India's Central Bank Chief Warns of 'Another Crash' in Global Financial Markets

Raghuram Rajan, chief of India's central bank, has warned that global financial markets are at risk of a crash, as economies are trying to escape crises at each other's expense.

In an interview with the Central Banking Journal, Reserve Bank of India (RBI) governor Rajan, who is known for his prediction of the 2008 financial crisis, said a number of macroeconomists have not fully learned the lessons of the Great Recession in 1930s.

He noted that the lack of coordination between policymakers – as in the 1930s – is causing spillovers that may be difficult to control.

"They still do not pay enough attention - en passant - to the financial sector. Financial sector crises are not as predictable. The risks build up until, wham, it hits you," Rajan said.

"At the moment you see favourable unemployment and low levels of inflation, and think you have a lot of policy room for manoeuvre. The concern is that central banks may be exhausting room on the financial side and creating a situation where there will be a discontinuous movement in the financial sector."

"Some of our macroeconomists are not recognising the overall build-up of risks. We are taking a greater chance of having another crash at a time when the world is less capable of bearing the cost."

Rajan added that a sudden shift in asset prices could happen in a variety of ways. Investors may get into trouble as they chase higher yields at a time when they believe central bank policies will protect them against a fall in prices.

"They put the trades on even though they know what will happen as everyone attempts to exit positions at the same time - there will be major market volatility," Rajan said.

"True, it may not happen if we can find a way to unwind everything steadily. But it is a big hope and prayer."

He pointed out the over valuation of the euro as a clear symptom of the major imbalances in the global financial market.

"The exchange rate is too strong given the euro area's economic standing," said Rajan.

"In a world where demand is weak and not strongly influenced by monetary policy, the effect of monetary policy may be more 'demand shifting' that is operating through the exchange rate, rather than 'demand creation' that is operating through credit growth and credit flows domestically. So we are back to the 1930s, in a world of competitive easing."