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30 November 2016, Gateway House

The politics of global capital flows

The global monetary and financial system is lopsided and designed to favour rich countries; an alternative economic and political doctrine, which takes into account the needs of emerging economies like India, must now be articulated to end this one-sided architecture

Former Senior Fellow, Geoeconomics Studies

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The following article was part of The Gateway of India Dialogue 2016 compendium ‘Where Geopolitics meets Business‘. This piece has been published separately.

The Gateway of India Geoeconomic Dialogue will happen on 13-14 February 2017.

At the spring meetings of the International Monetary Fund (IMF) and the World Bank in April 2016, Reserve Bank of India governor Raghuram Rajan was bitingly critical of how multilateral financial institutions were influenced by dominant western economic philosophy, but dismissed ideas from emerging economies as “crankiness”. [1]

Earlier, in March, at a seminar jointly organised by the IMF and Indian government in New Delhi, Rajan had presented a vision [2] for creating a new global regulatory compact which will attempt, in this inter-connected world, to minimise the deleterious effects of a country’s domestic monetary policy on other countries. He followed this up with a syndicated column advocating a new form of Bretton Woods agreement. [3]

Rajan has been deeply critical of western economic orthodoxy for a while. His campaign is part of a movement launched by emerging economies to re-align the prevailing ideological architecture and power structure in West-dominated multilateral institutions (IMF, World Bank) and private financial institutions (global pension funds, hedge funds, rating agencies), as well as in central banks and sovereign wealth funds. The need to construct an alternative architecture forms the ideological bedrock for regional groupings like BRICS as well.

Argentina’s brush with vulture capital exemplifies the egregious domination of western precepts in the global financial system. Not only did U.S. courts exercised extra-territorial jurisdiction over another country in this instance, but a handful of private U.S. financial institutions were also able to hold a sovereign and its citizens to ransom through the dominant Anglo-Saxon model of global capital markets. The enervating effect of unilateral economic sanctions imposed on Iran, or the sectarian manner in which ruling western economies have carved up leadership roles of multilateral institutions among themselves, are other examples.

It is now widely accepted that both the basic plumbing of the international monetary and financial system (IMFS) and the political philosophy behind the architecture, need radical reforms in favour of a system that is even-handed, not rooted to a dominant economic strategy that imposes a one-size-fits-all solution for all problems. This will not be easy, given the reluctance of the political class in rich countries to cede control over a system that’s served them so well and for so long.

Problems related to the IMFS were discussed extensively in multilateral platforms like the G20 following the global financial crisis of 2008. In the immediate aftermath of the crisis, the G20 issued solemn homilies on coordinating monetary and financial policies. However, once the U.S. economy showed the first signs of green shoots, this promised coordination was quickly forgotten.

For example, the U.S. Federal Reserve Bank’s loud thinking in May 2013 on rolling back its quantitative easing programme resulted in a taper tantrum, with sudden capital outflows causing intense volatility and economic instability in emerging economies. India, and most other emerging economies, experienced a sharp currency depreciation; this forced central banks to intervene in the currency markets, including by raising domestic interest rates to staunch the outflow. This constrained the economic impulse in the domestic economy.

According to the United Nations Conference on Trade and Development (UNCTAD), the IMFS faces three fundamental challenges: [4]

One, the earlier practice of countries accepting one or several currencies as store of value or means of payment, has been replaced by the dollar. This has attendant costs: large swings in the availability of international liquidity and exchange rates depending on the shift in currency-issuing country’s central bank policies. Financial globalisation and the increasing role of private financial intermediaries in providing international liquidity are compounding the problem.

Two, while the IMF was created for providing access to short-term liquidity to overcome balance of payments shocks, the institution’s handling of the Asian crisis has seriously dented its credibility. Countries have instead opted to accumulate forex reserves as a buffer against such crises. This has also contributed to global imbalances.

Finally, the contractionary bias of the IMFS forces current account deficit countries to curtail spending without symmetrical pressure on surplus countries to cut spending, leading to disequilibrium and low economic growth.

Another source of deep anxiety is the role of private financial flows, which rise and ebb in pro-cyclical response to their home country central bank’s monetary and exchange rate policies. In fact, low interest rates in reserve currency issuing countries (such as the U.S. or Eurozone countries), which encourage rapid credit expansion in emerging economies, when combined with the IMF’s past convertibility doctrine and the restrictive role of free trade agreements and bilateral investment treaties, leaves little room for recipient countries to implement remedial measures in crises. What’s more worrying is the shortened time interval between such crises, leaving emerging economies with little time to recover or rebuild defences. [5]

There are many other broken parts of the system that directly affect the fortunes of emerging economies like India: vulnerability of international rating agencies to home country politics; the manipulative grip of systemically-important institutions over key commodity and financial indicators;, the rich countries’ cliquish and vice-like control over multilateral financial institutions; beggar-thy-neighbour policies of western central banks; the undue influence acquired by a couple of currencies. All these flawed components add up to waves of pro-cyclical capital flows from developed to emerging economies, with long-term deleterious implications for recipient countries.

An alternative architecture, or a new global monetary order, is now indispensable to guard against the vagaries of global capital flows, which often leave behind serious economic damage in the wake of their exit. Many experts have suggested the creation of a common global currency, perhaps something like the special drawing rights, to delink the global economy from the overwhelming influence of the dollar or euro. However, this will require sweeping changes to not only the IMF’s governance matrix and policy doctrines, but also need American politicians to agree to these changes. That currently seems unlikely.

One component of a possibly alternative architecture already exists, but needs further strengthening: currency swap arrangements between emerging economy central banks to address liquidity shortages. These should also be supplemented by regional monetary arrangements, like the Chiang Mai Initiative or the contingency reserve arrangement initiated by the New Development Bank.

This configuration also needs to be layered with local currency trade settlement between larger regional groupings, such as SAARC or ASEAN-plus-6. It will require rejuvenation of local currency settlement platforms, like the Asian Clearing Union, which went into a funk because of U.S.-imposed economic sanctions against Iran. [6] But it now stands a good chance of revival.

Rajrishi Singhal was Senior Geoeconomics Fellow, Gateway House. He has been a senior business journalist, and Executive Editor, The Economic Times, and served as Head, Policy and Research, at a private sector bank, before shifting to consultancy and policy analysis.

The Gateway of India Dialogue was co-hosted by Gateway House and the Ministry of External Affairs on 13-14 of June 2016. The 2017 conference, The Gateway of India Geoeconomic Dialogue will be held on 13-14 of February 2017.

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[1] IMF Seminars Event, ‘Fortifying the Global Safety Net’, 2016 Spring Meetings, International Monetary Fund-World Bank Group, <>

[2] Rajan, Raghuram, ‘Towards Rules of the Monetary Game’, Speech at conference Advancing Asia: Investing for the Future; New Delhi, 12 March 2016, <>

[3] Rajan, Raghuram, New Rules for the Monetary Game, Project Syndicate, 9 May  2016, >

[4] UNCTAD, ‘Systemic Challenges in the International Monetary System’, Chapter 3,  Trade and Development Report, 2015, <>

[5] UNCTAD, ‘The Recent Turmoil in Emerging Economies’, Policy Brief No 29, March 2014, <>

[6] Singhal, Rajrishi, NDB: A Pivot to Financial Alternatives, Gateway House: Indian Council on Global Relations, 7 October 2015, <>


1. The International Monetary and Financial System, Chapter 5, 85th Annual Report, Bank for International Settlements, June 2015, <>

2. UNCTAD, Credit Rating Agencies: Junk Status?, Policy Brief No. 39, November 2015, <>

3. Bordo, Michael and Harold James, Capital Flows and Domestic International Order: Trilemmas from Macroeconomics to Political Economy and International Relations, WP 21017, NBER Working Paper Series, March 2015, <>

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