National Council of Applied Economic Research
Opinion: Poonam Gupta and Kavya Singh
It is widely believed there is an unevenness in the way rating agencies treat the countries in the Euro zone versus elsewhere. A better governance structure and operating framework are needed to ensure that in situations when EMs are grappling with capital flow reversals for no fault of theirs they are not slapped with a rating downgrade as well.
Often decried as being ineffective and irrelevant G20 received a lease of life during the 2008-09 global financial crisis and the Covid-19 pandemic in 2020. During the decade between these two crises global trade and financial flows have undergone a significant evolution. While trade has slowed down conspicuously capital flows have become larger and more volatile than before. These developments have implications for G20 emerging countries.
After registering growth of about 10% a year during 2001-2012 global trade grew by only 1.5% a year during 2013-2018 and contracted by 1.5% in 2019. Despite the recent buoyancy in global trade it is unlikely to revert to the levels achieved in the era of hyper globalisation. International trade adds nearly 1-2 percentage points to India’s economic growth each year. Indeed global trade buoyancy can make the difference between an annual growth rate of 6% versus 7.5% for its economy.
It would be mutually beneficial for economies to expand the scope of trade to include not just goods and services but also the mobility of people. India is well-equipped to supply the kind of human capital the richer G20 countries need – medical personnel engineers programmers educationists accountants content creators etc. along with blue-collar workers. For India this will incentivise households to invest into exportable education and skills. It will help it overcome the slow pace of domestic job creation while encouraging more rapid transition of the labour force out of lower productive activities in agriculture and elsewhere.
Unlike trade the unhindered flow of capital is a mixed blessing for emerging markets (EMs). All non-FDI forms of capital flows to EMs are fickle. They are driven by the conditions in source countries rather than by the demand or absorptive capacity in the host countries.
Large inflows of such capital create result in exchange rate appreciation asset price or general inflation and a widened current account deficit (CAD) in EMs. They face an even bigger challenge when capital retreats on its own accord due to the normalisation of policy by advanced economies. The reversals are abrupt and sharp. Even though the EMs don’t woo this ‘hot capital’ the onus rests on them to pick up the pieces after the storm has passed. Policy choices of the advanced G20 countries and the externalities they generate for other member countries must be reassessed.
Taper Tantra
During both aforementioned crises the advanced economies undertook an unprecedented monetary policy expansion increasing the size of their central bank balance sheets multifold. A significant chunk of this liquidity found its way into EMs. The first time around capital flows reversed was in 2013 during the ‘taper tantrum’ crisis. After the jitters created by the tapering episode the then Bank of Mexico governor Agustin Carstens and RBI governor Raghuram Rajan had voiced strong concerns about the spillover impacts of the capital flow cycles on their respective countries.
A positive outcome of those complaints was the adoption of better guidance from the US Federal Reserve Board. The Federal Reserve started cautioning the markets of its intent to withdraw liquidity much in advance to lower the element of ‘surprise’. However little else changed. Consequently the capital flow cycles have continued and even if forewarned about them EMs have continued to suffer disruptions caused by them.
Advanced Warning System
What more can the advanced economies do to forestall such disruptions? For one they ought to work on the quantum of policy easing and its withdrawal. At one level advanced economies can print ‘hard currencies’ at zero cost to them. Yet if they were to internalise the impact of their actions on the EMs the optimal level of policy intervention would be smaller than the one currently undertaken by them.
A related issue is the role that the exchange rates play in helping EMs navigate the capital flow cycles. EMs should be allowed to use the exchange rates as a stabilising mechanism without any fear of being declared ‘currency manipulators’. Advanced G20 countries should also develop financial safety nets such as swap lines for EMs. Through these they can offer timely liquidity in hard currency to EMs during reversal episodes.
It has been widely believed there is an unevenness in the way credit rating agencies treat the countries in the Euro zone versus elsewhere. A better governance structure and operating framework are needed to ensure that in situations when EMs are grappling with capital flow reversals for no fault of theirs they are not slapped with a rating downgrade as well.
So four things can make G20 relevant for all its member countries. One facilitating greater trade integration through the exchange of goods services and human capital. Two the impact of G20 policies on EMs should be regularly evaluated and internalised resulting in a gentler cycle of monetary expansion and withdrawal. Alongside exchange rate adjustment should be accepted as a legitimate shock-absorber for EMs during the cycle.
Three provision of hard currency liquidity during the periods of reversals through swap agreements. Finally the need to discuss the role that credit rating agencies have been playing in perpetuating capital flow cycles and initiate reforms that would make their assessments fair for G20 EMs.
Poonam Gupta is Director General and Kavya Singh is Research Associate at NCAER. The views expressed are personal.