Shaktikanta Das: Central banking at crossroads
Keynote address by Mr Shaktikanta Das, Governor of the Reserve Bank of India, at the
RBI@90 High-Level Conference on "Central banking at crossroads", organised by the
Reserve Bank of India, New Delhi, 14 October 2024.
* * *
I feel highly privileged to be here at this High Level Conference on 'Central Banking at
Crossroads' and share some of my thoughts. When the definitive history of our times is
written, the turn of the current decade will, in all probability, be regarded as a watershed
in the evolution of central banking. In the aftermath of the COVID-19 pandemic and the
persistent geopolitical strife thereafter, central banks are treading in the uncharted
terrain of a twilight zone. Today, like never before in the five centuries of their existence,
central banks are confronted with a future where their mandates, their functions and
their performances are all up for unforgiving scrutiny.
Around them, the environment in which central banks have been operating is
undergoing tectonic transformations. Structural changes are underway that have the
power to fundamentally alter the context of central banking with headwinds from
geoeconomic fragmentation; muscular industrial, trade and financial policies that are
already reshaping supply chains and the availability of critical minerals, intermediates,
resources and services; new technologies; and climate change. In this rapidly evolving
environment, central banks are required to navigate not just known unknowns but
unknown unknowns too.
Yet, even at these exceptional intersections, central banks are exploring new pathways
and striving to reinvent their remit and functioning as the guardians of financial stability.
Their effort is to stay ahead of these developments by strengthening guardrails and
leveraging on technological innovations.
For the Reserve Bank of India (RBI), as we commemorate its 90th year, it has been an
eventful journey since its establishment in 1935. In many significant ways, the Reserve
Bank embodies the developmental aspirations of India. The landmarks of its journey are
equally milestones in the progress of India. At the current juncture and looking ahead,
developments around the world are impacting India on a continuous basis and
challenging us as practitioners of central banking.
Today's conference gives us an opportunity to introspect on the journey of central
banking so far and how we want to visualise and shape our role in the future. In my
remarks today, I propose to briefly focus on three areas where central banking is likely
to be redefined in the future: monetary policy; financial stability; and new technologies.
In fact, these are among the themes of specific sessions in today's conference. My
observations would be mainly in the context of central banking across countries.
Monetary Policy
The three decades of restrained volatility of business cycles and the co-existence of
price stability and uninterrupted growth that preceded the global financial crisis (GFC),
perhaps lulled central banks into the belief that inflation expectations are enduringly
anchored. The beast of inflation of the 1970s and early 1980s seemed completely
behind our times. Conditioned by that experience, central banks shed their role of
'lender of the last resort' and became lender of the first resort to defend their financial
systems when they responded to the GFC. They continued from their GFC moment and
once again rushed to the frontline as warriors of the first resort to protect and preserve
lives and livelihood when the COVID-19 pandemic hit the world. They took interest
rates to all-time lows, undertook unconventional policy measures to reach out to interest
rates across the spectrum, including at the longer end, and gave assurances about low
for longer interest rates. This was an uncharacteristic departure from the monetary
mysticism that had prevailed up to the 1990s. Clearly, central banking has evolved in
line with the developments of the 21st century.
While the pandemic time measures provided the much needed support to the
economies, in the aftermath of the pandemic the limits and downsides of easy monetary
policy in protecting economic activity in a crisis period became evident. Today, rightly or
wrongly, the central banks are accused of distributional consequences of their actions.
The negative equity that weighs in the balance sheets of certain central banks is seen
as compromising their independence in the conduct of monetary policy. The story in
India was, however, different as most of our liquidity measures were calibrated and
carried end dates at the time of their announcement itself.
Another challenge staring at central banks today emanates from soaring public debt
caused, in a considerable measure, by the pandemic-related fiscal stimuli and the
subsequent efforts for fiscal consolidation not gaining adequate traction. Such a
situation is becoming a binding constraint on monetary policy in several countries.
Global public debt has surged post the pandemic to 93.2 per cent of GDP in 2023 and
1
is likely to increase to 100 per cent of GDP by 2029 . In major economies, debt-GDP
ratios are on an upward trajectory, raising concerns about their sustainability and their
negative spillovers for the broader global economy. In several other countries, central
banks are willy-nilly expected to facilitate financing of such huge public debts. In fact,
the debt overhang is simmering underneath the radar of central banks, threatening to
un-anchor inflation expectations and undermine macroeconomic stability.
For emerging market economy (EME) central banks, the international dimensions of
monetary policy continues to be a testing challenge. For them, the trilemma is real.
Today the global economy is more financially integrated than ever before. Monetary
policy actions in systemic economies produce large fluctuations in capital flows and
exchange rates, which can then feed into domestic liquidity, inflation and eventually
affect the real economy. While monetary policies in the systemic economies are
determined by their domestic inflation-growth considerations, they have large spillovers
to the emerging and developing economies and even to other advanced economies.
These spillovers can be expected to accentuate as capital flows dwarf trade flows.
Quite naturally, emerging economies are having to strengthen their policy frameworks
and buffers to manage this external flux and mitigate its adverse consequences.
Financial Stability
Financial stability is the essential reason why central banks exist. Price stability as a
central bank objective is of more recent vintage. There is a growing opinion today that
'low for long' policies practiced during the GFC and again during the pandemic, apart
from providing support to the real economy, also produced exuberant financial asset
prices that have come back to haunt central banks in their role as guardians of financial
stability. Amidst ultra-low interest rates and super abundant liquidity, leveraging and
risktaking were celebrated as if there is no tomorrow. Consequently, when central banks
were confronted with inflation surges in 2022 in the shadow of the war in Ukraine, they
reacted with one of the most aggressive and synchronised tightening of monetary
policies in history. This resulted in risks to financial stability, especially when these risks
morphed into banking crises in certain countries in March 2023 and sell-offs in financial
markets in August and September 2024. These developments have once again brought
to fore the role of central banks in securing and preserving financial stability.
Specifically, how should they account for financial stability considerations in their pursuit
of price stability?
Let me now address some of the emerging risks to financial stability. First, the
divergence in global monetary policies - monetary easing in some economies,
tightening in a few, and pause in several other economies - can be expected to lead to
volatility in capital flows and exchange rates, which may disrupt financial stability. We
saw a glimpse of this with the sharp appreciation of the Japanese Yen in early August
which led to disruptive reversals in the Yen carry trade and rattled financial markets
across the globe.
Second, private credit markets have expanded rapidly with limited regulation. They
pose significant risks to financial stability, particularly since they have not been
stresstested in a downturn.
Third, higher interest rates, aimed at curtailing inflationary pressures, have led to
increase in debt servicing costs, financial market volatility, and risks to asset quality.
Stretched asset valuations in some jurisdictions could trigger contagion across financial
markets, creating further instability. The correction in commercial real estate (CRE)
prices in some jurisdictions can put small and medium-sized banks under stress, given
their large exposures to this sector. The interconnectedness between CRE, non-bank
financial institutions (NBFIs), and the broader banking system amplifies these risks.
New Technologies
In recent years, the technology-driven digitalisation wave in the payments sphere has
been revolutionary. While most of the innovations have been at the national level
focusing on retail payments, the market for cross-border payments has also expanded
substantially. The significant volume of cross-border worker remittances, the growing
size of gross flows of capital, and the increasing importance of cross-border
2 3
ecommerce have acted as catalysts to this growth. Remittances are the starting point
for many emerging and developing economies, including India, to explore cross-border
peer-to-peer (P2P) payments. We believe there is immense scope to significantly
reduce the cost and time for such remittances.
India is one of the few large economies with a 24x7 real time gross settlement (RTGS)
system. The feasibility of expanding RTGS to settle transactions in major trade
currencies such as USD, EUR and GBP can be explored through bilateral or multilateral
arrangements. India and a few other economies have already commenced efforts to
expand linkage of cross-border fast payment systems both in the bilateral and
multilateral modes.4
India has developed a world-class digital public infrastructure (DPI), which has
facilitated the development of high-quality digital financial products with enormous
potential for cross-border payments. India is now home to the world's third most vibrant
startup ecosystem, with over 140,000 recognised startups, more than a hundred
unicorns, and over US$150 billion in funding raised. India's experience in DPI can be
leveraged by other countries to improve and usher in a global digital revolution.
Central bank digital currencies (CBDCs) is another area which has the potential to
facilitate efficient cross-border payments. India is one of the few countries that have
launched both wholesale and retail CBDCs. Programmability, interoperability with the
UPI retail fast payment system and development of offline solutions for remote areas
and underserved segments of the population, are some of the value added services
which we are now experimenting as part of our CBDC pilot.
Going forward, harmonisation of standards and interoperability would be important for
CBDCs for cross-border payments and to overcome the serious financial stability
concerns associated with cryptocurrencies. A key challenge could be the fact that
countries may prefer to design their own systems as per their domestic considerations. I
feel we can overcome this challenge by developing a plug-and-play system that allows
replicability of India's experience while also maintaining the sovereignty of respective
countries.
It is well recognised that growing digitalisation of financial services has enhanced the
efficiency of the financial sector across the globe. At the same time, it has brought in
several challenges which central banks have to deal with. For instance, in the modern
world with deep social media presence and vast access to online banking with money
transfer happening in seconds, rumours and misinformation can spread very quickly
and can cause liquidity stress. Banks have to remain alert in the social media space
and also strengthen their liquidity buffers.
Latest technological advancements such as artificial intelligence (AI) and machine
learning (ML) have opened new avenues of business and profit expansion for financial
institutions. At the same time, these technologies also pose financial stability risks. The
heavy reliance on AI can lead to concentration risks, especially when a small number of
tech providers dominate the market. This could amplify systemic risks, as failures or
disruptions in these systems may cascade across the entire financial sector. Moreover,
the growing use of AI introduces new vulnerabilities, such as increased susceptibility to
cyberattacks and data breaches. Additionally, AI's opacity makes it difficult to audit or
interpret the algorithms which drive decisions. This could potentially lead to
unpredictable consequences in the markets. Banks and other financial institutions must
put in place adequate risk mitigation measures against all these risks. In the ultimate
analysis, banks have to ride on the advantages of AI and Bigtech and not allow the
latter to ride on them.
Conclusion
Despite the difficult trials and trade-offs, central banking in the current decade is a
success story. In the realm of monetary policy, central banks have been successful in
bringing inflation closer to targets. Major financial collapses or recessions, seen during
earlier episodes of crisis, have been averted. Central banks are now at the forefront of
technological innovations and are driving them through sandboxes, innovation hubs and
hackathons.
As we navigate the high intensity tail events and black swans of the current decade, the
lessons imbibed can well form the basis of our deliberations today to chart out a course
for the future. Central banks must remain vigilant, adaptable, continuously assess risks
and build resilience. They should remain prepared to navigate complex challenges,
support sustainable growth, maintain price stability and promote sound and vibrant
financial systems.
Thank you.
1
IMF Fiscal Monitor, April 2024.
2
The value of global cross-border payments is estimated to surpass US$ 250 trillion by
2027 ( Cross-border payments | Bank of England )
3
The global cross-border B2C e-commerce market which was valued at US$ 889
billion in 2022 is estimated to grow by more than six times to US$ 5.6 trillion in revenue
by 2030 ( Cross-border B2C E-commerce Market Size Report, 2030 )
4
These include Project Nexus , a multilateral international initiative to enable instant
cross-border retail payments by interlinking domestic Instant Payment Systems (IPSs)
of four ASEAN countries (Malaysia, Philippines, Singapore, and Thailand) and India.
Under bilateral arrangements, cross-border payment linkages have already been
established by India with Singapore, UAE, Mauritius, Sri Lanka, Nepal, etc.