Public finance & fiscal policy remain important in achieving national macroeconomic objectives
The recent meeting of the G20 finance ministers in Shanghai did not produce any big-bang announcements on future global economic policies. But it did yield insights on what national economic policies of the world’s major developed and emerging markets might start focusing increasingly less on.
At the outset, fears of competitive devaluation among major currencies setting off a spiral of uncontrolled jerky movement of capital across the world were put to rest. China was in the spotlight in this respect. Assurances from China on refraining from ‘stealthy’ devaluations went down well among the rest. What also went a long way in soothing jittery nerves was China’s sharing of its confidence in the meeting about its ability to handle the internal economic slowdown. This prevented the G20 from mentioning China in the final communique as a major concern to the global economic prospects.
But much as the meeting ended on a calming note, reinforcing trust among major economies in mutual sharing of information and plans before embarking on policies that might have global impacts, there was little doubt about the mounting cynicism on effectiveness of major policies. The focus was clearly on interest rates and the fact that their downward plunge was not a final answer to economic revival. Across developed and emerging markets, banks have begun worrying seriously about their abilities to remain effective engines of mobilising and lending resources in face of low, and more perilously, negative interest rates, as being witnessed in Japan. The problems of interest rates become more serious if viewed in conjunction with exchange rates. With both headed southward for safeguarding investment and exports, doubts have begun emerging on the limitations of monetary policy in not only achieving macroeconomic goals, but also in protecting financial strengths of banks and financial institutions.
Apart from the helplessness in realising the inadequacies of monetary policy, what has also become evident is the amazing extent by which stock markets across the world have become benchmarks of effectiveness of national policies. This was another sentiment that prevailed across the G20 meetings: markets worry too much. The frustration with stock markets had much to do with the volatility that has prevailed in these markets over the last one year. Indeed, national stock markets seem to have developed an unusual tendency of reacting to global cues, with market actors not necessarily having clear ideas on what these cues are.
Ironically, the stock markets themselves after the G20 meeting reflected the lament of G20 financial heads over markets worrying too much. Markets gave a clear thumbs down to the lack of action coming out of the meeting. Even China’s assurances on it being able to hold fort did not do much to cheer stock markets.
For several years now, macroeconomic policy has become entirely dominated by money and banking. Global financial integration has much to do with the domination, given that no other industry has witnessed as much bonding across national boundaries as the financial industry. The outcome, however, has had downsides.
Leave alone developed country policy-makers, even emerging market finance ministers and central bank governors, while crafting policies, have begun doing so in anticipation of their impact on markets. This is true for several emerging markets—China, India, Indonesia, Turkey, Mexico, Saudi Arabia and South Africa—where financial savings and prevalence of financial products among households is often not as large as physical savings. Indeed, these are the countries where domestic households are not necessarily looking at the equity and debt market for greater returns on savings, and commodities continue to remain important.
The problem is that these countries, notwithstanding limited domestic financial inclusion, have been witnessing large participation of foreign institutional investors in their capital markets. These investors, given their large grip on mobile global capital, have the ability to influence balance of payments and exchange rates of emerging markets. Most emerging markets, including partly China, have experienced that with their currencies fluctuating and capital account balances and foreign exchange reserves swinging back and forth, dollar-denominated global capital moves vigorously back and forth from their economies.
With the financial industry having created numerous interested stakeholders in keeping the pressure on emerging market ministers and governors, the latter have increasingly been drawn into market-sensitive reaction modes. There is very little that ministers can do if markets do not react according to economic fundamentals. That is precisely what has been happening in India and in several other emerging markets. Resorting to the obvious and popular recipe of interest rate, exchange rate and money supply has hardly been effective.
If anything, the latest G20 meeting is perhaps an indication of how important public finance and fiscal policy continue to remain in achieving national macroeconomic objectives. If done sensibly, resource mobilisation and allocation can also captivate markets. Otherwise, why did a predominantly ‘rural’ Budget produced by finance minister Arun Jaitley give the stock market the lift that other previous ‘industrial’ Budgets could not?
The author is senior research fellow and research lead (Trade and Economic Policy) at the Institute of South Asian Studies in the National University of Singapore. He can be reached at firstname.lastname@example.org. Views are personal