Stiglitz warns on capital flows

Noted economist Joseph Stiglitz today favoured a cautious approach to capital account convertibility even as the Reserve Bank has charted a five-year roadmap to attain full float of the rupee.

Noted economist Joseph Stiglitz today favoured a cautious approach to capital account convertibility even as the Reserve Bank has charted a five-year roadmap to attain full float of the rupee. Delivering a lecture on the new paradigm for monetary policy at the RBI here, Stiglitz said that liberalisation of capital account 8212; lifting controls on the currency 8212; has witnessed more risk, less prudential behaviour and lesser lending from the banking system.

8220;There are increasing evidence and theory that capital account liberalisation does not lead to faster growth, but does expose the country to more risk,8221; the Columbia University professor said. Stiglitz who won the Nobel Prize in 2001 for his work on the economics of information was the former chairman of the White House council of economic advisers under President Bill Clinton. During his tenure as Chief Economist at the World Bank in 1999, Stiglitz irritated many powerful colleagues by publicly criticizing IMF moves and calling for more open debate about global economic policies.

Citing the Chinese example, Stiglitz said that the Asian nation has not liberalised its capital account but receives the largest foreign direct investment FDI. 8220;The money that can come in and out overnight does not lead to faster economic growth but leads to instability,8221; he said.

He pointed out that short term capital flows are often pro-cyclical and it reduces the ability of government to respond to risks with countercyclical monetary and fiscal policies. Stiglitz referred to the East Asian crisis where an inadequate regulatory oversight before liberalisation of capital market led to large ratios of short term debt relative to reserves. In india, a committee under former RBI deputy governor S.S. Tarapore has put in place a five-year plan towards the full float of rupee. As per its recommendations, RBI is phase-wise moving towards the fuller capital account convertibility.

Stiglitz said the monetary policy should use multiple instruments rather than only depending on interest rates to contain inflation. The simplistic rules don8217;t use all relevant information as it is not just the target and the level of inflation that mattered, but also the source of inflation, he said.

8220;Interest rates are not the only channel8230; If there is an aggregate demand shock, tightening interest rates may not be optimal way to re-equilibrate economy,8221; the Columbia University professor said. He also pointed out that adverse effects of interest rate increase could be long lasting and could persist even after the rates are lowered.

Stiglitz cited East Asian currency crisis during which International Monetary Fund had suggested increasing rates to stabilise exchange rates. But this led to many Indonesian firms to go bankrupt with interest rates raised as much as 80 per cent. This in turn affected many banks as well apart from pushing the economy further into recession.

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8220;Inflation, money supply and T-bill rates are intermediate variables not clearly correlated with variables of fundamental importance,8221; he explained stressing the importance of using multiple instruments.

8212;With agencies