A calibrated exit from stimulus packages will be one of the key challenges for governments, including India’s, as the world recovers from the 2008 financial crisis, according to a report by the Reserve Bank of India’s (RBI’s) economic analysis and policy department.
Governments across the globe had cut taxes and interest rates to help economies cope with the global financial crisis that began in 2008. RBI had cut its key repo rate to 4.75 per cent by April 2009 from 9 per cent in late 2008 as the financial crisis that emanated from the western economies enveloped the emerging economies too. RBI raised the repo rate by 25 basis points in March and April this year to 5.25 per cent.
Authorities faced the dilemma whether to unwind the stimulus aggressively and whether to first unwind monetary and fiscal policies or if to exit in a coordinated manner, said RBI’s Currency and Finance report, titled “Global financial crisis and Indian economy”.
Fiscal authorities in both developing and developed economies are likely to face the challenge of bringing the government debt to prudent levels. Given the low tolerance to high debt in some emerging markets, the authorities might have to lower debt ratios that were even below the pre-crisis levels, it said.
| DEBT SUPPORT EMERGING MARKET BOND ISSUANCE | |||
| Region | 2007 | 2008 | 2009 |
| Latin America | |||
| Argentina | 3.40 | 0.10 | 0.50 |
| Brazil | 9.90 | 6.70 | 10.10 |
| Chile | 0.30 | 0.10 | 3.00 |
| Mexico | 6.30 | 4.50 | 15.50 |
| Emerging Europe | |||
| Hungary | 4.10 | 5.30 | 3.00 |
| Poland | 4.10 | 3.80 | 10.20 |
| Russia | 30.20 | 22.10 | 10.80 |
| Asia | |||
| China | 2.10 | 2.10 | 3.30 |
| INDIA | 7.50 | 1.40 | 2.20 |
| Indonesia | 1.80 | 4.20 | 5.50 |
| Malaysia | 0.90 | 0.40 | 0.10 |
| Philippines | 1.00 | 0.40 | 5.40 |
| Thailand | 0.80 | 0.50 |
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Emerging economies can protect themselves better by building sufficient foreign exchange reserves and keeping currency volatility under check. These economies must develop active local bond markets as they provide an alternative to bank intermediation as also reduce dependence from overseas, it said.
The Indian economy, which benefited from its increased integration with the global economy, also increased its vulnerability to global shocks, the report said. Sectors, including textiles and gem and jewellery, were the ones to get hurt the most and about 42 percent of exports were impacted.
The global financial crisis also exploded the myth of the “decoupling theory”. Emerging markets, including India, remained largely insulated from the first-round effects of global financial crisis markets, but as the crisis deepened in advanced economies, the complex and wide-ranging interaction between the financial and the real economy began to have an impact on emerging economies, it said. The real sectors in emerging market began to feel the impact in the second stage, it added.
India, which has a sound banking system and a smoothly functioning financial system, also suffered from the spillover effects. It was through sudden capital flow reversals, as part of the global deleveraging process, and liquidity hiccups, mainly through the confidence channel.
Among the issues authorities are debating today include whether the mandate for central banks should be broadened to go beyond inflation-targeting to include taking cognisance of build-up of financial bubbles, and also whether they should do both bank supervision and regulation, the report said. Going ahead, the authorities would need to strike a right balance between regulation and market innovation, it said.
Concerns have been raised about the use of dollar as the reserve currency because of the economic and financial problems in the US and its fiscal imbalances. While the US represented about 25 percent of the world GDP, the dollar represented as much as three-fourth of central banks’ international reserves, it said.
“The underlying factors responsible for the crisis range from excessive leverage and risk appetite fuelled by an extended period of unusually low interest rates and large global imbalances, deficient risk management practices, uncontrolled financial innovation, lack of investor due diligence and weaknesses in regulatory and supervisory arrangements,’’ the report said.
Authorities must begin working on potential corrective action in case of a future recurrence of similar crisis, it said.
