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‘Rich nation follies may cause asset crash’

Reserve Bank Governor Raghuram Rajan has warned that global markets are at the risk of a ‘crash’ due to the lingering competitive loose monetary policies being followed by the developed economies.

Warning that the current build-up of financial sector imbalances may cause sudden price reversals and sharp spikes in volatility, Rajan said, ‘we are taking a greater chance of having another crash at a time when the world is less capable of bearing the cost’.

In an interview to London-based Central Banking Journal on Wednesday, he said, ‘unfortunately, a number of macro- economists have not fully learned the lessons of the great financial crisis. They still do not pay enough attention -en passant- to the financial sector. Financial sector crises are not as predictable. The risks build up until, wham, it hits you’.

The governor expressed fears that central banks ‘may be exhausting room on the financial side and creating a situation where there will be a discontinuous movement in the financial sector.’

Discounting arguments from a section of economists that asset price hike is not due to credit growth, Rajan said problems do not appear to be arising from credit growth although this is an issue in some emerging markets.

‘They (global investors) put trades on even though they know what will happen as everyone attempts to exit positions at the same time, there will be major market volatility,’ the RBI chief said.

Reiterating his warnings that emerging markets are especially vulnerable to big shifts in capital flows brought on by unprecedented monetary accommodation in rich nations, Rajan warned, ‘there will be major market volatility if such a crash occurs. True, it may not happen if we can find a way to unwind everything steadily. But it is a big hope and a prayer’.

The former IMF chief economist, who famously predicted the 2008 financial meltdown — three years before at an event in the US — from which the global economy is yet to recover fully, compared the current global markets to the 1930s which marked the worst recession in the financial history of the world.
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