The International Monetary Fund (IMF) has revised upwards its estimate of world output growth for 2010 to 4.2%, but that number conceals a wide divergence in growth rates between countries. Among developed nations, growth rates are expected to vary from 1% for the euro zone to 3.1% for the US. While emerging economies are expected to do better, their growth rates too are different, ranging from 10% and 8.8% for China and India, respectively, to 2.8% for central and eastern Europe. As IMF’s World Economic Outlook puts it, it’s a multi-speed recovery.

Illustration: Jayachandran / Mint

This means you require different policies for different countries. So IMF advocates keeping expansionary fiscal and monetary policies in place for advanced economies this year, pushing back fiscal consolidation to 2011. On monetary accommodation it is even more generous, claiming that it can remain supportive even as fiscal consolidation starts, provided inflation remains subdued. Emerging countries, with their higher growth rates, will have to put very different policies in place. The net result will be that global liquidity can be expected to remain abundant this year. With interest rates expected to remain very low in advanced economies, money will flow to where growth is. In fact, these are conditions that have seen a rush of funds to emerging markets in the past year. That is why IMF says the challenge for emerging economies is to absorb rising inflows without triggering a new boom-bust cycle. The Reserve Bank too is getting increasingly concerned about capital flows. In his recent monetary policy statement, the RBI governor said capital inflows and high inflation have sharply pushed up the rupee. IMF’s Global Financial Stability Report warns of potential asset bubbles.

What should policymakers in emerging economies do? One way out is to try and limit capital inflows; the government’s recent move to restrict external commercial borrowings is one example. In fact, IMF specifically says the best response would be to improve “macroprudential, regulatory, and supervisory frameworks to stem speculative flows". It also suggests fiscal tightening, removing controls on outflows and some capital controls. But capital controls are at best a short-term fire-fighting solution, unsuitable for a capital-hungry and poor economy in need of high growth. For India, the long-term solution is to increase the absorptive powers of the economy and use the money to fund infrastructure. But for that to happen, hard and politically challenging reforms are necessary.

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