Why India and Canada Should Collaborate on Global Monetary Reform
July 22, 2014 marks 70 years since the end of the 1944 Bretton Woods conference—the ground-breaking gathering of major economies, including India and Canada, that gave birth to the International Monetary Fund (IMF) and World Bank, and laid the foundations of post-war international economic cooperation.
The multilateral system has survived and adapted to major economic crises every decade since then. With the help of the G20, it succeeded in preventing a global meltdown after the 2008 collapse of Lehman Brothers. It also prevented a revival of 1930s-style trade protectionism and beggar-thy-neighbour exchange-rate policies. As American political scientist Daniel Drezner argues, ‘The System Worked’.
The G20 has not, however, halted an increasing fragmentation in international economic decision-making. Mega-regional trade pacts such as the Trans-Pacific Partnership (TPP), from which India is excluded, are one of several diversions from the World Trade Organization’s (WTO) multilateral processes.
Fragmentation in international financial arrangements receives much less attention, but is just as pernicious to the multilateral system. A less-noticed but more important threat to India’s multilateral interests comes from the growing web of currency liquidity-swap lines between the world’s major central banks.
A liquidity swap allows central banks to exchange their currencies at agreed rates with an understanding that they’ll unwind the transaction at a specified rate on an agreed future date. A country that encounters balance of payments difficulties can pledge its own currency as collateral and then use the stronger currency it receives through a swap to meet its debt obligations or finance its imports.
Some countries have signed a spaghetti-bowl of overlapping bilateral swap agreements, with China being particularly active.
The so-called C6 is the most exclusive club of central bank swap arrangements: it comprises the US Fed, the Bank of England, the ECB, the Bank of Japan, the Swiss National Bank, and the Bank of Canada.
Created at the height of the 2008 crisis, and made permanent in 2013, this network of bilateral swaps allows for these six central banks to draw on each other with no questions asked, no prior approval and no strings attached.
While Canada was lucky enough to be included in the C6 club, India was not. India is also outside ASEAN’s $240bn regional swap arrangement under the Chiang Mai Initiative, and New Delhi was denied a request to the US Fed for a bilateral swap line along the terms granted to South Korea and Mexico.
Without recourse to a standing swap line with a ‘hard money’ central bank, emerging countries are forced to self-insure by building up their own war-chests of foreign exchange reserves.
Reserves don’t come cheap: every extra dollar held is a dollar that could be used to fund the growth-enhancing investment at the heart of the new Modi government’s agenda.
In a globalized world of heightened trade and financial linkages, what used to be considered ample insurance now looks meagre. India’s reserves tripled between 1996 and 2013, up from 5 to 15 percent of GDP. But during the same period, emerging markets’ reserves as a whole soared from 9 to 27 percent of their total output. Against its peers, India’s rainy-day fund is a little feeble.
The IMF estimates that excess reserves cost the typical emerging economy about 0.5 percent of GDP annually during the first decade of the 2000s. If the RBI were to raise India’s reserves to the level of a typical emerging market, it would cost around ₹13,000 per capita by 2024. In a country of over 1.2 billion people that’s real money.
In April, RBI Governor Raghuram Rajan joined other emerging-market leaders in a call for better international monetary policy coordination and centralization of liquidity swaps at the IMF. A short-term liquidity facility at the Fund would be cheaper, more widely shared, and easier to monitor than the growing welter of bilateral swaps. It would also make rapid access to liquidity in times of crisis more equitable. But the US shut the idea down, just as it did in 2011.
In the face of the US intransigence on both swaps and the reform of voting rights in the IMF, India seems to be throwing in the towel. The Reserve Bank of India (RBI) recently upped its swap line with the Bank of Japan from $15bn to $50bn and India will be part of the $100bn framework of currency swaps announced last week under the BRICS’s Contingent Reserve Arrangement (CRA).
It’s too early, however, to give up on multilateralism. Whether on trade, capital flows or international security issues, India’s interests have always been served best when they’ve been pursued in multilateral, rules-based fora. India just needs to find new allies in the pursuit of a more effective and equitable multilateral system: allies—such as Canada—whose interests are tied just as closely to the multilateral system as India’s.
As co-chairs of the G20’s most senior governance body—the Framework Working Group (FWG)—India and Canada are ideally positioned to bring central bank liquidity swaps into the IMF. Success would give substance to the G20’s commitment to improve the exit from unconventional monetary policies in the industrialized world—policies that have wrought havoc on emerging economies.
It’s time to end the zero-sum game of competitive reserve accumulation and the messy scramble to sign bilateral and regional swap agreements. The opportunity costs of excess reserves are just too high. And swaps have become too much of a good thing: instead of mitigating risks, they’re creating unmanageable transmissions channels for crisis to spread even faster between countries.
It’s time for India and Canada to collaborate on global monetary reform.