Emerging economies that are feeling the pain as the U.S. winds down its liquidity injection must use the G-20 summit that begins tomorrow to formulate a pragmatic response
The G-20 summit in St. Petersburg, Russia, that begins on September 5 will probably show greater urgency in tackling emerging risks to sustainable global growth. It will call for much closer cooperation between the developed and developing worlds, as also among emerging economies, in dealing with the “catastrophic consequences” of the United States Federal Reserve withdrawing its $85-billion-a-month liquidity support to the domestic economy over the next year. Cumulatively, the U.S. has pumped an additional $2 trillion of freshly printed greenback since the 2008 global meltdown to support its banking system and the economy at large.
The prospect of the withdrawal of some of these dollars from the global system has sent shivers down the backs of many emerging economies, including India. The rapid currency depreciation in many of these countries, such as Indonesia, Turkey, South Africa, India, Brazil and Malaysia these past few months, especially after the Fed’s statement in May indicating withdrawal of liquidity in the near future, was discussed at the G-20 Finance Ministers’ mid-July meeting in Moscow. Finance Minister P. Chidambaram had spoken to U.S. officials at the Moscow meeting and expressed concern at the negative impact of the Fed’s actions on the emerging economies.
India has already flagged the issue by stating how “unconventional monetary policies” followed by the U.S. and EU have ended up creating new risks in the system. Deputy Chairperson of the Planning Commission Montek Ahluwalia says after the economic crisis in 2008 the focus largely remained on boosting the global economy through fiscal expansion. There was consensus among all G-20 economies to go for a fiscal booster. There was hardly any formal discussion on coordinating the monetary policies at that time. The U.S. then resorted to the most unprecedented injection of liquidity in its history as the central bank balance sheet expanded from about $870 billion before the crisis to $3 trillion today. The additional $2 trillion freshly printed dollars were pumped in three phases, described as QE1, QE2 and QE3. This was done largely because the U.S. economy was not showing any signs of reducing its unemployment rate since the peak of the crisis. In all past episodes of depression/recessions, the U.S. economy had bounced back to its pre-crisis employment within 12 to 24 months. This time things did not improve significantly even after 50 months. This resulted in the highly “unconventional monetary policy” which is coming back to haunt the emerging economies.
According to Dr. Arvind Virmani, who represented India as Executive Director at the IMF in the post-crisis period, “We at the IMF did express concern that the massive quantitative easing by the United States was particularly going into some eight emerging economies, India being one. The liquidity boost also led to a big increase in oil and commodity prices which also contributed to high inflation in emerging economies.” Dr. Virmani agrees managing such massive inflows, and now possible outflows, is a big challenge for developing economies like India.
One of the key concerns of the G-20 meet in St. Petersburg will be how emerging economies can manage the outflow of dollars that is bound to occur as the U.S. shows recovery and the Federal Reserve begins to taper excess liquidity as a consequence.
Indeed, beyond a point U.S. monetary policy cannot address global concerns. The U.S. will necessarily look inward until there is some visible improvement in its own employment data. In fact, one of the criticisms of the G-20 forum was that it had become just a talk-shop after the first two meetings in 2009 in Washington and Pittsburgh. The first two meetings showed urgency among countries to work together in a coordinated manner because the economic crisis was at its peak. Recall how President George W. Bush told the first G-20 meeting at Washington, after the 2008 financial meltdown, that the emerging economies will have to play a big role as engines of world growth. At that time America looked most vulnerable. But today some of the emerging economies seem more vulnerable with their currencies crashing.
The possibility of a substantial tapering of the dollar deluge of the past is making developing economies think hard about innovative solutions. They will also have to come up with unconventional alternatives like bilateral and regional currency swaps to tide over short term liquidity problems. For instance, there are reports that BRICS countries may reach a quick consensus on the sidelines of the G-20 summit and work out the modalities of the proposed $100 billion Currency Reserve Fund(CSF) to tide over short-term liquidity problems. This was decided in principle at the BRICS summit at Durban, South Africa earlier this year. China has apparently agreed to contribute to nearly 50 per cent of this fund. India, on its part, is trying to save up on its dollar liability by preparing to discuss local currency trading with its non-U.S. trade partners. It is going back to Iran for rupee denominated oil purchases. India must be pragmatic and not get ideologically constrained in this hour.