The Hindu Business Line : Managing the crisis

There is something basically rotten in the ‘system’, which has been given enough leeway by the world’s financial regulators over the past decades to develop into a lurking monster. The need of the hour is to tackle this monster and strengthen the foundations of the international financial structure.

Ranabir Ray Choudhury

Even seasoned financial analysts find looking into the crystal ball at this juncture a difficult proposition, the inference to be drawn being that it is better not to stick one’s neck out and pontificate which way things will go.

On the contrary, it would appear to be infinitely more sensible to focus on damage-control measures — as the Reserve Bank has been doing over the past week — see how effective the steps have been and to continue to devise methods to grapple with newer crises and get things back to normal as quickly as possible.

If the current most pressing problem is perceived to be one of liquidity, then clearly steps have to be devised to increase it. The CRR rates have been juggled by the RBI, which will now wait and see whether the action has worked at all.

If there are good signs, then a decision will have to be taken whether to wait further for more evidence along these lines or whether to increase the dose and strengthen the improving trend and make the recovery faster. If it is perceived that the CRR reduction has not worked in the way expected then it has to be decided whether to go in for a further cut or whether to tap other instruments which the RBI has in its arsenal.

No room for leisure

Quite clearly, however, there is no room for leisure in the present unfolding scenario of the gravest international financial crisis the global economy has seen over the past eighty years.

When the crisis broke in the middle of last month, people in the know did not have a clue that things were going to go bust so rapidly and on such a big scale.

They may have had an inkling though that there was great instability built into the international financial system, but the scale of the manifestation of the crisis was probably totally unexpected.

The only settled conclusion that intelligent observers could arrive at was that the emerging crisis had ripened over the past years without giving any indication of how bad the situation was, only to break in a deluge which has shaken up the world’s financial capitals as never before.

The lesson here is, of course, the fact that there is something basically rotten in the “system”, which has been given enough leeway by the world’s financial regulators (based in the economically powerful national capitals) over the past decades to develop into a lurking monster, which has now suddenly bared its fangs.

Clearly, assuming that the lesson has been learnt by the financial capitals of the world, the need of the hour is to tackle this monster (really a “weak link” in the system), in the process strengthening the foundations of the international financial structure.

On the face of it, it would appear that unregulated “investment firms” have gone about their job of lending funds in a totally unrestricted way, thus allowing the system of investment financing to develop gaping “holes” which have weakened the overall structure.

The sub-prime crisis detonated the fuse as it were, which took some time to work itself through the system before it led to the biggest investment firms collapsing like a pack of cards.

State regulation needed

In the new dispensation — which must follow the present crisis since Doomsday is still some way off — regulation of the activities of investment firms is therefore absolutely indispensable.

While this is a relatively simple conclusion to draw from the current goings-on, at a deeper, theoretical level what it really means is that free-market operations have no role to play in today’s financial world (no matter of what variety and hue), the inference being that State regulation is essential if the natural propensity of finance engineers to earn money from loans made on the flimsiest of asset bases is to be curbed in the interest of the investing community.

Some may hark back to the great debate between Capitalism and Socialism, but that would be a trifle unrealistic because the concept of neither Socialism nor Capitalism has remained static since the Cold War days.

But this is the international scenario since investment firms operate at that level on a much larger scale than, say, in India. Here, the authorities have not only to worry about liquidity, they have also to keep an eye on the state of manufacturing activity, the inflation rate, the rupee’s value, etc.

It is a complex task no doubt, the over-arching concern being the stability of those scheduled commercial banks which have a reasonably high exposure in the international finance market.

The stock market really should not be the focus at this moment because, as always, it is built on expectations, which themselves have no finite bases, at least in India if one goes by recent history.

Even so, action has been taken (last week) to make the funds flow from abroad easier, the objective being to facilitate the inflow of funds which could shore up the market. Manufacturing activity has taken a hit, if the latest industrial growth figures are any indication.

It is not yet a situation of classic recession, but then it is still early days to arrive at a definitive conclusion in this respect. Inflation has gone down, but then it should if the economy slows down because of factors like a shortage of funds.

The rupee’s value has plummeted vis-À-vis the dollar because of hot-money flows out of the national economy, which is going to hurt imports greatly if the lower values get into the New Year.

Best bit of news

Clearly, the issue is one of prioritisation and one would imagine that the Government and the RBI would focus, to the exclusion of everything else, on the stability of the financial system within the economy.

Once people feel that things are getting back to normal, the stock market will return to its normal band of volatility, and the pressure on the rupee should subside a bit.

The best bit of news, however, is that, at the “real” level, the economy is on a sound footing and there is no reason why production indices should not resume their upward journey once the flow of loans is regularised.

We are living through precarious as well as exciting times. It is an unmixed blessing that the financial crisis should have broken at a time when the Indian economy is strong enough to weather it provided “expectations” are within reasonable bounds, which however is uncertain.

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