Millennium Post

The great financial crisis

If the fiscal stimulus put in place by emerging economies such as India and China in the aftermath of the world’s worst financial crisis of 2008 cost them dear in terms of high fiscal deficit and slowdown in growth, the accommodative monetary policy of advanced countries continues to exert a disruptive and disproportionate spillover effect across the globe. More particularly so, in emerging economies such as India which has had to contend with the abrupt exit of institutional investments and speculative attacks on currency.

No wonder, India’s central bank Governor Raghuram G Rajan railed against competitive monetary easing and fervently pitched for global monetary policy coordination in professional platforms the world over. More recently addressing a convention organised by the Institute of Monetary and Economic Studies, Bank of Japan in Tokyo on 28 May, Rajan proposed that ‘large country central banks, both in advanced countries and emerging markets, internalise more of the spillovers from their policies in their mandate and are forced by new conventions on the ‘rule of the game’, monitored by an impartial agency, to avoid unconventional policies with large adverse spillovers and questionable domestic benefits’.

Even as there are no matching and meaningful pleas by fellow central bankers to buttress Rajan’s loud thought on this vital issue, the world’s central bankers’ bank, the venerable Bank for International Settlements (BIS) has chipped in and thrown its weight. In its Annual General Meeting on 29 June at Basel, Switzerland, BIS General Manager and distinguished banker. Jaime Caruna remarked that the central banks the world over are today confronted with three key challenges. First is to transit towards a less debt-driven growth model and the second is to transit towards a more normal monetary policy and the third is to the step out of the shadow of the crisis. He rightly said the key to mastering the three transitions is close international cooperation and a better understanding of how policy action will affect others in a highly integrated world is therefore more important than ever, while promising that the BIS stands ready to promote this cooperation in the area of monetary and financial stability.

It would not be off the mark to highlight some of the salient points flagged off by the BIS Annual Report as it succinctly but sharply stated that though the global economy has displayed encouraging signs over the past year, its malaise persists ‘as the legacy of the Great Financial Crisis and the forces that led up to it remain unresolved’. Without mincing little words, it said that in order to overcome that legacy, policy needs to go beyond its traditional focus on the business cycle. It must perforce address the longer-term build-up and run-off of macroeconomic risks that characterise the financial cycle and to shift away from debt as the main engine of growth.

The report took due cognisance of the prompt policy response of rich countries to the financial crisis which did cushion the blow and forestall the worst. Specifically, an aggressive monetary policy easing in crisis-hit economies restored confidence and obviated the financial system and the economy from plunging into a tailspin. But the relief gave way to disgruntlement before long as the global economy did not recover and fiscal policy expansion failed to jump-start the economy. Stating that the recession was not the typical postwar one to quell inflation, it said this was a balance sheet recession, associated with the bust of an outsize financial cycle. As a result, the debt and capital stock overhangs were immense, the damage to the financial sector far greater and the room for policy man oeuvre much more limited. Tracing the fallout of the crisis, BIS noted that extraordinarily easy monetary conditions in advanced economies have spread to the rest of the world, encouraging financial booms there because currencies were used well beyond the borders of the country of issue. In particular, there is some $7 trillion in dollar-denominated credit outside the United States and it has been growing strongly post-crisis! They have also done so indirectly through arbitrage across currencies and assets.

The report also highlights another disquieting trend as over the past few years, non-financial corporations in a number of emerging market economies had borrowed heavily through their foreign affiliates in the capital markets, with the debt denominated mainly in foreign currency. This has been labeled the ‘second phase of global liquidity’ to differentiate from the pre-crisis phase, which was largely centred on banks expanding their cross-border operations. The corresponding debt may not show up in external debt statistics or, if the funds are repatriated, it may show up as foreign direct investment! BIS cautions that this could signify ‘a hidden vulnerability, especially if backed by domestic currency cash flows derived from over-extended sectors, such as property, or used by carry trades or other forms of speculative position-taking’.  Emerging economies such as India need to be overly careful on this count.

An impartial take-away from this erudite report is a call for return to healthy global growth which demands adjustments to the current policy mix.
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