Not double dip, but recovery will be very slow: Arvind Virmani, International Monetary Fund Executive Director

What we are seeing today is the aftereffect of the 2008 crisis; policy reforms to deal with the financial crisis have not been adequate so we are getting these aftershocks, says International Monetary Fund Executive Director Arvind Virmani. As a result, the developed world could lose many years because of their debt problem. He says emerging economies need to focus on domestic growth to ensure they do not land in trouble. Excerpts from an interview to ET:

What is your assessment of the current situation?

It is quite different this time. In 2008, it was a fundamental crisis of the kind that combined both financial and economic crises...something not seen since the Great Depression. What we are seeing today is the aftereffect of the 2008 crisis. Policy reforms to deal with the financial crisis have not been adequate so we are getting these aftershocks. This is the result of a combination of inadequate policy response and natural evolution of economy. The critical difference between financial crisis and economic crisis is the issue of de-leveraging. A financial crisis creates certain dynamics in bubble period that have to be sorted out.

Is the developed world staring at a lost decade?

The risk of lost decade for the US and the EU is very high. They are already seeing some movement against service imports and immigration.

In the US, the critical issue of household mortgages has not been sorted out yet. The whole system got over-leveraged. One way to say is that this will work itself out. Now, the problem is that working out on an average may take 10 years. There were several good proposals to deal with the situation, but the political dynamics did not allow them. So as long as such problems are not solved it's quite likely that you will get what they call a lost decade. That does not mean growth will be below trend. What it means that GDP will remain below trend. In a normal recession, dip happens then GDP grows faster to catch up. This catch-up is not going to happen now.

In Europe, it is the problem of coordination in the union. The political system has been slow. There is a solvency problem. So whatever structural reforms or squeeze on expenditure they undertake, they will not be able to get out of it unless they resolve the solvency problem. If you take appropriate policy action you take the pain for one or two years then you can get back to normal. But if you don't do it then it will be prolonged. This crisis is a reflection of political systems not reacting.

Has the latest crisis arisen because we did not deal with the 2008 crisis well?

This is not a new shock. It's the recognition that problem has not been solved. I do not expect a double dip or a W-shaped recovery. It's just that recovery will be very slow. Markets have suddenly realised this. It is a wakeup call for the US. The wakeup call for the EU came when Italy came under threat. In that sense it has wider implications. Other countries that have been growing well such as India, China and other emerging economies need to take this matter very seriously. There is a real problem going out there. Don't engage in petty politics as the problem may take longer. So focus on your problem and sort them out.

Did the quick rebound in financial markets led to this complacency with regard to reforms?

When GDP falls there are two responses. One is to get back where you were. This happened quickly. Second is to get back to trend level and this is to reach where you would have been on the trend. What people thought that the quick rebound happened and all the rest will follow as in a normal recession. But, it does not happen like this in financial-crisis-driven recession. And that's where the distinction between financial and economic recession comes. You got back to where you were very quickly. But to reach where you would have been going by trend level will take time. The normal for a financial crisis is not two-three years; it is 10 years.

What could be the impact of this crisis on emerging economies?

India and China have the ability to grow. Slow growth means you will suffer. If we can take appropriate action then the impact will be limited. The EU crisis, Greece and Portugal, has taught us that it is very easy to get complacent about fiscal deficit. It hits you when you are not prepared. With the developed world in trouble, you can't export your way out of trouble. All emerging economies will have to focus on their domestic growth.

So you will need to remove all constraints. Otherwise growth will slow down. If external environment improves then everyone will benefit. The political system has to appreciate there is a very dangerous global situation. Once again it comes back to political system. Countries that take steps to improve regulatory environment, policy environment and remove constraints to growth will benefit.

What are the areas that India needs to act upon to bolster growth?

There are four-five complexes on which we need to work on. One of the key areas is agriculture. The problem has been analysed

for decades. The question is can we try to do some new things. We need to set up a more automatic system of import duties so that the farmer has an idea of the duty structure to help him make long-term decisions. Secondly, it is important to develop a supply chain. One way would be to allow FDI in but not allow them to overwhelm. We need a more efficient system for energy.

Whenever prices of crude go up, we are rendered poorer. Thirdly, urban infrastructure. There is arbitrariness in the allocation of land. So there is a need to have a better such as auction to ensure that better price discovery takes place. Skill development is another area that needs to be given adequate attention to boost growth. Fifthly, decontrol in some areas, some measures in financial sector. But, it ultimately comes down to political economy.

There has been criticism of the country facing policy paralysis...

I would not like to comment on specific events in India. But I would like to emphasise that this is a wakeup call. Even if direct effect on India may not be large, please do not ignore it. Global situation is not good. There is no flexibility left in the global system. Earlier, whenever there was a problem, the US would act as a backup. But that flexibility has gone. This is the time to act.