Fi­nan­cial sta­bil­ity in the age of crises

Mint Asia ST - - Views Otherviews - Ramk­ishen S. Ra­jan

When Raghu­ram Ra­jan was the gover­nor of Re­serve Bank of In­dia (RBI), he high­lighted the spillovers to emerg­ing mar­ket economies (EMES) like In­dia from changes in US mone­tary pol­icy stance and their im­pact on global fi­nan­cial mar­kets. He has re­peat­edly sug­gested the pos­si­ble need for some “rules of the game” in man­ag­ing cross-border mone­tary spillovers.

Hélène Rey of Lon­don Busi­ness School ob­served that re­gard­less of a coun­try’s ex­change rate regime, prices of risky fi­nan­cial as­sets glob­ally tend to co-move, largely driven by global risk per­cep­tions (prox­ied by VIX in­dex) and the Fed Funds Rate. She has opined that if EMES wanted to use mone­tary pol­icy to have an im­pact on the do­mes­tic econ­omy, the only way to do so would be by im­pos­ing cap­i­tal con­trols, as the in­su­lat­ing prop­er­ties of ex­change rates are min­i­mal at best.

Sev­eral aca­demic pa­pers since then have sug­gested that the Ra­jan-rey the­sis of com­plete “help­less­ness” of the EMES to global fi­nan­cial cy­cles is ex­ag­ger­ated. Ev­i­dence sug­gests that coun­tries with more flex­i­ble ex­change rate regimes have gen­er­ally been bet­ter able to buf­fer them­selves against ex­ter­nal shocks com­pared to those with more heav­ily man­aged regimes. This is an im­por­tant mes­sage in the cur­rent en­vi­ron­ment where quan­ti­ta­tive eas­ing (QE) poli­cies in the US are be­ing wound down and those in the eu­ro­zone may fol­low soon.

How­ever, the spate of fi­nan­cial crises glob­ally over the last few decades has il­lus­trated the im­por­tance of main­tain­ing fi­nan­cial sta­bil­ity, some­thing which fi­nan­cial glob­al­iza­tion has made much more com­plex. Ex­change rates and in­ter­est rates are grossly in­ad­e­quate in­stru­ments and too blunt to deal with fi­nan­cial sta­bil­ity con­cerns as the pri­mary ob­jec­tive.

Some coun­tries in Asia have been among the lead­ers in the ac­tive use of macro­pru­den­tial poli­cies (MPPS) to cor­rect as­set price mis­align­ments and limit sys­temic risks by mod­er­at­ing the pro-cycli­cal build-up of vul­ner­a­bil­i­ties and fi­nan­cial im­bal­ances. The use of th­ese tools has in­ten­si­fied glob­ally since 2009.

MPPS take many forms—price­based in­stru­ments such as higher taxes or du­ties on cer­tain trans­ac­tions, or quan­tity-based ones such as debt-to-in­come lim­its on mort­gages and other bank loans, ceil­ings on loan-to-value (LTV) ra­tios, and such. Sin­ga­pore has been es­pe­cially ag­gres­sive in us­ing hous­ing-re­lated MPPS, es­pe­cially caps on LTV ra­tios on home loans, ceil­ings on to­tal debt ser­vice ra­tios (TSDRS), lim­its on hous­ing loan tenures, and the tax­a­tion on hous­ing trans­ac­tions (in the form of stamp du­ties). Prop­erty is, af­ter all, the largest com­po­nent of house­hold wealth and real es­tate mar­ket sta­bil­ity is usu­ally closely linked to over­all fi­nan­cial sta­bil­ity. Hong Kong, with its US dol­lar-based cur­rency board ar­range­ment, has also been proac­tive in im­pos­ing MPPS aimed at the hous­ing sec­tor. Apart from th­ese two smaller economies, In­dia too has been known to ac­tively use MPPS such as time-vary­ing risk weights and pro­vi­sion­ing norms in a coun­ter­cycli­cal man­ner to pre­vent po­ten­tial build-up of fi­nan­cial vul­ner­a­bil­i­ties in cer­tain sec­tors, in­clud­ing hous­ing, com­mer­cial real es­tate and non­bank­ing fi­nan­cial com­pa­nies (NBFCS). Un­like in Sin­ga­pore and Hong Kong where MPPS are un­der the di­rect ju­ris­dic­tion of their cen­tral banks, In­dia cre­ated a Fi­nan­cial Sta­bil­ity and De­vel­op­ment Coun­cil (FSDC) in 2010 to su­per­vise the use of MPPS. The FSDC is chaired by the fi­nance min­is­ter and has mem­bers from RBI and other fi­nan­cial sec­tor reg­u­la­tory bodies.

De­spite their grow­ing pop­u­lar­ity, given that MPPS are still in their in­fancy, pol­i­cy­mak­ers have lim­ited guid­ance on their best prac­tices, lead­ing to a great deal of “trial and er­ror” in their use. Un­like frame­works for in­ter­est rate and ex­change rate poli­cies which are by now wellestab­lished, MPPS re­main highly dis­cre­tionary. Much work re­mains to be done on fun­da­men­tal is­sues such as which in­stru­ments are most ef­fec­tive un­der what cir­cum­stances, when and how to exit suc­cess­fully from th­ese poli­cies, how best to com­mu­ni­cate th­ese poli­cies to mar­kets, and how to eval­u­ate and man­age any ad­verse dis­tri­bu­tional con­se­quences.

An im­por­tant con­cern with MPPS is that they are highly sus­cep­ti­ble to leak­ages within the coun­try, which un­der­mine their ef­fec­tive­ness (i.e. risk trans­fer as op­posed to risk mit­i­ga­tion) or cause spillovers across coun­tries, hence im­pact­ing the credit cy­cle in an­other ju­ris­dic­tion. For in­stance, im­po­si­tion of greater prop­erty curbs in China seem to have led Chi­nese de­vel­op­ers to shift their fo­cus to global prop­erty mar­kets, in­clud­ing Hong Kong and Sin­ga­pore, hence cre­at­ing ad­di­tional land price pres­sures in th­ese economies.

Thus, while MPPS are na­tional in na­ture, given their po­ten­tial un­de­sir­able spillovers ef­fects on other coun­tries, their con­duct calls for more co­or­di­nated global mone­tary con­sul­ta­tion if not out­right co­or­di­na­tion. Coun­tries in Asia and else­where would ben­e­fit from in­ter­na­tional rules of good con­duct with re­gard to their use while still en­sur­ing suf­fi­cient flex­i­bil­ity given dif­fer­ing coun­try con­texts.

The G20 Em­i­nent Per­sons Group on Global Fi­nan­cial Gov­er­nance chaired by Sin­ga­pore’s deputy prime min­is­ter Thar­man Shan­mu­garat­nam—and whose mem­bers in­clude Ra­jan— would be an ideal fo­rum for dis­cussing is­sues per­tain­ing to spillovers from MPPS as well as re­lated is­sues and pol­icy trade-offs that af­fect the highly in­ter­con­nected but rather un­governed global fi­nan­cial ar­chi­tec­ture.

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