04 November 2009

Revisiting the orthodoxy: the experience of emerging economies

An edit in the Business Standard today highlights the changes in thinking with regard to forex reserves and cross-border flows:

This episode has clearly highlighted the need for re-assessing the benefits of accumulating large foreign exchange reserves. Once viewed as inefficient by the orthodoxy, “self-insurance” is now being seen as a legitimate crisis-management strategy.

Alongside this, the orthodoxy about the desirability of capital inflows is also being questioned. Brazil is a prominent example of having recently imposed a tax on short-term portfolio inflows, a variant of the class of instruments generally known as Tobin taxes.
Contrary to the orthodox view that Tobin taxes will queer the pitch for foreign capital, a clear delineation of the transactions on which they are to be levied may actually incentivise more desirable long-term portfolio and direct investment inflows because they promise a more stable balance-of-payments and exchange-rate environment. 

RBI Deputy Governor's speech at the FSA Turner Review Conference also deals with the space for unorthodoxy

Much of the current debate on many issues centres on the epicenter of the crisis, the developed economies with relatively advanced financial systems. The emerging markets, though, can bring a different perspective from their own past experience. Many of the emerging countries, including India, are part of the global effort in search of a harmonized framework but certain key differences in perspectives in these two sets of economies need to be appreciated. The status of the financial sector of the emerging economies is different from that of the advanced economies with different set of imperatives having different implications for the trade off between financial stability on the one hand and financial development, financial inclusion and growth, on the other. For instance, with regard to identification and mitigations of sources of systemic risk, the emerging market concerns are heightened because of the fact that many sources of systemic risk lie outside their jurisdictions. There could also be the issue of negative externality of larger than warranted capital requirements without careful calibration which could adversely impact the flow of credit to productive sectors, particularly in bank funding based financial systems. Emerging economies are faced with the challenge of managing volatile capital flows which is not a source of systemic vulnerability for developed economies,

Clearly the experience of the developing/emerging economies has much to offer in reshaping the prevalent ideology.

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