IMF warns India on growth without sprucing up financial system

"I don’t think any government should commit itself to a higher growth without putting in place firmly a robust financial system" especially during a difficult external economic situation as at present, IMF deputy director Flemming Larsen told reporters here.

Larsen, who headed the team that prepared IMF’s World Economic Outlook this year, said India was justified in its "cautious approach" in moving towards capital account convertibility particularly after the east Asian meltdown.

He, however, said capital account convertibility was essential in the long run if India were to integrate itself with the global economy.An important lesson of EastAsian crisis was that strong growth was not sustainable when high capital accumulation was not matched by adequate rate of return, he said.

It was more dangerous if capital accumulation was through a lot of borrowing at a time when the rate of return was nil or negative.

Larsen said huge non-performing assets in the banking system and massive lending in real estates contributed to the East Asian meltdown and this emphasised the need for carrying out financial sector reform.

He said neither an average annual five per cent growth as in India was good enough nor a high 10 to 12 per cent growth as in South-East Asia was advisable.

But a moderate six to seven per cent was sustainable and the South-East Asian economies were expected to bounce back to this level from middle of 1999, he said.

Larsen was against stepping up public expenditure by resorting to fiscal deficit and said this would push up interest rates which would amount to diverting scarce resources.

He said there was no way one could push upgrowth rate without a check on fiscal deficit and this applied more so to India.

Citing the example of Brazil, he said the government’s failure to check fiscal deficit had led to the current economic crisis and it was now facing the arduous task of resorting to fiscal discipline when there was a global recession.

"It is easier to carry out fiscal reforms when the global economy is looking up," he said adding India should effect fiscal discipline when the going was relatively good.

Referring to seriousness of Asian and Russian crises and intensity of contagion effects to other emerging markets, he said a key lesson from this experience is the need to address promptly any signs of weaknesses in policies and institutions that may provoke sharp revisions in investor perceptions of country’s prospects.

Countries also need to limit the potential damage from shifts in investor sentiment by fostering the development of robust financial systems, Larsen quoted IMF’s latest economic outlook as saying. ThoughLarsen underlined the need for cautious approach towards capital account convertibility, he was against turning the clock back in those countries which had already done it like South-East Asian economies.

This, he said, would amount to forgoing benefits of countries’ rapidly growing ability to attract foreign saving to help realise their potential as well as broaden welfare gains from international portfolio diversification and risk sharing.

But for emerging markets like India, he said "there is clearly scope for strengthening efforts to ensure that capital account liberalisation is well sequenced and prudent."

"Well sequenced external financial liberalisation mean that structural reforms in other areas are often needed prior to, or along with capital account liberalisation to reduce the risk that resource misallocations stemming from distortions elsewhere in the economy are exacerbated when capital controls are removed," he said.