You are here: Home » Opinion » Columns
Business Standard

N Chandra Mohan: Emerging lessons

Many developing countries have lessons in financial crisis management relevant to developed countries

N Chandra Mohan 

When this writer was doing his research at the Centre for Development Studies in the late 1970s, Professor Kazushi Ohkawa of Hitotsubashi University gave a talk on Japan’s successful economic development and the lessons it held for developing economies. In the early 1990s, the East Asian miracle economies were exemplars of rapid growth. With the global crisis of 2008-09, developing economies are now believed to have lessons for crisis-ridden advanced countries.

As rapidly growing countries like China, India and Brazil are becoming engines of the global economy, the importance of highlighting their experiences is being increasingly felt in the academic world to help advanced countries move from short-term crisis management to a new growth paradigm. To this end, a workshop was organised by the Department of International Development, UK; the National Council for Applied Economics Research, New Delhi; the World Bank and New York University’s Stern School of Business on October 7-8.

A couple of contributions captured the flavour of the workshop. Indira Rajaraman, honorary visiting professor at the Indian Statistical Institute, presented a paper titled “Lessons for advanced economies from developing countries’ experience of the last few decades”. The focus was on India’s monetary policy that ensured there was minimal damage to the economy from the crisis. This example was cited earlier by Nobel laureate Joseph Stiglitz when he argued that if America had a central bank chief like India’s Dr Y V Reddy (former RBI Governor), the US economy would not have been in such a mess.

Prior to the 2008-09 crisis, standards for greater monetary policy transparency were frequently addressed to developing countries. According to a widely cited assessment of 100 central banks over the period 1998-2006 by Nergiz Dincer and Barry Eichengreen in an NBER working paper published last year, India’s central bank scored a lowly two out of 15. Yet, this hopelessly non-transparent Reserve Bank of India (RBI) effectively faced an unprecedented surge in capital inflows and kept a tight lid on appreciation pressure on the Indian rupee.

Flouting standards that required it to focus solely on inflation, the RBI acted quite flexibly to ensure macroeconomic stability. The central bank did this through “sterilised purchases of dollars during the unprecedented quadrupling of capital inflows over the four years preceding the crash. By so doing, the RBI effectively protected the economy from the disastrous financial instability that would have been the consequence of an unconstrained appreciation of the India rupee,” argued Professor Rajaraman.

The RBI also acted flexibly to contain the build-up of a real estate bubble by raising risk weights on commercial real estate loans in stages from July 2005. Though asset markets are not recommended by conventional wisdom to be on the watch list of a central bank for monetary or regulatory purposes, the RBI went against these conventions, demonstrating the advantages of flexibility in responding to unforeseen eventualities that threaten macroeconomic stability.

Besides, developing countries’ experiences are relevant for advanced countries’ fiscal policies. Professor Jeffrey Frankel of the Kennedy School of Government, Harvard University, argued in his paper titled “What lessons do developing countries have for fiscal policy in the US and other advanced countries?” that American policy over the last decade has been pro-cyclical instead of being counter-cyclical. Policy makers wasted the opportunity of a boom in running large budget deficits when a more desirable course of action should have been to register surpluses to enable the economy to ride out a recession as in 2008-09. Thanks to limited fiscal headroom, US policy makers feel constrained with less ambitious stimulus measures when the process of recovery from the global crisis is still fragile.

In sharp contrast, during the last decade, a range of developing countries from China to Chile, learned to take advantage of a boom to achieve high budgetary surpluses, which allows some fiscal ease in response to a bust. Thanks to a stronger fiscal position, China could afford to undertake a much more ambitious fiscal stimulus in response to the 2008-09 crisis. Brazil and Indonesia “also found themselves freed of the need to cut spending in recession and were better able to sail through than the industrialised countries,” argued Professor Frankel. Advanced countries like the US and the UK wasted the preceding expansion and became heavily constrained by their debt burdens in 2010.

Chile’s example is even more relevant since its fiscal policy has been governed by a structural budget rule that enabled it to implement a counter-cyclical fiscal policy. Thanks to the 2003-2008 upswing in copper prices, it registered a substantial increase in national savings, some of it dedicated to funding the government’s pension-related liabilities. As the computation of a structural budget requires an estimate whether the boom is permanent or temporary, this task has been given to a panel of independent experts and insulated from the wishful thinking of politicians who act as if the boom will continue indefinitely and spend irresponsibly and regret later. Clearly, this workshop threw up interesting developing country experiences that can better inform policy discussions in advanced countries.

First Published: Fri, November 19 2010. 00:52 IST
RECOMMENDED FOR YOU