Euro Zone Crisis Could Extend to Emerging Markets Like India

A report released by the International Monetary Fund (IMF) on the Regional Economic Outlook for Asia and the Pacific notes that stronger economic and policy fundamentals have helped buffer the region’s economies against the global financial crisis, by limiting adverse financial market spill-overs and improving the impact of deleveraging by European banks. 

Gateway House’s Hari Seshasayee interviews Anoop Singh, Director of Asia and Pacific at the IMF, to discuss the way forward for Asia and the lack of reform in India.

Q: Two weeks ago, Standard & Poor’s cited lack of reform as one of the reasons for their lowering India’s investment outlook from stable to negative. What can India and institutions like the IMF do to ensure that New Delhi enacts long-term reforms?

A: If the business community feels that a country is not carrying out the reforms needed for growth, investment tends to fall. This is what we’ve seen in India in the last six months — a fall in corporate investment. Investors want to be convinced that governments can enact reforms which will yield long-term returns.

With regard to the reforms that India needs, much of it is already laid out in the 12th Plan Approach Paper. These reforms are suited for long-term growth. But they will take time to be put into effect because laws must also be changed to enforce these reforms. The challenge for government is to work out what must be done until these laws change. If India intends to return to a rate of growth of around 9%, these reforms are essential as recognized in the 12th Plan documents.

Beyond this, it is significant to note that countries in Asia have begun to build their corporate bond markets. This is required for financing longer-term investments, because bank credit is typically short-term. What these sectors need is longer-term capital.

Q: There was a certain emphasis on China in the IMF’s new report on Asia, but the region follows a different trajectory than China. There is a large need for capital in the rest of Asia. Could measures like the intra-BRICS trade in local currencies and the multi-lateral letter of credit be the way forward for Asia?

A: If you look at Asia in the next 10-15 years (even if you exclude China) you’ll find that Asian countries – and also the other BRICS countries – will grow much faster than the advanced economies. Therefore, you can expect capital to continue to flow into Asia and other emerging markets.

The way forward is two-fold. One is to direct capital inflows to the right areas. A framework must be built to attract capital into areas like energy, infrastructure and FDI, and not into short-term speculative capital. That needs to change.

Secondly, many countries in Asia have a lot of domestic savings, but the financial sector in Asia has been unable to keep those savings in the region. Countries with excessive savings tend to send their surpluses to advanced economies; these surpluses come back as capital flows. If we in Asia build up our financial sectors to ensure savings remain in the region, it would reduce volatility in capital flows.

In the short run, this volatility may be a problem, but in the long-term, it need not affect growth. And the signs are already here: in the first quarter of this year, money has come back.

Q: The on-going financial crises in Europe and the U.S. have already resulted in slowing growth in many emerging economies. In this context, how sensitive is India to the crisis?

A: India is clearly exposed to the crisis. Of late, the country has become more financially integrated – on trade, services, capital, and financial markets – with Asia and the global economy. Although this may increase the risk India faces in the event of a global crisis, India is not nearly as exposed to the crisis as many of its Asian counterparts. This is primarily because its economy is more driven domestically rather than by exports. This helps create a buffer to regional or global shocks.

What must also be noted is that in the past five years, the Indian corporate sector has begun to rely on financing from foreign institutions. As much as one-quarter of the financing needs of the corporate sector in India is met by foreign capital. If there were to be a renewed phase of increased de-leveraging due to the crises in Europe, India could be affected.

Q: And how do you see the results of the recent elections in France and Greece impacting India?

A: It is too early to tell now. According to our projection for this year, the euro zone area will go through a recession. It will contract by roughly 0.3%. There is a strong commitment to address public debt in Europe, but a balance is required: along with fiscal measures to re-structure the economy, these should be balanced with rebuilding competitiveness and ushering in growth.