The Hindu Business Line : A solvent country can have an insolvent government

WHEN THE going is good it is time to strengthen our defences. From that perspective, Managing Currency Crises in Emerging Markets from the National Bureau of Economic Research (www.nber.org) should make timely reading. Edited by Michael P. Dooley and Jeffrey A. Frankel and published by The University of Chicago Press (www.press.uchicago.edu), the book, according to the blurb, highlights how in a global economy we cannot be immune to crises anywhere.

And financial crises are high stakes affairs where unsinkable ships can flounder and robust markets find their Waterloo. Normally, you cannot get economists and central bankers to agree on most issues, yet one thing they all would concur on is that we should "consider how best to reduce the frequency and cost of such crises."

As with frogs and butterflies that have their own lifecycles, so do these catastrophes. The first three chapters, therefore, discuss "the earliest responses and the immediate defence of a currency under attack, exploring whether unnecessary damage to economies can be avoided by adopting the right response within the first few days of a financial crisis."

Then come adjustments programmes, to "shorten the recovery phase, encourage economic growth, and minimise the possibility of future difficulties." The book then wraps up with what should interest accountants, if they were all along sitting on the fence: "Costs".

Because, adjustments are often like amputations, and there is the risk of cutting off the wrong thing, or as in cancer treatment, decimating the good cells along with the bad ones.

So, the book devotes attention to the key question: Whether the remedial programmes accomplish what they are designed to do and whether they "impose disproportionate costs on the poorest members of society."

So, do we have here a book that is the cure-all and comprehensive insurance? Wait. "It would be nice to believe" that all our questions on crises are resolved in the pages between the covers, but "that goal is surely unrealistic."

Yet, it is a valiant attempt for policy framers and model makers to expound on topics such as `IMF and World Bank structural adjustment programs and poverty', `Fiscal implications', `Proposals to reform the international financial architecture', and `Recovery and sustainability in East Asia', as also look for answer to questions such as `Does it pay to defend against a speculative attack?' and `A cure worse than the disease?'

I fast forward to a chapter titled `Rescue packages and output losses following crises' written by Dooley and Sujata Verma.

"Rescue packages are designed to limit the damage that follows financial crises by reassuring private investors, stopping runs, and limiting contagion to other countries," explains the chapter.

World is not first best, so creditors who do not want to "shoot themselves in the foot" may be driven "to punish even though the punishment benefits no one."

Well, a default becomes possible when there is "uncertainty about the size of the bad luck". And bad luck includes crop failures and political events.

There are also those catchy one-liners: "Predictable crises generate unpredictable costs. A solvent country can have an insolvent government. Bad luck defaults are observable but not verifiable. An insurance crisis is simply an asset exchange between the government and private investors."

On that last statement, I look for some enlightenment and find it in the `discussion summary': "Investors cheat the government, which gets money from the IMF to pay those investors. The workers, in turn, pay for these loans. Thus, during crises, there is real transfer from workers (taxpayers) to investors and financial institutions."

A book to be read before a crisis comes in the way and `transfers' take place.

Economics@thehindu.co.in

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A solvent country can have an insolvent government