The Hindu Business Line : `Reduction of US debt needs global adjustments'

The most surprising development in the international financial system in the last five to six years is the large flow of capital from the emerging markets to the traditional industrial countries and the associated build-up of reserves in the developing world, said Professor Lawrence H. Summers of Harvard University. He was speaking at the ninth L K Jha Memorial Lecture here on Friday.

The US is an absorber of global savings while the rest of the world is a supplier. Japan and the non-European industrialised countries contribute about 35 per cent of net international borrowings by the US. The rest is financed by emerging markets and oil exporting countries. "This broad pattern has been going on for several years now and on current projections will continue for quite some time," Prof Summers said.

Current account deficit

The US current account deficit is close to 7 per cent of GDP and likely to increase. It is creating an export stimulus demand approaching 2 per cent of global GDP. Any reduction in this would require substantial adjustments in other parts of the world to avoid a recession.

The build-up in US net foreign debt is substantially mirrored in the reserve accumulation by emerging markets. These reserves have grown from $0.5 trillion in 1999 to over $2 trillion today, Prof Summers said.

The opportunity cost of holding the surplus reserves comes to 1.85 per cent of the combined GDP for the top 10 leading holders of excess reserves. "If the wealth tied up in reserves were invested either domestically in infrastructure or in a fully diversified long-term way in global capital markets, 6 per cent would not be an ambitious estimate of what could be earned. The resulting gain would be close to $100 billion a year," he said.

Of greater concern is the risk composition of the assets in which reserves are invested. When the levels of reserves were enough to protect the economy from a possible financial crisis, they could have been invested in `maximally liquid, maximally safe' asset forms. But now as the reserves have increased, there seems to be a case for more aggressive investment either in support of imports that have a high social return or in a much richer menu of international assets.