The annual report of any globally known and prestigious central bank is always looked upon with reverence not only in banking circles but also elsewhere including by other countries’ financial institutions and policy wonks to take a cue or two to read the pulse of the international monetary and financial system (IMFS). So, when the report is from what is termed in financial parlance the central bankers’ central bank, the Bank for International Settlements (BIS), billeted in Basle (Switzerland) with a host of 60 central bank members including our Mint Street (Mumbai) RBI, the interest in and the message this hoary body conveys axiomatically evoke deserved reaction from all the stakeholders in the global economy.
The pronouncement of the BIS that “interest rates in the rich world have been extraordinarily low for an exceptionally long phase with the international monetary and financial system spreading easy money and financial conditions from the core economies to other economies through exchange rate and capital flow pressures, furthering the build- up of financial vulnerabilities” is turning out to be true to the dismay of the rest of the West!
For India, the BIS report is pregnant with objective messages and the failure to forearm the now two-trillion-dollars economy with appropriate policy action by the authorities right in time should have the macro-economic fundamentals rudely shaken and withal broken its ambitious agenda to rev up its growth engine in full throttle.
A key manifestation of the potential vulnerabilities has been the strong expansion of US dollar credit in emerging market economies, mainly through capital markets. It is a sheer coincidence that when the cheap and plentiful dollar credit is sloshing around the money markets, countries like India had liberalised norms for external commercial borrowings (ECBs) and raised ceilings on borrowings in recent months for its corporate entities.
Interestingly, the June quarter International Banking and Financial Market Developments journal of BIS noted that the share of the US dollar in total cross-border bank claims remains “very high for a number of large Emerging Market Economies (EMEs), exceeding two thirds for Brazil (78 per cent), India (74 per cent), Chinese Taipei (70 per cent) and Indonesia (68 percent)”.
The report gravely cautions the borrowing countries that the “system’s bias towards easing and expansion in the short-term runs the risk of a contractionary outcome in the longer term as these financial imbalances unwind”.
The BIS rightly contends that though the reliance on a single global currency has diminished slowly since Bretton Woods, the US dollar continues to play a key role in global trade and finance. As a means of exchange, the dollar is on one side of no less than 87 per cent of foreign exchange market transactions, with an even higher share of forward and swap transactions.
Its dominance in foreign exchange markets makes the dollar the sole intervention currency outside Europe and Japan, which bolsters its high share in foreign exchange reserves. More than half of world trade is invoiced and settled in dollars, pointing to the greenback’s pre-eminent role as a unit of account. Interestingly, the advent of the euro and the dollar’s trend depreciation since the 1970s did not materially challenge the dollar’s role as a store of value.
At 63 per cent, Dollar maintains well-nigh three times the share of the Euro in foreign exchange reserves the world over! The second volume of Economic Survey 2014-15 notes that the currency
composition of India’s total external debt (at $ 456 billion in end-September 2014) shows that the share of US dollar-denominated debt in external debt stock continued to be the highest at 60.1 percent.
Looking ahead as monetary policy in major economies slowly reverts to normal cycle with interest rates likely to harden incrementally but not dramatically, the BIS contends that in several respects EMEs are today in “better shape” than in the 1980s and 1990s.
The favourable factors include, it said, stronger macro-economic framework and flexible exchange rates, a robust financial infrastructure and prudential regulation with larger foreign exchange reserves. Still, “caution is called for”, BIS said adding that a seemingly solid performance in terms of growth, low inflation and fiscal probity did not insulate Asian economies in the 1990s.
What is worrisome is that foreign exchange exposure is now concentrated in the corporate sector, where currency mismatches are harder to measure. There are also limits to how far official reserves can be mobilised to plug private sector funding liquidity shortfalls or to defend currencies.
Today EMEs produce half of the world’s output in purchasing power parity (PPP) terms. EME borrowers account for 20 per cent of banks reporting into the BIS banking statistics and for 14 per cent of all outstanding debt securities. All these are very significant numbers to treat lightly.
The Bank further argued persuasively that it remains to be seen “how the shift from banks to asset managers will influence asset price dynamics: the size asymmetry between suppliers and recipients of funds has not got any smaller, and markets could react violently if pressures become one-sided—liquidity will certainly evaporate in the heat of a rush for the exits.
The 2013 ‘taper tantrum’ was only an incomplete test; it reflected traditional balance of payments and macro-economic concerns, but did not coincide with any more damaging unwinding of domestic financial imbalances”.
So EMEs like India and its apex bank under the deft watch of the ace central banker Dr Raghuram Rajan has its tasks cut out in being vigilant on the headwinds from the external front. This is the takeaway from a cursory study of the BIS report.
For countries like India that do have fiscal space and need to use it for the benefit of demographic dividend it is suffused with, the BIS said the challenge is “how to do so most effectively”.
This means, first and foremost, facilitating private sector balance sheet repair, supporting reforms that boost long-term productivity growth and a greater but judicious emphasis on investment at the expense of current transfers.
the last meaning consumption expenditure and unmerited subsidies that India has a dubious distinction to splurge on! Similarly for monetary policy, for all the crescendo of rate cuts one gets inured to from trade and industry and other stakeholders of the economy from the central bank, the BIS favors “a balanced approach”.
This it meant “attaching more weight than hitherto the risks of normalising too late and too gradually. And, where easing is called for, the same should apply to the risks of easing too aggressively and persistently”. Indubitably the BIS has flagged off real-time vexatious problems plaguing the global financial system. Hence, it is time the individual central banks got the message right and got around their political bosses to play strictly by rules to stave off any eventuality of deleterious kind.