Globalisation and Monetary Policy : Some Emerging Issues (Inaugural address by Dr.

Y V Reddy, Governor, Reserve Bank of India on March 1 , !""# a$ %o$el &a' (residen$, Mu)bai*

Professor Radhakrishna, Professor Eichenbaun, Professor Rebelo, Professor Christiano, Professor Nachane, Dr. Rakesh Mohan and friends, Happy New Year to all of you. or Dr. Rakesh Mohan, it is a holiday issue, as he described. or !e, it is a festi"al issue also, since # a! a $elu%u. &o, !y address will be in the for! of sharin% of the festi"e !ood also. 's you !ay be aware, today is a festi"al celebrated as New Year by the &tate of Maharashtra, and is called (udipadwa by the Marathi)speakin% people, who nu!ber about *+ !illion. #t is also celebrated by about ,- !illion .annada)speakin% people as /0%adi/. 1e, the 2+ !illion $elu%u)speakin% also celebrate the festi"al as 0%adi. $he festi"al !arks the New Year day for people who follow the southern #ndian lunar calendar. $his calendar reckons dates based on the &ali"ahana era 3&ali"ahana &aka4, which be%ins its count fro! the supposed date of the foundin% of the E!pire by the le%endary hero &hali"ahana. $he &ata"ahana kin% &hali"ahana 3also identified as (auta!iputra &atakarni4 is credited with the initiation of this era known as &hali"ahana. $he &hali"ahana era be%ins its count of years fro! the year correspondin% to *2 'D of the (re%orian calendar. $hus, the year 5+++ 'D corresponds to the year 6755 of the &ali"ahana Era. #n the ter!inolo%y used by this lunar calendar, 0%adi falls on Chaitra &udhdha Paadya!i or the first day of the bri%ht half of the Hindu !onth of Chaitra. $he $elu%u and .annada people celebrate the festi"al with %reat fanfare8 %atherin%s of the e9tended fa!ily and a su!ptuous feast are de ri%ueur. $he day, howe"er, be%ins with ritual showers followed by prayers, and then the eatin% of a specific !i9ture of Nee! :uds; lowers for :itterness, <a%%ery for &weetness, Raw Man%o for =a%aru , $a!arind <uice for sour. $his !i9ture, called >0%adi Pachhadi> in $elu%u and >:e"u):ella> in .annada, sy!boli?es the fact that life is a !i9ture of pleasure and pain, which should be accepted to%ether and with e@uani!ity. People traditionally %ather to listen to the recitation of the reli%ious al!anac 3Panchan%a!4 of the co!in% year, and to the %eneral forecast of the year to co!e. $his is the Panchan%a &ra"ana!, an infor!al social function where an elderly and respected person opens the new al!anac pertainin% to the co!in% year and !akes a %eneral benediction to all present. $he ad"ent of radio and tele"ision has chan%ed this routine so!ewhat, especially in the cities. Nowadays, people turn on the radio or $= to watch the recitation. 0%adi celebrations are also !arked by literary discussions, poetry recitations and reco%nition of authors of literary works throu%h awards and cultural pro%ra!!es. Recitals of classical carnatic !usic and dance are held in the e"enin%s. #n Maharashtra, it is custo!ary to erect A(udisB on the first day 3Padwa4 of the Marathi New Year. >(udi> is a ba!boo staff with a colored silk cloth and a %arlanded %oblet atop it, which sy!boli?es "ictory or achie"e!ent. Hence, this day is known as /(udipadwa/ in Maharashtra. $he New Year is ushered in with the worship of the >(udi> and the distribution of a specific >Prasada!> co!prisin% tender nee! lea"es, %ra!)pulse and Ca%%ery. $he sy!bolis! of tastes is the sa!e as that of 0%adi. #t is belie"ed that the creator of the Hindu pantheon Dord :rah!a started creation on this day E Chaitra suddha padhya!i or the 0%adi day. 'lso, the %reat #ndian Mathe!atician :haskaracharyaBs calculations proclai!ed the 0%adi day fro! the sunrise on as the be%innin% of the New Year, new !onth and new day. Det !e confess that # a! not able to predict for the ne9t year, the future of !onetary policy in the

open econo!ies in %eneral or openin% econo!ies like #ndia, since # a! yet to hear /Panchan% &ra"ana!/ for the New Year na!ed as /&ar"aCeet/. $here is an interestin% reason why # could not hear the authentic Panchan% &ra"ana!. $here is a difference of opinion a!on% the top pundits in 'ndhra Pradesh as to whether Panchan% &ra"ana! should be on the 67 th or the 5+th March, 5++*, and a leadin% li%ht insisted that it should really be on 5+th since /&urya)(rahana!/ 3solar eclipse4 on the 67th bars /Panchan% &ra"ana!/ on that day. &o, the Panchan% &ra"ana! is slated for the 5+th March at 66 a! on &apta%iri official $= channel. &o, # understand that the (o"ern!ent of 'ndhra Pradesh has declared that in addition to today bein% a holiday, the 5+ th March would be an optional holiday for those who would choose to!orrow for their festi"ities. riends, the #ndians !ay be ar%u!entati"e but the $elu%us are not only ar%u!entati"e but lo"e freedo! to choose E e"en their 0%adi festi"al day, e"en when based on a readin% of celestial stars. #n the festi"e !ood that lasts for two days this year for the $elu%us, let !e wish the deliberations of the conference on /'d"ances in Fpen Econo!y Macroecono!ics/ a "ery producti"e and pleasant ti!e. # reco%nise that a nu!ber of e!inent econo!ists fro! the North 1estern 0ni"ersity and other 0& uni"ersities are participatin% in the conference and # would like to e9tend a hearty welco!e to the!. # con%ratulate the econo!ists fro! the #(#DR, the R:# and other #ndian uni"ersities for their contributions to this conference. Det !e e9tend a personal war! welco!e to our %uests fro! other countries E we belie"e in /'tithi de"o bha"a/. # would like to take this opportunity to share a few thou%hts on a possible rethink that !ay be occurrin% in re%ard to %lobalisation that could affect how the open econo!ies would choose to be ) to the e9tent the public policy has choices. $hat would lead !e to share so!e of the challen%es for conduct of !onetary policy, in a world currently less certain of the costs or benefits of %lobalisation. # a! afraid, # !ay be repeatin% what # had said in so!e other fora recently but, # hope to conte9tualise the presentation. #n the recent period, a reassess!ent of the costs and benefits associated with %lobalisation see!s to be takin% place. Do!estic structural refor!s in the e!er%in% econo!ies are unlockin% the pent)up do!estic de!and and, in turn, enablin% a %reater realisation of the hu%e potential for %rowth. &o, what is causin% the rethink in both E the de"eloped and the e!er%in% econo!iesG irstly, the traditional postulate that the capital flows fro! the capital)surplus or de"eloped countries to the capital)scarce or de"elopin% countries, see!s to ha"e been dispro"ed in recent years. $he world>s lar%est econo!y, the 0nited &tates, currently runs a current account deficit, financed to a substantial e9tent by capital e9ports fro! the e!er%in% !arket econo!ies. Ff course, it can be ar%ued that the so)called A%lobal i!balancesB are a reflection of inco!plete %lobalisation. :ut the fact re!ains that as lon% as %lobali?ation happens to be inco!plete, public policy has to !ana%e the conse@uential /i!balances/. &econdly, in a %lobalisin% world, the conte9t in which !onetary policy is set, often leads to a confrontation with the i!possible trinity E independent !onetary policy, open capital account and !ana%ed e9chan%e rate. $he theory holds that at best, only two out of the three would be feasible. #n practice, howe"er, there is a shift in preference away fro! the corner solution with respect to financial i!balances. Currently, inter!ediate solutions, which were earlier re%arded as Afu??yB, are now beco!in% increasin%ly rele"ant. Moreo"er, in reco%nition of the differences between trade and financial inte%ration E first pointed out by <a%dish :ha%wati E there is less certainty today about the corner solutions than in the past. $hirdly, at a practical le"el, the recent e9perience see!s to indicate that %lobalisation !ay ha"e

had accentuated potential conflicts that can i!pact the fabric of our societies, particularly, in "iew of risin% corporate profits coupled with a reduction in share of re!uneration for the labour. #n this re%ard, # was struck by what Mr. <ohn Micklethwait, Editor)in)Chief of $he Econo!ist is reported to ha"e said in an inter"iew, as !entioned in a leadin% daily yesterday 3March 62, 5++*4. He said this in the conte9t of the process of %lobalisationH /:ut as far as %lobalisation %oes, # a! worried about one thin%H if you look at ine@uality, particularly in '!erica, the rich ha"e %ot e"en richer and the !edian inco!e has barely bud%ed. 1hat is interestin% is that Cust in the last couple of @uarters, you be%an to see a si%n of the wa%es be%innin% to rise. 1hat if you ha"e seen in the last ten years is the returns to capital increasin% dra!atically and returns to labour proportionately %oin% downG 1hat is happenin% now is that if you ha"e the prospect of a downturn, then ine@uality will beco!e !uch bi%%er issue in the '!erican elections. 'round the world it is already a !uch bi%%er issue, includin% in places like <apan. $he corporate boss in <apan now is paid I- ti!es what the !edian worker is paid. #n '!erica, it is J66 ti!es./ ourthly, there are wide)spread concerns about the %aps in international trade rules and re%ulations, the i!passe in !ultilateral trade ne%otiations and conse@uently, a risin% nu!ber of re%ional and bilateral trade arran%e!ents. ifthly, the rapid pace of %lobalisation in !onetary and financial relationships has not been acco!panied by an i!pro"e!ent in the international financial architecture. Mana%in% financial crisis re!ains lar%ely a national responsibility. 's the 0NC$'DBs $rade and De"elop!ent Report, 5++, has notedH AA$he bulk of adCust!ent in case of e9ternal i!balances is often concentrated on a %roup of de"elopin% and transition econo!ies, despite the fact that the source of such i!balances !ay occur in the de"eloped worldBB 3F"er"iew, p. I2)I74. #n the wake of these de"elop!ents, there is a %rowin% e9pression of hei%htened sensiti"ity to the costs associated with %lobalisation. #t is reco%nised that in the ulti!ate analysis, public policy has i!portant role in !ana%in% the costs and benefits of %lobalisation. $o @uote Chair!an :ernankeH AA urther pro%ress in %lobal econo!ic inte%ration should not be taken for %rantedKas in the past, the social and political opposition to openness can be stron%K !uch of it arises because chan%es in the patterns of production are likely to threaten the li"elihoods of so!e workers and the profits of so!e fir!sK$he natural reaction of those so affected is to resist chan%e, for e9a!ple, by seekin% the passa%e of protectionist !easuresBB 3<ackson Hole, 5++,4. #n brief, the unfoldin% path of %lobal econo!ic inte%ration and conse@uently, preferences for open econo!ies are beset with unknown uncertainties. #n this broader settin%, let us look at the e!er%in% challen%es to !onetary policy. irst, considerations relatin% to !a9i!isin% output and e!ploy!ent wei%h as !uch upon !onetary authorities as !aintainin% price stability, particularly in the de"elopin% countries. $he twin)obCecti"e is often enshrined in the le%al pro"isions e9cept where inflation tar%etin% is !andated. Howe"er, do!estic inflation has increasin%ly beco!e less sensiti"e to the do!estic output %ap and potentially !ore sensiti"e to the world output %ap. Each country !ay, therefore, take a holistic approach to the trinity of free flows of capital, fi9ed or !ana%ed e9chan%e rates and independent !onetary policy. $he i!possible trinity has to be often !ana%ed in the e!er%in% econo!ies and this is ensured by close coordination between !onetary and other public policies. &econd, the central banks are often concerned with the stability ; "ariability of inflation rather than the le"el of prices. Howe"er, inflation processes ha"e beco!e hi%hly unclear, a!idst these uncertainties8 central banks are faced with the need to reco%nise the i!portance of inflation

perceptions and inflation e9pectations also, as distinct fro! inflation indicators. $he distinction between inflationary e9pectations and current inflation perceptions in the conte9t of inflation policy is also worth bearin% in !ind. urther!ore, often than not, the e9pected chan%e rather than the actual chan%e in real interest rate, followin% a chan%e in the policy rate, often dri"es the actions of the econo!ic a%ents. #n this conte9t, credible co!!unication and creati"e en%a%e!ent with the !arket and econo!ic a%ents has e!er%ed as the critical channel of !onetary trans!ission. $he e9istence of ad!inistered prices in co!!odities critical to inflation e9pectations, perceptions or indicators co!plicates the relationship between prices and !onetary policy trans!ission, thou%h the outco!e !ay be socially desirable. $hird, the presence of ad!inistered interest rates, e"en in se%!ents of a financial syste!, could hold back appropriate adCust!ents in real rates as a se@uel to chan%es in the policy rates. $he ad!inistered interest rates do occur in different for!s, instru!ents and !a%nitudes but these could be, to so!e e9tent, !onitored. 1hat is surprisin%, howe"er, is that the financial !arket rates could also display so!ewhat ine9plicable i!per"ious beha"iour and thereby, act as the source of no!inal ri%idities in the econo!y. &o!eti!es, it is described as a conundru!, or !i%ht # say /# do not know/G ourth, the central banks are now takin% baby steps E so!eti!es !ore fre@uent steps and at other ti!es after a lon% %ap, and in both directions E to respond to, what appear to be, ripples rather than hu%e wa"es in the sea of econo!ic acti"ity. urther, while what is considered as a Aneutral rateB of interest, in the present period, appears to be !uch lower co!pared to se"eral years before, the issue is whether the neutral rate in respect of the e!er%in% !arket econo!ies, which has been co!in% down in tande! with %lobal rates, will tend to be distinctly hi%her than in the de"eloped econo!ies. ifth, if the do!estic inflation rate of an econo!y, howe"er low it !ay be, is hi%her than the a"era%e inflation rate of its tradin% partners, it puts pressure on the e9chan%e rate. #n this conte9t, the @uestion of si!ultaneous balance of the internal and e9ternal sectors beco!es a !aCor issue if the fle9ibilities in the econo!y are less than ade@uate. $he conduct of !onetary policy ine"itably in"ol"es a careful Cud%!ent on the relati"e wei%hts assi%ned to the do!estic and the %lobal factors and constant reassess!ent and rebalancin% of these in response to e"ol"in% circu!stances. &i9th, since e9ternal capital flows to e!er%in% econo!ies cannot be easily predicted and can also re"erse e"en in the presence of sound funda!entals, !onetary authorities often ha"e to, in consultation with the %o"ern!ent, !ake choices in re%ard to e9chan%e rate and !onetary !ana%e!ent. &e"enth, financial stability considerations !ay re@uire the use of !onetary policy !easures, in conCunction with other prudential !easures. &o!e ti!es, there could be e"en a trade)off between raisin% the short)ter! interest rate and ti%htenin% of prudential nor!s, if the risks are percei"ed to ori%inate fro! certain se%!ents of the !arket. $he hi%hly le"era%ed lendin% operations in the backdrop of asset)price bubbles !i%ht re@uire adCust!ents in the lendin% !ar%ins and risk)based capital re@uire!ents. Ei%hth, in ter!s of financial stability, so!e new challen%es are e!er%in%. $he international financial !arkets are currently do!inated by pri"ate e@uity funds like hed%e funds, which are lar%ely operatin% outside the A.now)your)custo!erB; A.now)your)in"estorB 3.YC;.Y#4 nor!s. Hed%e funds ha"e lon% used arran%e!ents that allow the! to e9ecute trades with se"eral dealers but there is now an increasin% tendency on their part to consolidate the clearin% and settle!ent of their trades at a sin%le fir!, the >pri!e broker>. Pri!e brokera%e poses so!e uni@ue challen%es for the !ana%e!ent of counterparty credit and operational risk. Recent e"ents ha"e reinforced

the possible ad"erse i!pact of their risks. urther, it is co!!only obser"ed at the %lobal le"el that hed%e funds are >opa@ue> E that is, infor!ation about their portfolios is typically li!ited and infre@uently pro"ided. ro! a policy perspecti"e, transparency to in"estors is lar%ely an issue of in"estor protection, but the need for counterparties to ha"e ade@uate infor!ation is a risk) !ana%e!ent issue. inally, there are so!e uncertainties associated with the settlin% of trades in newer types of o"er) the)counter 3F$C4 deri"ati"es, particularly credit deri"ati"es. 's part of recent financial inno"ations, the credit)deri"ati"e and structured)credit !arkets ha"e %rown rapidly durin% the past few years, allowin% dispersion of credit risk by financial players. 's we are aware, the i!pact of instability in the e!er%in% econo!ies in ti!es of crisis appears to be borne by the ho!e or do!estic public sector also, alon% with the %lobal pri"ate sector. '"oidin% crisis is ulti!ately a national responsibility. #n such a !ilieu, the policy !akers are often confronted with co!petin% positions and !ake choices in the face of dauntin% dile!!as. Concluding Remarks :efore concludin%, it will be re!iss of !e not to address the relationship between the real and the financial sectors in the conte9t of %lobalisation, open econo!ies and !acro finance. Econo!ists ha"e for lon% reco%nised the stron% co!ple!entarities between the real and the financial sectors. inancial de"elop!ent contributes to %rowth in either a supply)leadin% or a de!and)followin% se@uence8 that is, either the financial sector de"elop!ent creates the conditions for %rowth or the %rowth %enerates de!and for the financial ser"ices. #t is i!portant to reco%nise that the financial sector in #ndia is no lon%er a constraint on %rowth and its stren%th and resilience are acknowled%ed, thou%h further i!pro"e!ents need to take place. Fn the other hand, without the real sector de"elop!ent in ter!s of the physical infrastructure and i!pro"e!ent in supply elasticities, the financial sector can e"en !isallocate resources, potentially %enerate bubbles and possibly a!plify the risks. Hence, public policy !ay ha"e a crucial role to play in ensurin% balanced refor!s in both the real and the financial sectors. $he criticality for the policy !akers is not only to ensure that there are no financial sector constraints on the real sector acti"ity but also to assure that the financial sector refor!s ha"e co!ple!entarity with the pace and process of refor!s in the real sector in #ndia, alon% with, no doubt, fiscal e!power!ent E as consistently e!phasised by the Reser"e :ank. Det !e conclude by co!pli!entin% all those who ha"e de"oted their ener%ies to brin% to fruition this inno"ati"e collaborati"e acade!ic acti"ity with policy si%nificance for the Reser"e :ank of #ndia. # a! thankful to the or%ani?ers, specially Prof. Nachane for %i"in% !e this opportunity to be with you. 1e, in the R:#, look forward to the benefit of discussions in this conference. Det !e wish the conference all success, and, with success, hopefully !any happy returns. $hank you.

#nau%ural address by Dr. Y = Reddy, (o"ernor, Reser"e :ank of #ndia on March 67, 5++* at Hotel $aC President, Mu!bai at the conference on >'d"ances in Fpen Econo!y Macroecono!ics> or%anised by the Center for Econo!ics and De"elop!ent, Northwestern 0ni"ersity, 0&' and the #ndira (andhi #nstitute of De"elop!ent Research, Mu!bai.