India's position on the current international financial and economic crisis

The global crisis requires global solutions. It is imperative to bring about basic reform of the financial sector to reduce the likelihood of similar crises in future and to build institutions that can intervene more effectively if such crises do occur. It is essential for the world to act cooperatively in a manner commensurate with the scale of the crisis. While dealing with the immediate problems, it is necessary not to sacrifice the gains of openness of trade, direct investment and immigration.

There is no doubt that restoration of the banking system in the industrialized countries to full functionality is necessary for successful revival of the global economy. This is primarily a task for the governments of the individual countries concerned. It is a task that will require commitment of resources on an unprecedented scale. The International Monetary Fund (IMF) has estimated that the write down of toxic assets needed may be as high as USD 2.8 trillion in US and USD 1.4 trillion in Europe and Japan. Many governments, most recently the United States have made large commitments of resources to deal with the problem of tainted assets and also recapitalize the banking system. It is possible that more may be required to be done.

A rescue effort on this scale will place a huge burden on tax payers. This has given rise to considerable public anger which is entirely understandable. However, it needs to be explained to all concerned that anger at the irresponsible and even morally reprehensible behaviour on the part of managements of financial institutions should not come in the way of efforts to resurrect the system.

This is ultimately a political problem that has to be handled by each national government. It is necessary to avoid a repeat of the Great Depression of the 1930s. Governments today know a great deal more about the reasons for the Great Depression and are also willing to act. It is necessary for credit and funds to flow where it is required. It needs to be explained to the people that reviving the banks is important not for the banks but for the economy, for employment and for global prosperity in general.

The world has seen a massive contraction in consumer demand in industrialized countries arising from the decline in prices of housing and stock market values. This is compounded by uncertainty about future employment prospects. The emergence of excess capacity in several sectors is bound to discourage private investment.

Most industrialized countries as also developing countries have responded by using monetary policy fairly aggressively to counter the downturn. They have also resorted to a fiscal stimulus to varying degrees. It needs to be recognized that expansionary policies are most effective when they are coordinated.

IMF has estimated that a discretionary fiscal stimulus of about 2% of GDP in 2009 would be required in addition to the operation of automatic stabilizers. This needs to be followed by a similar stimulus in 2010.

Several steps need to be taken to ensure the revival of growth in developing countries. These countries have suffered a double shock. They have seen a collapse in world trade, with an unprecedented decline of almost 9% in trade volume in 2009. They have also suffered a massive decline of private capital inflows estimated at around USD 700 billion in 2009 with little prospect of a significant revival in 2010.

India has been fortunate in having dealt with the global downturn better than many other countries. Our growth rate which was close to 9% in the previous five years will be around 7% in 2008-09. We hope to achieve a similar growth rate in 2009-10. Effective regulation of the baking sector has gained us much more than any additional strain imposed by temporary fiscal expansion.

Expansionary policy at home in an environment where exports are weak and private capital flows have dried up would normally lead to pressure on the balance of payments. In our case, this has been partly offset by the fall in oil prices. Even so, India's current account deficit in 2009-10 is likely to be about 1.4% of the GDP. We expect to be able to finance this without difficulty. In any case, our strong foreign exchange reserves position of USD 250 billion enables us to cope with any shortfall in capital flows that we may experience.

While India will be able to manage quite well, many other developing countries may not be in the same position. This is where the international community can help. It is necessary to ensure that countries hurt by the massive withdrawal of capital are able to rely upon an increased flow of resources from the international financial institutions. This will help these countries to maintain a higher level of demand than would otherwise be possible and thus help global revival.

In addition to increasing the resources with the IMF as was done at the G-20 Summit in London on 1st April, conditions associated with the use of IMF resources should be made more appropriate and flexible.

The Multilateral Development Banks can play an important role in maintaining the flow of resources to developing countries particularly over the next two years. The World Bank should expand its lending in the next two to three years in a manner which helps to fill the gap left by the withdrawal of the private capital flows.

Concrete steps also need to be taken to revive trade finance which has been adversely hit in part on account of financial protectionism. Export credit agencies need to expand their lending.

An issue of vital concern to developing countries including India is the rise of protectionist sentiment in the industrialized world. This phenomenon is not surprising given the downturn in economic activity and the rise in unemployment. This is a time for test of leadership. It is essential not to repeat the past mistakes. The Great Depression was as deep and prolonged as it was because countries resorted to protectionism which triggered retaliatory protectionist responses leading to a downward spiral.

The hard won gains on opening up of economies by developing countries will be destroyed if industrial country markets are not kept open in these difficult times.

It is also necessary to focus on longer term reform of the global financial system. The crisis has drawn attention to some basic flaws in the functioning of the banks and other parts of the financial system which enabled a dangerous build up of risks. It is necessary to move to stronger regulation and improved supervision if we are to prevent repeat of the crisis.

It is necessary to expand the scope of regulation to cover the non-banking sector, the need to avoid a build-up of excessive leverage and the need to subject systemically important institutions to supervision by a college of supervisors. It is also necessary to share information and bring tax havens under closer scrutiny.

It is also necessary to develop an effective early warning system which can identify a build up of risks which would threaten global financial stability. This task could be performed by the IMF.

It is necessary to enhance the representation of developing and emerging market countries in the decision making apparatus of multilateral financial institutions to bring them in tune with the current realities. This is essential if these institutions are to have the legitimacy they need to play their role in an increasingly integrated world in which actions taken in one country affect many other countries.