The Hindu Business Line : ‘Corporate bond market, vital for developing infrastructure’

There must be a financial system that will deliver long-term funds for infrastructure needs. We need to look carefully at the impediments to such financing. The most glaring one is the lack of a corporate bond market. Typically, long-term funds for infrastructure projects are obtained by issuing bonds, which is difficult in India now.

Mr Joshua Felman, Senior Resident Representative of IMF in India.

B. Baskar

Joshua Felman is the head of the IMF office in New Delhi. He has held this position since August 2006. Prior to this, he was a senior official at the IMF headquarters in Washington DC, where he was in-charge of the IMF’s operations in Korea, handling research on Asian issues. Mr Felman was the IMF’s representative in Indonesia during the Asian crisis where he worked closely with the country’s monetary authorities.

Speaking to Business Line in Chennai recently, Mr Felman covered a range of issues, including the sub-prime crisis and the financial reforms in India.

Excerpts from the interview:

What are the lessons that the Indian banking and financial sector can learn from the recent sub-prime crisis in the US?

Two things. There are probably a hundred things that can be learnt; people are going to be studying this for a long time and, in the process, drawing lessons out of it. Striking among them are those that are not easy to quantify, lending standards, for instance.

In the US, people were for a long time confident that the housing boom would never end, certainly not the way it did. This was because they focussed on the level of housing prices as is happening in India.

The conclusion was that housing prices had not gone up the way it had in the UK or Australia, where the boom ended without too much problem for the economies. So, it was felt that since the boom was much smaller in the US, its aftermath would be even easier to handle.

What was not factored in was that, in the US, towards the end of the boom, particularly in 2005-06, the creditors relaxed the lending standards. They started lending considerable sums to the so-called sub-prime borrowers, who could not normally get loans. And this in the end is what did them in.

Not so much the volume of lending, not so much the prices, not so much the speculation, but the fact that they lent to people who were not credit-worthy.

This is an important lesson for banks in India. Yes, the economy is growing rapidly, there is increasing demand for credit, so it is natural that there will be a fair amount of credit boom.

But it is important for banks to make sure that in their drive to expand their businesses they do not lower their lending standards. This will come back to haunt them in a bad way.

The other important lesson is not to underestimate the impact that relatively small problems can have. In the end, the sub-prime element in the US financial market is a small percentage of the overall financial market.

When you talk about actual foreclosures, the foreclosure rate right now in the US on home mortgages put together is 1.5 per cent. And the default rate, (default is when you miss your payments), not to be confused with foreclosure rate, is 5 per cent.

This is only a part of the mortgage market, which is a small component of the overall financial market. Yet, look at the tremors this has caused throughout the world.

Let me cite another example specific to Korea. In the 1990s, there was tremendous expansion of credit-card use, as a result of which default rates rose sharply.

This did not cause any tremor in the banking system. The banks handled the crisis without much difficulty.

Yet, for six quarters, there had been no growth in consumption in an economy which had seen rapid growth in consumption.

So it is easy during the course of a boom to dismiss problems, and assume that it will not have a big impact. But these problems become big enough to bite. One has to, thus, be vigilant and careful.

I think these are the two problems that would directly apply to India. There are many other issues such as regulation, the role of the rating agencies, and so on, but it is too early to make a judgment on that.

Another important issue is that of transparency. One of the reasons why the impact of the sub-prime crisis has been so large, despite the default rates being relatively low, is that these loans were repackaged and nobody was sure what they were holding indirectly.

If they lend money to a bank, the bank may have no such loans on its balance-sheet, but off the balance-sheet it may have loans that could come back to it.

This may get the banks into trouble and, hence, lenders are wary of lending to them. So one of the lessons that the IMF has drawn is that we need to find a way to improve transparency, help people assess risk much better, both before and after the crisis.

Given the scale of this crisis, do you think a case can be made for more and better regulation of the global financial system?

The first thing I would say is that we are in mid-crisis, which is never the right time to draw policy prescriptions. We need to wait, see how things unfold and when we get a better perspective, draw up new policies. So it is a little too early to answer this question. But we need to be a little careful about regulation.

Governments and central banks always need to strike a balance. If you regulate things too much, you will notgive people a chance to take risk.

Risk and reward are two sides of the same coin. People take risks in the hope of gaining rewards; so, if you prevent people from taking risk, they cannot hope for rewards.

When that happens, there will be no dynamism in the economy. So, you need to encourage people to take risks and drawing a line between an appropriate, healthy amount of risk and excessive risk is always difficult. That is why we need to wait for a while before deciding to shift that line one way or the other.

It has been more than 16 years since reforms were initiated in this country and we have come this far. What do you think should be next on the agenda?

Of course, there are many things that need to be done. Obviously, everyone is aware of the needs in infrastructure and social sectors. But what I would like to single out, in addition to what has already been said, is the financial sector.

This sector is important for two reasons: One, India needs enormous funds to build up capacity and for infrastructure. And there must be a financial system that will deliver long-term funds for these investment needs. We need to look carefully at the impediments to such financing.

The most glaring one is the lack of a corporate bond market. Typically, long-term funds for infrastructure projects are obtained by issuing bonds, which is difficult in India.

The other issue is that of risk management. The financial sector has two functions — to allocate capital and to help companies manage risk.

One of the problems that Indian companies face is that they do not have the appropriate financial management tools to manage interest rate risk or exchange rate risk. And that is going to handicap them in the global market. This is what makes financial sector reforms so important.

The other area that needs urgent reforms is the labour sector. In fact, if we go back to the 1980s, there has been reforms in the product market and financial sectors. The lack of labour market reforms has impeded India from developing a labour-intensive manufacturing industry as seen in other Asian countries.

The textile sector, in particular, which has so much potential, has suffered due to lack of labour reforms.

India has traditionally had good growth in high-skilled capital-intensive industries, iron and steel, chemicals, petrochemicals, and, more recently, the IT sector. Is this growth trajectory different from other emerging economies? What do you think should be done to promote more labour-intensive industries?

I would not like to come out with any specific policy proposals on this issue. But what I would like to point out is if you look at India’s development path, what is striking is not the large role played by consumption.

In fact, investment has played an equally large role. In that respect, India’s development path is quite normal. Also, the domestic market is very important. But exports have come to play an important role and, in fact, they now touch a quarter of GDP.

But what is unusual in India’s case is the reliance on skilled labour, which is more typical of countries that have a per capita income several times India’s. It is unusual and even unprecedented for a developing country that has a large pool of unskilled labour to be so reliant on skilled labour.

This is a problem because it means that a large number of people are not participating in the economic boom.

Is this why, despite the reduction in poverty, we still have growing inequality in this country?

I would draw a distinction here. All countries have income inequality. What is important, for social cohesion, is to ensure that a vast majority of people participate in the growth process, get a chance to see their incomes rise.

And, of course, that is happening going by the poverty rates that have come down quite rapidly. I just hope that this process continues.

More Stories on : Interview | Debt Market | Corporate Bonds

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page

Stories in this Section
Rice strains

PDS: Bridging the gap better

The fundamental dilemma

Americans’ interest in nuke deal

‘Corporate bond market, vital for developing infrastructure’

Debt recovery