Rakesh Mohan, RBI deputy governor, on Wednesday cautioned that as the global economy starts recovering, a calibrated exit from this unprecedented accommodative monetary policy will have to be ensured to avoid the recurrence of the financial crisis being experienced now.
?Abundant liquidity, if not withdrawn quickly, runs the risk of inducing the same excesses and imbalances that were witnessed during 2003-07. Excess liquidity could also take the form of large capital flows to the emerging market economies (EMEs) and their likely recycling back to the advanced economies,? said Mohan in a paper titled Emerging Contours of Financial Regulation: Challenges and Dynamics.
With effect from June 15, 2009, Mohan will take up as the distinguished consulting professor at the Stanford Centre for International Development at Stanford University, for a period of six months.
Mohan also noted that from the point of view of EMEs at the macro level, the volatility in capital flows has led to severe problems in both macro management and financial regulation.
?These capital flows have been influenced significantly by the extant monetary policy regimes in developed countries and hence their volatility is not necessarily related to economic conditions in the receiving economies,? said Mohan.
He added that excess flows, sudden stops and reversals have significant effects on EME financial sectors, the working of their capital markets, and asset prices, and hence their economies as a whole.
Management of this volatility involves action in monetary policy, fiscal management, capital account management, and also financial market regulation. This will remain a challenge since there is little international discussion on this issue, remarked Mohan.
Finally, in response to the crisis, monetary policy has been loosened substantially in major advanced economies since the second half of 2007, he said. ?Policy rates have been cut to near zero levels, even lower than that in 2003-04, and the financial systems have been flooded with large liquidity,? he added.
The debate on financial innovation and regulation has to be considered in terms of potential and systematic relevance of such innovations besides the capabilities for bringing them effectively under the regulatory umbrella. There is a need for reform of the regulatory framework to shield the financial system from potential crises, while identifying measures to mitigate the consequences of any future episodes of financial stress, he said.