BIS Bats for Fiscal Consolidation

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The BIS contends sans frills that the vulnerabilities are ‘worrisome’, given the more limited room for policy manoeuvre relative to pre-crisis of the Great Financial Crisis (GFC) that engulfed the world a decade ago. Since 2008, it said, historically low, even negative interest rates and unprecedentedly large central bank balance sheet have provided important support for the global economy and contributed to the gradual convergence of inflation towards objectives. A report, for Different Truths. 

The central bankers’ central bank, the Basel-based Bank for International Settlements (BIS) has sounded the bugle of manifest vulnerabilities in the global financial system in particular and the world economy in general even as the near-term prospects remain ‘bright’.

In its Annual Report, released at its annual general meeting (AGM) on Sunday in Switzerland, the BIS contends sans frills that the vulnerabilities are ‘worrisome’, given the more limited room for policy manoeuvre relative to pre-crisis of the Great Financial Crisis (GFC) that engulfed the world a decade ago. Since 2008, it said, historically low, even negative interest rates and unprecedentedly large central bank balance sheet have provided important support for the global economy and contributed to the gradual convergence of inflation towards objectives. Yet, central banks the world over were largely left to “bear the burden of the recovery, with other policies, not least supply-side structural ones, failing to take the baton”.

Stating that as a consequence the recovery was unbalanced and central banks were overburdened, BIS maintained that since the crisis both public and private debt has soared in relation to the gross domestic product (GDP). Easy financial conditions have led to more leveraged households or corporates in many economies with the depreciating U.S dollar fanning a build-up in dollar-denominated debt in emerging markets. These vulnerabilities have heralded problems in previous episodes, including recessions, the BIS warned.

In his remarks at the AGM, BIS General Manager Agustin Cartsens argued that even as the current economic upswing noticeable in the global economy still relies on extraordinary support from central banks, the latter might find it difficult to manage both financial stability and price stability objectives of the apex bank. Pointing out that the stronger performance of the world economy gives “a window to pursue necessary reforms and recalibrate policies, he warned that the opportunity” should not be missed.

The BIS report duly cautioned that the role of financial forces in business fluctuations has grown substantially since the early 1980s across the globe when financial liberalisation took hold. And post-crisis (2008), the weight of non-bank intermediaries, such as asset managers and institutional investors, has risen substantially and is likely to sway the dynamics of any future episodes of financial stress in familiar but also some unexpected ways.

One possible trigger of an economic slowdown or downturn could be an escalation of protectionist measures, it said adding that the impact could be very significant if such escalation was seen as threatening the open multilateral trading system. Without referring to the US tariff hike on aluminum and steel on China and a host of other trading majors with equally strong trade reprisals from the rest, the BIS said: “there are signs that the rise in uncertainty associated with the first protectionist steps and the ratcheting up of rhetoric has already been inhibiting investment”. It further cautioned that “were the recent reversal in the U.S dollar depreciation to continue, trade negotiations would become more complicated”.

A second possible trigger could be an abrupt decompression of historically low bond yields or snapback in core sovereign bank yields, notably in the U.S as a fall-out of only mild inflation surprises, following the steady reversal of ultra-low-interest policy. If US yields jump, that would spread tighter financial conditions around the world. The latest tightening of financial conditions, including the dollar appreciation, has already sparked stress in some emerging markets such as Argentina and Turkey. Thirdly, a reversal in global risk appetite could push core yields the other way, fanning the buildup of vulnerabilities. This could be triggered by concerns about sovereign debt sustainability or political events, for instance, as recently seen in the euro area periphery as well as some emerging markets.

Laying out a raft of measures for global financial market stability, BIS said the first line of action is to redouble efforts to implement structural policies, which remain by far the only way to raise sustainable growth without generating inflationary pressures. It said structural policies, in particular, can alleviate the dilemmas monetary policy is now facing and that are narrowing its room for maneuver. The essence of the reforms is to render product and labour markets flexible, enabling them to allocate resources more efficiently and to absorb technical innovations more easily.

The second line of action is to strengthen further the resilience of the financial system, which requires completing and consistently implementing the post-crisis financial regulatory reforms. Ideally, where appropriate, this should be complemented by steps to remove structural impediments to banks’ efforts to attain sustainable profitability, which is critical to absorb any losses smoothly and swiftly should these materialise at some point. Instances of such steps encompass tackling the obstacles to the necessary consolidation and cost-cutting. This is also especially important at the current juncture when banks have been facing the dual interest margins and growing competition from new technology-savvy players such as big tech and fin-tech companies.

Without much ado, BIS states that strengthening resilience also requires the active deployment of macro-prudential measures in those economies where financial imbalances have been building up and the improvement of macro-prudential frameworks more generally. The macro-prudential framework is meant as the use of (primarily) prudential tools to target specifically systemic risk and mitigate its macroeconomic costs. Thus the macro-prudential approach to regulation and supervision differs from the more traditional micro-prudential one as the latter focuses on the assessment of the risks institutions face on a standalone basis, with little consequence to the financial system as a whole or the macro-economy.

The third line of action is to ensure the sustainability of public sector finances and to preclude pro-cyclical fiscal expansions. The importance of this cannot be emphasized enough, it said adding that public debt has risen to new peacetime highs in both advanced and emerging market economies. As fiscal space is likely to be overestimated in countries where financial imbalances have been imperceptibly building up, fiscal consolidation is a priority. This is a principal takeaway from this year’s thoughtful BIS tome as India is facing a general election next year with the incumbent government fain to indulge in all sorts of sops and populism to get itself re-elected with scant regard to the much-needed fiscal consolidation and in extension the financial stability of the economy, policy wonks wryly say. With India’s Urjit R Patel, Governor, RBI being a member of the Board of Directors of this prestigious grouping of the BIS and who relentlessly battled the inflation demon to get the blame for being not pro-growth, how would he handle the situation if the North Block is slack on the fiscal front to score some brownie points by way of patronising the vote banks with no fear for the cruelest form of taxation as inflation is so grimly and graphically portrayed.

G. Srinivasan

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