The Hindu Business Line : Financial crisis: Finding country-specific solutions

While searching for remedies, a clear difference has to be made between the EU countries and Japan, whose financial sectors fell for the ruses of US rogue institutions, and developing countries, which are unwitting victims of the effects of the shady transactions, says B. S. RAGHAVAN

The recently held G-20 summit in Washington on Financial Markets and World Economy was hobbled by two factors from the very beginning, raising questions about its making any durable difference to the current grim scenario. The first has to do with the unwillingness of the President-elect to send even an observer to the summit on his behalf. That means he wants to keep his options open without being bound by any conclusions that are reached.

The second handicap robbing the summit of much of its significance is the way it was planned and organised. It turned out to be no more than a desultory exchange of perceptions from the standpoint of countries with varying political dispensations, economic backgrounds and financial resources. The dissimilarities among them have come in the way of concerted action in the past.

Irony of ironies

The irony of ironies was that the US, having turned the Nelson’s eye to the corporate anarchy and financial chaos that were brewing within its borders, was palming off the fallout of its own failings and failures on the rest of the world as a global phenomenon. Grandiose pronouncements such as re-engineering global financial architecture, reform of global financial institutions and finding global solutions to global problems conveniently masked the fact that the epicentre of the present crisis is one country, the US, and that it brought it on itself by letting the free market degenerate into a free-for-all.

The surprise was not that the ‘bubble on the whirlpool of speculation’ (John Maynard Keynes’ picturesque phrase, borrowed by Dr Manmohan Singh) burst but that it did not burst very much earlier.

Actually, as the developing countries are the ones that have invariably to bear the painful consequences of crises originating in industrial countries, they should have insisted on the summit specifically going into what Dr Kenneth S. Rogoff, Professor of Economics at the Harvard University, has called “the huge culpability of the political leadership in the US and Europe.”

This was particularly necessary considering the magnitude and spread of what has turned out to be a tsunami-like devastation of markets and households. In such situations, it stands to reason that unless the disease and its causes are properly and pointedly diagnosed, any attempt at curing it may misfire.

It is not difficult to see why the summit refrained from undertaking such an exercise. It would have sparked off acrimonious controversies as to who did, or failed to do, what. For instance, few among those present from emerging economies would have been able to endorse making available, in the name of stimulus package, billions of dollars of public funds to firms that had brought the world to this desperate pass by their misdeeds.

Obviously, the dissenters did not want to cause embarrassment to a lame-duck President in no position to respond definitively to contentious issues. Understandably, therefore, they confined themselves to drawing up ‘common principles’ that were nothing but bland generalities with which nobody could quarrel. It is a time-honoured technique of papering over differences in approaches and avoiding a forthright analysis of the issues involved.

The summit has left the task of formulating a tangible and concrete framework for financial stability and institutional reform to experts and professionals who are expected to come up with a plan of action for adoption at another such gathering on April 30, 2009.

Any search for remedies will have to clearly differentiate between countries of the European Union and Japan, whose plight is a direct consequence of their financial sectors falling for the ruses of rogue institutions in the US, and emerging economies and developing countries which are the unwitting victims of the unwanted ripple effects of shady transactions elsewhere. In that sense, the nature, severity and duration of the crisis differ markedly with respect to different economies.

In Japan and Germany it looks like recession (defined as a decline in the gross domestic product (GDP) for two or more consecutive quarters), in the US and the UK it resembles a depression (a longer-lasting recession leading to a larger decline in business activity, in some instances pulling the real GDP by more than 10 per cent).

India perhaps is experiencing a slowdown. Hence, the treatment too will have to be country-specific without parroting the same mantras and performing the same rites of bailout, stimulus, interest paring, job cuts, and the like.

Essential pre-requisites

The thrust will have to be on putting the domestic economy in every country back on the rails instead of frittering away energies in riding unrelated hobby horses such as revamping the IMF and the World Bank, outlawing protectionism and pushing for the Doha Round.

There is no dearth of proposals to that end, but the one that has a direct or immediate bearing on the specific context of the present crisis calls for replenishing the corpus of the IMF to enable it to go the assistance of developing countries and vest in it the responsibility of oversight of financial institutions.

Unfortunately, though, the capabilities of the IMF to serve as an early warning mechanism, identify the crux of a monetary and exchange crisis and manage it intelligently have been in doubt since the Asian meltdown of the 1990s. Equally in doubt is the extent to which it will measure up to the proposed role of global regulator to prevent recurrence of the kind of turmoil now engulfing the world.

If at all it is to be made part of any effort at rescue and recovery, it should be on the basis of agreement on three essential pre-requisites:

(a) the infusion of any additional funds should be tied to particular purposes in particular countries;

(b) there should be a broadening of representation so that developing countries have an effective say in decision-making; and

India has so far been playing its cards well. Its vast domestic market, vibrant consumer base, a burgeoning upwardly mobile middle class, relatively high domestic savings and investment, a self-confident and worldly-wise corporate leadership, reasonably well-conceived and well-administered regulatory framework and low share of foreign direct investment as the driver of the economy set it apart from the general run of world economic communities.

As was noted at the 24th India Economic Summit held at New Delhi, India’s financial sector is ‘much cleaner’ than that of other countries owing to the calibre and competence of finance professionals and watchful regulators. The deft use of the repo rate, cash reserve and statutory liquidity ratios and intervention in the forward exchange market by the Reserve Bank of India (RBI), as well as the low level of non-performing (or toxic) assets have kept the economy stable and steady.

The ICICI Bank CEO and Managing Director and CII President, Mr K. V. Kamath, did well, while speaking at the same summit, to warn against over-reaction to the crisis and point out: “The fundamentals which created the crisis do not exist in India today… Fear has overtaken business to a level beyond what it should be”.

China’s example

There is one caveat, though. Thanks to the measures taken by the RBI by way of relaxation of various ratios, release for debt waiver scheme, propping up mutual funds, and so on, the country is simply awash with liquid funds approximating Rs 2,00,000 crore.

It is not clear whether this is the result of any realistic computation of the actual need or just a leap into the unknown, hoping for the best. There is also no indication of follow-up to have projects in readiness for channelling the funds into, and to gear up banks and financial institutions to meet their requirements.

Unless the liquidity is mopped up and converted into productive assets, it will also boomerang in the form of an acute inflationary spiral.

Here, India can learn from China, which has already lined up projects in areas such as housing, rural infrastructure, new railways, roads and airports, health and education, environmental protection and technology, for absorption of its stimulus package of $586 billion announced a few days ago.