Financial Integration and Monetary Policy: Is there a new normal?

IV Astana Economic ForumMay 3, 2011 Suman Bery

Prime Minister’s Economic Advisory Council, IndiaInternational Growth Centre, New Delhi

Overview

• Honored to be invited. Speaking in a personal capacity.

• Intervention explores two linked issues:• Framework for monetary policy for a semi-

open “large” emerging market (i.e. India)in present global environment

• Agenda for international monetary reform to serve developmental interests of such an economy.

Monetary Policy

• India resisted earlier EM consensus on inflation target, flexible exchange rate, independent central bank.

• Operating environment: fiscal dominance, high public debt, low political tolerance for inflation.

• Central Bank prefers to retain flexibility on multiple goals, multiple indicators.

• Facilitated by public dominance of the banking system, reasonably effective capital controls.

Financial Stability

• Increasing integration with global finance through debt, equity, FDI channels.

• Exchange rate increasingly market-determined, supported by reserves accumulation.

• Strict controls on entry of foreign banks; local branch expansion.

• Regime has succeeded in shielding banking system from major crashes, partly because of implicit government deposit guarantee.

What now?

• Need for monetary regime to anchor inflation, inflation expectations.

• Low tolerance for extreme volatility in nominal exchange rate, particularly if driven by large swings in capital movements.

• Upward nominal exchange rate flexibility constrained by actions of other regional actors.

A New Normal?• Indian system likely to remain a pragmatic

hybrid• Inflation and the current account deficit will be

the proximate targets of monetary policy• Private sector credit growth an important

intermediate indicator, interest rates and bank liquid assets operational instruments

• Reserves accumulation driven by a mixture of precautionary and ‘competitiveness’ considerations. Capital controls will remain.

International Monetary Reform• Effective safety nets, maintenance of real value of reserve

assets, controlled supply of international liquidity all important issues for India.

• Recent experience (notably QE2) has confirmed that US monetary policy will remain primarily domestically focused.

• Accordingly move to a “multi-polar” system seems inevitable, but raises issues of stability, runs without some global support.

• India’s increasing integration with Asia suggests it should participate more actively in regional safety net arrangements.

Thank you