Description
topics of global trade, capital flows, emerging market economies (EMEs).
Monetary Policy in an Open economyWith growth in global trade in goods and services outpacing growth in world output, the share of external trade in output has increased further. Opening up of the services to international trade and remittances flows have accelerated the integration process. The opening up of the economy has implications for the conduct of monetary policy as well as the monetary transmission mechanism. Global capital flows impact the conduct of monetary policy on a daily basis, imparting volatility to monetary conditions. Along with the explosion in financial innovations and the information technology revolution, this has led to the swift transmission of market impulses across countries and a structural change in the process of financial intermediation. A stylised fact in regard to many emerging market economies (EMEs) is that their external borrowings are usually denominated in foreign currency. A more recent challenge in monetary management in EMEs has emanated from a significant increase in capital flows coupled with current account surpluses which have led to large overall balance of payments surpluses in these economies. In their efforts to maintain external competitiveness and financial stability, the central banks in EMEs have absorbed the market surpluses. Consequently, the foreign exchange reserves of the EMEs have nearly doubled in the last seven years. Typically, central banks attempt to overcome the policy dilemma by undertaking a variety of operations such as open market sales of government/own bonds to neutralise the expansionary monetary effect arising out of their market purchases. Such sterilisation operations, in turn, have their own limitations and involve costs, especially if external flows are persistent. INDIA- External sector reforms were a key aspect of the structural reforms initiated in the early 1990s. While current account convertibility was achieved in 1994, the Indian approach towards capital account liberalisation has been one of caution. Trade openness of the economy has increased significantly. There has been a sustained increase in capital flows and the balance of payments has recorded large surpluses. Net capital inflows to India have been largely stable. While trade flows continue to be an important source of global transmission of shocks, a fundamental change that has taken place in recent years is the movements in capital flows. . Liberalisation of trade in services has, in particular, received a focus in the recent decades. Reflecting this progressive opening up of capital accounts, capital flows to EMEs increased significantly during the 1990s. As a consequence, it is capital flows that now influence exchange rate movements significantly as against trade deficits and economic growth. Capital flows have become the primary determinants of exchange rate movements on a day-to-day basis. . Thus, the analysis of capital flows and their behaviour - the volatility on account of the boom-bust pattern - becomes important for the conduct of monetary policy. With external and financial liberalisation, net capital flows to developing economies have increased rapidly. This step-up was entirely on account of private capital flows, which increased from fairly low levels. Another factor that can lead to a sustained rise in capital flows to emerging economies emanates from the evolving pattern of demographics and this could exacerbate the challenges to monetary policy formulation over the longer term. According to estimates made by IMF (2004), both savings and investment rates increase with an increase in the share of working age population. More importantly, the increase in the savings rate outpaces the increase in the investment rate and this increases the current account balance An increase in the share of elderly population, on the other hand, has the reverse effect - both savings and investment rates decline, and the current account balance deteriorates as the decline in savings exceeds that in investment.
The behaviour of the capital flows during the 1990s reveals that these flows can increase rapidly but can be highly volatile. Surges in capital flows and the associated volatility have implications for the conduct of monetary, exchange rate and foreign exchange reserve policies. Emerging market economies, thus, need to be equipped to deal with such volatility in order to ensure monetary and financial stability. The need for reserves as self-insurance emanates from the volatile nature of the capital flows. Capital inflows can reverse quickly, leaving the country exposed to a liquidity crisis. . In this context, the distinction between push and pull factors becomes important. While ‘push’ factors attribute capital flows to conditions in creditor countries, the ‘pull’ factors refer to conditions in debtor (recipient) countries. There implies a need for caution by EMEs in borrowing too heavily during times of benign external financing environment, as a reversal in credit conditions is more often than not beyond the control of the borrower. Therefore, it would be more apposite if central banks attempt to hold these volatile flows into their reserves. The precautionary demand for reserves has increased. The overall experience is that capital flows are characteristically volatile, both in terms of longer term waves and even more so in the short term. The longer term waves influence monetary policy thinking during each era, whereas the short term volatility has to be mitigated through day to day monetary policy operations. Monetary authorities, therefore, need to decide as to whether capital flows are durable or reversible. In case, flows are perceived to be reversible, authorities need to be prepared through building up foreign exchange reserves.
doc_243400019.docx
topics of global trade, capital flows, emerging market economies (EMEs).
Monetary Policy in an Open economyWith growth in global trade in goods and services outpacing growth in world output, the share of external trade in output has increased further. Opening up of the services to international trade and remittances flows have accelerated the integration process. The opening up of the economy has implications for the conduct of monetary policy as well as the monetary transmission mechanism. Global capital flows impact the conduct of monetary policy on a daily basis, imparting volatility to monetary conditions. Along with the explosion in financial innovations and the information technology revolution, this has led to the swift transmission of market impulses across countries and a structural change in the process of financial intermediation. A stylised fact in regard to many emerging market economies (EMEs) is that their external borrowings are usually denominated in foreign currency. A more recent challenge in monetary management in EMEs has emanated from a significant increase in capital flows coupled with current account surpluses which have led to large overall balance of payments surpluses in these economies. In their efforts to maintain external competitiveness and financial stability, the central banks in EMEs have absorbed the market surpluses. Consequently, the foreign exchange reserves of the EMEs have nearly doubled in the last seven years. Typically, central banks attempt to overcome the policy dilemma by undertaking a variety of operations such as open market sales of government/own bonds to neutralise the expansionary monetary effect arising out of their market purchases. Such sterilisation operations, in turn, have their own limitations and involve costs, especially if external flows are persistent. INDIA- External sector reforms were a key aspect of the structural reforms initiated in the early 1990s. While current account convertibility was achieved in 1994, the Indian approach towards capital account liberalisation has been one of caution. Trade openness of the economy has increased significantly. There has been a sustained increase in capital flows and the balance of payments has recorded large surpluses. Net capital inflows to India have been largely stable. While trade flows continue to be an important source of global transmission of shocks, a fundamental change that has taken place in recent years is the movements in capital flows. . Liberalisation of trade in services has, in particular, received a focus in the recent decades. Reflecting this progressive opening up of capital accounts, capital flows to EMEs increased significantly during the 1990s. As a consequence, it is capital flows that now influence exchange rate movements significantly as against trade deficits and economic growth. Capital flows have become the primary determinants of exchange rate movements on a day-to-day basis. . Thus, the analysis of capital flows and their behaviour - the volatility on account of the boom-bust pattern - becomes important for the conduct of monetary policy. With external and financial liberalisation, net capital flows to developing economies have increased rapidly. This step-up was entirely on account of private capital flows, which increased from fairly low levels. Another factor that can lead to a sustained rise in capital flows to emerging economies emanates from the evolving pattern of demographics and this could exacerbate the challenges to monetary policy formulation over the longer term. According to estimates made by IMF (2004), both savings and investment rates increase with an increase in the share of working age population. More importantly, the increase in the savings rate outpaces the increase in the investment rate and this increases the current account balance An increase in the share of elderly population, on the other hand, has the reverse effect - both savings and investment rates decline, and the current account balance deteriorates as the decline in savings exceeds that in investment.
The behaviour of the capital flows during the 1990s reveals that these flows can increase rapidly but can be highly volatile. Surges in capital flows and the associated volatility have implications for the conduct of monetary, exchange rate and foreign exchange reserve policies. Emerging market economies, thus, need to be equipped to deal with such volatility in order to ensure monetary and financial stability. The need for reserves as self-insurance emanates from the volatile nature of the capital flows. Capital inflows can reverse quickly, leaving the country exposed to a liquidity crisis. . In this context, the distinction between push and pull factors becomes important. While ‘push’ factors attribute capital flows to conditions in creditor countries, the ‘pull’ factors refer to conditions in debtor (recipient) countries. There implies a need for caution by EMEs in borrowing too heavily during times of benign external financing environment, as a reversal in credit conditions is more often than not beyond the control of the borrower. Therefore, it would be more apposite if central banks attempt to hold these volatile flows into their reserves. The precautionary demand for reserves has increased. The overall experience is that capital flows are characteristically volatile, both in terms of longer term waves and even more so in the short term. The longer term waves influence monetary policy thinking during each era, whereas the short term volatility has to be mitigated through day to day monetary policy operations. Monetary authorities, therefore, need to decide as to whether capital flows are durable or reversible. In case, flows are perceived to be reversible, authorities need to be prepared through building up foreign exchange reserves.
doc_243400019.docx