The Hindu Business Line : Japan experiments with Singapore sling!

With Japan considering the setting up of a special investment fund, modelled on Singapore's Temasek, and the runaway success of the latter, it seems that state agencies run by bureaucrats may dominate the stock markets, instead of the reverse. This piquant situation has lessons for the RBI, should it choose to adopt a similar model. Experience has shown that state-run investment vehicles can also turn out good returns.

The East Asian miracle was basically a story of South-East Asian countries trying to follow Japan's example in building up an industrial base, based on exports and improved labour productivity, aided by a depreciated local currency, thanks to central bank intervention. Other features of the phenomenon were fiscal prudence and financial probity, besides encouragement of competition and technological innovation. The East Asian countries proved efficient disciples of Japan and surprised the world.

The magic spell of the Asian miracle was broken by the crisis of the 1990s, which came about mainly because these nations forgot some of the basics of the Japanese success story. They allowed open capital inflows and outflows and experimented with pegged exchange rates — a sure recipe for disaster as it turned out that businesses borrowed abroad at seemingly cheap rates.

As outflows and speculation started pulling down the local currency, the peg no longer worked. Businesses had to ultimately bear the higher costs of their loans, but in depreciated currency, which meant a heavier burden. GDPs plummeted. Finally, the adverse cycle was reversed by a combination of massive IMF aid and plenty of advice.

The East Asian countries are back to a respectable and stable growth pace. Among the South-East Asian nations, Singapore fortunately survived all the pulls and pressures of the crisis, thanks to an effective control of speculative outflows and inflows and a masterly policy of supervision on banks. Singapore has become a byword for sustainable economic growth.

Of late, the Singapore experience has been even more tempting than that powerful cocktail, the Singapore sling. This has happened in respect of management of forex reserves, and Singapore has become the role model for countries in the region. China was among the first to follow the Singapore model. Following this now comes the newspaper report that Japan, with nearly $1 trillion of reserves, may also soon experiment with the Singapore procedure of investing part of its reserves in the stock market and away from fixed income securities, which were basically US Treasuries.

Japan's Concerns

The Financial Times reported in late April that Japan was considering establishing a special investment fund, modelled on Singapore's Temasek. The matter was discussed by key members of the Prime Minister's Economic Advisory Council, the financial service agency as well as leaders of the ruling Liberal Democratic Party. The reasons urged for such consideration were, besides ensuring higher returns on forex reserves, the need to sustain the pensions of Japan's growing and aging population.

The report cited the special concerns arising from the greater number of Japan's aged population and the decline in the returns on the pension funds. Japan's pension funds, admittedly one of the largest in the world, were deriving incomes essentially from the investment in government securities, which recently had been low. This was added to the concerns about the returns on forex reserves. Hence, the latest experiment with the Singapore model.

Japan's entry into the Singapore brigade brings to the forefront an important issue regarding the consequential internationalisation of global stock markets, which is only slowly percolating into the minds of global policy-makers. A recent issue of The Economist incidentally comments that closely following World War II, many developed nations undertook nationalisation of their businesses. Now, we seem to be at a stage in which developed countries are facing the internationalisation of their stock markets, thanks to the reserves of other less-developed economies.

Japan is a rich nation, however. With Japan joining the group of nations that invest their forex reserves in stock market-traded securities, the world stock markets are entering a new phase and responding to a different market dynamic. This reflects the fact that instead of the "hated" state bureaucracies staying off stock markets, the Great Wall of money from China, Japan and the OPEC countries, all managed by bureaucrats, albeit of the central banking type, will be calling the shots in the not-too-distant future in deciding market behaviour on global bourses, particularly of developed countries.

Good Transition?

The question naturally arises is whether this transition is a good one from the point of view of global stock markets and the global economy. At the outset, one has to concede that there is no evidence that funds managed by state professionals have performed less efficiently than those run by pin-stripe suited bankers. Indeed, as pointed out by Mr Lee Kwan Yew, the venerable Singapore leader under whose Chairmanship Temasek functioned for more than 20 years, the fund has declared a return of 9.5 per cent in real terms, year after year.

True, the organisation had taken the help of professional investment bankers, such as Goldman Sachs, but the ultimate authority was that of the state of Singapore. With Japan joining the Temasek-type funds, the glory days of financial professionals' monopoly may well be over. Some of them have to play second fiddle to the central bankers and finance ministry professionals of these countries, who are, after all, managing mega-sized investment funds running into billions of dollars.

Obviously, this development may not be to the liking of purist private enterprise oriented economists. But the dialectics of the process of development is quite interesting. In the view of pro-free enterprise economists, stock markets are supposed to discipline the state and its powers. But now, with the emergence of mega-state investment funds, the state agencies run by bureaucrats are going to dominate the stock markets themselves, instead of the reverse.

Surely, a piquant situation! Of course, the path of wisdom would lie in the new masters of the financial universe observing the rules of due diligence, which are expected to be followed in the unadulterated free enterprise model. In the new mixed international market economy, pure finance professionals will still have a say, whether to operate for the Morgans or for Temasek-type entities. Ultimately, the professionals' best practices will decide the outcome.

Model for the RBI

The question of questions for us in India is: How is the RBI going to resolve the issue of governance of the new Temasek-like entity — if and when the Government decides to follow Japan's and China's example a la the Singapore model. It is necessary that professionalism is given total autonomy and political direction abjured. That way alone lies success. This is the lesson Temasek has demonstrated. May this be the model that the central bank and the Government follow!

Higher returns are surely welcome, but political risks have to be carefully mitigated by adroitly choosing the personnel and policies adopted by our own investment vehicles. Already, in India, there are examples of such successes. Experience has shown that state-run investment vehicles can also turn out good returns.

We should choose to follow these successful paradigms if the new experiment with a Temasek-like vehicle in India is to turn out a success. Above all, human resource management is the key to the success of investment managers in this venture. Hopefully, the RBI and the Government will use their own best models, besides Temasek, to guide their further decision-making in this matter.

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