Global challenges, global solutions

Updated on: Apr 22, 2011

To the extent that lumpy and volatile flows are a spillover from policy choices of advanced economies, managing capital flows should not be treated as an exclusive problem of emerging market economies.

Recent experience suggests that globalisation offers incredible opportunities but also poses immense challenges. If the years before the global financial crisis — the period of the so-called ‘Great Moderation' — demonstrated the benefits of globalisation, the devastating toll of the crisis showed its costs. The post-crisis reform effortis aimed at managing the forces of globalisation for maximising our collective welfare.For these reforms to be sustainable, it is important that they are even handed as between those who shape the forces of globalisation and those who have to adjust to the forces of globalisation.


The shift in the global balance of power in favour of EMEs is by now a familiar story. It may be useful to put some numbers around that. Setting GDP at 100 in the base year of 2000, against the aggregate growth of 17 per cent in the decade 2000-10 of advanced economies, emerging market and developing countries (EMDCs) grew by 82 per cent and BRICs (Brazil, Russia, India, China) by a whopping 127 per cent. When we look at shares in global GDP, the share of advanced economies in the global GDP dropped from 80 per cent in the year 2000 to 67 per cent in 2010, with a mirror increase in the share of EMDCs.

The year 2010 was one of recovery, and EMEs powered this by contributing to nearly three quarters of global growth in 2010. EMEs were also the motive force behind the estimated expansion of world trade by 12 per cent last year, an impressive reversal from a shrinkage of 11 per cent in 2009. These trends have an interesting implication for the decoupling hypothesis, which was intellectually fashionable before the crisis.

As a matter of fact, the crisis failed to validate the decoupling hypothesis, as all EMEs were affected, admittedly to different extents. What the crisis, in fact, reinforced is that the economic prospects of advanced economies and EMEs are interlinked through trade, finance and confidence channels.

Let me now move on to specific issues.


First is the issue of global rebalancing. Global rebalancing will require deficit economies to save more and consume less, while depending more on external demand relative to domestic demand for sustaining growth. Surplus economies will need to mirror these efforts — save less and spend more, and shift from external to domestic demand. The problem we have is that while the adjustment by deficit and surplus economies has to be symmetric, the incentives they face are asymmetric. Managing rebalancing will require a shared understanding on conducting macroeconomic policies to minimise disruptions to macroeconomic stability.

These adjustments have several components. Importantly, letting exchange rates remain aligned with economic fundamentals, and an agreement that currency interventions should not be resorted to as an instrument of trade policy should be central to a coordinated approach at a multilateral level.

That takes me to the second facet of global imbalances — return of lumpy and volatile capital flows.


Since capital flows have become such an emotive topic around the world in recent months, it is important to be mindful of a few realities. First, EMEs do need capital flows to augment their investible resources, but such flows should meet two criteria: they should be stable; and they should also be roughly equal to the economy's absorptive capacity.

The second reality that we must remember is that capital flows are triggered by both pull and push factors. The pull factors are the promising growth prospects of EMEs, their declining trend rates of inflation, capital account liberalisation, and improved governance. Among the push factors are the easy monetary policies of advanced economies which create the capital that flows into the EMEs.

To the extent that lumpy and volatile flows are a spillover from policy choices of advanced economies, managing capital flows should not be treated as an exclusive problem of emerging market economies.

The intellectual challenge is to build a better understanding of the forces driving capital flows, what type of policy instruments, including capital controls, work and in what situations.


The adjustment process to secure and preserve global financial stability should ensure that individual actions of countries add up to a coherent path forward. I want to emphasise two aspects.

First, the IMF's surveillance function is critical — it assumes a vital, pre-emptive role in preserving global and national stability. The forthcoming Triennial Surveillance Review provides an opportunity to take stock of the steps taken and to assess recent experience, including the adequacy of the legal framework for surveillance.

Second, reserve accumulation has to be viewed in the context of economic growth and development. The insurance that reserves provide against sudden stops and reversals of capital flows far outweigh the opportunity costs of holding reserves. The experience of the crisis has amply demonstrated this. What constitutes an adequate level of reserves is a country-specific question, involving a judgment based on practical experience. Clearly, there can be no “one-approach-fits all” to such assessments.

My fourth point relates to a global reserve currency. The recent crisis has brought home the complex challenges arising from the world having a single reserve currency.

In the ongoing search for solutions, one option is to have a menu of alternative reserve currencies which fulfil the required criteria – full convertibility; the exchange rate determined by market fundamentals; a significant share in world trade; liquid, open and large financial markets in the currency issuing country; and also the policy credibility to inspire the confidence of potential investors.

There is a debate on whether the SDR can be a reserve currency. For the SDR to take on this significant role, several prerequisites have to be in place.

At the present time, the SDR does not satisfy these conditions. Thus, we see the move to a multicurrency world as a gradual evolution.

(Dr Subbarao is Governor, Reserve Bank of India.)

Edited excerpts from an address to the International Monetary and Financial Committee, IMF, Washington DC on April 16.

Published on April 28, 2011

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