In the three years since Dr Stephen Roach, inarguably one of the world’s most influential economists, moved from New York to Hong Kong as Morgan Stanley’s Asia Chairman, he logged 1.2 million air miles. “I travel more than George Clooney,” he jests, referring to the Hollywood actor’s ‘high-flying’ role in the comedy-drama Up In The Air; in fact, Roach recalls he walked out of the movie mid-way because Clooney’s ‘up in the air’ life, which mirrored his own, was “too painful for me to see.”
Later this week, Roach will return to New York, where in addition to serving as Morgan Stanley’s Non-executive Chairman, he will join the faculty of Yale University, which is setting up a new global institute to study international affairs. “It’s a great forum to express my thoughts on Asia from the US, rather than from the heart of Asia,” says Roach. In particular, he is looking to “re-educate” US policymakers about Asia. “There is a lot of misunderstanding about Asia in the US, and I want to be part of that re-education process.”
In a “farewell interview” he gave DNA Money’s Venky Vembu in Hong Kong, Roach shares his thoughts on what he does like – and doesn’t – about the Indian economy, why developed economies must chart out a roadmap for withdrawal from crisis-mode policies, and what “tough action’ China might take if it’s pushed too far by US trade sanctions. Excerpts:
You’ve often likened India to a three-legged stool, the three legs being micro, macro and politics; and you’ve spoken favourably of how it’s all coming together. But recently you appear to hold the view that policymakers in India need to frame an effective ‘exit strategy’ from crisis-mode fiscal and monetary policies. Is the economic engine humming nicely enough in India to warrant a withdrawal?
I do. Your economy grew at 8.6% year-on-year in the first calendar quarter of 2010: that’s a very strong growth rate, and inflation is on the rise. And yet you have unwound only 50 basis points of the 425 basis points of monetary easing that was put in place during the crisis. Economies like India, where there is very strong post-crisis resilience and where there is rising risk of serious inflation, need to be more aggressive in implementing a monetary policy exit strategy.
Is the failure to do that a big risk?
I’m disappointed it hasn’t happened yet. The situation in Europe has certainly caused some consternation within the RBI as to exactly when to do it. But as the situation in Europe begins to settle, the RBI needs to move. If the RBI starts moving three months or even six months from now, it won’t make much of a difference; it would be a bit later than I’d like, but it’s better they move than don’t move at all. A year from now, if we’re still looking at the same policy rates in India that we see today, that would be a source of great concern.
Is the RBI already behind the curve?
They are running the risk right now of falling behind the curve, given the strong growth in the economy, the accelerating inflation, and the low levels of policy interest rates.
Given India’s disproportionate reliance on export markets in Europe, how vulnerable is it to the debt crisis in Europe?
India’s export sector is a lot smaller than that of the typical developing Asian economy, but there’s no mistaking the sharp increase in exports as a share of GDP over the last 10 years in India; and equally, there’s no mistaking the role of Europe as India’s largest trading partner. So, a shortfall in European economic growth will definitely take a toll on Indian GDP – less so than in China, with a much larger export sector, but nevertheless a meaningful toll for India as well. And that’s one of the reasons why the RBI probably remains a little bit more cautious in taking interest rates back up to pre-crisis levels.
You’ve flagged the risk arising from a decline in domestic savings rates in India from 36.4% in 2008. Why is it significant?
One of the biggest pluses that India has accomplished in the last five years is to boost domestic savings from the low 20% readings of the 1990s into the high 30% readings in 2007-08. There was a fallback in 2009: I’d attribute that mainly to the widening of the government budget deficit in the aftermath of the financial crisis. But it’s very important for the government to focus on fiscal consolidation to make certain that last year’s widening of the budget deficit is not repeated in the years ahead. And by doing that, the government’s offset to improve private sector saving will be reduced.
Won’t the recent windfall from the auction of 3G and broadband spectrum help the fiscal consolidation process?
The 3G auctions are certainly a positive way for the government to extract revenue from a rapidly growing Indian economy but it’s a one-off measure, not a sustainable set of options for deficit reduction. The government has to do more on the tax front and the presumed tax consolidation that’s out there will be very important in that regard.
When the Left parties were voted out of the ruling coalition in India last year, you said the third leg of the stool – politics – was coming good. But is the absence of forward movement on structural reforms disheartening?
No, the process of reform in India is just that: it’s a process; it doesn’t happen overnight. There is a great culture of give-and-take in political debate, and with the Communists no longer a part of the ruling Congress-led coalition, there is a much greater chance that the pace of reforms will accelerate in the years ahead. I like what I see in terms of the government’s focus on tax reforms, and infrastructure. There is a huge infrastructure bottleneck in India, but I’m actually more optimistic that it’s being addressed today than I’ve been in a long time.
Economic data out of the US indicates the recovery is stalling. Europe is mired in a debt swamp. China too is slowing down. Is the global economy facing a double-dip recession?
The big risks for a double dip will, if they do come, will come more from the developed world than from the developing world. China is slowing down for sure, but the growth rate is unlikely in my view to go much below 8-9%. That’s actually a welcome slowing from a pace that was too fast earlier this year.
Europe is most disconcerting right now because the European growth outlook before the sovereign debt crisis was really not a good one in any case, maybe a 2% trend over the next three years. And now, because of the sovereign debt crisis and the fiscal consolidation, you have to subtract maybe 1-1.5 percentage points off of that. It puts the European growth rate very close to zero.
The US is stronger than that, but it’s not a very strong classic cyclical recovery. The ongoing pressures on the American consumer to deleverage, to save more will restrain spending growth for several years at a pace well below that which we had in the decade or so before the crisis.
So, the global recovery is going to be weak at best, and when you have a weak recovery, you don’t have much of a cushion to offset the blows of a shock. We always have shocks, and we could have more: it’s impossible to predict shocks by definition. But when you have a weak recovery and if you have a shock, you could have a relapse or a double dip. I’d put about a 40% chance on that possibility at some point in the next year. That’s been my view since the start of this year.
In the event of a slide into a double-dip, do policymakers in the developed world have any policy weapons left in their armoury?
It’s a question I’ve worried about. We don’t really have any traditional ammunition to deal with a relapse because we’ve got policy interest rates at zero, fiscal deficits running at double digit rates as a share of GDP… Sure, you could print more money, embrace more “aggressive” (as policymakers call it) Quantitative Easing, but I’m not convinced that really works. I think we’re in a very difficult period where businesses and individuals are not responding to monetary and fiscal accommodation. So it would be exceedingly difficult to restimulate a global economy that goes back into another recession.
Commentators like Martin Wolf and Paul Krugman have argued that this isn’t the time for austerity measures. What are your thoughts on the merits and demerits of the timing of austerity measures?
I have great respect for Martin; he’s a friend of mine. I think Martin is saying – or at least I hope he’s saying – that this is not the time to push policy interest rates up. But where I would disagree with him – and where I would disagree with Paul Krugman – is that while this may not be the time to push interest rates back up or reduce deficits, this is the time to begin talking about the exit strategy. How are you going to do it when you do it – and under what conditions would you do it… We need to have a debate about changing our policies. We need to know how we’re going to do it, and under what conditions. And if we can’t have that debate now, my fear is that we’ll never do it.
Last week we saw the first of the spend-slashing budgets – from the UK. Is that the kind of roadmap you want other developed economies to lay out in terms of a withdrawal from crisis mode?
I think we need to do three things here: First, we need to lay out goals of what we think are ‘normal’ levels of policy interest rates and deficit-to-GDP ratio. In the US, for example, let’s say the goal should be a normal Federal Funds Rate of 4% or a normal deficit-to-GDP ratio of 3%. Second, we need to lay out a forecast of how we see our respective economies growing with respect to GDP growth and inflation. So we have some understanding of what the macro outlook is likely to be over the next three to five years. And the third step is: what is the appropriate way that we would approach those goals, given that conditional forecast. This is a fairly systematic, methodical exercise. Then, as the economic conditions play out, depending on whether the world does better or worse than the conditional forecast, you can adjust your policies accordingly. But we’ve got to be transparent and very clear in setting the goals and objectives of a post-crisis normalisation.
In the absence of such a roadmap, is there a risk that bond vigilantes will be unnerved?
If we don’t have a clear understanding of how to get out of easy money, then at some point, when we begin to recover, we could certainly have a major sell-off in bond markets around the world that would reflect understandable fears and concerns about inflation. If we have a more credible view as to where policy is going to go, in a recovering economy, I think we can keep inflationary expectations relatively well anchored or well contained.
On China, even Premier Wen Jiabao has repeatedly pointed to imbalances in the economy. Given that policymakers in China have more levers in their control than policymakers elsewhere, is it fair to say that the imbalances are the result of policy errors?
No, I think the imbalances are a result of the extraordinary efforts that have been made over the last 30 years to take an economy that was on the brink of collapse, post-Cultural Revolution, to a much higher place in terms of economic development than anybody ever dreamt possible. Ten per cent growth over 30 years is unprecedented in the annals of economic development. But to achieve that, there’s been a disproportionate focus on exports and export-led fixed investments in the macro policies, whether they are currency, monetary or fiscal, foreign direct investment, tax incentives, all focussed on the export model. This is now time for China to change the approach and to move away from external demand and more towards internal demand. This is a huge challenge, but I think China’s up to the challenge. They will do it with a radically different approach to economic policy in the 12th Five Year Plan to be enacted in early 2011.
What’s the biggest macroeconomic risk in China?
I think the biggest risk is that they don’t change the model along the lines of what I just said: that they cling to the old export-led model under the false hope that the global economy will rebound sharply in the aftermath of this crisis. I do not think the global economy will rebound, but inertia is a very powerful force in shaping development strategies – whether it’s China or India.
In recent months, there’s been a lot of commentary on bank lendings to local government investment vehicles, which are at risk of turning bad. In your estimation, how bad is it, and could it contribute to a banking crisis?
There’s no question that there were some bad loans made by local investment companies who were funded by some of the larger national banks in China. The Chinese banking regulators are examining the books of these local loans on a case-by-case basis. I think there will be some provisioning announced in the second half of this year as Chinese banks write down their bad loans. I don’t think it’s anywhere near serious as the bad loan problems that were prevalent in the early 1990s, and while there are certainly some excesses in the high-end property market in major coastal cities in China, the more broad-based property construction sector is in much better shape underpinned by massive rates of rural-urban migration, running between 15 million and 20 million people a year. The fears of a major banking crisis that will cripple China are overblown.
Are even the ‘property bubble’ fears overblown?
The ‘property bubble’ is narrow, not broad. It is concentrated largely in high-end and luxury property in major coastal cities. The bulk of the property investment has gone towards affordable housing for low-end income individuals and for newly migrated rural families moving to China’s new urban cities.
We recently saw a policy move on the Chinese currency, the renminbi, but not much appreciation. You’ve argued that blaming China won’t solve America’s problem and that a yuan appreciation won’t end global trade imbalances. But given the realpolitik situation in Washington, has the risk of trade tensions increased since last weekend?
I don’t think it’s increased, but I don’t think it has declined a lot. I think it’s a very real risk that the US Congress will move ahead at some point between now and the November mid-term elections with broad bipartisan support for an anti-China trade sanctions bill. And if that were to occur and then be signed into law by President Barack Obama, I think the Chinese would retaliate with tough measures of their own. And that’s a very dangerous and worrisome outcome for the global economy.
What ‘tough measures’ would the Chinese take?
I think they’d do three things in response to trade sanctions imposed by the US: one, file a WTO complaint; two, impose reciprocal sanctions on US exports to China – and China is now America’s third largest export market. Third, if the US were to retaliate to China’s retaliation, I think the Chinese would begin to pull back their purchases of US Treasuries with ominous consequences for the dollar and long-term real interest rates in the US.
In your book, you’ve spoken of ‘The Next Asia’, which would be dependent less on exports for growth, and more on domestic consumption. Do the prospects for ‘The Next Asia’ appear nearer or farther today?
I think they are nearer because (Asia) is a practical region that has been hit with a massive external demand shock for no fault of its own, and as I was writing the book, the crisis was unfolding before my very eyes. And to the extent that you believe this crisis is going to have a lasting impact on end-market consumer demand in the US and Europe, there’s better reason to expect ‘The Next Asia’ today than when I wrote that book. If Asia wants to keep growing, absorb surplus labour, avoid unemployment, it has no choice but to redirect itself to an internal demand model is the core thesis of ‘The Next Asia’.
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Why China needs to change: Interview with Arthur Kroeber
‘China’s nuclear bomb is a dud’: Interview with Michael Pettis