The global economy has continued to improve over the past year. Growth in emerging markets has been strong while advanced economies have been moving towards a self-sustaining recovery, states the Bank for International Settlements (BIS) in its 2011 report.
However, the report warns that ?numerous legacies? and lessons of the financial crisis still require attention. International financial imbalances are re-emerging with highly accommodative monetary policies fast becoming a threat to price stability. Financial reforms are yet to be completed and fully implemented, while frameworks that should serve as an early warning system for financial stress remain underdeveloped.
BIS states that addressing private and public indebtedness is the key to building a solid foundation for high and balanced real growth and a stable financial system. Thus substantial action should now be taken to reduce deficits in the countries that were at the core of the crisis, as well as drive up private saving.
The lessons of the crisis also apply to emerging market economies, as well as those economies where debt is fuelling huge gains in property prices and consumption. They are running the risk of building up the imbalances that now plague the advanced economies.
Global current account imbalances are still there, which could lead to disorderly exchange rate adjustments and protectionism. In fact, imbalances go beyond current accounts to gross financial flows, and they pose perhaps even bigger risks by giving rise to potential financial mismatches and facilitating the transmission of shocks across borders. The financial flows today dwarf the net movements commonly associated with the current account.
Cross-border financing facilitates rapid credit growth even when domestic financing is absent. A reversal of strong cross-border capital flows can inflict damage on financial systems and ultimately on the real economy.
On monetary policy, BIS calls for sound macroeconomic policies which will play a key role in addressing the imbalances in current accounts and gross financial flows, which are related and therefore need to be addressed together.
Capital controls can only offer temporary relief. International coordination is essential to break the policy gridlock, for countries may find unilateral adjustment too costly, the report says.
Dwindling economic slack and increase in the prices of food, energy and other commodities have driven up inflationary risks. The spread of inflation from major emerging market economies endangers advanced economies. Therefore, policy rates should rise globally, the report suggests.
On India, the report says regulatory reforms have been impressive but critical steps such as the implementation of Basel III and adoption of measures to address systemic risks associated with very large global institutions still remain to be taken.