Domestic demand has been robust in India: Nouriel Roubini

Don’t socialise private loss on a scale that would break the government’s back, that is one clear lesson from Ireland’s experience for Dr Nouriel Roubini, professor of economics at New York University.

ET caught up with Dr Doom, who is in India to deliver the Lala Lakshmipati Singhania Centennial Lecture, hosted by JK group president Hari Shankar Singhania. Global finance has to be regulated globally, not nationally, and that means through coordination of national regulation.

Controls on short-term capital flow are fine, but these will only jack up long-term flows and limit the overall efficacy of capital controls in preventing currency appreciation, Dr Roubini told ET. Excerpts:

People call you Dr Doom. Why?

I don’t think I am Dr Doom. I prefer to be called Dr Realist . You should not be an optimist or pessimist but do a reasonable and realistic assessment of both upside and downside risks.

We are in a very complex global economy . There are some parts of the world that are doing very well including India and Asia. Advanced economies are currently weaker. So, we have to be sensible, objective and realistic about it.

How do you assess the EU response to the crisis in Ireland? Is the bailout enough to tide over the crisis?

Well, my fear has been that unfortunately in the case of the eurozone and a number of insolvent or nearly insolvent countries in it, their problems may just not be of liquidity but also the amounts of debt in the private sector and the banks.

The robust backstopping of the financial systems by the governments has made them near-insolvent . So, provision of liquidity might not be sufficient. At some point down, there might be coercive restructuring of public debt of countries like Greece and Ireland.

And unfortunately, problems are now spreading to Portugal, possibly Spain and other parts of the eurozone. There is also problem of competitiveness. And now, restoring of not only large stocks of public debt but also private liabilities owned by organisations.

Is the economy heading towards a double-dip ?

Well, in the case of Eurozone, five economies, three are still contracting, Spain, Greece and Ireland, two of them Portugal and Italy, are barely growing. So, it is not even a question of double dip they never got out of the first dip.

It is more like the shape of an L of stagnation like in the case of Japan in the longer term unless they solve their own problems. So the risk of double dip and continuation of recession is highest in the periphery of the eurozone.

Ireland got into problem because it tried to bail out its banks by taking over their debt as government debt. Now, what is the regulatory lesson from this?

There are many lessons. Like in US, UK, Ireland, Iceland , Spain, if you let the real estate bubble to get out of hand and burst, then the collateral damage, in the real economy, to the public finances is severe.

And deterioration in public finances is both driven by the need to bail out banks and also by surging deficits due to collapse of their real economic activity. In case of Ireland, one of the lessons is that, I think it was a mistake to honour unsecured claims on the banks amounting to 10% of GDP. By the sovereign guaranteeing these claims, the public debt has grown by another 10% of the GDP. In this case, sovereign was already distressed.

So, if you keep on socialising private losses and putting them on the back of the sovereign, then at some point the back of the sovereign is going to crack. And the insolvency of the sovereign is going to be damaging back into the real economy and the financial system because the sovereign will not be able to backstop the financial system.

So I would have responded by imposing a haircut on the unsecure senior creditors of the bank.

Would it be a good idea to allow a foreign bank to operate in the jurisdiction only through a subsidiary which is capitalized adequately in relation to its operations within that jurisdiction?

A gradual and progressive liberalisation of the financial system will allow the operations of foreign financial institutions in any economy, including India.

It is a good idea. Of course, you have to do it to make sure that these institutions are well supervised and regulated. That they have enough of their own capital and liquidity . And they operate on a fair basis compared to domestic financial institutions.

The problem seems to be that finance is global, but regulation is still national. Is there anyway nations can cooperate and coordinate sufficiently to ensure that regulation also becomes global?

That is necessary. The Basel 3 criteria will apply to a large range of financial institutions in a large number of countries . In some sense, even Basel 2 was a global agreement about regulation. The problem was not that it was not global enough, it was that the criteria of Basel 2 were not actually appropriate.

In practice, excess reliance on market disciplines, self regulation and internal risk management , pro-cyclical kind of capital standards. It is not just enough to have global rules, but the rules about regulation and supervision should be appropriate.

Is there a case for India to go for capital controls ?

This is one of the options that countries are increasingly considering and applying. Brazil and Korea have done so. If inflows of capital becomes excessive and this leads to excessive appreciation, one could impose controls on short term capital inflows. The evidence, however, shows that control on short term capital flows tend to affect the composition of inflows between short term and long term capital.

They don’t tend to affect very much overall volume of inflows. So, if you are concerned about hot money, it is effective. But if your concern is about inflows appreciating your currency, those controls are not affecting the overall volume of flows.

India’s GDP is growing. At the same time, government is having problems tackling inflation. How do you assess the situation?

In part, what is happening is that some of the inflationary pressures are external to the country. There is increase in global commodity prices. Oil, energy, food-... that is not directly in your control.

But it is also that domestic demand has been robust for good reasons. But, constraints are on the supply side. If demand is growing, supply has to grow as fast to maintain price stability. There are bottlenecks on the productive side of the economy because of lack of infrastructure.

Invest in a various range of economic reforms to sustain an increase in potential growth. Make sure that as potential growth becomes higher, actual economic growth becomes higher and then inflationary pressures get contained. If actual growth becomes higher than potential, then one of the consequences will be rising inflation.

How do you assess the G20 process for efficacy?

I believe, on one side, it is necessary because the global economic and financial problems require a systemically important emerging market economies to be on the table.

You cannot resolve problems of global imbalance , energy security, financial stability and climate change without having countries like India and China and many other emerging markets on board.

In that sense, G7 was obsolete. But in other sense, it is much difficult to reach an agreement with 20 countries on the table and therefore, agreements were only in the time of crisis. But now there is wide divergence of views on a wide spectrum of issues.