Last week I was at the Bankers' Lunch organised by the Emirates Banker's Forum. The meal was lavish, but the keynote address by KC Chakravarty, deputy governor of the Reserve Bank of India, was all about virtues of frugality and need for tighter monetary policies.
Chakravarty told the bankers in the room that, apart from the inflationary pressure it brings, low interest rates over a long term would be a crime against savers. While hinting at a gradual rate hike in India in the near future, he said the RBI is headed in the direction of withdrawing all the monetary policy easing measures it introduced last year to relax liquidity. Earlier this month it raised the cash reserve ratio (CRR) from 5 per cent to 5.75 per cent.
In China, the central bank surprised markets earlier this month by raising bank reserve requirements 50 basis points, its second increase this year. So a habit is forming in the face of a changing reality. While India and China have shown their inclination towards monetary tightening, the developed world seems to be heading in the opposite direction.
Last week, the US Fed raised the discount rate, at which banks take out emergency loans, by a quarter-percentage point. Markets read it as a precursor to a monetary tightening.
But on Wednesday, Federal Reserve Chairman Ben Bernanke told the US Congress that record-low interest rates will remain for the foreseeable future. He offered no clue when the Fed would reverse the policy.
In the UK, Bank of England Governor Mervyn King highlighted last week a policy dilemma in tightening credit. With credit availability remaining weak, the central bank had hoped that external demand would play a key role in driving the UK recovery, boosted by the depreciation in sterling. But the weakness of the euro zone, UK's biggest trading partner, has raised the chances that the Bank of England may be forced to restart its quantitative easing policy.
The euro zone economies are recovering slower than the US, and the sovereign debt worries of member nations are likely to slow down and complicate the ECB's liquidity withdrawal.
The policy mix of record high debts and lending rates at their historical lows are proving to be disastrous for countries such as Greece, Ireland, Spain and Portugal which have debt-to-GDP ratio above 100 per cent or close to it.
Some of the world's largest economies, including the US and UK, are already close to the 90 per cent mark, suggesting that the threat of economic drag from sovereign indebtedness is becoming universal.
Independent policy
But what differentiates EU members from others is their absolute lack of independent monetary policy tools to manage the debt.
For the EU, the choice appears to be between a break-up and bailout. Technically, the EU has no mandate to bail out any member state. But the EU faces bleaker prospects in the event of a default by Greece that would result in global investors losing their trust in the stability of the weaker euro-zone members.
With EU leaders' February 11 pledge to support Greece's efforts to control its finances, it is highly unlikely that ECB would opt to hike borrowing costs in the near future. Both stalemate and any move away from it in these circumstances are an uncomfortable situation.
Of course, Chakravarty, in his capacity as a RBI deputy governor, won't give policy advice to the EU or rest of the world. But certainly the RBI's modest efforts have valid lessons for even the central banks of the developed world to emulate.
Certainly, overborrowing, and having to borrow more to pay for it, at low interest rates which hurt savings, is a precedent the emerging world could well do without.
