Introduction:

With global crisis and recession haunting most advanced economies, the high-growth economies in Asia have drawn much less attention than what is deserved. The oversight leaves the analysis incomplete, not only by missing an important link in the prevailing network of global trade and finance but also by ignoring the structural changes in these developing economies, many of which are often related to the pattern of financialisation as well as turbulence in advanced economies. In the present chapter I draw attention to the high growth economies of China and India, reckoned as ‘emerging economies’ in the literature. Incidentally, both countries, and especially China, occupy centre stage in the context of the prevailing global imbalances. The growth momentum in the two countries, and the rapid increases in their official reserves even in the face of the global recession, makes these two rather special among developing countries. However, while aspects as above are mentioned in the literature, what is often left out relates to the structural changes within these economies, which has a bearing not only within but also across countries.

We focus in the present chapter on the changes in the financial sectors of China and India which, along with most developing economies, have been exposed to the vicissitudes of global finance. In our analysis we try to unfold the set of constraints which these two countries had to face in the process of their financial integration. As we have argued, the above changes often led these countries to lose autonomy in their monetary policy.

The outcome has been described in the literature as situations of an 'impossible trinity'. As we point out, the measures to maintain the three goals of exchange rate stability, capital account opening and monetary autonomy often turn out as not only impossible but also contrary to the interests of the real economy, say in depressing further the level of activity in a bid to contain inflation. The contractionary effects that result within the country are also likely to spill over to other countries, by shrinking the magnitude of import demand from the former. Financial integration also instils added degrees of volatility in multiple markets, relating to financial assets, commodities as well as for real estate. As we observe in the following pages, China and India have both faced added degrees of volatility in all three of those markets since their de-regulation.

We initiate the discussion by providing, in Section 2, an account of the prevailing global imbalances, dwelling on countries with large current/capital account imbalances. Countries with current/capital account surpluses per force experienced reserve accumulations in the process. This narrative is followed by an account as well as critical assessment of interpretations which are often advanced in the literature on issues relating to global current account imbalances. Section 3 invokes the theoretical premises of what in the literature is known as the 'impossible trilemma' of continuing with free capital flows and exchange rate management along with monetary autonomy. While questioning some of the assumptions behind the static framework underlying the above theorem, which is essentially an offshoot of the Mundell-Fleming IS-LM framework for open economies, we draw attention to the relevance of uncertainty and expectations as dimensions which can make the analysis relatively complete. Section 4 dwells on China and India, providing instances of the trilemma, which include the limits faced in pursuing an autonomous monetary policy to instil growth in the face of instabilities related to changing expectations in the de-regulated financial sector which include the open capital account. Section 5 brings together the policy conclusions, which question the current ethos of policy making in de-regulated markets.