UN bats for cautious financial liberalisation

For the United Nations (UN), 2015 marked a watershed in its long career in the worthy cause of development cooperation as it hosted two significant meetings in the latter half to secure balanced growth of all. In September, world leaders adopted a new set of Sustainable Development Goals (SDGs) as part of the 2030 Agenda for sustainable development, close on the heels of their pact in July on a new financing framework for achieving sustainable development, embodied in the Addis Ababa Action Agenda (AAAA). Towards the close of 2015, under the UN Framework Convention on Climate Change (UNFCC) held in Paris, more than 192 countries signaled an end to the fossil fuel era, committing to emitting reduced greenhouse gas in a universal agreement for the first time eve in order to stave off the ravaging repercussions of climate change. Both the epochal events indubitably invest humanity with a ray of hope for a better tomorrow and to equally better days for the posterity to whom the current generation owes an implicit obligation.

The amount of financing needed to achieve SDGs as also to chart a new low-carbon paradigm of development to resource-starved developing nations including emerging economies such as Brazil and India is no doubt daunting. But the available global public and private savings would be sufficient if only the existing financial system were to effectively intermediate savings and investments in consonance with sustainable development objectives. However the latest flagship annual report of the UN released worldwide on January 22 under the rubric World Economic Situation & Prospects, puts in pointblank that “this is not currently the case”. Without mincing words, it lamented that the global financial system is neither stable nor efficient in allocating finance where it is needed for sustained and inclusive growth. Besides, finance is not generally channeled with social outcomes or environmental sustainability in view.

Given the gargantuan challenges of today’s complex world, action is required at both the national and international levels to simultaneously finance sustainable development and to foster sustainable finance, the report persuasively put. Sustainable finance is defined as finance that is long-term oriented and aligned with economic, environmental and social values through products and markets that balance inclusion with stability.  As spelt out unambiguously in the AAAA, the new financing framework for sustainable development incorporates all sources of financing, including the transfer of resources to developing countries in the form of foreign private capital inflows, official development assistance (ODA) disbursed annually by developed world to the rest and other forms of international cooperation. Viewed from this definition, net resource transfers to developing countries as a whole have been “negative, implying that resources are flowing from developed to developing countries”, the report rued adding that least developed countries (LDCs) with acute resource shortfalls, have been receiving “almost no resources in net terms”. This is a damning indictment on the colorful definition the western donors coined on development cooperation decades back when they launched ODA under the aegis of the Organization for Economic Cooperation & Development (OECD), the club of the rich nations.

Tracing the resources flow from the bountiful to the needful as also extreme volatile private capital flows, the UN report said that following the 2008 financial crisis, most forms of capital inflows initially rebounded but began to ebb after 2010 with total net capital inflows to developing and transition economies turning negative in 2014. In 2015, it is estimated that over $700 billion of capital left developing and transition economies, greatly surpassing the magnitude of net outflows during the Great Recession. It is estimated that even the non-debt creating and desirable inflows such as foreign direct investment (FDI) plunged by $145 billion, driven by large declines in East and South Asia and that portfolio flows which tend to be more volatile, turned negative.  One need not stretch one’s memory to recall how countries like India had to build firewalls against taper tantrum, a reference to the possible lift-off of interest rate by the US Federal Reserve in the midsummer of 2013 and the mayhem it wrought on the domestic and other bourses worldwide.

The greatest decline, however, was in “other” investment, mostly interbank loans and currency/deposits, trade credits and other equity, which has historically been the most volatile form of capital flow. This decline partly reflects a persistence of commercial banks reducing their exposures to higher risk emerging economies and could “potentially be further impacted going forward by the introduction of Basel III capital adequacy standards for banks, the  report warned duly. There is also evidence of recent increasing financialisation of FDI with cross-border merger and acquisition sales in developing countries surpassing pre-crisis peaks to hit an historic high of $120 billion in 2014. Overall, the UN report reckons that the largest net capital outflows in 2015 were from East and South Asia and Commonwealth of Independent States (CIS) countries.

The report attributes the flight of capital from where it is needed to where it is already overstocked, to the slump in commodity prices, the slowdown in China and other emerging economies and the dim prospects of higher interest rates in the US. Even governments facing large net capital outflows typically responded by raising interest rates and/or letting their currencies devalue, these types of measures quite often failed to stem outflows and/or had negative fallouts on the domestic economy, often adversely affecting growth because of the higher costs of capital for domestic borrowers. When the previous UPA government Finance Minister P Chidambaram talked up the markets by concentrating on quotidian market fluctuations rather than concentrating on beefing up macroeconomic fundamentals in 2013, it was given to the new RBI Governor Raghuram Rajan to do the firefighting and the impact of the steps he had undertaken in a textbook fashion as outlined by the UN report still lingers. The slowdown of the economy for two years in a row with borrowing cost not coming down an inch to fire the animal spirit of entrepreneurs are proof enough that  the country had lost its appetite to retain policy space to safeguard itself from  external shocks, policy analysts wryly say.

The UN report rightly hoists the red signal that since the early 1980s there have been multiple waves of large short-term capital flows to developing nations, “but not one of them resulted in growth miracle”. Per contra, any abrupt surge in outflows generally engenders large exchange rate depreciation which raises the costs of servicing foreign-currency denominated debt. 

This has the unintended upshot of forcing firms into bankruptcy, destroying jobs and increasing macroeconomic instability. Given this harsh reality and given the nature of the global economy in which each nation is now relearning what it had neglected by quirk of circumstances in the wake of Washington Consensus of deregulation and financial liberalisation, it is time India treaded on the path of liberalisation of financial services in general and more so capital inflows of all forms save FDI in particular, so that any potential disaster or mayhem could be averted.