Ground rules for intervention

At the start of the new year, a number of developments suggest that monetary authorities around the world will have to grapple with the problem of cross-border flows on a priority basis. The International Monetary Fund, in a recent report, has listed it as one of the two key challenges for emerging economies during this year. Many of them, including India, continue to receive large capital inflows that are potentially destabilising. Perhaps, the most deleterious consequence of capital inflows has been the strengthening of domestic currency leading to a loss in export competitiveness. That, in turn, has led to a rash of currency wars — the phenomenon of several countries intervening in the currency markets simultaneously in order to ensure that their currencies will not be the only ones to rise. Such actions, though self-perpetuating and mutually injurious, have continued into 2011. Brazil, one of the countries most affected and whose finance minister was the first to speak of ‘currency wars' last year, has taken additional steps to check the rise of the real. Even Chile, which has a record of free market economic policy, followed suit by unveiling its own campaign of intervention. While it is clear that government action to stem the destabilising flows has become the rule, attention has begun to shift towards having some kind of ground rules for such intervention that can be monitored by an institution such as the IMF. A study released by the IMF last week underlined the need for such rules.

However, global coordination, besides being extremely complex, is impractical in the current context of disharmony among the major economic powers. Still, even the very advocacy of such ground rules recognises the considerable distance mainstream opinion on capital inflows has travelled over the past two decades. Both the World Bank and the IMF are now supporting the short-term measures of individual countries in curbing inflows. In the 1990s, the fascination for free market solutions led the U.S. Treasury and the IMF to promote capital account liberalisation. The effort floundered because of opposition from some emerging market countries and the East Asian currency crises that clearly demonstrated the dangers of the speculative capital reversing suddenly. Besides, as Jagdish Bhagwati has pointed out, it is wrong to equate free trade with liberalisation of the capital account. India has followed a measured approach to full convertibility of the rupee but so far desisted from imposing short-term controls on volatile capital. The need to bridge the widening current account deficit seems to be the reason. But then over-dependence on such flows is a matter of serious concern and a threat to macroeconomic stability.

(Source:The Hindu,15 Jan,2011)