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It’s Not Their Fault, It’s Ours. (On Rajan’s Blaming Western Monetary Pullbacks)



“International Monetary Cooperation has broken down”, says Rajan, the head of the Indian Reserve Bank, which has been fighting inflation, the falling rupee, the sentiment that the Indian story is over for now, and all sorts of things. There’s that and a lot more about the whole emerging market situation in an interview with Bloomberg India.

Emerging markets were hurt both by easy money, which flowed into their economies and made it easier to forget about the necessary reform, the necessary fiscal actions that had to be taken. And this came on top of the fact that emerging markets tried to support global growth by huge fiscal and monetary stimulus across the emerging markets. The easy money overlaid.

The reason emerging markets were unhappy with this money was that they were saying, this is going to make it difficult for us to do the necessary adjustment. And the industrial economies said, what do you want us to do, we have weak economies, let the money flow.

And now they say you complained when it went in, why do you complain when it goes out? We complain for the same reason: it distorts our economies.

Pardon me for not clapping.

Firstly, emerging markets didn’t try to support WORLD growth by doing their stimuluses. Oh no, I was there, and I have strained very hard to hear what India and other economies were saying in 2008-09. It was not to help the world. We had our own stimulus because we wanted to help ourselves, not for some global growth cause. We reduced duties and taxes because our economy was bound to slow with the global economy.

China went mad because it is dependent on exports, which would obviously suffer if the US and Europe were in the trash bin.

When Iceland let its banks default, the west shunned it. I wrote in 2008 that India should go buy Iceland debt as Iceland was doing the right thing.

Iceland now shuts down stock exchange for two days, and creates a new bank. This is a country in bad shape – its three biggest lenders had to be nationalized or went bankrupt, it’s lost some 24% against the euro in the last few days and it’s looking desperately for about $5 billion. (Why won’t India give this money? I think it’s a far better bet to give it in Krona today, and get it back in Krona a few years later…far better than holding some obscene quantities of dollars, at least)

We didn’t support Iceland and now Iceland has recovered so well that it’s almost a case study for how to handle a banking collapse. It indicted bankers responsible for the crash. forgave homeowner debt (thus reducing stress on households) and introduced currency controls to stabilize. We don’t speak of Iceland now, even in hushed tones.

But I digress. The point is that we didn’t really do our shit to support global growth, we did it for ourselves. We could have – and should have – become fiscally better (given low inflation in 2009, low interest rates and a not-so-bad dollar rupee rate). We could have cut down the insane layer of monetary stimulus we had done the 2003-2008 era buying dollars like crazy, but we didn’t. We could have created long term hedges for our oil requirements because crude was trading at $40 but we did not. And no one recommended it.

The second theory is that Rajan’s assertion that we didn’t like the “hot money flows” didn’t translate into any layer of monetary tightness, and letting the rupee appreciate. We should have curtailed our reserve building exercises – I’ve been screaming off the rooftops about why reserves are not required – and used the opportunity to make the rupee free and usable in trade (which, again, I’ve been screaming off the rooftops about, and I’m not the only one). We didn’t do that and it was not the bloody industrialized countries’ fault.

There is a problem in international monetary co-operation. The problem isn’t that it is breaking down. The problem is that it shouldn’t have ever existed in the first place; monetary policy is a country-specific issue, and has to react to other countries policies in a way that stabilizes the home country.

The RBI should have freed limits on foreign ownership of debt – the reason only hot money comes in is that you have ludicrously small limits for foreign “cold” money to bother. ($30 bn of government debt is the limit for FII ownership).  The RBI should have let currency markets deepen – with limits on banks, exchanges and foreigners, they strangled this bit. The RBI should have pushed for rupee-based trade. And if we had done this, we should not complain when foreign investors demand that we get our fiscal house in order, or that we keep inflation low, because we never had to. (our insurers and banks have to buy government debt, whether they like it or not!)

Read Rodrick and Subramanian on why the victimhood argument is unfounded, really.

Mr. Rajan’s outburst will hopefully remain that – a one-time pouring out of emotions that will not see the light of day again. At this point, our reaction cannot be to impose capital controls, but to democratize trade into rupees immediately.  India is one of the largest countries that runs a current account deficit in the emerging world (along with Brazil) and that gives the two countries enough to use their currencies for trade (a surplus country like China can’t do so – it will need to get paid more than it needs to pay). For that we need a free rupee and better markets.

In the end, we’re going to get a crisis, and I hope  we don’t waste it like we did the last one.


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