in formulating and driving the agenda. The G 20 leaders meet at the summit level once
a year.1 Besides, the Finance Ministers and central bank governors of G 20 meet twice a
year. All the meetings are typically held in, and hosted by, the chair country. The President of
the World Bank and the Managing Director of the IMF attend the G 20 meetings, thereby
ensuring that the activities of the G 20 are integrated into the agenda of the Bretton Woods
Institutions where necessary. There are also other invitees to the G 20 meetings such as the
OECD, UNDP and the regional development banks.
Why is the G 20 important?
The G 20 can be seen as a watermark in international economic diplomacy in at least two
ways.
First, it is a major step forward from the old divisive style of global governance of the Bretton
Woods system characterized by little communication and much acrimony between major
developed (G 8) who were largely seen as donors, and developing (G 77) countries that
were seen as the recipients of bilateral and multilateral aid. Differences in perception remain,
but there is now a paradigm shift in the donor-recipient equation, a better appreciation of
each other's viewpoint, and an emerging consensus on what increasingly appears to be an
incipient new international order through G 20 reports and declarations to which both sets of
countries are committed.
This new style of international governance had been in the making for some time. The bigger
EMEs, particularly the BRICS,2 were growing at a much faster pace than OECD countries for
a long time, and were becoming increasingly systemically important. It became clear that for
any multilateral economic consultative process managing globalization to be effective, their
inclusion in the process was imperative. Even prior to the global crisis, the G 8 found it
expedient to invite the big emerging economies - the G 5 (Brazil, India, China, Mexico and
South Africa) - to their Summits as special invitees, but only to select sessions in what was
termed the Heligandamm process. The global financial crisis has simply underscored the
need to associate major emerging economies in global economic governance. From being
the sources of constant instability in the global economy, some of the larger emerging
economies are now increasingly seen as nodes of stability and growth.
The second factor that makes the G 20 unique is its attempt to coordinate the
macroeconomic policies of systemically important economies to make them more effective in
a world where national macroeconomic policy instruments are being blunted via rapid global
integration through trade and financial markets. Following its concerted and coordinated
policy response to the crisis, the G 20 set about the task of addressing reform of the global
economic and financial architecture, and to remove long-standing structural impediments to
strong, sustainable and balanced global growth going forward by launching its signature
"mutual assessment process" which is increasingly seen as the heart and soul of the G 20.
The success of this process is important for global financial stability, as I will explain later.
Main issues on the G 20 agenda
In that context of the origins and importance of G 20, let me now turn to some of the main
issues on the G 20 agenda after the world surfaced from the depth of the 2008/09 global
financial crisis. I will also give the Indian perspective where appropriate.
Global rebalancing
The first issue I want to address is global imbalances. Almost everyone is agreed that one of
the root causes of the global financial crisis is the build-up of global imbalances. In as much
as global imbalances - no matter whether they were caused by a "consumption binge" in
advanced economies or a "savings glut" in EMEs - were the root cause of the crisis,
reducing imbalances is a necessary condition for restoring global financial stability.
The post-crisis debate on global imbalances has three interrelated facets. The first is the role
of exchange rates in global rebalancing. The second relates to capital flows into EMEs
raising the familiar challenge of managing the impossible trinity. And the third facet is the
framework for the adjustment process. Let me turn to these one by one.
First, on the role of exchange rates - a prime lever for redressal of external imbalances.
Global rebalancing will require deficit economies to save more and consume less. They need
to depend for growth more on external demand which calls for a real depreciation of their
currencies. The surplus economies will need to mirror these efforts - save less and spend
more, and shift from external to domestic demand. They need to let their currencies
appreciate. The problem though is that while the adjustment by deficit and surplus
economies has to be symmetric, the incentives they face are asymmetric. Managing
currency tensions will require a shared understanding on keeping exchange rates aligned to
economic fundamentals, and an agreement that currency interventions should be resorted to
not as an instrument of trade policy but only to manage disruptions to macroeconomic
stability.
That takes me to the second facet of global imbalances - capital flows. The problem of
capital flows came centre stage in the aftermath of the quantitative easing by advanced
economy central banks when the excess liquidity in the global system found its way into
faster growing EMEs. The most high profile problems thrown up by capital flows, in excess of
a country's absorptive capacity, are erosion of monetary policy effectiveness, currency
appreciation and loss of competitiveness. Speculative capital flows could also lead to asset
and commodity bubbles potentially threatening both financial and economic stability.
In the G 20 debate on capital flows, popularly but mistakenly referred to as "currency wars",
EMEs agitated mainly two points. First, that in as much as lumpy and volatile capital flows
are a spillover from the quantitative easing of advanced economies, the burden of
adjustment has to be shared. Second, that capital controls should be understood as
legitimate and acceptable defence against speculative capital flows.
Global imbalances and their correction were the main concern in the G20 Framework and
Mutual Assessment Process (MAP) exercise. The MAP exercise is aimed at making
countries commit to external sector policies that lead to strong, sustained and balanced
growth at the global level. The understanding is that global imbalances, especially
imbalances built on the strength of undervalued exchange rates accompanied by a build-up
of reserves, threaten the stability of the global economy due to the possibility of disorderly
unwinding.
China's exchange rate policies were at the centre of the debate in the G 20. As on date,
China's current account surplus (in relation to its GDP) has declined from the pre-crisis peak,
and China's real effective exchange rate has also appreciated since 2005, even though it is
widely believed that it needs to appreciate further. In the meanwhile, however, the cumulative
surpluses of oil producing countries (mostly OPEC, Russia and Norway) have increased and
now account for the lion's share of global current account surpluses. While global imbalances
have declined in the post-crisis period, their nature and composition continue to evolve. It is
important that the MAP exercise in the G 20 keeps a watch on changes in the composition,
nature and distribution of global imbalances and their implications, and to steer the work
towards their underlying causes.
Now let me comment briefly on the India perspective on the global imbalance problem. India
did not contribute to the generation or transmission of global imbalances. As much as we
want to enhance our export competitiveness, we believe that it should come from improved
productivity rather than an artificially calibrated exchange rate. Our exchange rate is largely
market driven, and we intervene in the forex market only to manage volatility in the rate and
to prevent macroeconomic disruptions. As a developing economy, we run a large current
account deficit (CAD) that has in recent period expanded relative to our historical record. We
need capital flows to finance the CAD. We have an express preference for equity flows over
debt flows, for direct investment over portfolio investment and for long term over short term
flows and. We are moving gradually towards opening our capital account along a roadmap,
the roadmap itself being recalibrated to the evolving global situation. Our policy, in short, is
festina lente which is Latin for "make haste slowly".
India co-chairs, along with Canada, the G 20 Framework "MAP" Working Group (FWG). This
provides India an opportunity not only to get an early preview of the macro and micro
consequences of global initiatives, but also to actively contribute to such initiatives. India's
suggestions on the role infrastructure investment can play in the global recovery and
rebalancing is a case in point. As a co-chair, it may be important to ensure that the work of
the FWG is not seen as merely a technical exercise but as an effort towards a genuine
dialogue on macroeconomic policies of the 20 most significant economies and for engaging
in a cooperative game that results in greater policy coordination which is a public good.
Global reserve currency
The global crisis has revived the familiar concerns about the robustness of the international
monetary system, and in particular about the global reserve currency and the provision of
liquidity in times of stress. The system we now have is that the US dollar is the world's
reserve currency by virtue of the dominant size of the US economy, its share in global trade
and the preponderant use of dollar in foreign trade and foreign exchange transactions. And
as Barry Eichengreen told us in his book on the story of the dollar,3 the reserve currency
status depends also on a host of intangible factors such as strategic and military
relationships, laws, institutions and incumbency which he referred to as "network
externalities".
In line with the Triffin paradox, the US has met the obligation of an issuer of reserve currency
by running fiscal and external deficits while enjoying the "exorbitant privilege" of not having to
make the necessary adjustment to bridge the deficits. With no pressure to reduce the deficit,
a dominant economy can potentially create imbalances at the global level as indeed
happened in the build up to the crisis. An argument can be made that even in the context of a
single reserve currency, global imbalances are not inevitable. The US could not have run
persistent deficits had not the EMEs provided the demand side impetus by accumulating
reserve assets either for trade advantage or as a measure of self-insurance against external
shocks.
The problem with the world having only a single reserve currency came to the fore during the
crisis as many countries faced dollar liquidity problems as a consequence of swift
deleveraging by foreign creditors and foreign investors. Paradoxically, even as the US
economy was in a downturn, and its central bank resorted to extraordinary quantitative
easing, the dollar strengthened as a result of flight to safety.
Based on the experience of the crisis, several reform proposals have been put forward to
address the problems arising from a single reserve currency. One is to have a menu of
alternative reserve currencies. But this cannot happen by fiat. To be a serious contender as
an alternative, a currency has to fulfill some exacting criteria. It has to be fully convertible and
its exchange rate should be determined by market fundamentals; it should acquire a
significant share in world trade; the currency issuing country should have liquid, open and
large financial markets and also the policy credibility to inspire the confidence of potential
investors. In short, the "exorbitant privilege" of a reserve currency comes with an "exorbitant
responsibility".
A second solution to the single reserve currency issue is to develop the SDR as a reserve
currency. This does not seem to be a feasible option. For the SDR to be an effective reserve
currency, it has to fulfil several conditions: the SDR has to be accepted as a liability of the
IMF, it has to be automatically acceptable as a medium of payment in cross-border
transactions; it should be freely tradeable and its price has to be determined by forces of
demand and supply.
Another option, a third possible solution, is to expand the SDR basket by including the
currencies of countries that are increasingly important economically and politically. With the
increasing economic weight of emerging markets, it seems inconceivable that emerging
markets will not want to see their currencies play a greater role in international transactions.
Recent initiatives by some EMEs, especially China and Russia, aim at facilitating
international use of their currencies. The exclusion of emerging markets currencies makes
emerging markets bystanders of the system rather than stakeholders. Integration of
emerging markets into the international monetary system could increase their incentives to
gear their policy conduct towards contributing to the stability of the system. However, the
pros and cons of this alternative have yet to be fully studied. In particular, we have to reckon
with the question of whether emerging market currencies, not being fully convertible, can
meet the demanding criteria required for inclusion in the SDR.
The fourth option is not actually an alternative, but is in part a solution. It aims at reducing the
need for self-insurance and thereby the dependence on a reserve currency by supporting a
multilateral option of a prearranged line of credit that can be easily and quickly accessed.
The IMF has designed some line of credit specifically with this objective in view.
None of the above solutions fully addresses the problems arising from a single global reserve
currency. What this underscores is that at the global level we need to explore these and
other options for protecting ourselves from the vulnerabilities that we confront as a
consequence of a single reserve currency.
India's own position on the global reserve currency is that the world will be better served by
increasing the number of reserve currencies, but this has to happen in an organic way, not
by fiat. Meanwhile countries need safety-nets to protect themselves against the
vulnerabilities of the global currency system. Also, the US has the responsibility of ensuring
that every country has access to dollar liquidity, especially in times of stress.
According to this view, countries cannot be asked to desist from building up reserves and
depend entirely on external safety-nets. Foreign exchange reserves should invariably form
the first line of defence. On top of that, they need currency swap arrangements. In fact, the
US obligation, by virtue of its status as the issuer of the global reserve currency, to provide
dollar swap facilities to all large economies, including India, is one of the issues that we
discussed in the Ministerial Level Indo-US Dialogue last month.
Protectionism
In the post-crisis world, there may not actually be "deglobalization" but the earlier orthodoxy
that globalization is an unmixed blessing is being increasingly challenged. The rationale
behind globalization was, and hopefully is, that even as advanced countries may see some
low end jobs being outsourced, they will still benefit from globalization because for every low
end job gone, another high end job - that is more skill intensive, more productive - will be
created. If this does not happen rapidly enough or visibly enough, protectionist pressures will
arise, and rapidly become vociferous and politically compelling.
Recent international developments mark an "ironic reversal" in the fears about globalization.
Previously, it was the EMEs which feared that integration into the world economy would lead
to welfare loss at home. Those fears have now given way to apprehensions in advanced
economies that globalization means losing jobs to cheap labour abroad.
Following the global financial crisis, the G 20 leaders were determined not to repeat the
mistakes of the 1930s when the brunt of protectionism exacerbated the Great Depression.
However, there is concern in some quarters that even as open protectionism has been
resisted relatively well during the current crisis, opaque protectionism has been on the rise.
Opaque protectionism takes the form of resorting to measures such as anti-dumping actions,
safeguards, preferential treatment of domestic firms in bailout packages and discriminatory
procurement practices. To strengthen multilateral trade discipline, the need for a quick
conclusion of the Doha Round can hardly be overemphasized. In a world with growing
worries about the debt creating stimulus packages, a Doha Round agreement should be
welcomed as a non-debt creating stimulus to the global economy.
India opposes protectionism in all its forms. However, at the same time, we have to respect
the WTO-consistent policy space available to the developing countries to pursue their
legitimate objectives of growth, development and stability. We are encouraged by the
analysis of the recent trade monitoring report jointly released by WTO, OECD and UNCTAD
on G 20 economies which shows that majority of the trade measures taken by India in the
review period were either trade facilitative or roll back measures.
IMF quota and governance
The global economic and financial crisis of 2008 exposed critical weaknesses in the structure
of the International Financial Architecture as well as in its governance. The G 20 has been
trying to address these governance and structural weaknesses while at the same time
endeavouring to stabilize the global economy through a process of mutual consultations and
policy co-operation. An important motivation for these reforms is that the global economy has
undergone fundamental changes in the past decade and a half and these changes have not
been reflected appropriately in the International Financial Architecture.
While agreement has been reached in the G 20 for effecting major reforms, implementation
has so far has been disappointing. The agreement for IMF quota and governance reforms in
2010 has not yet been implemented. India's major concern is that we should adhere to the
timeline for completing the IMF Quota reforms by January 2013, so that it serves as the basis
for the 15th General Review of Quotas to be completed no later than January 2014.
There has been some criticism that IMF quota and governance issues should be settled
within the IMF management and not at the G 20. The dominant view though has been that
the G 20 should continue to be the main forum for overall guidance not only on the direction
that the comprehensive review of the formula should take but on continued reform of the
International Financial Architecture, as it may be difficult to reform this from the inside in view
of its flawed and outmoded shareholding structure. The G 20 has played a crucial role in
steering discussions on the quota formula in the past and it will be unfortunate if this aspect
is diluted going forward.
Global institutions can only be legitimate and credible if their vote share and governance
structure reflect members' share in the world economy. It is in this context that India and
other emerging countries believe that GDP should have predominant weight in the quota
formula as it is the most robust measure of relative economic weights in the global economy.
Financial sector reforms
Received wisdom today is that financial deregulation shares the honours with global
imbalances as being one of the twin villains of the crisis. Not surprisingly therefore, reforms
to the financial sector regulation have been on top of the G 20 agenda.
The broad contours of the international initiatives spearhead by the G 20 on financial sector
reform rest on four broad pillars: regulation, supervision, resolution, especially in respect of
global systemically important financial institutions (or SIFIs), and assessment of the
implementation of new standards. So far, one pillar that has received substantial public
attention is regulatory reform, where there have already been some notable achievements,
including agreement on the new Basel III capital and liquidity standards.
However, the process of regulatory reforms that is proceeding across various jurisdictions
has come to pose new challenges especially as the global economy continues to be marked
by new risks. The uncertain and uneven recovery has led to calls in some quarters to dilute
or slow the financial reform initiatives. While there may be a case for some back loading of
difficult adjustments to strengthen the recovery of the financial sector, any weakness in our
resolve or commitment to reform will sow the seeds for a fresh crisis down the line. The key
task is therefore to fully implement what has been agreed in a cooperative manner.
All G 20 members have committed to the implementation of the Basel III package. However,
major jurisdictions have come out with their own regulatory standards. It is important that
there is no disharmony that could be confusing. We need to guard against the possibility of
regulatory arbitrage. If comparable standards are not implemented in all jurisdictions
simultaneously, financial activity will likely migrate to less regulated jurisdictions as well as
into shadow banking with disruptive consequences for the entire global financial system.
As we move forward in the area of regulation, the investment needs of the emerging market
and developing economies also deserve special attention. There are two important points in
this regard. First, it is important to ensure that financial intermediaries in emerging and
developing economies are not disadvantaged in the new regulatory framework, especially
since the opportunities and challenges in their systems are quite different.
Second, the more demanding regulatory standards should not lead to deleveraging by global
financial institutions out of emerging markets. It should be noted in this regard that the
financial regulatory reform has so far focused on reducing systemic risks, and rightly so, but
not much attention has been devoted to redirecting savings from investment in volatile
financial assets to financing investment in the real economy, where the impact on growth and
jobs is more tangible and direct. We need to recognize that it is income from the real sector
that must ultimately pay for the profits of the financial sector. Standards setting bodies should
design incentives in a manner that helps redirect global savings into investment in the real
economy, particularly in infrastructure, supports demand and enhances long-term potential
growth thereby fulfilling the original role of intermediating for growth and development of the
real economy.
Collaboration between financial authorities on these issues is an important, albeit a difficult
and painstaking task. Collaboration becomes difficult especially when it entails profound
structural changes in the face of volatile financial markets and anemic growth. Yet, it is
precisely these challenges that make it so vital that the regulatory response in the G 20
should be well coordinated internationally to ensure that the new regulatory framework is
effective and globally implemented and the follies of the past that led to the financial crisis
are not repeated.
Future challenges for the G 20
I have so far discussed some of the major items on the agenda of the G 20. Let me now look
ahead to the challenges that confront the G 20 on the way forward.
The first challenge is drawing a balance between short term compulsions and medium term
sustainability. A case in point is the intense debate in the advanced economies on fiscal
vs
austerity growth. Everyone is agreed that long term fiscal consolidation is critical to
macroeconomic sustainability. At the same time, everyone is also aware of the pains of fiscal
adjustment in the short-term. If fiscal profligacy is seen as consumption of future income and
shifting the burden to a future generation, fiscal austerity should be seen as the price for the
necessary correction so that burden sharing across generations is fair and optimal. If the
compulsions of short-term and long-term policies point in different directions, how can these
be harmonized, especially since the long-term is a stringing together of the short-terms? How
can G 20 commitments and the "Mutual Assessment Process" (MAP) commitments and
assessments accommodate such dynamic policy shifts?
The second challenge for the G 20 is to nudge countries' policies in mutually agreed
directions and hold sovereigns accountable for commitments given, especially since these
are not legally binding and there is no enforcement mechanism. This is particularly difficult in
vigorous democracies where the popular perception could be that national interests are
being compromised for the sake of global stability. How can national leaders build and
nurture, within their national boundaries, a constituency for the global optimal?
Seeking firm, forward looking commitments, or pointed criticism of policy frameworks of other
countries, on the lines of the European Union, or even the OECD, style of functioning, may
be difficult and divisive at this stage. A more ambitious style of global governance would
understandably take some time to take shape. At this stage the issue really is monitoring and
assessing whether the general direction of G 20 member country policies is heading in a
mutually consistent and agreed fashion over