To avoid market freeze, central banks have to act: Gokarn

The seemingly innocuous step of devaluating Chinese yuan against the US dollar jolted markets across the globe igniting some sort of currency war. This was further aggravated by the realization that one of the world's second largest economy's sluggish exports are not going to see a pick up any time soon.  The most severe impact of this was felt on Monday with Nifty cracking crucial levels. Although Tuesday Indian equity witnessed early recovery, it no way suggests an end of turbulance, says says Subir Gokarn, director-research at Brookings India.Instead, he foresees more disruptions in financial and other markets unless central banks take necesary actions to ensure markets do not freeze. "The lesson we learned from 2008 was don’t let markets freeze under any circumstances which means the central banks have to be watching out for signs of liquidity stress." Below is the transcript of Subir Gokarn’s interview with Latha Venkatesh & Sonia Shenoy on CNBC-TV18. Sonia: What is your own assessment of how this core problem of slow growth can be resolved because you can inject liquidity how much ever you want but at some point in time you have to address the real problem at hand. What do you think a market or a country like China should do at this point? A: There are two parts to this question. The first is what do you do to prevent the kind of potential meltdown, the risks of another recessionary shock that emanates from the financial markets. We saw that happen in 2008 and there are some legitimate concerns that a similar process is getting started this time. Last time around it was in the US and Europe, this time it is in Asia and China. However, both the US and China are now kind of twin poles, twin pillars if you will, of global growth and so a shock in any one of them is going to have the kind of repercussions that we have seen. The immediate question as you said is about liquidity about ensuring that markets don’t freeze. The lesson we learned from 2008 was don’t let markets freeze under any circumstances which means the central banks have to be watching out for signs of liquidity stress both in the domestic markets and from an external viewpoint, from a dollar or a foreign exchange viewpoint and that lesson has been well learnt. We are seeing banks quite sensitive to this potential threat and are reacting. The messaging from central banks also both China and our own is be prepared to do anything in terms of interventions, to stabilise, to reduce volatility and so on. The longer term issue is more complicated. A lot of the growth that we saw after the crisis including in our own economy was the result of this extremely powerful fiscal response. Lots of money being spent in China, it was this huge infrastructure binge and that is coming back to haunt these economies. So, the growth momentum that we saw post the crisis lured people into little bit of a false sense of complacency and right now the growth drivers are starting to flag. It is difficult to address that because there isn’t much fiscal space, you can’t just do the same thing again. It comes back then to the much longer term drivers of innovation, productivity and all those good things you like to talk about but don’t give us immediate solutions. The world has to be prepared for a period of somewhat slower growth, let us not benchmark ourselves with the early 2000s when global growth was booming – 4.3-4.5 percent for the world as a whole is settling into a less attractive but possibly a more sustainable growth trajectory. We need to have both China and the US if not booming at least stable. Fortunately if the US is showing signs of stabilisation which will be helped by lower energy prices as you can see most people are now postponing their forecast of a US monetary policy action. That suggests that inflation expectations are very muted now. What China is going to have to do is to sort of get – the depreciation will help but they should also make sure that they are not doing things that de-stabilise the rest of the world, that threatens the stability of other markets. It means in a sense rediscovering their competitiveness. How they are going to do that, there are transitions at work, very long and complicated adjustment and my basic concern is that this is not the end of the story. Market recovery today is not going to signal the end of turbulence. We should be prepared for a potential disruption both in financial markets and in product markets for some time to come. Latha: Are you getting a sense that the global economy especially the two big ones, are slower than what the markets are prepared for and therefore we are going to see more such jitters in the market in the days to come. Would it go to the level of currency wars to grab whatever little growth that is available? A: I think that is a very real threat. I do hope that China recognising its global status now as the world’s second largest economy desists from open overt mercantilism in terms of a steady depreciation, they have to exercise control. We have seen a little bit of restraint now, we have seen the currency depreciate by 3 percent and then stabilise but when you have this kind of capital outflow and that is what has been happening, the pressure of the currency is going to be intense. So, at some point it is going to be very difficult to maintain exchange rate that is completely out of sync with the underlying market pressures and you might see further depreciation. If the currency stabilises at this point, at least the fears of mercantilist kind of strategy should abate, should recede. However, let us not forget that even with the exchange rate being stable, Chinese exports have been sluggish for a while as have ours all of which point to the question of the preposition that you are putting across that the global growth is slower than people expected. I would expect to see very aggressive selling by the Chinese and that is something we have to be prepared for because there are lots of things that China’s sells to us which competes very directly and aggressively against our own producers. So, all of these labour intensive exports, textiles, electronics, footwear, appliances, the sourcing could well shift very quickly and that is something we have got to be concerned about.