MUMBAI: Central banks must increase cooperation to meet any turbulence across global financial markets following increase in interest rates by the US Federal Reserve, Christine Lagarde, Managing Director of International Monetary Fund said here on Tuesday.
“There is scope for greater international policy cooperation to minimise the negative spillovers,’’ Lagarde told top bankers at the Reserve Bank of India.
“Clear and effective communication of policy intentions can reduce the risk of creating very large market volatility. ‘’
Emerging markets need to prepare well in advance, she recommends.
If the market volatility materialises, central banks need to be ready to act. Swift action by central banks of India, Indonesia, Brazil,
Uruguay and Korea helped these economies tide over the previous crisis in May-June 2013, when talks of ending quantitative easing by the US triggered an outflow of funds.
An immediate challenge is strengthening of the dollar along with divergence of monetary policy paths in advanced economies.
Monetary policies being followed by countries such as the US and the UK were at variance with Euro area and Japan, she pointed out.
Likewise, economies of India faced different challenges compared with Russia, Brazil or South Africa, the other BRIICS nations.
Strengthening of the dollar hurts those countries with external trade in non-dollar currencies, as also countries borrowing in global markets, and companies and banks that borrow in dollars but have assets or earnings in other currencies, said Lagarde.
“India’s corporate sector, which has borrowed heavily in foreign currency, is not immune to this vulnerability,’ said Lagarde.
“Corporate sector debt has risen very rapidly, nearly doubling in the last five years to about $120 billion.’’
Another risk is to the financial market and capital flow volatility, along with sudden increases in interest rate spreads, remains a real possibility as the US interest rates begin to rise.
The accommodative monetary policy of the US because of which about $4.5 trillion gross capital inflow, went to emerging markets between 2009 and 2012. Such inflows were concentrated in a group of large countries, including India, which received about $470 billion. “The danger is that vulnerabilities that build up during a period of very accommodative monetary policy can unwind suddenly when such policy is reversed, creating substantial market volatility,’’ she said. “We already got a taste of it during the “taper tantrum” episode in May and June of 2013, when most emerging market economies suffered indiscriminate capital outflows. India was also affected.’’
The IMF MD stressed that events like the taper tantrum may not be one-off episode, because the timing of interest rate lift-off and the pace of subsequent rate increases can still surprise markets.