'Crisis: There is scope for India to do well'

Martin Feldstein is the George F Baker Professor of Economics at Harvard University and a member of the Economic Recovery Advisory Board convened by the US President. He is also President Emeritus of the National Bureau of Economic Research and served as former US President Ronald Reagan's chief economic advisor.

In India to address the Canara Robeco Thought Leadership Series, Feldstein, who is also a Business Standard columnist. spoke to Niladri Bhattacharya and Sidhartha about the global economic situation. Excerpts:

Do you see some change in India in the last 12 months?

It has slowed down more than I expected. I thought India would be more immune to the global slowdown. I was quite worried about the global economy, and India, unlike the other Asian countries, is less involved in manufacturing, and I thought it would therefore be less adversely affected.

It was affected, partly due to a lack of credit, which affected large industries, and also because of the equity market, due to panic selling by emerging market investors.

They did not make a distinction between the potential health of the Indian economy and the hit that Thailand and Malaysia have taken. You were also hit very hard by high energy and food prices, and that led to a tightening of monetary policy.

But I remain relatively optimistic about India, with energy prices down and food prices no longer at such elevated levels. There is more scope for India to do well than what it's been doing over the past year.

How does India compare with China?

China is going to do very well. It is suffering because of a loss of exports and due to a very sharp decline in manufacturing.

But Chinese officials have made it clear that they are going to use this as an occasion for a major shift to domestic activity, which is not just cyclical but for bolstering both consumer spending and government spending to provide services to consumers. China has the levers or controls to do it.

In the past few days, there has been some optimism, especially in the stock markets. Do you see certain signs of revival in the global economy, given the latest data?

There have been some recent statistics in the US about aggregate demand and housing and retail sales. I would like to believe that it's the beginning of a recovery, but I really do not. January was awful and so the fact that February bounced back a little may be just that. If you take the two months together, we are still looking at a net decline and that's not something very positive.

If we have two more months of positive numbers, then I would be surprised and pleased and start seeing things coming back.

There is a good chance that we see a few months of very positive news, not necessarily positive GDP growth, when the stimulus is introduced. The stimulus is going to add $250 billion in a year and about $60 billion on a quarterly basis. It's not a lot, but it's about 1.5 per cent of the quarterly GDP.

A national income accountant will multiply that by four and make an annual rate out of it and say it's a 6 per cent increase in GDP.

Even if the rest of the GDP is falling by 5 per cent, you put the two together, and the national income accountant would say it is zero or one per cent and politicians can say growth is back. But it would just be a mechanical, one-time level effect.

A year ago, the NBER had not officially declared the US in recession but my sense, by looking at individual monthly numbers, was that we were sliding into a recession and a deep-lasting recession. It took us several months before we got a confirmation.

We will not turn the corner in 2009. If we are lucky, it will happen by this time in 2010, but it may well not happen. It is very hard to see anything and say with confidence that there is a recovery.

Will the recovery start from the US?

China will get its act together sooner than anybody else. Who goes first will depend on trade patterns and things like that. But we (the US) will come out before Europe.
Will the Geithner plan be one of the key drivers?

It has the potential to be so. It's not clear that it is ready to do the full job. There are a number of problems, but it's much better than any of the plans that have come along before. A trillion dollars sounds like a lot of money, but if the purpose is to cleanse the balance sheets, then banks have $10 trillion worth of securities.

They have large amounts of underwater paper in residential and commercial mortgages and consumer loans. It's not clear if $1 trillion is enough to make the institutions and counterparties say, this is cleared up and start lending. If it is not a big enough step, then people may say it has failed.

It's not clear if the whole process will deliver that. It's not clear if the banks will be willing to sell the mortgages they have, because if borrowers are paying, then the loans can be carried at the initial value and do not have to be marked down. Once banks sell it, they have to take the loss and they will see if they have the capital to do so.

Do you see more shocks like Lehman going down?

A shock is something that you did not expect. The risk is that we will see declines, especially in commercial real estate and you may see some significant losses that could bring down commercial banks.

It is not clear if the plan is going to succeed in avoiding nationalisation or avoiding bank failures. They have got the right idea and they will discover if banks are ready to sell. If they are not, they have to go back and reconsider what the viable strategies are.

There is talk of tighter regulation and better supervision. Will we see overregulation?
It may happen. What's needed is more supervision and not regulation. One of the reasons supervisors did not do a good job was because they were falling back on the language of Basel.

For instance, Basel allowed them to ignore off-balance sheet assets. If that's what the Financial Stability Forum and BIS concluded, then who is a bank supervisor to question that? Bank supervisors did not use common sense to go beyond what was written.

Do you see traditional banking making a comeback?

There was a strong case for the repeal of the Glass-Steagall Act for integrated financial services. That is not what brought us down. A very high loan-to-value ratio and things such as that are the problems that have to be dealt with. The fundamental structure of banks need not be changed.

What are your expectations from the G 20 meeting?

These things do not normally produce much. With the conflict of what ought to be done, I do not see them producing much.

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