Why Raghuram Rajan matters

 

The Reserve Bank of India (RBI) governor attracted a lot of global attention recently after a series of public comments he made on how the US Federal Reserve (Fed) should take into account the impact of its actions on emerging markets as it winds down the programme to buy bonds through the creation of new money, a.k.a. quantitative easing (QE). US policymakers such as new Fed chairperson Janet Yellen have brushed aside his concerns with the argument that any country should be free to pursue policy according to its national interest. Others have said that countries such as India should focus on domestic imbalances that reduce their vulnerability rather than bet on US empathy.

Rajan has good reason to be concerned. There has been a renewed bout of global volatility ever since Ben Bernanke first indicated in May 2013 that the QE would be rolled back, though the actual taper began in January. It must be remembered that the unconventional monetary policy that the US has pursued since 2009 is part of a broad global stimulus programme put in place by the heads of important governments after the world economy was nearly brought to its knees after the global financial crisis. This is what the joint statement of leaders of 20 nations after their April 2009 meeting in London said: “We will conduct all our economic policies cooperatively and responsibly with regard to the impact on other countries and will refrain from competitive devaluation of our currencies and promote a stable and well-functioning international monetary system.”

The emerging markets are essentially complaining that the spirit of cooperation that was central to the stimulus should also be part of the exit strategy. The US is behaving in an asymmetric manner. There is also enough empirical evidence that unconventional monetary policy pursued by the Western central banks has indeed had an impact on emerging market economies through pro-cyclical capital flows, currency appreciations and asset price bubbles. The opposite effect—currency depreciations and falling asset prices—are thus inevitable risks during the ongoing QE taper

The emerging markets did not try to stop such effects through the imposition of capital controls, though some such as Brazilian finance minister Guido Mantega did complain about the prospect of currency wars. Most emerging markets—India included—in fact went out of their way to attract more short-term debt at low interest rates to fund their current account deficits rather than deal with the underlying structural causes of such deficits. The focus was thus on funding the external gap rather than reducing it. It is no wonder countries with the worst current account deficits were hit the hardest during the risk aversion that gripped the global markets in August. The rupee was almost in freefall.

Tanay Tapas

PGDM,1st Year.

Source:-Mint