Transcription
Now, as we all know, the war in West Asia has shaken the global economy and India. The fear of war clouds returning has sent jitters. As I said, handling the economy is now possibly the biggest challenge facing the Narendra Modi government in the next 1 year, and there are many worrying signs that we've seen.
Remember, the rupee recently hit 96 to the dollar. It's among the worst-performing currencies right now. Crude oil prices have risen, and the government has increased domestic fuel prices multiple times. Forex reserves have fallen from $728 billion on February 27th to now $682 billion on June 5th. Wholesale inflation is at a 3 and 1/2 year high of 8.3%. Food inflation is at 7.1%. Fertilizer subsidy is expected to rise from the allocated 1.71 lakh crore to 2.5 lakh crore rupees. These are the worrying signals.
I'm now joined by a special guest who I spoke to earlier, one of the world's leading voices on the economy. Listen in to Raghuram Rajan. So, in the backdrop of the uncertain global climate created by the conflict in West Asia, the focus remains on the Indian and global economy. What lies ahead? What are the headwinds that we will now face? Joining me now is one of the world's most distinguished economists, a former Reserve Bank of India governor, professor of finance at Chicago Booth, and also has been with the IMF in the past. Dr. Raghuram Rajan, good to have you as always on the show. Thank you very much for joining me.
I recall speaking to Dr. Rajan in March, soon after the conflict broke out in West Asia, and then you had said if this conflict continues into the summer and beyond, then the world could be heading for a very grave situation. We're now in the month of June, and there is no end yet to the conflict. How do you see therefore all of this playing out in terms of the global economy and India's economic challenges?
Certainly, what has happened is that this conflict has lasted way beyond what the initiators, Israel and America, thought would happen. And negotiations are also underway. I think there is some hope that an agreement will be reached. The hope is always in the next week. But every week, we are disappointed. So, it clearly is harder. There are some issues which it's very hard to bring the two parties together. Of course, this is not even talking about the nuclear issues which early signs suggested would be postponed into the future.
The world has actually managed better than one expected in the beginning, and that's because there have been all manner of adjustments. First, we have run down the buffers that existed, both the commercial buffers as well as the strategic buffers of oil and other forms of fuel. So that's one source of adjustment. Another has been kinds of substitution. Countries have moved towards using more coal. China is an example. We also have seen that in China, cars are not using gasoline anymore. They're using electricity. Of course, China has a big EV population, and that has taken some of the brunt off. In fact, if you look at oil production also, that has increased substantially in the United States, while oil consumption by China has fallen, in part because they're not filling their strategic reserves anymore, and a number of industries have moved away from high-priced oil to much lower-priced coal that they have. And I think such substitutions are taking place across the world.
What is true is this room for maneuver is reducing. Ultimately, the fact that around 10% of world energy is shut out will play a part in slowing economies down because the buffers will run out. When the buffers run out is everybody's big question. Nobody quite knows when. But if we see this kind of impasse by the end of summer, almost surely we're looking at much lower growth in the world economy than we anticipated initially, partly because of the effects of oil shortages. And that too, it will affect India for similar reasons.
Let's come to India for a moment because you mentioned oil shortages and the energy crisis. We're already slowly feeling the heat. There have been a half a dozen hikes of fuel prices at different times in just the last month alone. And when you then speak to government policymakers, they say, "Look, we are better off than the rest of the world. Compare the hike in fuel prices in India to what the hike in fuel prices have been in parts of the Western world or indeed in our neighborhood." Do you go along with that argument? Is that a good enough argument to make that, "Look, we are no different to the rest of the world. In fact, we are better off," they say, "than the rest of the world even though we are a heavily oil import-dependent economy?"
Well, the reason the government can say that it hasn't passed through is because it's taking the hit on the fiscal. There is a limit to how much hit you can take on the fiscal without concerns of serious long-term damage being done via, for example, the higher debt that has to be issued, the need to finance that debt, the interest payments that will go out, and so on. Remember, we're trying to bring down the debt. We have a target. We're also trying to bring down the fiscal deficit. There is some leeway. The government is using that, but this is not a pleasant state of affairs where you're trying to cushion the blow from higher oil prices by either forcing the oil marketing companies to take it on their books, which ultimately is a hit to entities that are partly in the private sector, which you shouldn't be doing, and longer term, taking it on the government's sort of budget and balance sheet, which effectively is postponing the problem to future generations of Indians. We have so many needs for government spending, including schools, healthcare, and so on. And, you know, subsidizing especially richer households who consume more oil by keeping the prices low is not the most sensible government policy if this continues into the medium term.
So, so what would you suggest? Given as you're saying that there is pressure on the fiscal, that this cannot be sustainable for an extended period, and there is, as I said, no clear sign of when the Strait of Hormuz will open, when those oil flows will be back to what they were pre-war. What is the is the solution, particularly let's look at the energy crisis first. The government keeps talking about the fact that we are diversifying our basket, looking for other countries from which we can import oil. What is it that we really need to do in the short term over the next few months?
In the short run, almost surely, we have to pass it on. Maybe not in one jerk, but in steady sort of increases in the prices of all manner of energy, including gas and oil, petroleum, as well as diesel. So, this has to be a steady process, and you know, the longer it lasts, the more adjustment you will have made. You can't sort of wait and hope and pray that the Strait opens up because it may take longer than you think, given that on both sides of the bargaining table, you have some very, very strong and determined interests who may not give in that easily. So, I would say a steady sort of process of raising the price to meet to make it match the market eventually is what is important because part of the adjustment to higher oil prices is lower demand, and it is important that if these prices stay higher, our industry, our restaurants, as well as our people, especially the richer ones who consume more of the stuff, adjust. Now, that doesn't mean that you can't find ways to help those at the bottom of the pyramid. You could still subsidize gas cylinders, for example, for those. But I would say by and large, you know, any kind of subsidy should be very targeted at this point, and we have methods of doing that targeting, but pass on the prices more generally.
Let's look at some of the headline numbers, Dr. Rajan. The figures that came out just a few days ago showed the Indian economy showing some resilience in FY2026 with 7.7% GDP growth. The government said, "Look, this is a sign that the economy is far more resilient than many people believe." The RBI, though, has cut its financial year 27 growth forecast to 6.6% while raising CPI inflation, consumer price index inflation, to 5.1% against earlier projections of 4.6%. So, are we going to see possibly the concern over inflation and the impact that could then have on purchasing power of consumers? That is the real challenge, isn't it? Because the Modi government has been very successful, reasonably successful over inflation in the past. But they now could face a fresh challenge. Is that, according to you, going to be one of the big challenges? How do you keep inflation under control?
It will be a challenge for sure because inflation comes in through higher oil prices and then feeds through to almost everything else in the economy. What the government and the RBI will be watching is how much this is a one-time effect with higher oil prices feeding into prices of goods and services. As you said, given that the prices haven't been passed through so far, it's not surprising that inflation is a little calmer than it would be. But eventually, as you pass through, it is going to show up. The real question for the Reserve Bank will be if these kinds of higher inflation, one-time higher inflation, starts prompting more of an inflationary spiral that people start expecting higher inflation, and then it gets more out of control. Right now, are still that inflation will stay within the RBI's band, and it can, you know, be a little calmer about raising interest rates and slowing the economy while that is the case. But it may not last forever, especially if this war lasts longer and prices move. Right now, oil price today's oil price is $93 a barrel. This, if it goes to actually slow down demand, could be much higher. You know, some people say maybe 150 to $200. That is anybody's guess, but if it gets to those levels, then you're seeing both prices go up, but also expectations of prices going up go up, and that is the killer as far as inflation goes. When people sort of start believing inflation will be higher and make inflation actually higher because they themselves will demand higher wages, businesses will pass through higher prices.
Now, the other issue, and this may seem strange given the high GDP numbers, is that there does seem to be, you know, some spare capacity in the economy. I can't find other ways of explaining why investment by corporations is so tepid. If investment is so tepid and there is some spare capacity, it may well be that corporations themselves don't raise prices that quickly. So, there may be another margin there for India to go slow on raising interest rates. That said, you know, either one or the other has to be a little iffy. Either the GDP numbers don't reflect the true state of the economy, or corporations, for some reason, are overly pessimistic and are not investing. It's not clear how you can have an economy growing north of 7% as the GDP numbers say and investment, the corporate investment really so tepid?
Have you tried to Have you What is your view of that? As I said, the headline numbers showing the economy growing at 7.7% slowing down, yes. And yet private investment not picking up. What could be the reason? Arvind Subramanian the other day seemed to suggest that there is an element of fear factor that could exist or a sense that cronyism has grown in the economy, and hence many others are not investing. The MSMEs, the smaller and micro enterprises have taken a bit of a hit, is another view. What's your view? Why is it that investment is not picking up if the headline number shows 7.7%? Why is private investment, in your view, still not picking up?
I don't understand if I GDP numbers falsified? Look, I think if it was growing at this rate, you would definitely expect investment to be higher. You know, this was a puzzle 10 years ago. It still is a puzzle today why corporate investment hasn't taken off. And so, I mean, the only answer with the kind of growth we've seen over the last 10 years in the official numbers is that perhaps we are growing less strongly than those numbers suggest. But you know, again, I don't know where the discrepancy is. You know, Arvind Subramanian, as you know, has pointed to a number of data points where growth is less than it should be, even while we are seeing very strong GDP growth. But I cannot fathom why corporate investment is not picking up because with this kind of growth, you reach capacity, you know, sooner. And one of the things you see in the capacity numbers that RBI reports.
So, do you the growth numbers? I I You know, I I I I don't the growth numbers. Sorry to intervene. Do you trust the growth numbers? Let Let me put it this way that something is off. And and I have to believe that you can't just attribute the lack of investment to fear. Our industrialists are fairly money-minded, also. If they saw the opportunity in investing, they would. The fact that they're not investing suggests that, you know, they're not seeing the kind of demand that would be consistent with these growth numbers, which which suggests the growth numbers aren't fully reflective of what the economy is doing.
Can I Can I move to an issue which of course you've written about in the past, the rupee? When we last spoke in March, it was about 93.4 to the dollar. It's gone up to 95.6. You also had, you know, the depreciation of the rupee. Do you believe that as as one member of the Prime Minister's Economic Advisory Council says, there's nothing wrong if the rupee falls further, even goes, you know, above 100 to the dollar? Do you believe that there will come a time when that will stretch us, particularly on our on our forex reserves? Or do you believe it's okay to have a free fall?
Steady adjustment is okay. A free fall is not. So, um, you know, with our current account deficit larger, but more important, the fact that capital is not coming into India to the extent that we need to finance our deficit, you know, the rupee adjustment, some of it is necessary. What you don't want is a situation where the rupee falls because people think it's going to fall, and you've got a lot of investors abandoning rupee assets because they fear a further fall in the rupee. That kind of free fall can be very damaging because it can take you far beyond what the reasonable value of the rupee should be. This is what the situation we faced in 2013 with the taper tantrum, where the rupee plunged 25, you know, significant amount over the space of 2-3 months. And you know, there was a clear case for rescuing the rupee at that point because the free fall was unwarranted, which, you know, as the rupee recovered its strength, that was certainly the case that perhaps it had been oversold. You know, one could debate whether that's a reasonable place we're in that kind of place today. I don't think we are. But nevertheless, what is worrisome is the fact that capital inflows are not coming in to the extent India needs. With all this talk about what a wonderful economy India is, the 7.something percent growth that we saw in the year so far, it is not consistent with the kind of investment from foreigners also. FDI is down significantly. They're not bringing in money to build factories in India, and portfolio investment, as they've been selling and getting out, which is consistent with a lack of confidence in the Indian economy. Now, this may be, you know, headlines. India is not positioned well for AI, which I think is a debatable question. And second, India is not benefiting from the China plus one strategy. We're still not a manufacturing power despite all the efforts of the government. But this set aside, I think part of the problem is nobody knows what India's vision is other than it wants to be a country by 2047. What are you going to emphasize? What is the economic sources? What is economic growth going to be? How much are you going to invest in your people? None of this is particularly clear, even while we have probably the strongest government politically speaking in decades. What is the government trying to do? You know, we what we had in the recent past is a bunch of.
Go ahead. Go ahead. No, no, please go ahead because, you know, taking up from what you just said, Surjit Bhalla, former executive director at the IMF, was on my show a few weeks ago. He created a controversy by suggesting that while the Modi government was politically strong, it was at its economically weakest. And he argued that policy uncertainty, domestic structural bottlenecks were discouraging long-term capital formation, and that is why there was this sharp decline in net FDI. He said inconsistent taxation, regulatory unpredictability, compliance burdens, retrospective disputes. So, obviously, it's not just the war, the conflict in West Asia that's obviously adding to the stress, but this is there is a need for, as you said, a clear vision, direction, and specifics to be addressed.
Absolutely. So, the weaknesses in capital inflows into India pre-date the war. We've seen slower inflows for the last couple of years. Of course, the stock market reflects some of that, but the FDI numbers most clearly reflect, and that's consistent with the fact that Indian entrepreneurs are not investing, the point we talked about earlier. So, both foreign investors as well as Indian investors aren't putting assets on the ground. That is suggestive that they see something that is not reflected in the headline GDP growth numbers. But, to the point that what does India stand for economically speaking? I mean, this whole, you know, Make in India idea. Yeah, it has had some successes. We brought cell phone assembly into India. But the kind of growth that we expected, both in terms of manufacturing output growth, but also job creation, is much more tepid than India needs. I mean, you saw the cockroach party take off partly because we have millions of unemployed youth that we're not providing jobs for. What is the strategy to provide them jobs? And talking about 2047 is a little irrelevant when you're not describing the pathway to 2047. What are we going to do? And to your point, you know, start first by reforming the the kind, getting rid of some of the irritants that make it harder to invest. Now, what we had last week with the proposals on the, you know, attracting foreign investment are important band-aids, but they are band-aids. They are ways to, you know, bring in money perhaps by liberalizing some of the frictions which kept the money out, but also providing a huge subsidy in terms of the foreign exchange swap that the RBI is providing. The question is, why do we still need to subsidize foreign investment if we want if we had a strong growing economy which would attract that investment? And my worry is, yes, we'll get the money coming in, but we need to also accompany that with important reforms that actually make India a better place to do business and give people a sense of what the Indian narrative is. Is it going to be more services-oriented? Is it going to be high-tech manufacturing? If so, do we have the necessary inputs, such as stronger engineers? I was, you know, I told you a little bit about being back at my alma mater, IIT Delhi. And it needs massive resources to be competitive with some of the universities that China is producing. Our engineers are going to compete with Chinese engineers. They were better than what China was producing in the late 1990s and early 2000s. Now, I have to say, China has far better universities than India has at the top. We need to understand that we risk not investing in our human capital. If we If we don't invest in our human capital, we risk our future. But again, what you hear about is talk about freebies to win elections. The government was trying to stay away from freebies, but now it's fully participating in that. What is its strategy for long-term Indian growth? I don't see it.
In, you know, given what you've done and you've given us a broad sweep, in conclusion, therefore, given that we are in these stressed times, given that the war in the Gulf has aggravated the sense of trust, what is your economic outlook for the next 6 months? Is it that it's Is there an opportunity that you see in this crisis? Or do you believe that it will get worse before it gets better?
I think the pain will have to be borne. There are no two questions about it because most of our pain is imported from the Middle East. If the Strait stays closed for much longer, you know, towards the end of summer, I think we will have to absorb significant pain because we import so much of oil from that from that direction. But I think if it causes us to, you know, experience a wake-up call that, you know, maybe all this, you know, this presentation of a wonderful economy doing so well, we need to re-examine and find out what is really going wrong. And I would say the lack of investment is a canary in the coal mine. It's telling us something is not quite right. Can we figure out how to liberalize the economy, reform it in such a way that we can propel investment? And that would mean also many more jobs to satisfy our hungry youth, many of whom legitimately now are saying, "What is going wrong?" I would say that we need to create those jobs. A rethink forced by more tighter circumstances would be very welcome. And there are so many ways we can move forward, but first we need the willingness to acknowledge that something is going wrong.
I'm going to leave it there, Professor Rajan. As you said, first we need to acknowledge that something is going wrong. Thank you very much, in a way, for giving us that what you believe is a wake-up call for the Indian economy and giving us the big picture as you see it from your vantage point. Thanks very much for joining me on the show today.