IMF chief Christine Lagarde today warned of a repeat of high market volatility and capital outflows when US Fed hikes rates next time and asked India and other emerging markets to be prepared for such an eventuality.
Echoing RBI Governor Raghuram Rajan, she also called for greater co-ordination between central bankers because “the timing of the interest rate lift-off and the pace of subsequent rate increases can still surprise markets”.
Addressing a gathering at the Reserve Bank here, she asked central bankers in the West to give a clearer, effective communication of their policy intentions to the emerging world to help them contain market volatility.
“I am afraid this (“taper tantrum of May and June of 2013″) may not be a one-off episode. This is so, because the timing of the interest rate lift-off and the pace of subsequent rate increases can still surprise markets,” she said.
Warning of a possible repeat of the high market volatility and indiscriminate capital outflows when the US hikes its rates, she said a portfolio rebalancing out of emerging economies is possible leading to market volatility.
She also asked emerging markets to be prepared to tide over a repeat of the 2013 volatility by effectively dealing with the market uncertainties.
The last time the US hiked rates was in 2006 during Alan Greenspan time who had brought to record lows.
The IMF Managing Director, however, said she sees scope for the greater international policy cooperation to minimise the negative spillovers.
Supporting Rajan’s previous calls for greater co-ordination between central bankers of the emerged market and the emerging market, she said:
“Clear and effective communication of policy intentions can reduce the risk of creating very large market volatility.
“Though admittedly it is a difficult task, there is scope for greater international policy cooperation to minimise the negative spillovers.”
The IMF chief was giving a speech on ‘Spillovers From Unconventional Monetary Policy: Lessons for Emerging Markets’ at the RBI headquarters here.
Admitting that the easy money policy of the West since the 2007-08 credit crisis has helped the emerging world, the IMF chief said such policies also led to a build-up of risks in this part of the world.
It may be noted since the tapering talk began in mid-May 2013 by the then US Fed chief Ben Bernanke, the rupee went on free fall as FIIs pulled out nearly USD 19 billion from the country.
As the crisis persisted, the rupee touched a historic low of 68.85 to the dollar on August 30 2013. After Rajan took over in September there was a massive stability in the rupee and last year it was the best performing Asian currency.
Stating that between 2009 and 2012 emerging markets received about USD 4.5 trillion in gross capital inflows, representing roughly one half of global capital flows, Lagarde said that out of this India received a full USD 470 billion in foreign inflows.
Quoting the finding from Fund study on the impact of such large inflows on the emerging economies, she said this lead to a spike in bond and equity prices, apart from strengthening local currencies.
“Spillovers to asset prices and capital flows in emerging market economies from expansionary unconventional monetary policies were even greater than from earlier conventional policies,” she said quoting the study.
Noting that the world learnt many important lessons from the “taper tantrum” episode, she said first and foremost lesson is that advanced economies can help, secondly those emerging economies that addressed their economic vulnerabilities before the taper tantrum fared better during episodes of market volatility.
So, this means that the emerging markets need to prepare well in advance.
Thirdly, if market volatility materialises, central banks need to be ready to act. Temporary, though aggressive, domestic liquidity support to certain sectors or markets may be necessary, along with targeted foreign exchange interventions.
Moreover, cross-country foreign currency swap lines have proven helpful in enabling necessary access to foreign exchange liquidity at times of market stress.
Commending Rajan for steering clear of the 2013 currency crisis after he took over in September that year, Lagarde said the RBI measures like providing forex liquidity support to key sectors, allowed the rupee to depreciate, and provided judicious foreign exchange interventions to minimise disruptive movements in the rupee helped the economy a lot.
The RBI had also arrested the surge in gold imports, narrowed its current account deficits sharply, and started to rebuild foreign exchange reserves.
“So I am very pleased to say that, in a very short time span, India successfully contained its domestic and external vulnerabilities more than in many other emerging economies,” she said.
“My dialogue with Indian leaders has convinced me that the conditions are ripe for India to be a key engine of global growth,” Lagarde said in a statement on the conclusion of her two-day visit to India.
“My message here was that this is India’s moment it should seize this moment to build a bright economic future of rapid, inclusive, and sustainable economic growth and macroeconomic stability for many years to come,” she noted.
Lagarde said that she also had an interesting exchange of perspectives with women leaders in the financial sector and other senior representatives from civil society.
“We agreed on the need to strengthen the role of women in the economy and increase India’s low rates of female labour force participation,” she added.