After growing at around 10% per year between 2001 and 2012, world trade grew by only 1.5% per year between 2013 and 2018, and contracted by 1.5% in 2019. Despite the recent dynamism of world trade, it is unlikely to return to the levels reached in the era of hyper globalization. International trade adds almost 1 to 2 percentage points to India’s economic growth every year. Indeed, the dynamism of world trade can make the difference between an annual growth rate of 6% against 7.5% for its economy.
It would be mutually beneficial for economies to expand the scope of trade to include not only goods and services, but also the mobility of people. India is well equipped to provide the kind of human capital that the wealthier G20 countries need – medical personnel, engineers, programmers, educators, accountants, content creators, etc., as well as blue collar workers. For India, this will incentivize households to invest in education and exportable skills. It will help it overcome the sluggishness of domestic job creation, while encouraging faster labor transition out of less productive activities in agriculture and elsewhere.
Unlike trade, the free flow of capital is a mixed blessing for emerging markets (EM). All forms of capital flows other than FDI to emerging markets are unstable. They are determined by conditions in the countries of origin, rather than by demand or absorptive capacity in the host countries.
Massive inflows of this capital create an appreciation of the exchange rate, asset prices or general inflation, and a widening of the current account deficit (CAD) in emerging markets. They face an even greater challenge when capital retreats on its own due to the normalization of politics in advanced economies. The shifts are sharp and sharp. Even if emerging markets aren’t courting this “hot capital”, it’s up to them to pick up the pieces once the storm has passed. The policy choices of advanced G20 countries and the externalities they generate for other member countries must be reassessed.
Tapered Tantra
During the two aforementioned crises, advanced economies undertook an unprecedented expansion of monetary policy, multiplying the size of their central bank balance sheets. A significant portion of this liquidity ended up in emerging markets. The first time capital flows reversed was in 2013, during the “taper tantrum” crisis. After the jitters created by the downsizing episode, then-Bank of Mexico Governor Agustin Carstens and RBI Governor Raghuram Rajan had expressed serious concerns about the fallout from capital flow cycles. on their respective countries.
A positive outcome of these complaints has been the adoption of better guidelines from the US Federal Reserve. The Federal Reserve has started warning markets of its intention to withdraw liquidity well in advance to reduce the element of “surprise”. However, little has changed. Consequently, cycles of capital flows continued, and even though they had been warned, emerging markets continued to experience the disruptions they caused.
Advanced warning system
What more can advanced economies do to prevent such disruptions? On the one hand, they should work on the quantum of policy easing and its withdrawal. At some level, advanced economies can print “hard currency” at no cost to them. Yet, if they were to internalize the impact of their actions on emerging markets, the optimal level of policy intervention would be less than what they are currently undertaking.
A related issue is the role exchange rates play in helping emerging markets navigate capital flow cycles. Emerging markets should be allowed to use exchange rates as a stabilization mechanism without fear of being declared “currency manipulators”. Advanced G20 countries should also develop financial safety nets such as emerging market swap lines. With these, they can offer timely hard currency liquidity to emerging markets during reversal episodes.
It has been widely accepted that there is an inequality in the way rating agencies treat eurozone countries compared to others. A better governance structure and operational framework is needed to ensure that in situations where emerging markets experience capital flow reversals, through no fault of their own, they are not also hit downgrading of their rating.
So four things can make the G20 relevant to all of its member countries. First, to facilitate greater trade integration through the exchange of goods, services and human capital. Second, the impact of G20 policies on emerging markets should be regularly assessed and internalized, resulting in a smoother cycle of monetary expansion and contraction. At the same time, exchange rate adjustment should be accepted as a legitimate shock absorber for emerging markets over the cycle.
Third, the provision of hard currency liquidity during downturns through swap agreements. Finally, the need to discuss the role that credit rating agencies have played in perpetuating cycles of capital flows and to initiate reforms that would make their ratings fair for G20 emerging markets.