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Unresolved quickly, global problems can slam the brakes on emerging market economies (EMEs), said Dr D. Subbarao, Governor, Reserve Bank of India.
EMEs have been affected by the global crises in 2008 and 2011 with their macroeconomic stability, price stability and financial stability getting jeopardised through several channels, including trade, capital flows and commodity prices, he said.
The countries that are usually included in the category of EMEs are China, India, Indonesia, the Philippines, Thailand, Argentina, Brazil, Mexico, Poland, and the Russian Federation.
“We are rapidly running out of time, and may therefore be running out of solutions (to resolve the global crisis)… “There are strong expectations that we will converge on a plan of action that will reverse the crisis of confidence. We once again have to show the resolve that we did in 2008 to meet those expectations,” the Governor said at the meeting of the International Monetary Fund in Washington DC.
Renewed anxiety in the US about recession and the deepening of the sovereign debt crisis in the Euro area are the two big flashpoints.
“Each is by itself a big risk, but the bigger risk is that both could materialise simultaneously, and interact with each other with adverse feedback loops manifested through trade, finance and confidence channels,” the Governor cautioned.
Channels of contagion
The RBI chief said that the first channel of contagion to EMEs is the trade channel. With growth getting stalled in the advanced economies, external demand is slowing and affecting the exports of EMEs.
The second channel of transmission, according to Dr Subbarao, is through capital flows. The global crisis is permeating to EMEs through risk aversion and deleveraging to produce volatility in capital flows and in financial markets. This is impacting financing conditions, with feedback to economic activity.
The third channel through which shocks are being transmitted is commodity prices. Spikes of volatility in the already elevated levels of commodity prices are stoking inflationary pressures in some of the EMEs and complicating macroeconomic management in the face of slowing growth, the Governor explained.
“Among the drivers of commodity prices is accommodative monetary policy in advanced economies. Abundant liquidity is adding pressures to commodity prices. The negative outlook on growth should have driven down prices, but that has not been evident so far to any significant extent,” the RBI chief said.
Rising credit risks
Macro-financial loops could come into play as the fourth channel of transmission of shocks.
Rising credit risks due to deterioration in asset quality could impair the capital of banks or even render it insufficient. This could trigger a cascade of deleveraging with attendant real economy consequences.
By far, the most important channel of transmission, according to the Governor, is the confidence channel which could hurt investment and growth prospects in EMEs. When confidence is hit, even strong fundamentals do not matter, he added.
The probability that all these channels become active and feed on each other is quite high, the Governor warned.
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