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Reforming The Architecture of the International Monetary System: Managing The Impossible Trinity

Reforming The Architecture of the International Monetary System: Managing The Impossible Trinity. Rakesh Mohan Michael Debabrata Patra Muneesh Kapur. Conference of the The BRICS & Asia, Currency Internationalization, and International Monetary Reform Hong Kong 10-11 December 2012.

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Reforming The Architecture of the International Monetary System: Managing The Impossible Trinity

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  1. Reforming The Architecture of the International Monetary System:Managing The Impossible Trinity Rakesh Mohan Michael Debabrata Patra Muneesh Kapur Conference of the The BRICS & Asia, Currency Internationalization, and International Monetary Reform Hong Kong 10-11 December 2012

  2. Presentation Outline • IMS – Performance Evaluation • IMS Early Warning: Review and Reform • Managing Capital Flows: Country-centric or Multilateral • Issues in reserve management • Stylized facts • Dominant Reserve Currency – Risks to IMS; Demand-Supply Dynamics • Currency Internationalization: the Way Forward? • Costs and Benefits • IMS and Central Banks • Central Bank Mandate(s) – Rethink? • Key Takeaways

  3. What is the IMS? • Set of official arrangements comprising: • exchange arrangements and exchange rates • international payments and transfers relating • international capital movements; and • international reserves • What it is not • Mission creep • Shifting channels of contagion- This time will be different

  4. IMS Performance – Evaluation • Increasing incidence of crises

  5. IMS Performance Evaluation: Higher Exchange Rate Volatility

  6. IMS Performance Evaluation:Exchange and Payment Arrangements • Intermediate Solutions – managed floats; soft pegs • Current restrictions ebbing; capital restrictions well in evidence

  7. IMS Performance : EvaluationHigh flux in Capital Flows

  8. High Flux for AEs too

  9. Reserve Accumulation by EMEs and AEs

  10. AEs share in global reserves are coming down

  11. IMF Surveillance –Review and Reform • Gaps in Surveillance – Response • Enhancing integration of multilateral macro-financial analysis: WEO & GFSR • introduction of Early Warning Exercise, Fiscal Monitor, Spillover Report, Pilot External Sector Report, and the G-20 Mutual Assessment Process • Improvements in bilateral surveillance – multi-country perspective: timeliness and readability • The Financial Sector Stability Assessment (FSSA, a major component of FSAP) made mandatory for 25 key countries • An Alternative approach: an India example • Ensured compatibility with best practices and enhanced the skill-sets within the financial sector, leading to significant capacity building • 4 independent advisory panels • Reports peer reviewed • Integrated Surveillance Decision • Why not amend Articles? • More multilateral less bilateral • Dealing with spillovers – dialogue; encouragement? • Flawed governance, flawed surveillance

  12. Managing Capital Flows • Five challenges for collective action • Empirical evidence on beneficial effects of CAL weak • Danger of one-size-fits-all approach • Capital account management does not mean less openness – fully open capital account may not be desirable • Policies needed to counter externalities associated with cross-border flows • Even-handed treatment? • Advisory role for the IMF is the best option for now • Analysis of push and pull factors • Cross fertilisation of country experiences • Improve mapping • Capital controls legitimate part of policy toolkit

  13. Issues in Reserve Management • Massive Reserve Accumulation • Reserve Accumulation vis-à-vis Other Metrics

  14. Dominance of US Dollar in International Reserve Currency

  15. Demand for Reserve Assets continues to rise… • Demand likely to outstrip supply of reserve currencies

  16. Underlying Risks • Threats to IMS Stability • US debt sustainability and Triffin dilemma • Underpricing all Risks • Risks from policies towards domestic orientation in the US • Ability of US Dollar to meet future reserve currency demand?

  17. Trends and composition of GDP • Growth has moderated over last six quarters • Sluggish industry growth • Services has also shown moderation in last 3 quarters

  18. Inflation Persistence • February 2010 to November 2011 – Highly elevated inflation • Average Inflation 9.6 per cent • February 2012 to October 2012 - Sticky Inflation • Average Inflation around 7.6 per cent

  19. Movement of Indian rupee vis-à-vis US dollar • Market-determined-movements two ways

  20. Financial openness of India increasing Source: Lane and Milessi-Feretti Database

  21. India’s Currency Invoicing • US Dollar is also the major currency for invoicing software exports with 76% share, followed by Pound Sterling (10%) and Euro (7%) in 2009-10.

  22. EMEs account for 49% of global GDP in 2011; India: 5.6 %

  23. Currency Internationalization Growing scope for EME Currency Internationalization…

  24. EMEs’ share in global trade is rising but…

  25. …..Share of EME currencies in Fx turnover still negligible...

  26. …US Dollar and Euro continue to dominate in Global Fx Derivatives Market…

  27. …Rising presence of some EMEs..

  28. Prerequisites… • Acceptability is key, comprising • Deep and liquid financial and foreign exchange markets • Full currency convertibility and an open capital account • Wide use in international transactions • Macroeconomic and Political stability

  29. Cost and Benefits of Currency Internationalization • Reduces transaction costs • Reduces exchange rate risks • Access to international debt securities markets –domestic deepening • Complicates monetary management • Can hurt export competitiveness • Could make exchange rate more volatile • Exorbitant privilege or exorbitant risk • Systematic consequences Rush into currency internationalisation – repent at length

  30. Key Takeaways • Enlightened IMS Governance is key • More representative legitimate and effective IMF • Regional arrangement and national reserves integral part of global safety net • Domestic stability, external stability and global stability – new impossible trinity • Dealing with spillovers critical • Managing Capital Flows – One size fits all or customised to country context? • Central banks mandate in reformed IMS – financial stability; self FSAP • Future demand-supply mismatches in reserve currencies –recipe for future shocks? • Currency internationalisation • EMEs in a still nascent continuum • Managed internationalisation is flawed and dangerous • Economic size, financial depth, openness, credibility, usability, - set a high bar Blending fundamentals with country experience will balance desirable with feasible

  31. Thank You!

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