File photo of Finance Minister Arun Jaitley (2nd from r) and U.S. Treasury Secretary Jacob L. Lew at the 5th Indo-U.S. Economic and Financial Partnership Dialogue, in New Delhi, Feb. 12. RBI Governor Raghuram Rajan (r) and U.S. Federal Reserve Vice Chairman Stanley Fischer is also seen. (Shahbaz Khan | PTI)

Raising concerns over central banks globally being pushed into “competitive monetary easing,” the Reserve Bank of India Governor Raghuram Rajan said lower interest rates and tax incentives can boost investments, but it is consumer demand that holds the key for pushing economic growth, writes Yoshita Singh.

RBI Governor Raghuram Rajan also advocated stronger and well-capitalized multilateral institutions, as also better international safety nets.

Speaking on the issue of ‘Going Bust for Growth’ at the Economic Club of New York, Rajan said: “The current non-system in international monetary policy is, in my view, a source of substantial risk, both to sustainable growth as well as to the financial sector.

“It is not an industrial country problem, nor an emerging market problem, it is a problem of collective action. We are being pushed towards competitive monetary easing and musical crises,” he said.

Speaking about the reasons for why it is so hard for the world to restore pre-Great Recession growth rates, Rajan said, “How does one offset weak household and government demand if debt write-downs are off the table?

“Ideally, the response would be to incentives investment and job creation through low interest rates and tax incentives. But if final demand from consumers is likely to be very weak for a considerable period of time because of debt overhang, the real return on new investment may collapse.”

Noting that policy rates cannot be reduced significantly below zero, though a number of European countries are testing these limits, Rajan said equilibrium long term interest rates may stay higher than levels necessary to incentivize investments.

“Hence, central banks have embarked on unconventional monetary policy (UMP), which would directly lower long rates.

“Another way to stimulate demand is for governments that still have the ability to borrow to increase spending. Since this will increase already-high levels of government debt, proponents suggest investing in infrastructure, which may have high returns today when construction costs and interest rates are low.

“However, high-return infrastructure investment is harder to identify and implement in developed countries where most obvious investments have already been made — political influence is as likely to create bridges to nowhere or unviable high speed train networks as needed infrastructure.

“Also, while everyone can see the need for repair and renovation of existing infrastructure, this requires far more decentralized spending than mega projects, and may be harder to initiate and finance from the center.”

Rajan said he fears “that in a world with weak aggregate demand, we may be engaged in a risky competition for a greater share of it.

“We are thereby also creating financial sector risks for when unconventional policies.”

He further said that the world needs “stronger well-capitalized multilateral institutions with widespread legitimacy, some of which can provide patient capital and others that can monitor new rules of the game.

“We also need better international safety nets. And each one of us has to work hard in our own countries to develop a consensus for free trade, open markets, and responsible global citizenry.

“If we can achieve all this even as recent economic events make us more parochial and inward-looking, we will truly have set the stage for the strong sustainable growth we all desperately need.”

The RBI Governor, who has earlier served as Chief Economist at the IMF, said that emerging economies have to work to reduce vulnerabilities in their economies, to get to the point where, like Australia or Canada, they can allow exchange rate flexibility.

“Even while resisting the temptation of absorbing flows, emerging markets will look to safety nets. So another way to prevent a repeat of substantial emerging market reserve accumulation, this time for precautionary rather than competitive purposes, is to build stronger international safety nets.”

Rajan said that a big factor persuading authorities in industrial countries to push for higher growth is the fear of deflation. He gave the example of Japan, saying “the key mistake it made was to slip into deflation, which has persisted and held back growth.”

He further said that deflation increases the real burden of existing debt, thus exacerbating debt overhang, while admitting that “the specter of deflation haunts central bankers.”

“When coupled with the other political concerns raised by slow and unequal growth… it is no wonder that the authorities in developed countries do not want to settle for low growth, even if that is indeed their economy’s potential,” he said.

Rajan said that emerging markets have a clear need for infrastructure investment, as well as growing populations that can be a source of final demand.

“Why cannot industrial countries export to emerging markets as a way to bolster growth? After all, they have done so in the past. Emerging markets have no less of an imperative for growth than industrial countries.

“Ideally, emerging markets would invest for the future, funded by the rich world, thus bolstering aggregate world demand,” he said.

Later taking questions from the organizers, Rajan said the Narendra Modi government had come with tremendous expectations and “I think the kind of expectations were probably unrealistic for any government.”

He said Modi had the image of a “Ronald Regan coming on a white horse” to slay the unfavorable market forces. Such expectations were “probably not appropriate,” he added.

He, however, said that the government has taken steps to create the environment for investment, including labor reforms.

On taxes, he said the government has announced that it will not do retrospective taxation again.

“The Government is sensitive to the concerns of the investors,” he said, adding that going forward corporate taxes will come down one per cent every year.

The other areas where the government has taken “serious and significant” measures include doing away with petrol and diesel subsidies.

“Going forward subsidies will be transferred directly into bank accounts,” he said.

On the GST, Rajan said he had hoped for the passage of the bill in the just-concluded session of the Parliament.

“But my sense is that there is enough momentum that it will be done well in time and roll out by March 31 or April 1 next year. In fact (the government) is going ahead with the apparatus to ensure that it is actually done,” he added.

On inflation, he said, “It has come down tremendously in India.”

Rajan also argued that for better global coordination on monetary policy, central bankers in developed economies should keep in mind their international responsibilities.

“The current non-system in international monetary policy is, in my view, a source of substantial risk, both to sustainable growth as well as to the financial sector,” he said.

“I fear that in a world with weak aggregate demand, we may be engaged in a risky competition for a greater share of it,” he added. “We are thereby also creating financial sector risks for when unconventional policies end.”