India’s financial crisis a drag on region

After many years of galloping growth rates, India is grinding to a halt, and countries in the region may soon feel the impact.

To ease pressure on the rupee, the government said it had set up a panel to look at paying for imported items in rupees rather than foreign exchange under bilateral currency swap agreements. Photo: Reuters

INDIA is in the news and for all the wrong reasons. With the rupee collapsing, the current account deficit exploding and corporate debt set to melt down (trimming its contribution to Forbes billionaires’ list), China’s strategic challenger looks set to drag the rest of Asia-Pacific into a prolonged economic crisis.

After many years of galloping GDP growth rates, India is grinding to a halt. Growth in 2012 was 6.3% – this year it will be lucky if it can get above 3%.

For a proud nation with a US$4.684 trillion (RM15.4 trillion) economy, its own nuclear bomb and a navy equipped with both aircraft carriers and submarines, this is a massive loss of face and, indeed, opportunity.

India may well go down in the annals of contemporary economic history as being the trigger of the 2013 financial crisis – much as the South Koreans and Thais were the forerunners of the 1998 meltdown.

So what went wrong in India? Wasn’t the subcontinent’s giant supposed to be a great developmental success story and what are the lessons for us in Malaysia?

According to a pair of extremely high-profile economists, Jean Dreze and Nobel Prize winner Amartya Sen, whose book An Uncertain Glory: India and its Contradictions was launched earlier this year, India allowed its public sector, especially healthcare and education, to wither. This failure of governance and execution compounded deeply-rooted iniquities at the heart of its complex – a caste-driven society.

And with a general election slated for next year, there’s little doubt that a floundering Congress-led administration under Manmohan Singh will once again fail to tackle one of the world’s most inefficient and corrupt bureaucracies.

So, with the precipice fast approaching, it would be wise for Malaysian readers to acknowledge that India will not suddenly rebound and we will all be tainted by association. Moreover when the fear sweeps the markets, the contagion often ends up being far worse than anything crafted by Hollywood’s merchants of doom.

To be fair, India’s track record has been stellar if you’re middle-class and above.

Opportunities have abounded, despite the odd infrastructural glitch such as the July 2012 power blackout across Northern India (at the height of the summer heat).

However, for those at the bottom of the social scale, life has been less enthralling.

Take, for instance, the Indian government’s meagre spending on healthcare – only 1.2% of GDP alongside China’s 2.7% and Latin America’s 3.8%. Converted into absolute expenditure (at PPP terms), India has been spending US$39 (RM125) per capita whilst China has spent US$203 (RM655) per capita.

To put things into perspective, Malaysia spends 4.8% of its GDP on healthcare or about US$400 (RM1,292) per capita. Indonesia spends 2.7% of its GDP and US$100 (RM323) per capita.

Understandably, India has reaped a bitter harvest from this shocking under-investment, achieving Quality of Life indices that pale in comparison even with neighbouring Bangla-desh. This is despite Bangladesh having a GDP per capita of US$747 (RM2,413) compared to India’s US$3,557 (RM11,490).

But it’s the weaker sections of society that have been the most imperilled: women, tribal people and the lower castes. Indeed, female empowerment in Muslim Bangladesh far surpasses anything in India.

However, the story isn’t uniformly bad. India is a vast nation and there are differences in the various indices between the country’s North and West (sub-Saharan African bad) and its South (generally good). So, if one is to subscribe to the Sen/Dreze formulation, India’s failure is primarily a failure of governance with more public money being spent on notoriously corrupt fertilizer subsidies rather than healthcare and education.

We cannot underestimate the cost of this neglect to invest in its people: not only due to higher crime and squalor, but also in terms of lost opportunities via better human capital.

As a result of this terrible under-investment in their own people, India’s “demographic boom” may well be worthless as its burgeoning youth population of some 430 million won’t be adequately educated, employed and/or fed.

Of course, the two men’s thesis hasn’t been uniformly accepted. Free-market thinkers like Columbia University’s Jagdish Bhagwati have taken issue with their prescriptions, seeing rather the need for less state intervention and greater private sector participation. The ensuing debate between the two prominent thinkers has been sharp and acrimonious, reflecting the underlying sense of unease.

Ultimately, the correct policy path for India probably lies midway between the two positions, but for now, we can be sure that little will be done to improve the lot of India’s hundreds of millions of poor.

Dreze and Sen have also criticised India’s free market and much-lauded democracy, arguing that neither has helped address its fundamental inequalities.

Look across the Himalayas to China, however, whose authoritarian system has brought it great wealth, but also the same inequalities and social dislocations and things don’t seem that rosy either.

Where should developing economies go then? Perhaps this is the great paradox of modern capitalism: that nothing countries do will ever be right in the long run and that periodic market scares, if not an outright collapse are only to be expected!

Only then will governments be forced to reassess and change their policies. So as emerging markets ready themselves for the impending squalls, we in Malaysia should also be sharpening our policy “tools” and readying ourselves to address the many failings in our policy “tool-box”.

Contributed by KARIM RASLAN
> The views expressed are entirely the writer’s own.

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American banks need further capital topping

It is important that stress tests are being conducted to asses the health of US banks, some of which are so large that they pose a systemic risk to the world's financial sector - EPA

 Fed's stress tests unveil flaws in planning process

LARGE US banks have lagged in terms of stress tests conducted by the Fed, pointing to possible further capital topping.

The Fed said in a paper released recenty that banks participating in regular “stress tests” had flaws in their capital planning processes, such as being unable to show that they considered all of the relevant risks to their businesses, said Reuters.

The paper pointed to problems such as modeling techniques that did not address bank-specific risks, loss and revenue projections that could not be replicated, or problems with governance of the planning process.

It is important that stress tests are being conducted to assess the health of US banks, some of which are so large that they pose a systemic risk to the world’s financial sector.

It is a tedious process but there is no choice; it is on the Fed to come up with increasingly sophisticated tools to conduct these stress tests.

It is not only in terms of stress tests that the US banks are lagging; progress has been slow in terms of adopting the Dodd-Frank Act.

Four years into the 2008 financial crisis, financial reform is still creeping along.

This is despite the collapse of a 100-year old bank, Lehman Brothers.

In fact, President Barack Obama had recently met with Fed Reserve chairman Ben Bernanke and other regulators, where he received an update and he also urged them to fully implement the Dodd-Frank Act.

Banks are said to be resentful of the Volcker rule that prohibits proprietary trading.

China has set up an agency to co-ordinate among other things, monetary and financial regulatory policies and help regulate financial products where jurisdiction overlaps.

It also coordinated information-sharing and statistics, an announcement on the Chinese government’s Web site said.

Withdrawal of stimulus packages, tightening of monetary and regulatory policies have impacted the financial sector severely.

Hence the timely setting up of such an agency which has no decision making powers; nevertheless the members of this advisory scheme have considerable weight.

The entity would be led by the central bank and would include representatives from banking, stock market and insurance regulators, as well as the State Administration of Foreign Exchange, said the International Herald Tribune.

In its aim towards sustainable financial reform, the Chinese Government hopes that this agency will help smoothen a lot of the hiccups on the way. This agency will have plenty of work ahead, considering the size of the Chinese financial sector.

Despite a 28.4% year-on-year decline in revenue from continuing operations to S$7.38mil from S$10.31mil, the Singapore Exchange is proposing to reduce the standard size of securities traded from 1,000 units to 100 units, and one unit eventually.

Besides improving liquidity and retail interest, the exchange hopes to make the larger, more well-established available to investors.

This will have positive implications for Malaysians trading on the shared platform.

With the change, the minimum needed to buy a SS$10 stock falls to S$1,000, or 100 units of S$10.

Currently, eight out of the 30 stocks in the benchmark Straits Times Index (STI), a collection of the most stable and liquid stocks, trade at S$10 or higher.

In view of capital outflows experienced by emerging markets, this is a timely move to capture back some of the investors’ money.

Contributed by Plain Speaking by Yap Leng Kuen
Columnist Yap Leng Kuen hopes to see more measures aimed at preventing outflows.

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Financial crises a result of governance failures

ROMAN emperor Julius Caesar was famously warned by a seer about the Ides of March, traditionally March 15.

On March 15 this year, banks in Cyprus were closed to allow politicians time to decide how to raise 5.8 billion euros so that the country could qualify for 10 billion euros in bailout funds from the rest of eurozone and the International Monetary Fund (IMF). The solution suggested was to levy a tax on depositors, sparking a realisation that finally, the Europeans had decided to “bail-in” investors and depositors, rather than using public funds to “bail-out” everyone else.

The Cyprus crisis caused a stir in global financial markets, because it punctured expectations that the worst was over. Instead, it demonstrated another episode of muddling through.

Banks in Cyprus re-opened on Thursday with new capital controls on the amount depositors can take out. Larger depositors with over 100,000 euros would stand to lose up to 40% of their deposits. Of course, a significant portion of the deposits in Cyprus banks belong to Russians, who may suffer losses of 4 billion to 6 billion euros. For certain investors, this is the price of putting money in higher risk offshore financial centres. The price to Cyprus of operating as an offshore financial centre is likely to be a drop of GDP of more than 20% in the next couple of years.

The Cyprus outcome is not unexpected. If European governments are to be loaded with heavy debt burdens as a result of the crisis, they will be bound to start “taxing” offshore financial centres, where rich Europeans had been avoiding tax for years. If the eurozone banking union is to have any credibility, they will have to start controlling banking centres which operate largely on tax and regulatory arbitrage. Moreover, having banking assets seven to eight times GDP is no longer considered viable, whether for Cyprus or Iceland.

At the heart of such troubles lies the issue of governance. Financial crises are more governance failures than anything else.

Last week, The End of History philosopher and political scientist Francis Fukuyama published an important blog commentary on “What is governance?” This is the much-awaited part of his promised series on political governance, beginning with his 2011 book The Origins of Political Order. In that book, he looked at the three components of a modern political order a strong and capable state, the rule of law and accountability of the state to its citizens. Since the 2011 book stopped at the French Revolution, most readers would be curious to see how he handled the rise of China, which has a different political system from the West.

Fukuyama's new definition of governance is “a government's ability to make and enforce rules, and to deliver services, regardless of whether that government is democratic or not.” Notice that he has decided to remove any suggestion that democracy is automatically associated with good governance, appreciating that “an authoritarian regime can be well governed, just as a democracy can be mal-administered.”

Accordingly, he uses four approaches to evaluating the quality of governance: procedural measures, input measures, output measures and measures of bureaucratic autonomy. To put it into simple language governance should be measured according to how you govern (the processes); the efficiency of governance (how much tax or resources you need); the effectiveness (outcomes rather than objectives) and whether the bureaucracy is independent of politics or not (the autonomy question).

In dissecting governance into its different dimensions, Fukuyama has helped to clarify the methodology in thinking about the tradeoffs between the ability to have high discretion versus being bogged down by excessive rules, and high capacity to execute, versus low capacity to execute. Critics of that approach would argue that strong states with excessive discretion may not be sustainable. On the other hand, weak states with too many rules and no discretion may not be sustainable either.

Fukuyama is right to point out that the bureaucracy's interests may not be identical to those of the people. The bureaucracy is supposed to be agent of the people (the principal), but many bureaucracies serve their own interests, rather than the public to the extent that civil servants may be neither civil nor servants.

Indeed, the simplistic view that the state is deterministic versus the view of free market self-order misses the fundamental point that large bureaucracies also have self-order. Anyone familiar with working in large complex bureaucracies in China, India or the United States, with many layers of government, would recognise that it is not easy to implement policies from the centre. State or provincial governments have a mind of their own, with very different priorities from that of the centre.

Indeed, in the 21st century, many cities have become more effective instruments of state, and it is not surprising that effective mayors have become national leaders because they show a capacity to deliver close to the people.

The more interesting question about governance is: why are collective action traps so pervasive? In other words, it is understandable why ineffective and weak bureaucracies or political systems are unable to overcome gridlock in their systems, but it is common to see highly effective and capable bureaucracies also caught in gridlock.

These gridlocks are apparent in the resolution of the euro crisis, the stalemate in the Doha World Trade Organisation negotiations and the Durban climate change debates. In the first week of April, the Institute for New Economic Thinking, the Centre for International Governance Innovation and the Fung Global Institute will be hosting a major conference in Hong Kong on how creative and innovative thinking can open up new avenues of thinking on the solutions to global governance. As a respected member of the global economic community, Hong Kong should make its voice heard.

You can watch most of the podcasts on www.ineteconomics.org or www.fginstitute.org.

THINK ASIAN By ANDREW SHENG

Tan Sri Andrew Sheng is president of the Fung Global Institute. 

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