While India has in no way contributed to global financial imbalances, it has a huge stake in the process of unwinding of these imbalances and its impact on exchange rates, former Reserve Bank of India (RBI) governor Y V Reddy has said. He was speaking at the Indian Council for Research on International Economic Relations (Icrier).
Since India had not contributed to the problem, its ‘objective’ views on the resolution of the problem must be heard, Reddy said during a discussion on the impact of the European debt crisis organised by Icrier.
The most important lesson of the global financial crisis was that free capital account convertibility and free mobility of capital did not contribute to global economic stability but were potentially destabilising elements, he said. Since financial markets did not treat all countries equally, there was a need for developing economies like India to seek “self-insurance”, said Reddy. India’s experience in this regard had lessons for global economic management, he added.
Stating that he did not think that there was any threat of default or disintegration in the euro zone, he said, “There is enough political determination within the euro area to address the issue.”
Reddy, who left Mint Road a fortnight before the problems in the US financial sector hit markets and economies globally, said the European governments would defend the euro since they were politically committed to a multipolar world.
India, he said, had a stake in the economic management of the euro zone economies, since India seeks stable global financial and currency markets. Reddy said the Indian growth story was unlikely to be affected by the European sovereign debt crisis as economic fundamentals remained strong and the global economic scenario was also gathering resilience. But, he said, India should gaurd against the downside risks of adjustment that Europe would necessarily have to go through.
At the same time, he said managing the fiscal situation was the biggest challenge for the government and the central bank. “The real challenge is not the external sector, is not in the financial sector, it is in the fisc…In the external sector, the policy framework is reasonable in position and watchful of the global uncertainty as they were. The real challenge for India is domestic. You have to take care of the fiscal situation because ultimately fisc is the risk.”
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Strike a balance between US and China
On the raging debate over the need for an alternative global reserve currency, Reddy said the US dollar was likely to be the global reserve currency for the next few decades even as issues of convertibility to other potential reserve currencies would remain.
He suggested India should seek a discussion within the framework of the G-20 on the management of global reserve currencies. While the US dollar, the Japanese Yen, the British Pound and the Euro faced problems of deficit, Asian currencies were coping with the problem of surpluses, he said.
On the Chinese government’s decision to allow the yuan to appreciate, he said the step would hardly affect India and the major impact would be felt by the policymakers in the US and China. Last month, China, which is under pressure from economies globally to shift to a market-based exchange rate system, took the first step to reform the currency. He saw China’s reaffirmation of support for the Euro, during the recent meeting between Chinese Prime Minister Wen Jiabao and German Chancellor Angela Merkel, as a way of hedging against uncertainties with respect to the US dollar.
India, Reddy said, should strive towards creating a balance and initiate a dialogue among major reserve currency issuers like the US, the euro zone and Japan as well as countries with the largest reserve currency holdings like China and Korea.
“At the G-20 level, India should try to rope in and have a dialogue between the reserve country generating nations and those with the largest holdings and try to minimise the disruptions,” Reddy added.