EMs risk breaking out of the hegemony of dominant currencies: RBI Governor

Reserve Bank of India (RBI) governor Shaktikanta Das on Friday cautioned that global spillovers of lose monetary policy measures, in the absence of a global financial safety net could be unintentionally forcing emerging markets economies (EME) to “break out and challenge the hegemony of the dominant reserve currencies.”

Das was speaking at the IMF’s “Governor Talks” programme at the International Monetary Fund-World Bank Spring Meetings. According to Governor Das, managing the spillovers is a “formidable challenge” for EMEs.

“We live in a world of mobile capital flows where consequences of their arrivals, sudden stops and reversals are to be borne nationally,” Das said, adding that while a safety net remains elusive, the strengthening of resources of the IMF gets pushed out into time whenever EMEs come together for Spring or Annual meetings.

“Under these conditions, EMEs which are typically at the receiving end when global spillovers flare up, have no recourse but to build their own forex reserve buffers. Paradoxically, the accumulation of reserves has become stigmatised, including with labels such as “currency manipulation”.”

“As I see it, we may be unintentionally setting the stage for several EME currencies to break out and challenge the hegemony of the dominant reserve currencies. There is a need for greater understanding on both sides,” Das said, while assuring that the Reserve Bank of India (RBI) is not contemplating leading the pack of break out nations.

“In the meantime, so far as the Reserve Bank of India is concerned, we will continue to play by the extant rules of the game,” Das said.

Das’ comments come at a time when the IMF warned that 70 per cent of global economy is slowing down, while the rest, lead mainly by emerging markets economies are expected to grow. According to estimates by Bank of England, EMEs contribute 60 per cent of the global growth, while it was 45 per cent when the US Fed last raised rates in 2006.

At over 7 per cent, India continues to remain the fastest growing large economy in the world, according to IMF.

As the growth slows down and fiscal space gets squeezed, monetary policy is going to be the focus of both EMEs and advanced economies as first line of defence, therefore, “Central banks may once again be expected to assume the mantle of guardians of the world economy,” the RBI governor said.

However, after the global financial crisis exposed several limitations of conventional and unconventional monetary policy tools. This has led to a ‘modern monetary theory’, which is basically a heterodox evolution of ideas, including the thought that a nation can increase its debt as long as interest rates are low leading to low interest servicing cost.

“While the jury is still out on this idea, I have my own strong reservations on this due to its serious downside risks. In the end, monetary policy must touch the real economy, spur investments, and maintain monetary and financial stability,” Das said.

The RBI governor said after the global financial crisis, several EMEs embarked upon structural reforms to reorient their economies, but these reforms “inevitably involve sacrifices, including in terms of losses of growth momentum.”

“Conventionally, these reforms are best undertaken in the expansionary phase of the economic cycle. With growth slowing down in a synchronised manner across borders, the space for undertaking and/or pushing ahead with structural reforms is likely to become severely constricted or even deterred. But the fact remains that we need more structural reforms precisely when the economy is slowing down to ensure durable momentum to growth,” the RBI governor said.

“In this high flux and uncertain environment, EMEs could perhaps be better off by stepping up cooperation on all fronts, while recognising multi-polarity,” he said, adding, one area of cooperation could be to put in place an institutional mechanism which balances the concerns of both oil exporting and importing countries to ensure stability in energy prices.

Das suggested that the central banks should think in terms of tweaking with interest rate change. For example, if the conventional practice is to change rates by 25 basis points and multiples thereafter, there is no harm in changing rates by 10, or say 35 basis points if that is needed.

Governor Das emphasized the importance of interacting closely with financial markets for transmission of monetary policy impulses, which required a sound and efficient payment and settlement system.

“In order to ensure an orderly development of FinTechs and streamline their influence into the financial system, we are now working on guidelines to introduce a 'regulatory sandbox/innovation hub' within a well-defined space and duration to experiment with FinTech solutions,” Das said.