The messages that we heard are sharp, specific and candid. If I were asked to pick the headline message of the presentation, it is that we are rapidly running out of time, and may therefore be running out of solutions.
2. The two big flashpoints are: renewed anxiety in the US about recession, and the deepening of the sovereign debt crisis in the Euro area. Each is by itself a big risk, but the bigger risk is that both could materialize simultaneously, and interact with each other with adverse feedback loops manifested through trade, finance and confidence channels.
3. The problems are well known, and the solutions are on the table. The main impediment to an effective resolution common to both flashpoints appears to be political.
4. Let me look at the global situation from the perspective of the EMEs. Before 2008, it was intellectually fashionable to talk of ‘decoupling’ – that EMDCs will continue to be resilient even if there is a downturn in advanced economies, because of improved macroeconomic policies, robust foreign exchange reserves and resilient financial flows. In an age of globalization, the decoupling theory was never persuasive. The 2008 crisis dented its credibility and the 2011 crisis has completely demolished it.
Channel of Contagion to EMEs
5. EMEs have been affected by both crises. Their macroeconomic stability, price stability and financial stability are jeopardized by the global crisis through several channels.
6. The probability that all these channels become active and feed on each other is quite high. The impact on an EME depends on its objective conditions and on which channels become most active in its case. Thus, the crisis could affect different EMEs differently. But what is common across EMEs is that their growth momentum will be interrupted if the current global problems are not resolved quickly.
7. In trying to reach a solution, it is important to recognize what the markets are signaling, even though, admittedly the basis of some of these market engendered fears may not be objective. Let me illustrate with a metaphor from physics. It is well known that Einstein could not reconcile to the probabilistic nature of quantum mechanics all through his life. He famously said: “God does not play dice.” Less well known perhaps is the retort of his friend and mentor Niels Bohr who said: “Albert, stop telling God what he can or cannot do.” Similarly, it is possibly the case that all market signals are not objective. But as policy makers, we cannot presume to tell the market how to behave. We have to take market signals as given. The policy decisions that we take will be more effective if they are seen to be endorsed by markets.
2008 and 2011
8. To understand the situation today, let us throw back to the global crisis of 2008. Then too, we faced similar extreme siege conditions of the global financial system, and the challenge of responding immediately and decisively to the crisis within the boundaries of democratic processes. We managed that challenge. The G-20’s leadership and the all-out efforts mounted by the IMF and other multilateral institutions to do what it takes to pull back the global economy from the brink of collapse and set it on a path of recovery were applauded across the world.
9. There are important differences between the 2008 crisis and today’s situation.
10. Let me now conclude. There is a great deal of anxiety around the world about the outcome of this weekend’s Fund-Bank annual meetings and the G-20 meetings. There are strong expectations that we will converge on a plan of action that will reverse the crisis of confidence. We once again have to show the resolve that we did in 2008 to meet those expectations.