In the run-up to the G20 Leaders’ meeting in Seoul (where Prime Minister Manmohan Singh and President Obama were both present) China, Brazil and Germany were among the most vocal critics of this monetary expansion. These countries have portrayed it, in my view incorrectly, as an ill-disguised attempt by the US to depreciate the US dollar as part of a feared circle of competitive devaluations across the major economies.
As widely noted in the international press, India has been more supportive. At his joint press conference with President Obama, Prime Minister Singh observed, ‘A strong, robust, fast-growing United States is in the interests of the world … and therefore, anything that would stimulate the underlying growth and policies of entrepreneurship in the United States would help the cause of global prosperity.’ While some of this may just have been the courtesy of a polite host in the presence of an honoured guest, it also seems to imply a more mature and relaxed attitude towards exchange rate flexibility on the part of the government. This interpretation is also consistent with both the relatively limited intervention in the exchange markets by the Reserve Bank of India in recent times, despite strong capital flows, as well as statements by Finance Minister Pranab Mukherjee that India was not contemplating limiting foreign flows into its equity markets.
Nevertheless, this episode has served to crystallise the issues and tensions in the present international monetary system. If anything, these issues are likely to gain even greater prominence now that the meeting in Seoul has concluded, because France has taken over as the chair of the G20. President Sarkozy has already signalled that he intends to make review and reform of the international monetary system (IMS) a core agenda item of that Presidency, and is bound to raise these issues when he visits here early in December.
India has in general been relatively passive on these aspects of the global financial architecture, showing more interest in the governance reforms of the International Monetary Fund (IMF). Yet, as happened over the previous decade in the area of multilateral trade negotiations, India could easily be asked to play a central role in the redesign of certain aspects of that regime. Accordingly, it is important that there be a more robust domestic debate on the key issues, so as to help our officials better articulate our core concerns and interests.
What, then, are the important issues that might arise in an agenda for international monetary reform? Unfortunately, the public debate on these issues is rather confusing, combining as it does elements connected with what one might call the ‘real’ economy (savings and investment; current account deficits; global imbalances) with the monetary system. As Ted Truman of the Peterson Institute in Washington has observed, the enormous expansion of global finance over the last decade now means that the latter increasingly sets the rules for the former, at least until and unless there is a fundamental roll-back of private cross-border finance, of the type that took place during the great Depression.
Within the more narrowly defined monetary area, the key issues have to do with the exchange rate regime, the accumulation of reserves, the supply of reserve assets, volatility in exchange rates and volatility in private capital flows. While under the post-war Bretton Woods system, fixed exchange rates against the dollar were the norm, the vogue today is for ‘market-determined’ flexible exchange rates, at least for systemically important countries, even though ‘clean’ floats are more the exception than the norm in most emerging markets, India included.
At the same time, exchange market intervention has crept back into the financial armoury of even the advanced countries, such as Switzerland and Japan, with the clear objective of influencing (the polite word is ‘stabilising’) the nominal exchange rate. The challenge here will be to devise rules that are appropriate for both the advanced countries and for large emerging markets such as China, Brazil and India. India will need to be vigilant to ensure that these rules strike the right balance between policy flexibility and harmful mercantilism.
Equally difficult judgments arise on the appropriate stock of reserves. The bulk of reserves accumulation over the past decade has been by major emerging markets, primarily as a form of insurance against volatile capital flows and possible speculative attacks. Despite their high cost, such reserves did demonstrate their worth as a protective device in the crisis. At the same time, it is these reserves that have been cited as one cause of the financial crisis.
Finally, there is the role of the dollar as the central reserve asset. It is being argued again now as in the 1960s, that the reserve role of the dollar has encouraged unsustainable policies, and that a range of alternatives is needed. But a move to a multi-currency reserve system (or to a synthetic unit such as the IMF’s SDR) needs careful management to avoid destabilising flows.
Emerging markets have now become systemically important, China most of all, but India and Brazil in due course. Yet they remain ‘emerging’ and will be for a considerable time to come. At the same time, the negotiating skills and power of the advanced countries way exceed those of the emerging markets. As monetary reform approaches centre stage, we must be careful not to throw the baby out with the bathwater.
Suman Bery is Director-General, National Council of Applied Economic Research.
This piece originally appeared in the Business Standard and may be found here.