"In India, the need to reduce poverty and provide for steady employment growth are key challenges"

In the conventional hegemony thrashed out between the United States and Europe, the leadership of the Bretton Woods Twins-the Interna-tional Monetary Fund (IMF) and the World Bank-is divided between them. While the Europeans retain control of the IMF, leadership at the Bank is the prerogative of the Americans. So when Horst Kohler resigned as Managing Director of the IMF to pursue political ambitions, it was clear that another European would inherit the mantle. The choice fell upon Rodrigo de Rato, the former Vice President for Economic Affairs and Minister of Economy for the Government of Spain. The 56-year-old, a political heavyweight in his country, who succeeded Kohler to the job on June 7 last year, has taken charge at a very transitory time. Unlike even a decade ago, the Fund's role has changed with the growing influence of global private capital. Since his advent, the world is also seeing a slow transition of growth momentum to the East, with India and China leading the way. The Managing Director got a first-hand account of this when he visited India in mid-March. Ahead of his visit, he took time off to speak to Anil Padmanabhan at the Washington, dc office of the Fund. He addressed a host of issues and cautioned that the current regime of low interest rates cannot be taken for granted. Excerpts:

What are your initial thoughts ahead of your visit to India?

First of all, it is a very good opportunity for me to meet up with the Prime Minister and other members of the economic team. It is my first visit as Managing Director and it is a good chance to listen and to see first-hand the future direction of economic policy. In addition, I am also keen to understand how the Indian government sees the future role of the Fund. In fact, this is a very good and promising moment in India with a strong growth of more than 6 per cent in the last few years. The policy changes have augured well for India's future. Increasingly, India is a subject of analysis for foreign investors. So I believe it is a very promising moment in a country that has challenges like everybody else. In India, the need to reduce poverty and also the need to provide for steady employment growth-100 million jobs in the next 10 years-are important challenges in my view. These are important issues that will occupy me in my visit.

If you were asked to accord a report card on the Indian economy, what would be the three points of concern and three points of optimism?

I don't know whether I should undertake a grading exercise. But certainly India has changed dramatically in recent times. I was in India in 2001, and from what I hear, things have moved very quickly since then. So, certainly one point of optimism is the strong positive growth that India has achieved in a stable macroeconomic environment. The second point is India's performance in the global economy-especially in dynamic sectors like information technology. Thirdly, the presence of a huge workforce is a source of strength-though it is also a challenge (as they have to be productively employed)-for future growth.

I do not want to sound negative, but there are certainly challenges facing India. From the macroeconomic point of view, the reduction of the public deficit is a serious challenge and should be addressed. The other challenge is to generate sufficient employment to absorb the growing labour force. And finally, the fight against poverty is very important. It is still substantial and accounts for 30 per cent of the population.

The relationship between the IMF and India has changed, especially since the economic crisis of 1991. In fact, today India is a marginal lender at the Fund. How do you view this transformation? And, has this in any way impacted surveillance of the Indian economy?

"India's strong growth, performance in the global economy and a huge workforce are points of optimism"

That is an evolution that happens to many countries. Many developed countries have had moments when they had to face up to a balance of payments (bop) crisis and had to take assistance from the Fund. So I believe it is a healthy evolution that India has moved away from a financial crisis. Given its size and potential, it will become a global player and this will have systemic consequences. So we will have to look at India from a bilateral and multilateral point of view. I think our work with the authorities regarding technical assistance and design of different policies-like reducing the public deficit-are areas where we can still play a role. And we also view with appreciation the government's efforts to push structural reforms-like the recent tax reforms that were launched by the government.

Actually, my question is more in terms of India's sensitivity to criticism, as it has transformed from a borrower to a lender...

I think governments are always sensitive to criticism. I would say that it is normal. At the same time, the role of the Fund is not to criticise. Our responsibility is to apply surveillance to our member countries and through that to point out areas of weakness that a country can have. And certainly in the case of India we do it. That is what we are supposed to do.

You did mention the fiscal deficit to be one area of concern. Is it a structural problem that could derail much of the gains achieved so far? And how do you view the fact that even in the just-presented Budget, the government has expressed its inability to adhere to fiscal correction targets?

If I understand correctly, India has a medium-term framework set in a law to achieve fiscal correction. Of course, the law has to be applied. And if it is only created and then not implemented, it makes no difference. We understand the challenges the government is facing, but we have said it very clearly that efforts have to be increased to achieve the goals of the law. We understand very clearly that India has very important challenges, both in the social issues and in terms of its infrastructure needs. We think, therefore, that India should have a flexible budgetary policy that will meet these challenges, but at the same time take care of the debt burden. Reduction of debt will become the single most important measure to increase budgetary spending in the future on infrastructure and social services. There are other areas of structural reform, like tax reforms, that are important in curbing budgetary deficits and for growth. And also to face the evolution from a social policy based on subsidies to one that is targeted at the needy is also important.

What we have seen in the last decade or so is a distinct change in the economic contours of the world. There is a definite shift towards the East, particularly towards China and India. How do you see this new ordering and how it will impact the global economy?

I don't think we should see the global economic situation as a zero-sum game. What we are seeing are new potential sources of global growth. That does not mean that the traditional sources are going to be less important. In fact, to have a balanced situation in the world economy, we should have more evenly distributed growth. One of the problems on the ground today is that you have two very clear engines of growth-the United States and China-while other areas like Europe and Japan are not contributing to that growth. At least they are not doing it to their full potential. And that has consequences. One of these consequences is the current account imbalance-on the one hand you have the huge deficit in the US, and on the other you have a huge surplus in China, Russia, Japan and the Middle East. To avoid such an imbalance, different players will have to do different things. The US will have to reduce its public deficit and raise domestic savings. Certainly, Europe and Japan will have to contribute with stronger growth. But it is true that we are seeing growth in India, China, Eastern Europe and Latin America.

"India should have a flexible budgetary policy to meet its challenges and take care of the debt burden"

In such a changing situation, what is the leadership that you are seeking to impart at the IMF?

Well, it is true that the situation has changed drastically since the early 1990s. I did mention earlier that there are now new economic players-like India and China-in the world. In this context we need institutions like the Fund to dedicate more resources towards global surveillance and analyse linkages and consequences of the strength of the capital markets. These issues are certainly on the top of our agenda. And they were probably not so evident 10-15 years ago. But we are also facing bop issues in some countries. These are traditional problems. I don't think the world is free of financial problems. At the moment we are in a very comfortable situation given the low level of interest rates in the world. But that won't last forever. And when it ends there will be problems. The Fund will always be there to assist in such situations.

How do you see the long-term prospects for growth in the US economy? After all, it has potentially structural problems in a very high budgetary and current account deficit.

We see the US economy as one that will exhibit strong growth for a couple of years without any undue inflationary pressures. The gains in productivity achieved in the last 10 years are paying off. Therefore, prospects for growth in 2005 and 2006 are quite healthy. However, there are problems with the economy. One of them is the sustainability of the current account deficit. Up till now, it is clear that the attractiveness of the US economy is very strong. But I think most of us will maintain that the present level of current account deficit at 5-6 per cent of GDP (gross domestic product) should be corrected. We don't want to risk strong volatility in the currency markets and unwanted corrections. The US also faces some domestic challenges in terms of healthcare costs and social security reform. This, too, is a source of concern and we are advising the US authorities to face these challenges. That is another argument for regaining manoeuvre by curbing the fiscal deficit in the next (few) years.

You have touched on a host of issues. But if you were to be asked as to what is the single most pressing problem facing the global economy today, what would be your response?

I would say that there are two risks facing the global economy. One is the imbalance in current account deficits and the other is the price of oil. Both risks are not dramatic at this moment, but yet a point of concern. Another point of concern is the task of low income countries in reducing poverty. And in this context, ensuring macroeconomic stability can play an important role in eradicating poverty.

The 1997 currency crisis demonstrated the world's vulnerability to volatile global capital inflows. At the same time, the ready access to such capital flows also holds promise for emerging market economies to meet their resource shortfalls. How do you see global capital flows at the current juncture of the world economy? Is it a blessing or a curse?

I think they are a great source of potential. They are giving countries like India-and even the US-a chance to attract private investors either as portfolio investment or as foreign direct investment. It, therefore, provides the world with a means of financing that was not available even 10 years ago. In that respect, capital markets are performing a very important function. Additionally, they are also a good measure of discipline for countries that allow governments to measure their credibility in the markets. At the same time, capital markets are huge and they are getting bigger. They can be, and in some cases are, a source of contagion and volatility. So they have to be reckoned with. Reduction of vulnerabilities-like strengthening the banking sector-is very important. Right now we are living in a world where risk is assessed very cheaply. Not like they have been viewed in the past. And interest rates are at a surprisingly low level. In fact, there was an important meeting of central bankers in Basel last week to discuss this very same subject. All this shows that we might be going into a moment where we will go into a regime of higher interest rates and higher risk appraisal. So countries have to be aware that the current situation will not last forever and the reversal will happen. That will have a definite impact on capital markets and will affect countries differently.

So what safeguards should a country like India undertake in such a situation?

I believe one safeguard is to reduce public debt. I think India will gain a lot of room for manoeuvre to face the challenges and also gain budgetary capacity by reducing public debt. It will also reduce the cost of debt. But that of course demands important decisions like the one the Indian government is taking-tax reforms and shift to a more targeted subsidies regime.

In the last decade, the Fund, like other multilateral institutions, has begun to address the issue of governance. But now a new imponderable has cropped up in the form of terrorism and it has begun to affect governance. Is the Fund looking to address this issue?

We play a role in helping countries fight the financing of terrorism. This is being done by strengthening the financial system, particularly measures to curb money laundering. In that respect we are part of international efforts, but in a very specialised respect. Terrorism is certainly a very important threat to political stability around the world. And it is a very clear enemy of growth and democracy in the world. And our role as an international agency is to concentrate on the financial sector where we can make a difference.