Stating that the challenge before RBI is to minimise that cost, he said a prime lever for redressal of external imbalances is exchange rate flexibility.
Therefore, he said managing capital flows is not a problem that should be managed only by emerging market economies. “In as much as lumpy and volatile flows are a spillover from policy choices of advanced economies, the burden of adjustment has to be shared,” Subbarao said, adding, “it’s unrealistic to expect emerging market economies to carry the full burden of lifting global growth.”
“Managing currency tension will require shared understanding on keeping exchange rates aligned to economic fundamentals, and an agreement that currency interventions should be resorted to not as an instrument of trade policy but only to manage disruptions to macroeconomic stability,” he added.
Arguing that this massive fund flow is due to multi-speed global recovery and consequent differential exit policies from accommodative monetary policy, he pointed out, “the biggest problem thrown up by capital flows is currency appreciation which erodes export competitiveness.”
Pointing out that rebalancing requires deficit economies to save more and consume less, he said this would demand them to devalue their currencies, as they will have to depend more on external demand for growth. “The surplus economies will need to mirror these efforts - save less and spend more, and shift from external to domestic demand. They need to let their currencies appreciate,” he said.
He was delivering the keynote at the fourth Icrier-German Development Institute-InWent conference on ‘Policies for growth and financial stability beyond the crisis — The scope for global cooperation.’
Though he admitted that emerging and developing economies do need capital flows to augment their investible resources, he said they should guard themselves against lumpy and volatile capital flows.
Stating that capital flows are triggered by both pull and push factors, the RBI Governor noted that the pull factors are the promising growth prospects of emerging markets, their declining trend rates of inflation, capital account liberalisation and improved governance, while the push factors are the easy monetary policies of advanced economies which create the capital that flows into the emerging markets.