Speech

Remarks by Rodrigo de Rato
Managing Director of the International Monetary Fund
Reserve Bank of India
Mumbai, India, March 17, 2005

As prepared for delivery

Ladies and Gentlemen,

Let me begin by saying how pleased I am to be here in Mumbai and to be addressing such a distinguished group of leaders from banking, industry, and academia. It has been several years since I last visited India, and the change is palpable. One can of course see this change in the economic data-India is one of the most rapid growing economies in the world. But even more striking is the increased confidence of Indian business leaders and citizens. And the world has been beating a path to your door.

Before I move to the main theme of my talk today, please allow me a moment to express my heartfelt sympathy for the tragic events of December 26. The tsunami brought about overwhelming human suffering, which I observed first hand during my visit to Indonesia. At the same time, I cannot help but feel that the outpouring of support from around the world points, in its own way, to how globalization has changed our lives, and to our growing interdependence in the world. India's response to the tsunami was particularly impressive, not only moving quickly to address its own needs but also generously helping its neighbors.

Globalization is, of course, a much-discussed theme. But I believe India is the perfect venue to bring to it a new perspective. For India recently has grasped firmly the opportunities of globalization, as the international successes of so many of you in the audience can attest. At the same time, India remains a country struggling against poverty, inequality and poor living conditions for hundreds of millions of its citizens.

Is the stubbornness of these problems evidence that opening India's economy has failed to deliver on its promises? I would argue precisely the opposite. Much has already been achieved. But the opening remains incomplete. I would like to suggest today that now is a golden opportunity to complete the structural reform agenda and move India to a new, higher, growth path. At the same time, we must work to ensure that the benefits of globalization are broadly shared, both among and within countries.

One need only look at the historical experience of several of your Asian neighbors to grasp the full potential of India today. For example, with reforms and opening of their economies, Korea and Taiwan (Province of China) have been able to increase their per capita GDP from less than 5 percent of the level of the United States in the 1960s to more than ⅓ of U.S. levels in one generation.

Asia continues to be the most rapidly growing region in the world today. In fact, Asia's economic performance in 2004 was its best on record since the 1997 crisis. Growth in Emerging Asia—including India—rose to 8 percent, on the back of vigorous exports and brisk domestic demand. At the same time, inflation was held in check, despite much higher world oil prices. And, in recent months, the region has once again been deluged by capital inflows. While this no doubt reflects in part the weakness of the dollar, it is even more a reflection of investor confidence in the region.

This year looks set to be another good one, with growth in Emerging Asia likely to slow only moderately, to about 7 percent. Export growth may decelerate as the electronics boom subsides, but growth will continue to be powered by strong domestic demand. There are risks, of course: oil prices could move higher, the Chinese economy could slow more than anticipated, and global imbalances could result in a disorderly weakening of the dollar or a sharper-than-expected rise in interest rates. However, years of economic reform have left most Asian economies well placed to deal with such shocks.

Let me turn now from Asia to India specifically. India has increasingly opened its economy to the world over the last decade and a half, with dramatic results. Growth has been robust, even in the face of shocks, including the Asian crisis of the late-1990s, and recent sharp increases in energy price. Indian firms are increasingly competitive in international markets. And poverty has improved dramatically. One estimate indicates that the poverty rate fell from 41 percent in 1992-93 to less than 29 percent in 2000. The reform process has made steady progress, despite changes in political leadership. Looking ahead, it appears that the broad path of reform—if not the pace or details—is firmly established. And success begets success. India is now more than ever a focus for international investors, who are eager to take part in a new India.

The ability of India to compete on the global stage is amply illustrated by the boom in information technology. The exports of the Indian IT sector are expected to have grown by a remarkable 32 percent during 2004/05, following on similar growth last year. And while a rising home-grown demand is playing some role in the IT sector's growth, the story is overwhelmingly one of India competing-and winning-in the globalized economy. With Indian firms exporting services ranging from call centers to medical diagnostics to tutoring of American high school students, India's position of world leadership in IT is well known. A few years ago, when the IMF decided to overhaul its financial systems, we searched the world for the best firm to do the job. In the end, we settled on an Indian firm, a state of the art company that provided good value as well. Moreover, the IT success story is largely one of private sector initiative. Indeed, the government deserves credit for stepping back and focusing on providing an enabling environment for private initiative.

Information technology is far from the entire story. A few examples: India is projected to have the second fastest growing tourism sector of any country in the world over the next 10 years. Steel production in India is now among the lowest-cost in the world. Pharmaceutical and biotech firms are likewise very competitive internationally. And Indian firms are increasingly carrying out their own R&D. Last year alone, Indian pharmaceutical companies filed about 200 patents.

These successes are a reflection of a broader ongoing transformation of the Indian economy. In fact, India appears to be in the first stages of the sort of "take off" that several other Asian countries have experienced over recent decades, one which can raise its trend growth rate from 6 to 8 percent, or even beyond, for several decades to come. And the difference here is huge—at 6 percent annual growth, average incomes will double in 16 years, while at 8 percent it would take just 11 years. The impact of such a development on the living standards of the average Indian would be dramatic.

Such success is within India's grasp, but it is not assured. I believe that bold steps now are needed for India to take full advantage of this moment of opportunity. Your distinguished Prime Minister said it best in a recent speech: "We must think big and bold. We must move away from the paradigm of incremental growth to a paradigm of exponential growth and growth into uncharted territory." He stressed that success stories from both the public and private sectors should be replicated so that more and more Indian firms can "go global." So, what is needed to ensure that India reaches its full-and immense-potential?

First, you will not be surprised to hear me emphasize the need to put India's public finances on solid footing. The government's ability to finance large deficits domestically with apparent ease may have reduced the sense of urgency to make the difficult choices necessary to turn the fiscal situation around. But large deficits have had a major, if almost silent, cost.

First, reducing the borrowing needs of government would help free resources for private investment, which remains low by regional standards.

Second, public investment is also low compared with much of Asia. Interest payments, wages and subsidies take up nearly half of all central government spending leaving little room for much needed public investment and basic social services. India's large infrastructure gap acts as an important constraint on growth. I do not need to tell you, for example, how electricity shortages or delays at ports affect India's competitiveness. Fiscal reforms can, by creating space for high priority spending, have a major impact on economic growth.

Third, lower fiscal deficits will improve financial intermediation. India's banks currently hold about ⅓of their assets in the form of government securities, compared with 8 percent in Singapore and 15 percent in Thailand. This has contributed to a banking system that, until recently, seemed largely disinterested in financing private sector activity.

In keeping with the Prime Ministers theme of bold reforms, I would like to suggest that a reduction in the government's claim on resources must go hand-in-hand with a different way of thinking about the role of government. If this century is to be the Indian century, it will be driven in large part by the private sector, and the government must focus on creating the conditions to allow productive activity to flourish and give all Indians the tools needed to take part. This change is already underway in India. The government is pulling back from making or influencing decisions of what and how to produce, and from seeking to subsidize a wide range of people and activities. Instead, it is looking toward an economy where policy frameworks are credible, infrastructure and basic human services are adequate, and social safety nets protect those individuals who need a helping hand.

Let me now address directly India's integration with the globalized economy. With the debate about India's emergence as a global leader in service exports dominating the news, it may sometimes be overlooked that India remains a relatively closed economy. While exports have been growing robustly in recent years, India still accounts for less than 1 percent of total global exports. Average trade tariffs in India are now at about 22 percent. There are plans to bring these down to ASEAN levels, around 8 percent on average, by 2009. And the new budget makes a good start here. However, more dramatic action could have significant benefits. Quicker cuts in tariffs, combined with a lowering of nontariff barriers and improvements in the business climate, would allow Indian business to achieve scale economies and to fully take part in international production chains. India's comfortable external position—with reserves increasing steadily in recent years—presents a perfect opportunity to speed this reform.

Much of India's recent export growth has been fueled by trade with Asia, in particular China, where India has more than doubled its market share. But the process is just beginning. In particular, despite geographical proximity and cultural affinity, South Asian countries, including Pakistan, barely trade with one another. I welcome India's recent move to establish the Framework Treaty on creating the South Asian Free Trade Area (SAFTA). Such steps, if done right-in particular if accompanied by more general trade liberalization-can promote regional cooperation and serve as a stepping stone for further multilateral trade liberalization. Indeed, it is critical that India maintain its role as a leader for the developing world in WTO talks, seeking to ensure that trade liberalization benefits all.

Finally, India needs to continue to restructure its domestic economy, to allow it to reap the full benefits of globalization. India's young population augurs well for its future, but also poses challenges. It is sobering to think that India needs to generate in excess of 100 million jobs in the next decade simply to keep the unemployment rate from rising. To a large extent, it is manufacturing that will need to take the lead in job generation and, here, India is an outlier. The share of industry in GDP, at 27 percent is low by Asian standards. It is critical, therefore, that India create the conditions for increased investment. In this regard, I was delighted to learn that your Finance Minister, Mr. Chidambaram declared, upon taking office, that he wanted to become known as the Investment Minister.

Here, again, openness to the global economy can help. India lags well behind much of Asia in attracting foreign direct investment. In 2003, the stock of FDI to India totaled just 5 percent of GDP, compared to 31 percent for Thailand, and 35 percent for China. Yet the most striking thing is that, at the same time, surveys consistently point to India as being one of the top two or three destinations for FDI in the coming years. So, the opportunity is there for the taking. India has already gone a good distance toward liberalizing its FDI regime. What is perhaps even more important now is to make India an easier place to do business. While progress has clearly been made here too, a few sample statistics serve to define the problem. To start a business in Korea takes 22 days and in China 41. But in India it takes 89 days. And enforcing a contract takes 425 days in this country, more than five times longer than Korea and nearly double that in China.

Foreign investment is, of course, only part of the story. India has a huge and talented pool of entrepreneurs who are ready to invest, produce, and hire workers. The Prime Minister recently quoted Keynes, observing that "investment is an act of faith." Government needs to encourage such faith by rewarding creativity, risk taking, and the spirit of enterprise.

The recent lifting of remaining ATC quotas on textiles and clothing provides an excellent example of both the opportunities and challenges facing India. India has a centuries old tradition of producing textile admired throughout the world. And Indian exports were significantly constrained by quotas before 2005, pointing to the potential for large gains now with their elimination. Some projections point to a quadrupling of its market share of clothing in the United States in the coming decade, with important gains in employment as well. But the extent of these gains will depend critically on the ability to move ahead on structural reforms, including lowering trade barriers, liberalizing labor laws, and reducing the regulatory burden on business. Without key changes in these areas, India may be left without the flexibility to compete in an increasingly competitive industry.

I have talked at some length today about the trend toward increasing global integration and how the India can continue to gain from it. But I am here, of course, in my role as Managing Director of the IMF, an institution that has been focused in recent year on ensuring that globalization can truly benefit all its members. So, what role does the IMF actually play? Let me mention just a few points here.

First, the IMF is increasingly focused on crisis prevention. While globalization is providing tremendous benefits, greater interdependence has also increased the potential for financial crises and spillovers. When the IMF was founded in 1945, it was intended to serve, in part, as a forum for multilateral economic cooperation, in recognition of the fact that one country's policies affects other countries. This role has, if anything, grown more important.

The IMF has taken a number of steps to strengthen our dialogue with member countries seeking to improve their economic policies and prevent financial crises. We are paying more attention to the identification of vulnerabilities and the importance of adequate shock absorbers in economic policy. And, learning from our experience in Asia and elsewhere, we have strengthened our focus on the financial sector. India is one of the approximately 80 countries to have received "check ups" of the health of their financial system under the IMF's financial sector assessment program. We are also giving increased emphasis to surveillance at the regional and global levels, concentrating on the global impact that economic policies in key countries can have on the rest of the world.

We are seeking to make our policy advice more transparent and therefore more relevant to the ongoing policy debate in our member countries. Although the IMF will continue to pay the role of confidential adviser, increasingly our members are choosing to make public the results of IMF surveillance. Recently, India joined the more than 150 countries that have published IMF staff reports on our public website.

But not matter how good our surveillance is, crises will not disappear. The IMF will continue to play an important role in mitigating their impact by providing financial assistance, and in catalyzing other sources of support for countries with balance of payments needs.

Finally, the IMF will continue to play a key role in the global effort to eradicate poverty. In the past few years, poverty-reduction strategies drawn up by low-income countries have served as the basis for the IMF's partnership with them. We continue to emphasize that macroeconomic stability is necessary for poverty reduction, but we recognize that more needs to be done, especially if the Millennium Development Goals are to be achieved in the next decade-an objective agreed by the international community.

Allow me to end by coming back to the impressive changes seen in India. Economic reform has already-in just 1½ decades-revolutionized India's relationship to the IMF. India has moved from being an IMF debtor, to being a solid and reliable creditor, assuming a position of responsibility and voice in the international financial affairs. This of course simply mirrors the broader progress of the Indian economy over the same period. It is my fervent hope—and expectation—that the next decade will see progress on an even more dramatic scale, for the benefit of the Indian people and the world economy.