Kolkata, Sep 21 : Post pandemic, central banks in emerging economies are increasingly
faced with the impossible policy trilemma – monetary independence, exchange rate stability
and financial openness, according to Dr. Soumya Kanti Ghosh, Group Chief Economic
Adviser, State Bank of India.
“We, however, move a step further and state it as a policy quadrilemma, with financial
stability as the fourth pillar of quadrilemma, following Aizenman (2011). In effect, an
unintended consequence of financial integration is the growing exposure of developing
countries to financial market turbulences associated with sudden stop of capital (India
during taper tantrum and again in 2018 and in 2020),” Dr Ghosh on Monday said.
He said, “There is a significant cost associated with financial crises, adding financial
stability to the three policy goals, thereby making the Policy Trilemma into the Policy
Quadrilemma”, adding recent policy statements of RBI have repeatedly emphasised the
importance of financial stability in monetary policy making.
Pursuing financial openness while maintaining financial stability of emerging markets
typically manifests in jump in reserves. India’s international reserves/GDP ratio has thus
increased substantially in current fiscal year from 17.7% of GDP to at least 19.6% on
an FY20 base/ $63.8 bn jump, Dr Ghosh said.
“We estimated the extent of policy trilemma following Aizenman (2012) model. The
results from our exercise are revealing. Monetary Independence (MI) was at significantly
low level in Q4 FY20 (actually all-time low since 1997), implying significant loss of
monetary autonomy, when the pandemic had just broken out and India went into a
strict lockdown mode, but it significantly improved in Q1 FY21 with Exchange Rate
Stability (ERS) returning to markets. Historical trends suggest that any extended loss
in monetary autonomy is correlated with inflation volatility in India (CPI inflation ranged
between 3.0% and 7.6% during the FY20). Additionally, both ERS and Financial
OpennessIndex (KO) have also improved in Q1 FY21 after declining in Q4 FY20,”he
“However, what is striking in the current pandemic is that RBI stands out by achieving
comparable levels of exchange rate stability amidst growing financial openness while
increasing its monetary independence and even financial stability, reminiscent of Asian
economies. Our new measure of financial stability index of using market indicators also
clearly shows that the RBI has been relatively successful in ensuring financial stability
returning to the market since May. This indicates the policy quadrilemma is working well
in Indian context with RBI building up reserves through direct purchase and swap
transactions,” Dr Ghosh said.