Debt ceiling bigger concern, may halt US recovery: IMF

The International Monetary Fund on Tuesday downgraded its India outlook for 2013 and 2014. It projected growth by 3.8 percent this year and 5.1 percent next. Speaking to CNBC-TV18's Gopika Gopukumar, chief economist at IMF, Olivier Blanchard believes things are not as bad as they look, though, he admits, growth is a bit slow.

Blanchard says the issue of US shutdown is not as big as the debt ceiling. If it is not lifted, it can lead to the end of the US recovery.  "The combination of both can lead the US economy to stop growing, maybe go into recession. At the same time, the consequences are so bad that it will not happen,” he adds Below is the verbatim transcript of Olivier Blanchard’s interview on CNBC-TV18

Q: In April this year you spoke about a three-speed recovery, although that was not mentioned in the October World Economic Outlook, how is that recovery taking shape or has it slowed down? A: What we were trying to push in the spring was the notion that among advanced economies we have two different speeds. You had the US moving ahead and you had Europe going slower and the third was the emerging markets and that remains largely true. Over the last six months, emerging markets have slowed down a bit and so, the three-speed concept is still the right one, but this twist, which is the slowdown in emerging markets, that is what we are emphasizing this time. Q: You have also cut the world growth output this year to 2.9 percent. Do you see any possibility of the world economic growth slipping to recession again from a recovery stage? A: No. Anything is always possible, but in our base line we surely do not see this possible. It is very important not to focus on one number for the world. Over the last six months, the advanced economies are continuing to recover – not great but they are and then the emerging markets have slowed down. This is not recession. This means that the people, the countries which were sick are getting in better shape and the ones that were doing very well are not doing quite as well. So, I would not paint the situation as dire or really bad. Things are okay, growth is a bit slow. We have to work at all margins. Q: The US government shutdown has entered into the second week. What impact will it have on the GDP for every week of a shutdown going forward? A: The shutdown itself is not a major macro economic factor. It decreases production a bit. Some people are not working but it is not a macro economic catastrophe. The big issue is the debt ceiling. If the debt ceiling is not lifted then you have two things that might happen. The first one is government spending has to be cut drastically and that leads to an enormous fiscal consolidation – a big contraction of demand and possibly the end of the US recovery. Then if they satisfy the debt ceiling by not paying interest on some of the debt, this will have major financial implications. So, the combination of both can lead the US economy to stop growing, maybe go into recession. At the same time, the consequences are so bad that it will not happen. So, we see this very much as what we call a tail risk – a very low probability risk but if it happened it is not going to be nice.

Q: Will the breach be something like a Lehmanisk moment of crisis? A: We have to be careful about using Lehman too much. Yes, it is going to create instability in financial markets and we do not exactly know how much and we do not want to get there. _PAGEBREAK_ Q: Do you think the US lawmakers will be obdurate enough to allow this breach to happen? A: We are hopeful that if they understand the implications of what they might do, they will not do the wrong thing. Q: With regards to the emerging markets, you have said that the slowdown has been more than forecasted. You have also cut India’s growth to 3.8 percent from 5.6 percent. That is a drastic drop from your earlier forecast. What has gone wrong with India?

A: It looks as if it is largely cyclical. It looks like it is mostly domestic demand rather than slowdown in export. It is a combination of a few things, monetary policy had been tight and must have had some effect. The business climate is not great. There is clearly uncertainty about the future. So, this might be affecting investment, consumption. You have the striking number about gold imports which is very large and comprises most of the current account deficit at this point. The way to look at it is to say that people just don’t have confidence in the future and they want to hold more gold, an indication that the climate is not very good. It is important to take the right measures to change the climate. Q: Do you think there is risk of sovereign downgrade at this point in time? A: I have not heard of anybody talking about a sovereign downgrade. It can be avoided fairly easily if monetary policy is improved. With the new governor we are seeing good signs. If the fiscal deficit is kept under control and reduced over time, I think that can be done as well and in that case I see no reason why there should be a downgrade.

Q: Are you sanguine about the fiscal consolidation process that is currently on in India or do you think more needs to be done? A: I think eventually there has to be a plan. The fiscal deficit cannot remain as large as it is, but the target was achieved in 2012. It is going to be a bit tougher in 2013, because the depreciation makes the price of imported energy higher. But the government looks like it is going to try and then over time, the deficit has to decrease slowly. Q: The very expectation of tapering in May had caused a sudden flight of capital from emerging markets like India. Do you think these countries including India are prepared enough for the possible consequences of tapering if it has to start by the year end or next year? A: I think so. It depends on the country. Also, India is not a country which is very open to the rest of the world financially. It has shortcomings, but it is also less exposed to these movements in capital flows one way or the other. But most countries have now realised that the way to react to this is by letting the exchange rate adjust and India surely has had fairly major adjustments in exchange rate. So yes, most emerging market countries including India can deal with the tapering or normalisation of monetary policy in the US. Q: India had also undertaken a lot of capital management measures soon after the rupee started depreciating and also there was a flight of capital. Are you happy with those kind of measures or do you think the Reserve Bank of India (RBI) should let rupee depreciate? A: No, our view on capital controls is fairly well established which is on the way in. You would only expect the stuff which is good for you and try to keep the rest out and when you have depreciation, if you can do a few things which are going to lead people to buy more fine assets, you can do it. It was not done in a very clear way, but in a confusing way and so, the markets reacted badly. But we are open to capital controls to avoid too much turmoil in the foreign exchange market. _PAGEBREAK_ Q: The IMF also supported the Fed’s decision to delay tapering. When do you think the US is prepared to start tapering and by what quantum should it start? A: I think the issue of the amount on the first day is a non-issue. What markets care about is the whole sequence. They want to know, okay so you are going to start, at what rate are you going to do it? The number today whether it is USD 10 billion, USD 5 billion or USD 20 billion doesn’t matter. When the Fed is going to do it? I think they have been very explicit. They will do it when they think the recovery is very solid. They have said we are going to be data dependant. It is an awful expression, but it is clear. It means when we think we can slowly get out, we will do it. They will do it in the best way they can. It is going to be a difficult communication problem. We saw this a few weeks back, but they will do it in time and when they will do it, it will be because the US economy is doing well and so it will be on that good news. Q: What about the euro area? You sound very optimistic in the October World Economic Outlook. Do you see any more risk coming from the euro area? A: Such a thing is being less pessimistic, which is not the same as being optimistic. It looks as if at last there has been some growth in the euro and it looks like it could continue. This being said, it is still very low growth, so we are not sure. Some countries are still having negative growth. Most of them will have positive growth next year, but in very few will you see a decrease in unemployment. So we are very, very long way, yet it is better because last time when we had meetings, the numbers were really bad. Q: You also spoke about structural reforms happening in the euro area, talking of a bank consolidation or a union. When is that likely to happen? Do you have a roadmap in mind which you think euro should adapt? A: I think they are urgent structural reforms and probably most important one is what is known as breaking union. So there is a step there which should be starting which is the asset quality review which is a review of the balance sheets of all the banks to clarify what the good loans and bad loans are. There is a sense that people do not know the true health of the banks. It is very important to do it and maybe most of them are in good shape, maybe they are not, but that is very important. It has to be done. It has to start soon. It has to be done thoroughly. There has to be money at the end if it is needed. We see this as main priority. There are others, labour market institutions, but these can probably wait a big longer. Q: How much worse can it get from here? A: It can get much worse, it can get much better. There is always enormous uncertainty. But we do not see acute risks, the euro exploding or something like this. We are not in that mode. The main danger is that the recovery is just too sluggish. We talk about recovery, but we have to think about people and a sluggish recovery means a high unemployment for a long time. It means very high unemployment for the young. Q: Do you expect more than anticipated downside for the emerging markets? A: No. Our forecast for next year is actually higher than this year. India may not be able to have a growth that they had in 2000s but they can have sustained growth.

For CNBC-TV18's complete analysis on IMF downgrade, watch the accompanying videos.