Retrogressive as it may sound, the time might be right for the Reserve Bank of India (RBI) to reconsider some regulatory measures introduced in recent years, especially those launched in the wake of the 2008 global financial crisis. The action should not be viewed as a churlish reaction to international currency volatility, but as a course correction in RBI’s regulatory growth. In the aftermath of 2008, the developed world used the multilateral G20 platform, which included emerging economies like India and China, to frame a new financial architecture that would not only get the global economy back on the rails, but also install risk mitigation measures to avoid a repetition of 2008.
The G20 platform required emerging economies to coordinate their financial regulatory and supervisory actions with the rest of the developed world. In good faith, India implemented many policies that may not have been entirely necessary for the Indian financial landscape.
That belief has now been shattered: once the U.S. economy stabilised somewhat, the Federal Reserve has failed to coordinate its tapering programme with the rest of the G20 members, as it should have under the original compact. This has created havoc for emerging economies – from Turkey to Brazil and from Indonesia to Argentina. So much for a global financial architecture.
Some of the G20 measures, conceived as solutions to excesses in the western financial markets, can be immediately rolled back. One of the prominent decisions was to regulate bankers’ compensations. This made sense in the context of a rapacious Wall Street, but is inconsistent for the Indian financial system, where over 70% of banking is controlled by public sector banks. Compensation in state-owned banks is not market-related but administered by the government.
An argument can be made that compensation controls should be introduced for private sector and foreign banks, as a measure of abundant caution. However, if non-performing loans (NPAs) are used as a yardstick for mismanagement, RBI data for 2012-13 shows that the bulk of NPAs (when compared to total assets) originated in public sector banks: 4.1% against 2% for private sector banks and 2.9% for foreign banks.
Another G20 decision was to tighten regulation for “shadow banks” or financial institutions like Lehman Brothers that thrived in the cracks between regulatory jurisdictions. They were neither banks which could be regulated by the Fed or pure securities brokerages directly under the Security and Exchanges Commission’s regulatory thumb.
However, this inadvertently tightened the noose around Indian non-banking financial institutions (NBFCs), which were, in any case, subject to the RBI’s gimlet regulatory gaze. NBFCs perform many important functions, including providing the last mile link between banks and borrowers, especially MSME (micro, small and medium enterprises) clients. Eager to show off its multilateral credentials, the RBI squeezed the NBFC sector.
Many other policy decisions were similarly prompted – such as harmonising Indian accounting standards and reforming OTC derivatives trading, among others. These policy decisions were anomalous from an Indian standpoint: they were designed to rescue crisis-ridden western economies, while India (and other emerging economies) need forward-looking development and growth-oriented policies.
There were other aberrations as well. The G20 communique issued after the March 2009 London meeting stated: “…we agree that the heads and senior leadership of the international financial institutions should be appointed through an open, transparent, and merit-based selection process…” [1] But when a new International Monetary Fund (IMF) chief was selected in 2011, the developed world opted for the old formula of a European as IMF president, while reserving the World Bank corner office for a U.S. citizen.
The Fed’s unilateral action in the global financial markets has even led RBI Governor Raghuram Rajan to lament in an interview: “International monetary cooperation has broken down.” [2]
There is more than one reason for Rajan’s outburst; he was a co-author of a report in September 2011 that not only advocated an International Monetary Committee comprising representatives from major central banks, but also recommended that mechanisms should be adopted to allow central banks of large developed economies to internalise the spill-over effects of their monetary policies. [3] This is exactly what did not happen when the Fed started thinking aloud about tapering in May 2013.
The major reason for Rajan’s pique seems to be a breakdown in the promised coordination between central banks. Had the Fed adhered to the G20 spirit — the 2008 Washington communique promised, among other things: “Regulators should take all steps necessary to strengthen cross-border crisis management arrangements, including on cooperation and communication with each other and with appropriate authorities” — it would have coordinated its actions with the RBI and other emerging market central banks.
This would have allowed the RBI to forestall the egregious impact of tapering. The withdrawal of monetary easing threatened to tighten liquidity in the global financial markets. This — when combined with the twin fiscal and current account deficits — roiled Indian currency markets. The rupee plummeted sharply, taking its dollar exchange rate to almost Rs. 69. This could have been avoided if the RBI, forewarned and forearmed, had sold dollars in the forward market. This is a simple device and has been used by the RBI earlier to stave off speculative pressures.
All it means is that whenever foreign investors want to sell their investments in India and take out dollars to invest elsewhere, they will not encounter a shortage of dollars in the market. One reason for the panic in the currency market during July-August 2013 was the perceived shortage of foreign exchange in the Indian market, prompting foreign investors to crowd the exit. If the RBI had some fore-knowledge, it would have (apart from the other measures it initiated) bought dollars in the spot market and sold them in the forward market. Consequently, there would have been a steady supply of dollars over all time periods, posing no demand-supply imbalance.
But, caught unawares, the RBI could not exercise this option because if it started buying dollars in the spot market, along with other competing forces, it would have further damaged the rupee value. Eventually, once the market stabilised on the strength of some other emergency measures, this is what the RBI has finally done. Its outstanding net sales of dollars in the forward markets stood at $32.6 billion at the end of December 2013.
It is quite likely that global coordination would have also helped some of the other emerging markets to use their own indigenous devices, instruments or market practices to neutralise volatility.
It is equally unfortunate that some western commentators have not fully understood the impact of the Fed’s unilateral action in a multilateral world. Economists Dani Rodrik and Arvind Subramanian claim that emerging markets are only reaping what they sowed. [4] They are right — India has allowed its economy to slide into a morass of inaction, corruption, inflation and stagnation — but only partially. Rodrik and Subramanian have conveniently glossed over — as have some other western commentators — the relevant G20 communiques.
The latest G20 meeting on February 22-23 in Australia has included the emerging market narrative in its communique: “All our central banks maintain their commitment that monetary policy settings will continue to be carefully calibrated and clearly communicated, in the context of ongoing exchange of information and being mindful of impacts on the global economy.” Hopefully, this too won’t remain mere lip service.
Rajrishi Singhal is Senior Geoeconomics Fellow, Gateway House: Indian Council on Global Relations.
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References:
[1] G20, (2009). London summit – Leaders’ statement. Retrieved from G20 website: https://www.g20.org/sites/default/files/g20_resources/library/London_Declaration.pdf
[2] Goyal, K. (2014, January 14). Rajan warns of policy breakdown as emerging markets fall. Bloomberg. Retrieved from http://www.bloomberg.com/news/2014-01-30/rajan-warns-of-global-policy-breakdown-as-emerging-markets-slide.html
[3] Brookings, (2011). Rethinking central banking . Retrieved from Brookings website: http://www.brookings.edu/~/media/research/files/reports/2011/9/ciepr central banking/rethinking central banking.pdf
[4] Rodrik, D., & Subramanian, A. (2014, February 01). Emerging markets’ victimhood narrative.Bloomberg. Retrieved from http://www.bloomberg.com/news/2014-01-31/emerging-markets-victimhood-narrative.html