Raghuram Rajan explains why global markets may crash soon

Reserve Bank Governor Raghuram Rajanhas warned that global markets are at the risk of a “crash"due to the lingering competitive loose monetary policies beingfollowed by the developed economies.

Warning that the current build-up of financial sectorimbalances may cause sudden price reversals and sharp spikesin volatility, Rajan said, “we are taking a greater chance ofhaving another crash at a time when the world is less capableof bearing the cost”.

In an interview to London-based ‘Central Banking Journal’yesterday, he said, “unfortunately, a number of macro-economists have not fully learned the lessons of the greatfinancial crisis. They still do not pay enough attention -enpassant- to the financial sector. Financial sector crisesare not as predictable. The risks build up until, wham, ithits you”.

The Governor expressed fears that central banks “may beexhausting room on the financial side and creating a situationwhere there will be a discontinuous movement in the financialsector.”

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Discounting arguments from a section of economists thatasset price hike is not due to credit growth, Rajan saidproblems do not appear to be arising from credit growthalthough this is an issue in some emerging markets.“They (global investors) put trades on even though theyknow what will happen as everyone attempts to exit positionsat the same time, there will be major market volatility,” theRBI chief said.

Reiterating his warnings that emerging markets areespecially vulnerable to big shifts in capital flows broughton by unprecedented monetary accommodation in rich nations,Rajan warned, “there will be major market volatility if such acrash occurs. True, it may not happen if we can find a way to
unwind everything steadily. But it is a big hope and aprayer”.

The former IMF chief economist, who famously predicted the2008 financial meltdown - three years before at an event in US- from which the global economy is yet to recover fully,compared the current global markets to the 1930s which markedthe worst recession in the financial history.

Stating that the Great Depression was due to a longperiod of competitive devaluation of national currencies,Rajan said, “we are back to the 1930s, in a world ofcompetitive easing.

“Back then, it was competitive devaluation, butcompetitive easing could lead to competitive devaluation. Ifthere were no consequences, to competitive easing, fine; butthere are consequences.”

The central banks of the rich nations are now engaged inever more accommodative policies, he said, and called for morecoordination between the major monetary authorities.Rajan first made this demand early this year in Sydneyduring the BRICS finance ministers and central bankers summit.
He repeated the same at the annual summit of the World BankGroup in Washington a few months later.

Calling for more policy co-ordination and research intoeffects of central bank policy spillover and spill-backs, hesaid monetary policy changes by the developed world centralbanks can cause “substantial levels of uncertainty” at a timethat may suit the policy instigator but not be convenient forother central banks, especially in the emerging markets.

Welcoming the IMF recent statement that it would “examine"monetary policies of major central banks to check their netbenefits, the Governor said this is a major change in theinternational organination’s stance.
“The sensitivity this kind of discussion raises in centralbanks will make them think about the value of policies andwhether they are helpful elsewhere.““I have no doubt that countries will still do what islargely in their interests. But over time we need a littlemore effort looking at the global interest. My sense is thatonce the debate is engaged, we will figure out a way to movein that direction,” the ex-Chicago University professor said.

Expressing concerns about the impact of investors quittingemerging markets all at once after buying heavily into assetsinflated by these loose central bank policies, he saidcontinued failure of leading economies to comprehend thedangers of financial cycles pose significant risks to the
global economy

After May 24, 2013 tapering talk by the US Fed, Indiafaced its worst crisis since the balance of payment issue of1991. The rupee was one of the worst hit as current accountdeficit overshot to close to 5 per cent of GDP as FIIs dumpedGovernment debt and equities like hot coal.

On the continuing crisis in the Eurozone, the Governorsaid the common European currency is “too strong”. Thus, themonetary union faces similar problems to emerging marketeconomies, as it is affected by spillovers from ultra-loosemonetary policies being pursued by the central banks such as
the US Fed, Bank of Japan and Bank of England.The Governor noted that Europe faces a disinflationaryenvironment, close to deflation, despite pursuing a “very,very accommodative policy”.Eurosystem policy appears un-accommodative, he said,“because everyone else’s policy is even more accommodative”.

PTI