‘Beggar thy neighbour or enrich thy neighbour?’


By Sanath Nanayakkare

‘Sudden swings in cross-border capital flows and exchange rate movements could complicate macro-economic management in the Emerging Market Economies, therefore, EMEs would benefit from managing their Capital Flows and Exchange Rate Volatility, Dr. Rakesh Mohan, Executive Director, International Monetary Fund (IMF) said last week at the Center for Banking Studies in Rajagiriya.

"Ben Bernake, former chairman of the Fed Reserve said, Unconventional Monetary Policies of Advanced Economies are not ‘beggar-thy-neighbour’, but rather ‘enrich-thy-neighbour’ actions. However, the empirical evidence on this claim is mixed, he said.

Mohan said so at a public lecture based on a research paper titled, ‘Monetary Policy Coordination and the Role of Central Banks’.

This research paper authored by Dr. Rakesh Mohan and Muneesh Kapur did not necessarily represent the views of the IMF.

"The Unconventional Monetary Policies (UMPs) pursued by Advanced Economies (AEs) have posed macroeconomic challenges for the EMEs through volatile capital flows and exchange rates. AE central banks need to acknowledge and appreciate the spillovers resulting from such UMPs,he said.

"Central Banks of the AEs who have set up standing mutual swap facilities should explore similar arrangements with other significant EMEs with appropriate risk mitigation measures."

"These initiatives could do much to actually curb volatility in global financial markets and hence in capital flows to EMEs, thus obviating the need for defensive policy actions on the part of EMEs."

"According to the World Bank (WB), global factors, such as, US interest rates, risk and the UMPs accounted for about 60% of the increase in overall capital inflows to developing countries between 2009 and 2013."

"More generally, private capital flows are volatile for all countries, advanced or emerging, across all points of time".

"Large inward capital inflows during the initial phase add to nominal and appreciation of the domestic currency, leading to widening of current account deficits."

"Large capital flows also lead to a boom in credit aggregate and asset prices, and thereby to domestic demand and output, putting further pressure on the current accent deficit."

"Among the various categories of capital flows, the WB finds portfolio flows to be both the most volatile and the most sensitive to external drivers associated with global financial conditions, while Foreign Direct Investment is relatively insensitive to global push factors, Mohan explained.

"Within portfolio flows, the flow into developing-country bond and equity mutual funds are much more sensitive to push factors than the overall portfolio flows."

"An analysis of financial crises between 1970 and 2011 indicates these occur in clusters, which suggests that these crises are being caused by common factors or the existence of important contagion effects."

"UMPs have facilitated capital flows not only to the major EMEs, but also seem to have improved market access to international finance for a wider range of sovereign borrowers."

Foreign purchases of portfolio assets – mainly sovereign bonds and equities in several frontier markets— e.g. Ghana, Nigeria, and Zambia surged in 2012, and reached new-highs in some cases."

"Sovereign entities in other frontier regions have also accessed international capital market, either for the first time (Mongolia) or after a prolonged absence from the markets (Bolivia), or in greater size (Serbia)."

" The US Federal Reserve’s prolonged reliance on UMPs has confronted country after country with a difficult choice to either tolerate a significant exchange rate appreciation—thereby risking competitiveness, jobs and in some cases, domestic financial stability—or follow the Fed in loosening monetary policy."

"Given this disconnect between the perception of the EMEs and the advanced economies on the spillovers, it is apparent that the EME authorities would be better served by pursuing policies that minimize the spillovers for them."

"We would like to live in a world where countries take into account the effect of their policies on other countries and do what is right given the circumstances of that country, Mohan said.

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