The Reserve Bank of India (RBI) governor Duvvuri Subbarao said there is a bigger risk that the recession in the US and the sovereign debt crisis in European nations may materialise simultaneously, which can hit emerging market economies through several channels like exports, capital flows and confidence.
He said the main impediment to an effective resolution common to both flashpoints, the US recession and Europe debt crisis, “appears to be political”.
In the US, the tension is between fiscal stimulus in the immediate term and credible fiscal consolidation over the medium to long term. But in the euro area, there is a shared monetary framework, but without a shared fiscal framework.
“What is standing in the way of a credible and confidence inspiring resolution of the fiscal-financial imbroglio are political compulsions,” he said.
The World Bank said yesterday the euro zone debt crisis threatens the mild recovery underway in emerging European and Central Asian nations, adding main risks for parts of the region come from their exposure to banks in cash-strapped Greece and Italy.
At the IMF meeting, Subbarao said the present crisis has demolished the decoupling theory that assumed emerging market economies would continue to be resilient despite downturn in advanced countries. “In an age of globalisation, the decoupling theory was never persuasive. The 2008 crisis dented its credibility and the 2011 crisis has completely demolished it.”
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According to the RBI governor, stability of EMEs has been hit by the crisis in advanced economies through several channels like trade, capital flows, and commodity prices, but it is the confidence channel which is the most important one.
“By far, the most important channel of transmission is the confidence channel which could hurt investment and growth prospects in EMEs — when confidence is hit, even strong fundamentals do not matter,” he said.
He warned the probability that all these channels become active and feed on each other is quite high. Though the crisis could affect different EMEs differently, but what is common across EMEs is that their growth momentum will be interrupted if the current global problems are not resolved quickly, according to him.
Comparing the crisis of 2011 with that of 2008, Subbarao said the policy space for stimulus is much less now, as fundamentals of both advances and EMEs are different. In the years just before the 2008 crisis unfolded, advanced economies experienced steady growth and emerging economies saw accelerated growth with all round price stability, which is not the case now.
“In 2008, the world responded to the crisis in coordination. There were differences, but these differences were resolved, and governments and central banks acted firmly, decisively and where required creatively. A similar perception of coordination is lacking today,” he said.
Subbarao said the crisis of 2008 originated in the financial sector and transmitted to the real sector, but the rescue was by the public sector. “In 2011, it is the other way round. The crisis is originating in the public sector and hitting the financial sector, and undermining the confidence of the private sector.”
In addition, in 2008, both advanced economies and emerging economies were at the same phase of the business cycle and now, they are at different phases.
Subbarao concluded by saying as the world is waiting with great anxiety about the outcome of the weekend’s Fund-Bank annual meetings and the G-20 meetings, countries once again have to show the resolve of 2008 to meet those expectations.