Macro Economy

Breach Deficit Rules Only In Cases Of Extreme Shocks, Says IMF’s Gokarn

Praveen Chakravarty
December 22, 2017

<p>Subir Gokarn, then deputy governor of the Reserve Bank of India, speaks during an interview in Mumbai, India. (Photographer: Kuni Takahashi/Bloomberg)</p>

Fiscal rules should be adhered to except in situations of extreme exogenous shocks to lend sanctity, says Subir Gokarn, executive director at the International Monetary Fund. “If you are committing to a rule, then you have to accommodate the reality that there are very limited circumstances under which the system will tolerate deviation,” said Gokarn — who represents India, Bangladesh, and Sri Lanka at the IMF — in an interview with Praveen Chakravarty, contributing editor, BloombergQuint, and a senior fellow at IDFC Institute. With the Indian economy witnessing transition pains of formalisation as a result of the twin effects of the Goods and Services Tax regime rolled out in July and the note ban of November 2016, there have been calls from some quarters for the government to consider easing its fiscal deficit targets, and spend more to boost the economic growth.

Typically, in rule formation, these flexibilities are given to the government to deal with a very severe exogenous shock and not necessarily a policy transformation. Subir Gokarn, Executive Director, International Monetary Fund

On India’s struggle to boost exports, relative to Bangladesh and countries in South East Asia, Gokarn advocated a three-pronged strategy on labour reform:

  • Flexibility to the employer.
  • Safety net for the worker: via unemployment payment or clustering.
  • Being more responsive to changing skill requirements.

Unless we bring this together, competitiveness will be lagging and will be less than what it is. Subir Gokarn, Executive Director, International Monetary Fund As automation in sectors like automobiles casts a cloud over manufacturing jobs in the western world, Gokarn said he’s closely watching the penetration of artificial intelligence in “public relation functions”, which could disrupt outsourcing and call centre jobs in India. “The kind of investment we have made — and the success we have had — with BPO, is clearly under some sort of threat,” Gokarn added.

Watch the entire conversation between Subir Gokarn and Praveen Chakravarty: Read the entire conversation here: Let’s start with your experience with the RBI, but more to do with the technical framework. Since there is now anew inflation targeting and monetary policy committee regime, inflation expectations become quite central to an inflation targeting regime, isn’t it? And do we have to review how we measure expectations? The capturing of expectations is central to the inflation target regime because the target is not just the immediate rate of inflation. It is also an attempt to bring inflation into a narrow and a stable band, whatever the number may be. If you are stating 4 percent or 6 percent or 3 percent as the target, you are always going to be measured in terms of effectiveness and through credibility, as how close are you been able to stick, over a period of time.

Understanding what is happening to expectations gives you a sense of your risk of deviating from that target.

That’s the important feedback in the whole decision-making process. There are three ways of it. We have the household survey. They have started of a few years before I joined and in the sixteenth round we decided to publish it at give people sense of technicalities if doing whether it is credible or not. There was thinking in the RBI was whether it should made public. I am a firm believer in transparency and giving markets a clear sense of what the thinking is. We did it with that motivation. The second element of the expectations framework is business and we were helped in this by the Industrial Outlook Survey which was done by asking companies what their input prices were going to look like, and what their output prices are going to look like. That brings to another dimension to the expectations. Third is, markets. We did few years ago, introduce inflation-linked bonds. They are not trading with any stability or volume but that a very important market of what the financial players think about inflation. When you have all this three together, then you will have a robust triangulated mechanism by which you can gauge whether the inflation expectations are staying on track with your targets or they are deviating. That’s the key effective requirement for an inflation targeting framework which will not happen overnight, and we have to nurture it and bring it into play. We have household survey, and the IOS. I think we have got to get with the market piece to some level of efficiency which will give us very robust foundation for implementing this inflation target. But expectations seem to be high and sticky. How does one address this? When we are dealing with households we should recognise that the people who we are going to survey are going to respond based on their most immediate experience. So, there is a recency and frequency dimension to their responses – what did they buy most frequently and recently. It is usually food and vegetables which you buy almost daily.

So, the memory of the last buy is dominant input in this.

The number is important, but the pattern or persistence is a little more important – are they going up or down? How significantly is the volatility in vegetable prices shaping expectations? That is important input in the monetary policy process, in terms of deviations – are they coming up or down. Unless, you have these two other elements going to the judgement, you may be missing on a significant part of the puzzle. I would be less concerned about the numbers and more concerned about the patterns. That is something which we want to shape because for the average household the index number is of no relevance. One judgement you can make from this is how significantly the volatility in food prices causes disruption or is diluting the effort of central bank to manage inflation. The clearest explanatory variable of household inflation expectations is the previous three months’ CPI food inflation. But unfortunately,in India, that is most volatile. Yes, but we can’t wait for initial conditions to be perfect before treading down a path. One can discuss the merits of targeting versus a different approach endlessly. We have to recognise once the regime is in place is, what are the elements that are going to help it be successful and it is this triangular perspective on expectations. You have got household,firms and the market. When we get all these things in place it gives us an anchor. To me the most important role of that forward-looking view is to let us know if we are having or if central bank is having an impact on people’s thinking and if there is stability for long-term trajectory. Is it then going to help them to make meaningful long-term commitments in terms of household savings, consumption pattern and business and investment patterns. Moving to fiscal issues in India, in a structural, rules approach. There is a view that GST, demonetisation and other reforms like the Bankruptcy Code are one-time costs to economy and during such transition periods it’s okay to relax fiscal prudence. Do you subscribe to it? No. The issue of fiscal prudence transcends individual circumstances. Of course, you can always argue that rules when they are designed are meant to accommodate shocks. They have to be flexible so as not to lock the government into a situation where it cannot respond to a shock.I don’t think that there is any practical rule in place which does not give flexibility.

There have to be clear boundaries on what are the circumstances on which the rules can be bent or where the flexibility comes in.

Typically, in rule formation, these flexibilities are given to deal with very severe exogenous shock and not necessarily… well one could debate what an exogenous shock is. But using it during a policy transformation will have consequences. To use that flexibility to accommodate this becomes an issue because the ultimate test of rule is credibility. Once you set it up then how committed are you to adhering to it. This is true of inflation targeting, fiscal rules or any rule. If you undermine credibility, then the value of the rule is gone, and you might go to a discretionary framework.

If you are committing to the rule, then you have to accommodate the possibility that there are very limited circumstances under which system will tolerate deviation before saying that there is no credibility to that rule.

The benefits of the rule are also to be seen, as why you are getting rules in first place. It is largely because in absence of a rule, the kind of fiscal space which you need to pursue high priority, national interest, growth, inclusion or other critical objectives, that space remains. For example, you are committing to a publicly funded infrastructure strategy and one year down the road something happens which reduces the resources flowing into it, your strategy falls apart because you cannot stop and go on these kinds of commitments. We have many requirements which are going to put pressure on fiscal from a long-term perspective. You have to maintain commitments and be consistent over time. Infrastructure is primary example but there others as well. If you are not able to adhere to commitments, then your strategy falls apart. Rules help them to allow longer type of commitments with credibility, with the assurance that there will be resources. People can come in whether it is PPP, SPV or other mechanism with you can putting those things into play. You also represent Sri Lanka and Bangladesh on the board of the IMF. The one puzzle in India is exports growth. Can you explain the rise of Bangladesh in the global export market? 80 percent of Bangladesh exports are garments. We are seeing power of concentration of focus, but with focus it also brings risk. It’s a bit like picking winners. The whole system is geared in meeting the requirement of the garment industry which is so dominant in their radar screen. So, everything which comes in their way dealt with it quickly. And it is paid off in terms of growth, employment that garment manufacturing generates, and the garment constituency has become very influential in terms of their impact on policy decisions. If there is problem, they are heard and made every attempt to address it.

India’s exports are much more diversified, we have multiple lobbies and constituencies, so being able to focus on one thing could be challenging for us.

We have had success in past where it has worked, I.T., pharma or auto, there are number of them. People have pointed out that it is not traditionally not labor-intensive manufacturing activity we would like to succeed in, where are our exports languished a bit. Any specific policy lessons? The larger debate in India on facilitating employment through reforms of labour regulations, through combinations of market flexibility, safety net and skills – which can be the triangular model for employment generation… we have to try it. And it should not be confined to garments. Is there empirical evidence from Bangladesh? Did it undertake labor reform? They don’t have the legacy of the Industrial Disputes Act. So, the Bangladeshi labour market is what is we are aspiring to, which is of great flexibility. If business slumps, then there is nothing that prevents workers from being fired. But, because there is buoyancy in the industry, jobs are not very difficult to come by. There is a safety net provided by the focus. The whole industry will not slump at the same time, individual producers may. For example, Silicon Valley is clustered. If an I.T. company is shut down, there are five others who are going to hire your particular skill set, which works with clusters. We have had successful clusters where the safety net that the cluster itself provides is effective. One has to appreciate the safety net contribution of clusters.

If the worker is not threatened by if the fact that a particular employer is going to shut down, then he/she accepts the contract which indicates flexibility.

We have to build labor strategy based on these three elements. We have to give flexibility to employer. We have to have a safety net – which could be unemployment payment or a clustering benefit. And we have to be responsive to changing skill requirements. Like who produces it. Is it entirely for state or combination of state or public-private partnership that works? Unless we bring this together, competitiveness will be lagging and will be less that what it is. Did you see this in other countries too? When we look at origins of the Special Economic Zone model, we have given attention to China, but it originated in Malaysia. Malaysia had imposed a whole set of restrictions on domestic enterprise through the Bhumiputra requirements – which is employment, ownership, other preferential treatment. But they realised that this was not helping the industry to grow. They could not dismantle it because of the domestic political configurations. So, the zones where created to exempt enterprises located in these zones from all these requirements. So, it was a dual regulatory framework which put a new set of rules, of no restriction on hiring, firing and their exports took off. China followed that by creating special economic zones in late 1970s or early 1980s. They essentially exempted enterprises located in these zones. So, labor market flexibility was built into that model. They started to expand it in interiors in early 1990s. But for the first ten years of regime, the zones were exempt.

We had that debate in mid-2000s – if we can create zones where the labor law is not applicable – that debate went in the direction of to ‘one country, one legal system argument’ and there are merits to it.

But, if we are trying to replicate the success of these countries, then there are core lessons which come from labor market policies that these countries followed, and we cannot ignore these lessons. But if labour markets are such a road block for export prosperity, labour is a state subject. We should have seen some competitive forces kicking in between states. We have seen Rajasthan and Madhya Pradesh doing it. This is an important consideration because we are seeing states competing to outrank each other on the domestic ease of doing business framework. You have states which are at a very high rank on that list, but don’t see any immediate response. Immediate, in any case, I think, is unrealistic. Since you are talking about jobs, how is threat and opportunity of automation and artificial intelligence playing out in the emerging markets? Since I am representing countries which have a big stake in garment exports, I am watching the entry of automation in processing of soft material. So far, robots and the automation process are into into hard material processing and in certain sectors like auto and metal processing. Two issues, we should be concerned about. I am not sure that it should be categorised as a threat or opportunity yet, but we have to be thinking about this in a organised and a systematic fashion.

On the soft material side, we have entry of ‘sew-bots’ which are starting to show success in garment manufacturing.

There are number of ways which they do it, but bottom line is that it will displace people if it succeeds in these regions and our neighbors to the east who are heavily invested in garments. We need to watch it because it can be very disruptive, if garment manufacturing suddenly shifts its geographical axis back to where the big markets. We have seen this in footwear, the Nike robot-made shoe unveiled at the Rio Olympics and it has started coming into stores. And garments are not that far away. They are being made but at a low scale. The low-cost market which these countries cater to is not that far away. If these happens then how do, we respond to it? Do we locate robots here? There is no geographic compulsion. Do it if you are not using people and do it when you locate where the people and markets are.

The second thing we should be watch for is the penetration of automation and AI in public relation functions – work done in call centers, business process outsourcing.

I have personally dealt with it. They are very empathetic sounding and they don’t sound like machine language. The first time I did it I was told they are passing me on to a human operator who will solve my problem. The second time I used it, I was taken through a set of instructions and I solved the problem without speaking to a human operator. The kind of investment we have made, and success we have had, with BPO is clearly under some sort of threat. How are we going to respond to this? There is an aspiration aspect to BPO employment – which is seen as white collar, computer oriented. A lot of people who finishing school see this as entry into the middle class or down that trajectory. If it gets disrupted, then how we will deal it? There is significant economic dimension to this issue and a social dimension. This is the big part of that story. We’ve had technology shifts before. Why would it be different with this transition? I have tried to place this transition in a historical context. It is correct that previous technological disruptions have, over time, generally contributed positively. You have seen increase in labour productivity, household income and seen opening of opportunities outside the core which allowed transition. There would have been individual losers, but at social levels, along with these new opportunities, systems emerged to provide skills for formal education or vocational training. So, societies were able to demonstrate responsiveness to see changes and take advantage of them. I am agnostic on eventual outcome. But we have to be prepared for it. How? That is the question which this process must be asking. I will flag that it can hit us hard and adversely if we are not prepared. If we reach a judgement that we do not need to do anything different and that is the collective wisdom, that it will come, and we will deal with it or we can’t do anything about it. But then we say that’s where it stands. We should think this through at a public policy. or business, commercial, and education level. The larger worry is the public policy response to this is to raise barriers and protect the immediate. A race to the bottom. That’s one of the most significant findings in a chapter in the World Economic Outlook which the IMF produces. In 2016, they did it on trade. If we are talking of slowing exports, that has been the trend globally. But one important contributor to that trend is the rise of protectionism in a variety of forms like direct trade barriers, and other measures. There is very little else you can do in short term to resist the pressure. You have sovereign powers to raise trade barriers as we are seeing in the WTO process, and the ministerial which concluded recently. This has started to have some bearing directly or indirectly on the comfort that the world has had with the open trade regime. If we see roll back in platforms with mutual understanding, then that could have consequences across the board.

It is important to act collectively and protect what we have on global trading regime.

That is an important objective and aspiration to take further. Let not that resistance start pushing back and reduce. That is global understanding which we should try and achieve to work with other countries. That’s on trade, the policy response on technology could be very similar. I can understand how tempting it could be from a political economy perspective to have something like a ‘Robot Tax’. These responses are often based on a quick inference reference drawn from these forces without necessarily putting them into the wider context. We have to understand it as fully and completely as possible. Scare-mongering is easy to do; but so is denial. Somewhere between scary and denial we have to find middle ground and that’s what long-term policy should focus on.

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