Stronger financial system needed before full Re float
The current turmoil in the stock markets, with Indian stocks following the same path as the western markets, has again inspired the very old debate over the desirability of global financial integration.
By TNN |
MUMBAI: The current turmoil in the stock markets, with Indian stocks following the same path as the western markets, has again inspired the very old debate over the desirability of global financial integration. Should we go slow on reforms, especially on the capital account convertibility front?
The key issue in a recent paper written by the IMF staff on ‘Reaping the Benefits of Financial Globalization’ is whether financial globalisation is primarily an opportunity to share risk internationally.
The researchers are examining whether finance investment projects are good for growth or it is more a source of volatility and crisis.
Though the paper concludes that there are many benefits of globalisation even to the developing economies, there are several instances where it suggests that advanced economies have benefited more than developed economies.
Consider how China and India have fared in integrating their financial sectors with the global finance capital. At a recent seminar, Fitch Ratings’ Sovereign senior director James McCormack said that while in terms of economic integration China was much more globally connected than India, financially, Indian markets were much more globalised than China’s. Agreed. However, India still has a long way to go on this front. For example, India’s debt market still needs to be developed to reach the level attained by the markets in the West. This explains why Indian stock markets are comparatively less impacted by the recent global turmoil.
The policy considerations, the IMF paper says, are that while opening up to FDI at an early stage is likely to benefit all countries, a decision to liberalise short-term debt-creating inflows should take into account a country’s financial market development, perceived institutional quality and macroeconomic policies. But delays in opening up also carry costs. “Capital account liberalisation should be pursued as part of a broader reform package encompassing a country’s macroeconomic policy framework, domestic financial system and prudential regulation,” it says.
As per the IMF paper, international financial integration has increased dramatically in the global economy over the past three decades, though this process has affected advanced countries to a much greater extent than other segments of the IMF membership, in particular the developing countries.
Closer integration of emerging markets and developing countries into global financial markets may also provide significant benefits to advanced country residents through enhanced opportunities for portfolio diversification, the paper says.
Empirical evidence on the stability benefits of international financial integration is mixed. The results reported in the IMF paper suggest that for countries with relatively strong institutions, well-developed domestic financial systems and sound macroeconomic policy frameworks, greater integration has not been accompanied by significantly higher macroeconomic volatility whereas for countries without those conditions in place, volatility has tended to increase with greater openness.
Likewise, within a sample of financially open countries, crisis frequency is found to be lower in countries that are relatively open to international trade, and have strong institutions, sound policies and well-developed financial sectors, says the paper.
The empirical relationship between international financial integration and long-run economic growth is complex. Evidence based on case studies suggests that among financially integrated countries, those with sound macroeconomic and fiscal policies and well-developed and regulated financial systems are noticeably less likely to face crisis.
For countries that do not meet these preconditions, the case studies suggest a gradual approach to liberalisation, with appropriate sequencing of liberalisation of capital controls and improvements in the domestic financial sector and macroeconomic framework. Anyone listening?
The key issue in a recent paper written by the IMF staff on ‘Reaping the Benefits of Financial Globalization’ is whether financial globalisation is primarily an opportunity to share risk internationally.
The researchers are examining whether finance investment projects are good for growth or it is more a source of volatility and crisis.
Though the paper concludes that there are many benefits of globalisation even to the developing economies, there are several instances where it suggests that advanced economies have benefited more than developed economies.
Consider how China and India have fared in integrating their financial sectors with the global finance capital. At a recent seminar, Fitch Ratings’ Sovereign senior director James McCormack said that while in terms of economic integration China was much more globally connected than India, financially, Indian markets were much more globalised than China’s. Agreed. However, India still has a long way to go on this front. For example, India’s debt market still needs to be developed to reach the level attained by the markets in the West. This explains why Indian stock markets are comparatively less impacted by the recent global turmoil.
The policy considerations, the IMF paper says, are that while opening up to FDI at an early stage is likely to benefit all countries, a decision to liberalise short-term debt-creating inflows should take into account a country’s financial market development, perceived institutional quality and macroeconomic policies. But delays in opening up also carry costs. “Capital account liberalisation should be pursued as part of a broader reform package encompassing a country’s macroeconomic policy framework, domestic financial system and prudential regulation,” it says.
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As per the IMF paper, international financial integration has increased dramatically in the global economy over the past three decades, though this process has affected advanced countries to a much greater extent than other segments of the IMF membership, in particular the developing countries.
Closer integration of emerging markets and developing countries into global financial markets may also provide significant benefits to advanced country residents through enhanced opportunities for portfolio diversification, the paper says.
Empirical evidence on the stability benefits of international financial integration is mixed. The results reported in the IMF paper suggest that for countries with relatively strong institutions, well-developed domestic financial systems and sound macroeconomic policy frameworks, greater integration has not been accompanied by significantly higher macroeconomic volatility whereas for countries without those conditions in place, volatility has tended to increase with greater openness.
Likewise, within a sample of financially open countries, crisis frequency is found to be lower in countries that are relatively open to international trade, and have strong institutions, sound policies and well-developed financial sectors, says the paper.
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The empirical relationship between international financial integration and long-run economic growth is complex. Evidence based on case studies suggests that among financially integrated countries, those with sound macroeconomic and fiscal policies and well-developed and regulated financial systems are noticeably less likely to face crisis.
For countries that do not meet these preconditions, the case studies suggest a gradual approach to liberalisation, with appropriate sequencing of liberalisation of capital controls and improvements in the domestic financial sector and macroeconomic framework. Anyone listening?
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