It has begun to realise that wisdom can also be gleaned from the experience of emerging economies
The IMF has spoken. In its latest World Economic Outlook,the IMF forecasts that the advanced countries will continue to be in a difficult situation,with a grim fiscal position and vulnerable financial markets. In contrast,emerging markets have done well on the fiscal front and are expected to continue with a neutral fiscal policy in the medium term. There were lessons to be learnt from the emerging economies that,if shared earlier,could have saved the global economy from this unprecedented recession.
The IMF has come a long way in providing policy advice to its member countries. It has begun to realise that economic wisdom could also be gleaned from the macro-management experience of emerging economies. The view on capital flows has changed and is far more pragmatic and experience-based now,having evolved through an extensive,two-year consultative process with member countries. The emerging markets have been advised to stay alert to the risks stemming from increased cross-border capital flows,as low interest rates and a high risk appetite in advanced countries could result in a situation where too much money could be chasing too few emerging market assets. At last,the IMF has recognised what was being advocated by India and other emerging economies for more than a decade: easy monetary policy in advanced countries spills over to the emerging countries and causes disruptions in the smooth functioning of the markets.
Another interesting case is inflation targeting,being discussed by the IMF in the context of a flatter Phillips curve (which represents a historical inverse relation between inflation and unemployment). which is certain to gladden the hearts of many policymakers and central bank governors in leading emerging markets,including India. Indeed,policymakers from India had been in the forefront of arguing that given the status of financial markets,twin deficits and the economy,inflation targeting is not the appropriate regime for India. The researchers in the IMF are only now beginning to realise that suggesting inflation targeting to all countries and in all circumstances was probably not the best policy advice.
There is yet another case of change in policy advice. The IMF has now begun to question the impact of debt on economic growth,in the current context of deficient global aggregate demand and has offered research yielding mixed results on the effect of debt on growth. Historically,the IMFs advice was based on the premise that debt overhang has growth retarding implications on the economy through various channels like reduced public and private investment. In traditional literature,debt overhang threshold levels were discussed,which gave broadly similar results. In contrast,according to the IMF,recent studies to understand debt restructuring channels and its distributional effects across different sectors of the economy indicate a reverse result. Earlier,despite the celebrated 1944 article by Evsey Domar in American Economic Review,where two variables matter,the real interest rates and the growth rate of the economy the IMF would not consider the arguments of the emerging markets. Further,in 1992,after the Maastricht Treaty sanctified the two ratios of fiscal deficit and debt-to-GDP at 3 per cent and 60 per cent respectively,advocacy by the IMF became shriller. And Carmen Reinhart and Kenneth Rogoff raised the threshold level of debt ratio to 90 per cent before it negatively impacts growth in 2010. It now turns out that this number was based on an excel error. There was,and still is,no theoretical literature to justify these ratios,but the IMF assigned them a biblical status and applied it rigorously to all countries.
The IMF,five years after the onset of the crisis,is now advising select central banks on exit policy and the use of the macro-prudential toolkit to mitigate risks and strengthen supervision of the financial sector during the exit phase. The strategy and policy advice by the IMF seems familiar to many regulators and supervisors in emerging markets,especially India,who continue to believe that precaution is better than cure.
Another change is the recognition of the need to reflect emerging markets and developing countries in the governance and power structures in the IMF,which requires a reform of the quota formula and shares to reflect the changing structure of the global economy. With implementation of the 2008 reforms still pending and the formula reform deadline of January 2013 ignored,emerging markets wonder about the nature of the next quota revision promised by 2014 in the spring meeting communique.
With the growing integration of the global economy,the need for distilling and sharing lessons from the experiences of both developed and emerging countries is a necessity. An institution like the IMF should have been in the forefront of the two-way cross-pollination of such knowledge. Better late than never,the reversal in many policy stances by the IMF since the global financial crises in 2008,and particularly in the past three years,is expected to strengthen relationships and the path to recovery and growth. The strategy and vision of the Indian policymakers is increasingly recognised by the world and international institutions a matter of national pride for all of us.
Virmani is former executive director,IMF and Singh is RBI Chair professor of economics at IIM,Bangalore.Views are personal