At the Annual General Meeting on June28, the General Manager, BIS Jaime Caruana hoisted the red signal when he pertinently noted that “despite all efforts to step out of the shadow of the financial crisis, conditions in the global economy are still far from normal. The build-up of leverage and financial risks, the dependence of financial markets on central banks and the persistence of low interest rates—all these seem to have become routine”. He further quipped that “just because something is routine does not mean it is normal” and pitched for efforts for policy normalization in rich countries. This is important now than ever before since overall, lower oil prices provide the global economy with a significant growth dividend. He maintained that this tailwind could underpin a steady normalization of monetary policy with due regard to country-specific conditions. He did not rule out normalization generating “some volatility in the short-term” even as it might help to contain risks in the longer-term to the global financial stability.

Providing a synoptic profile of the global economy, the report contends that global economic growth may now be not far from historical averages but it remains ‘unbalanced’. Debt burdens are still high and often growing relative to output and incomes. The economies hit by a balance sheet recession are still struggling to return to healthy expansion, while in several others, financial imbalances show signs of building up in the form of strong credit and asset price spurts, despite the absence of inflationary pressures. The report is right in claiming that monetary policy has taken on “far too much of the burden of boosting output” even at a time when productivity growth has perceptibly plummeted across the world.

Stating that the very low interest rates that have prevailed for so long might not be “equilibrium” ones, which would be favorable to sustainable and balanced global expansion, the BIS argued that on the contrary low rates might in part have contributed to it by fuelling costly financial booms and busts. The result is, BIS noted, “too much debt, too little growth and excessively low interest rates with low rates begetting lower rates.”

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 at a time when cheap dollar credit is sloshing around the money markets, countries like India had liberalized norms for external commercial borrowings (ECBs) 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 per cent)”. The report rightly warns 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”.

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, when tighter monetary conditions in the US and an appreciating dollar triggered crises. The favorable factors include, it said, stronger macroeconomic 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 mobilized 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 with any levity to potential problems.

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 macroeconomic concerns, but did not coincide with any more damaging unwinding of domestic financial imbalances”. So EMEs like India and its apex bank under the adroit and eagle-eyed watch of the ace central banker Dr. Raghuram G 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 fiscal policy conduct, the BIS plumps for the sovereign debt on a sustainable path as the overriding priority, which unfortunately in many cases it is not. According to the BIS, this is “a precondition for lasting monetary, financial and macroeconomic stability and it is also what defines the near-term room for manoeuvre”. 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 normalizing too late and too gradually. And, where easing is called for, the same should apply to the risks of easing too aggressively and persistently”. As the central bankers’ central bank, the BIS has flagged off real-time vexatious concerns plaguing the global financial system and it is time the central banks got the message and imperceptibly persuaded their political bosses to play by rules to stave off any eventuality of egregious nature, analysts caution. (IPA Service)