UN pitches for global pragmatism

Are monetary policy mechanisms, excessively accommodative on the one hand and very tight on the other, delivering the desirable results to the global economy? It is a question that the UN Conference on Trade and Development (UNCTAD) rightly raised. In its annual flagship publication, Trade and Development Report (TDR), the Geneva-based UN body has examined in depth a raft of interconnected challenges confronting the international monetary and financial system. They range from liquidity provisions through banking regulation to debt restructuring and long-term public financing—all germane to the development concerns of emerging economies such as India.

The UNCTAD report highlighted that following the 2008-09 crisis, the global economy has been growing at around 2.5 percent. Such a figure is below the estimated benchmark of a three percent potential growth rate and significantly below the four percent average of the pre-crisis years. The growth rate for 2015 is expected to hover at 2.5 percent. Such an outcome is the combined consequence of a slight acceleration of growth in developed economies, a moderate deceleration in developing economies and a severe decline in transition ones.

Interestingly, since the crisis, many developed economies have turned to ‘unconventional’ monetary policy instruments in their efforts at recovery. Essentially, key central banks have been buying up the securities held by leading banks in the hope that increased reserves would generate new lending and stimulate new spending in the real economy.  But sadly, the results have been “underwhelming” with recovery in the rich world from the 2008 crisis the weakest on record! Curiously, while job growth was slow, investment unable to pick up the pace and productivity growth stuck in second gear, stock markets had recovered and property markets rebounded with profits going up in many cases beyond the highs scaled before the crisis, UNCTAD bemoaned. Meanwhile, debt levels have continued to climb with an estimated 57 trillion dollars added to the global debt since 2007.

The UN body justifiably contended that regardless of the future course, the fact remains that the medley of an easy monetary policy and a sluggish real economy has till date encouraged excess liquidity in developed economies to spill over into emerging economies. While this was evident after the dot.com bubble burst, it has escalated markedly since the 2008 global financial crisis. Noting that since the turn of the millennium, the rate of private capital flows into developing and transition economies (DTEs) has accelerated markedly, it said as a proportion of gross national income (GNI), net external inflows into DTEs increased from 2.8 percent in 2002 to 5 percent in 2013, after having reached two historical milestones of 6.6 percent in 2007 and 6.2 percent in 2010. At the same time, many DTEs experienced strong growth and improving current accounts, accumulating as a group considerable external reserve assets. 

Pertinently and persuasively the UNCTAD report does point out that foreign capital can play a useful role in closing domestic savings gaps, and foreign direct investment (FDI) can help promote domestic productive capacity. However, “part of the challenge is that an increasing proportion of the inflows is of a short-term more risky and speculative nature,” according to the report. These are symptomatic of the type of volatility reminiscent of inflows that preceded previous financial crises in the 1980s and 1990s, the report warned. Moreover, the report recalled past episodes to hammer home the point that “increasingly large and volatile international capital flows, even if they give a short-term boost to growth, an increase vulnerabilities to external shocks.” Besides, they have the added disadvantage also of limiting the effectiveness of policy tools tasked with managing them. As such, these flows “compromise the macroeconomic conditions necessary for supporting growth, structural transformation and inclusive development in the long-term.”

Moreover, large capital inflows can generate pressures for currency appreciations that are aggravated by a widespread commitment to maintaining extremely low rates of inflation as a goal, UNCTAD warned.  The resulting macroeconomic milieu, marked by high and volatile interest rates, combined with the appreciated currency, run the risk of discouraging both aggregate demand and the types of investment that deepen productive capacity.  Illustrations, if any were needed, in mid-2015, global financial markets were spooked by recessions in Brazil, the Russian Federation and South Africa (all prestigious economies belonging to the BRICS bloc) and by signs of economic weakening in China, the poster-boy of double-digit growth for three decades. Global investors, already anticipating a hike in interest rates in the US and a continuing fall in commodity prices, moved briskly to exit emerging economy equity and bond markets, causing mayhem and paranoia!

It is small wonder that UNCTAD Secretary-General Mukhisa Kituyi said “managing the persistent volatility of short-term financial flows requires an internationally coordinated policy response”, not merely a financial correction with few serious consequences for the real economy. He said that with developing countries contributing over 60 percent of the global growth since 2011, the knock-on effects of recent emerging market difficulties could be widely felt, a timely warning that the rich world pays due heed to if the global financial stability is not get rocked to the detriment of all stakeholders. UNCTAD report emphatically underscores the emerging economies, in general, and all economies susceptible to excessive short-term capital flows, in particular, to take efforts to strengthen the links between fiscal and monetary policies and development goals.

 Instead of relying solely on interest rates and very low inflation targets to manage capital inflows and the balance of payments, UNCTAD argued that “what is needed is a combination of appropriate capital account and exchange rate management that maintains access to productive external finance, including trade finance and FDI that builds local productive capacity, while also encouraging domestic investment.” Besides, central banks can and should do more than just maintain price stability or the competitive exchange rate to support development. By way of example, UNCTAD report points out that they could use credit allocation and interest rate policies to facilitate industrial upgrading and provide key support to development banks and fiscal policy. Such steps have been taken by central banks in many of the newly industrializing economies. These are nostrums the Indian authorities should pay heed to if their intention is to kick-start recovery before long.

In the end, as evidenced by the challenges encountered by rich countries in emerging from recent crisis, monetary policy alone is not enough. Proactive fiscal and industrial policies are also essential for generating the structures and conditions that bolster productivity growth and the expansion of aggregate demand.