The adverse consequences of the US subprime turmoil, according to Reserve Bank of India deputy governor Rakesh Mohan, could weigh heavily on the future stability of financial markets and has the potential to have a wider impact on global growth with particular concerns centred on the prospects for emerging market economies (EMEs).
?We will have to wait and watch. In general, recent financial markets developments are indicative of evolving uncertainties for EMEs with significant challenges for the conduct of monetary policy and for ensuring financial stability in their economies. As central bankers, we will have to enhance our vigilance,?? said Mohan in his valedictory address at Asia Regional Economic Forum on Thursday.
?If credit conditions tighten, EMEs could become particularly vulnerable to reversals of capital flows with serious implications for their future prospects,? he said.
According to Mohan slowing down of the US economy, in combination with capital reversals, could also have adverse consequences for growth on a prolonged basis by affecting exports of manufactures and services, depending on the extent of linkage with the US economy. On the other hand, the flight of capital to safety through diversification could even enhance capital flows to these countries. This could further complicate the conduct of monetary policy, he observed.
Also, the recent developments carry implications in the form of heightened market discipline and a stricter regulation of financial markets. Investors who relied on credit ratings of collateralised debt obligations (CDOs) and collateralised loans obligations (CLOs) are likely to question the value of ratings in other markets.
Moreover, leveraged buy-out activity is likely to wind down. While this could cause worries about equity valuations, it is expected that such concerns would eventually recede so long as corporate profitability remains strong. Furthermore, it is argued that carry trade, which has been a source of financial flows, may moderate and may even go through an abrupt unwinding and this would help in maintaining global financial stability, he explained.
Mohan pointed out that the conduct of monetary policy is also complicated by a host of factors which seem to be simultaneously at work: risk of sustained contagion, global capacity constraints, rising food prices, record high international crude oil prices, tensions in inflation expectations, evolution of sovereign pools of foreign exchange reserves, etc.