Some analysts are crying wolf over the current account deficit (CAD). This touched 4.

1% of GDP in Q2 of FY11, but now looks like falling to 2.5% of GDP in H2. The Prime Ministers Economic Advisory Council talks of stabilising the CAD at 2-2.5% of GDP. But we think even 3% is entirely bearable for an economy growing at over 8%, with exports growing at over 30%, remittances bringing in 4% of GDP, and domestic savings hovering around 35%. These factors add up to a dynamic, sustainable macroeconomic situation, notwithstanding long-term worries about the fiscal deficit. FDI is more stable than portfolio investment, so we need a better investment climate to revive FDI, which has fallen this year. History shows that running a large current account deficit is dangerous if domestic savings are low and exports are sluggish (Greece, Portugal), or if countries borrow abroad for reckless lending at home (Ireland and Iceland in 2008, Thailand, Indonesia and Korea in 1997). In a crisis, short-term loans cannot be rolled over and hence suck out reserves. Lesson: India should focus on the composition of borrowings more than the current account deficit. Forget fears that hot money will rush in and out of the stock market. If FIIs attempt a mass exit from bourses, they will cause a price crash that imposes a huge exit penalty. Bonds too will fall in a panic, and anyway bond inflows are limited by RBI rules. Long-term loans are by definition not a short-term problem. History shows that the most lethal problem is short-term borrowing. Its share in Indias external debt rose from 18.8% to 22.5% between March and September 2010. This is where the RBI needs to watch and exercise caution. A lot of corporate debt is used to finance foreign takeovers. This constitutes a liability for the country, whereas the assets lie abroad out of the RBIs control. The RBI needs to keep an eye on this too. Yet as of now the situation is well under control. A current account deficit of up to 3% of GDP will prove that India has more absorptive capacity than before, and be a sign of health rather than cause for panic. It is the build-up of short-term debt that the RBI and policymakers need to worry about.

Neural Net
Four Fallacies of the Crisis
JAGDISH BHAGWATI

The current twin crises in finance and the real economy, what Americans call Wall Street and Main Street, and the interminable discussions about financial reform and the prospects for economic recovery, have spawned several fallacies that need to be addressed and dismissed. Fallacy 1: The crisis would produce a free fall. A free fall means just that. But, surely, the world economy, or even the US or the European Union to which this dire prediction was applied (by Joseph Stiglitz, for example, who wrote a book entitled Freefall) has not been plummeting like Newtons apple. Animated discussions as to whether either or both economies face an L-shaped or a Vshaped recession have given way to the reality of considerable volatility, for both income and financial indicators, around a mild upward trend. Fallacy 2: Through monetary expansion, the US is manipulating the dollars exchange rate in the same way that it accuses China of manipulating the renminbis exchange rate. The two cases are dissimilar. If one grants the premise that there is an insufficiency of aggregate global demand, the alleged Chinese undervaluation of the renminbi can, indeed, be

seen as a beggar-thy-neighbour policy, which diverts inadequate world demand to Chinese goods at the expense of other countries. On the other hand, the dollars weakening is a sideeffect of US monetary expansion, undertaken after countries like China and Germany refused to spend more to increase world demand, and after no room remained for further fiscal stimulus. Fallacy 3: Current global imbalances will continue to afflict us. Economists inevitably generalise from the current situation, so that todays Chinese and German current-account surpluses and Americas deficit, for example, are seen as being here to stay. But history is littered with surplus countries that became deficit countries. One of my teachers when I was a student at Oxford, Donald MacDougall, a man who had once been Prime Minister Winston Churchills adviser, wrote a book entitled The Long-Run Dollar Problem, which suggested that the dollar was what the IMF called a scarce currency. By the time the book appeared, however, the problem had vanished. Initially, the Chinese surplus arose inadvertently, not by design. So did the US deficit, which resulted from the failure to finance the second Iraq war with new taxation. Today, the Chinese themselves realise that their surpluses fetch minuscule returns when invested in US Treasuries. So they are keen to spend their earnings from foreign trade on domestic infrastructure instead, thereby removing serious bottlenecks to further growth, as in India. As a result, Chinese imports will increase and thus its surplus will fall for two reasons. First, wages will be spent partly on imported goods. Second, infrastructure investment requires heavy equipment that is typically supplied by Caterpillar, GE, Siemens, and other, mostly western, suppliers. Moreover, immense pressure in the US to undertake fiscal consolidation, reflected in President Barack Obamas latest budget proposal, should reduce US import demand, further reducing the bilateral imbalance. Fallacy 4: Forget about Keynesian demand management. Some critics of Obamas Keynesian stimulus spending, among them the economist Jeffrey Sachs, claim that what the US needs is longterm productivity-enhancing spending. But this is a non sequitur. As a Keynesian, I believe that the state paying people to dig holes and then fill them up would increase aggregate demand and produce more income. But Keynes was no fool. He understood that the government could eventually get huge returns if the money was spent on productivity-enhancing investments rather than on directly wasteful expenditure-increasing activities. The question, then, is simple: which investments offer the greatest economic payoffs? But it is also fraught: when your bridges are collapsing, your school buildings are in disrepair, teachers are underpaid and have no incentive to be efficient, and much else needs money, it is not easy to decide where scarce money should be spent. But one structural consideration is not well understood. Given the need to cut the deficit in the future and the need to increase it now in order to revive the economy, the problem facing Obama is how to shift smoothly from top gear into reverse. Clearly, the lesson is that governments need to attach less weight to spending that cannot one day be cut. (The author is professor of economics and law at Columbia University) Project Syndicate, 2011