New Delhi: International Monetary Fund managing director Dominique Strauss-Kahn has warned that the subprime crisis which has affected the US and Europe was yet to pan out fully and that emerging markets too could come within its throes.
“Obviously, the major emerging economies are not yet in a downturn,” he said on Wednesday. “But, I think they should be prepared.”
Perfect storm: International Monetary Fund managing director Dominique Strauss-Kahn says Indian authorities are well aware of the risks of volatility in capital flows in the period ahead.
Strauss-Kahn was delivering a lecture on “Lessons from the Financial Market Crisis: Priorities for the World and the IMF”, organized by the Indian Council for Research on International Economic Relations.
Describing the crisis as “a perfect storm”, Strauss-Kahn said: “I don’t think the emerging economies are immune” and “effects would be felt, sooner rather than later.”
Referring to complex financial linkages and spillovers between emerging and industrial economies, he said “India has experienced very large capital inflows since the subprime crisis” but “there could also be a reversal of inflows, if there is a general retreat from risk by global investors.”
He added that the “Indian authorities were well aware of the risks of volatility in capital flows in the period ahead.”
Agreeing with the diagnosis, former Reserve Bank of India governor Bimal Jalan said: “There is no doubt that in real terms, the economy is on a sound footing. But, the capital markets are a different thing, they are absolutely fragile and volatile. And that kind of a crisis is self-feeding beyond a point. If the financial sector collapses, the impact would be definitely felt on the realeconomy.”
Firmly refuting the notion of a decoupling between the emerging and industrial world, Strauss-Kahn said: “Some would argue that growth in major emerging economies like China and India is now such a powerful engine that it can continue to move forward without the large industrial countries. I don’t think so—at least, not yet. The industrial and emerging economies are more like two horses yoked together. If one is tired, the other can take up more of the strain for a while. But if one stops in its tracks, neither is going to get very far.”
The reason, he said, is that sustained strong growth in emerging economies such as India has also been based on gains from trade and financial integration in the global economy. “In the past, a 1% decline in US growth has led to a decline in growth in emerging economies by 0.5-1%, depending on trade and financial links with the US.”
The trade links that bind emerging and industrial economies are “still tight, and perhaps more than they seem from a casual examination of trade figures”, he added.
In financial market policies, he said, emerging economies can learn from the risk-management and regulatory failures of industrial economies. He called for regulatory capacities to safeguard against the risks associated with non-transparent instruments and excesses in lending and, in some cases, consider change of framework for liquidity management and collateral.
In terms of economic policy, “emerging economies could consider how they would respond to a downturn: How much scope there is for monetary easing in some countries; how much scope there is for a fiscal stimulus in others.”
Strauss-Kahn also acknowledged that “emerging economies as a group must be given a greater representation and a greater voice” in IMF.