My Ramblings about Everything except Technology

Tuesday, June 12, 2007

Will politics push India and China into financial crises?

China and India are currently among the fastest- growing economies in the globe. Together, the two nations represent 38% of the global population. Continued growth of the world’s second and fourth largest economies, respectively, (measured by PPP-based GNP) at the current rates or higher, has enormous implications for the globalization process under way and the consequent restructuring of world economic order itself.

In 1997-98, several of the most dynamic and fast-growing East Asian economies suffered severe financial crises that devastated them. It revealed that growing economies could not be sustained with weak financial systems.

Economic history is strewn with examples of countries that grew promisingly at first, only to falter and fall behind because of a crisis, and were then unable to regain the earlier momentum. Such examples are found in Latin America and in East Asia.
There are other countries, such as the US and those in Western Europe, which experienced sustained growth in the modern period and matured economically to become developed countries.

Which category will China and India find themselves in? The question of some importance today is: Will China and India continue to grow at least at the same rate (of the last two half decades) or higher during the next two decades? Or, will either, or both, slow down or suffer a “bubble burst”, a crisis from which they will find it difficult to recover?

Economic history is full of favourable perceptions evaporating when the reality dawns with a bang.

According to scholars, an efficient financial system is the defining condition for determining into which of the two categories nations will, sooner or later, find themselves in. I will argue here that, China and India will fall into the first category, unless both countries carry out fundamental reforms of their financial systems.

Can the two nations reform their financial systems to obviate a financial crisis and also meet the requirement of sustained growth, or are there constraints that would prohibit this? I will argue that political constraints and economic compulsions in both countries are such that these required reforms cannot be carried out. Financial crisis thus seems highly probable.

The present system

The main function of the financial system is to mobilize resources through financial assets or debt instruments and to allocate these resources efficiently and optimally to achieve the highest rate of return, or maximize the growth rate of the economy.

This function is embedded in a “financial architecture”, i.e., a payments system with a medium of exchange, a transfer mechanism of resources mobilized from savers for lending to borrowers/investors, and with insurance and diversification, reduction in risk in repayment of this. The architecture encompasses institutional regulators such as the Securities and Exchange Board of India; international standards of accounting and transparency in transactions; corporate governance norms for management, shareholders and other stakeholders; banking and prudential norms such as the Basel II norms that limit soft-budget and moral hazard constraints.

By current standards, both China and India have impressive macro-economic fundamentals such as a high, 6-8% annual growth rate, relatively low inflation, foreign exchange reserves exceeding 10 months of imports, and a declining headcount ratio of poor people. The perception today is that both economies will fuel global growth in the future.

While this perception may be pleasing to the policymakers of the two nations, it is worth remembering that economic history is full of such favourable perceptions evaporating when the reality dawns with a bang. At one stage, many countries of Latin America were considered more wealthy and dynamic than North America. But, in the late 19th century, that was reversed. In the 1940s, Argentina, Brazil and Chile were thought to be the nations that would join the developed countries club. But, by the early 1960s, that perception evaporated. In the 1980s, Japan was expected to overtake the US and the Japanese, in fact, had begun to buy up prized real estate and major US corporations. That trend stands completely reversed.

In the case of the ‘Asian Tigers’, the World Bank, in a volume The East Asia Miracle, had unabashedly advocated the export-led free trade strategy of the East Asian economies. Its celebrated remark that these economies had got their “basics right”, implying other countries had not, came back to haunt the World Bank after the 1997 crisis. It did attempt damage control in a subsequent volume: Rethinking the East Asia Miracle, but the institution’s credibility was hit hard because the very area where the East Asian countries got their basics wrong was the financial system—it was to monitor this that the World Bank and IMF were set up under the 1944 Bretton Woods Charter.

India and China have secured their current macro-economic fundamentals by increasingly milking their financial systems without nurturing these with reforms. As a result, the structural parameters in their banking and fiscal sectors indicate a looming crisis. The institutional development in their financial systems is also out of sync with the needs of increasing globalization.

At present, the banking sectors in the two economies are internally ill-equipped to meet the challenge inherent in the developing financial crisis. This is because of dominant government ownership and lack of self-regulation on market principles; a lack of modern prudential and governance norms; weak, opaque, non-independent regulatory bodies; and directed credit and captive finances. Besides, their fiscal budgeting has limited scope because of large contingent liabilities and irreducible heads for fund allocation, e.g., subsidies, interest payments and defense.

Moreover, the financial systems are bank- and budget-centric because the stock markets are small, prone to insider trading and rigging. Their bond markets are underdeveloped.

However, India’s financial system is relatively better structured on prudential norms than China’s, even as it has yet to fully emerge from the shackles of the Soviet-style command mindset. Even today, state-owned banks, which receive 80% of all deposits, are compelled to deploy about half the funds in low-interest, albeit low-risk, government securities (to finance the fiscal deficit), another 20% in directed credit, and 25% in mandatory reserves. Such straitjacketing of bank fund dispersal applies to other financial institutions in insurance, provident fund and employees state insurance as well. Indian financial intermediation relies less on market-based risk management than government policy.

Imminent financial crisis

Empirically, it has been observed that a financial crisis descends on an economy via three different routes of causation:

(1) A run in the foreign currency market that induces a banking collapse, triggering a fiscal crisis.
(2) A banking collapse that causes a fiscal crisis, which induces a foreign currency run.
(3) A fiscal crisis that triggers a banking crisis, which induces a foreign currency run.

Which routes are China and India likely to follow to an expected financial crisis? Both countries do presently face severe financial systemic problems but these are of different kinds and require different corrective measures.

China needs to privatize its banking system. This would enable the private sector to emerge as an independent centre of economic power, which the Chinese Communist Party doesn’t seem ready to accept. The party had undertaken reforms because it wanted to legitimize itself and not to develop independent alternatives. After the failure of the Great Leap Forward, the Great Proletarian Cultural Revolution and the Gang of Four, the Communist Party’s credibility was low. Chairman Deng Xiaoping understood that and launched reforms.

Dramatic, but it is the reality in China. There is clearly a Catch-22 type political bind. Either China will have to carry out financial reforms and face political upheaval, or retain the political levers on the financial system and face an economic crisis. With a peaked domestic saving rate, a high incremental capital ratio, and an uncertain global market, there is no scope for even sustaining the present GDP growth rate, without increasing total factor productivity—which requires reforms that China can’t politically carry out.

India’s problem is that its budget finances are perilously close to a debt trap. For every 25 cents to a dollar as loans to finance the deficit, 24 cents is the budget allocation for amortization of past loans. And, pruning allocations for defence, pensions, subsidies, police, employees compensation, counter-guarantees etc., which account for over 90% of the revenue, is not politically feasible.

Besides, government investment in the economy has also been reduced progressively with the creation of a capital account surplus in the budget to finance the deficit in the current account.

Hence, the fiscal malaise in the Indian financial system is that the current macro-economic fundamentals have been attained by running the system to the ground, e.g., containing inflation by financing the large government deficit with a surplus of private savings over private investment.

Thus, political compulsion and constraints are driving both China and India into a financial crisis. India may be able to come out of it sooner than China because Indian democracy always intervenes in a crisis by electing those who will bring change.

Subramanian Swamy, a former cabinet minister, teaches economics at Harvard University in the summer term.

Wednesday, July 26, 2006

Myth of New India

The Myth of the New India



INDIA is a roaring capitalist success story." So says the latest issue of Foreign Affairs; and last week many leading business executives and politicians in India celebrated as Lakshmi Mittal, the fifth richest man in the world, finally succeeded in his hostile takeover of the Luxembourgian steel company Arcelor. India's leading business newspaper, The Economic Times, summed up the general euphoria over the event in its regular feature, "The Global Indian Takeover": "For India, it is a harbinger of things to come — economic superstardom."

This sounds persuasive as long as you don't know that Mr. Mittal, who lives in Britain, announced his first investment in India only last year. He is as much an Indian success story as Sergey Brin, the Russian-born co-founder of Google, is proof of Russia's imminent economic superstardom.

In recent weeks, India seemed an unlikely capitalist success story as communist parties decisively won elections to state legislatures, and the stock market, which had enjoyed record growth in the last two years, fell nearly 20 percent in two weeks, wiping out some $2.4 billion in investor wealth in just four days. This week India's prime minister, Manmohan Singh, made it clear that only a small minority of Indians will enjoy "Western standards of living and high consumption."

There is, however, no denying many Indians their conviction that the 21st century will be the Indian Century just as the 20th was American. The exuberant self-confidence of a tiny Indian elite now increasingly infects the news media and foreign policy establishment in the United States.

Encouraged by a powerful lobby of rich Indian-Americans who seek to expand their political influence within both their home and adopted countries, President Bush recently agreed to assist India's nuclear program, even at the risk of undermining his efforts to check the nuclear ambitions of Iran. As if on cue, special reports and covers hailing the rise of India in Time, Foreign Affairs and The Economist have appeared in the last month.

It was not so long ago that India appeared in the American press as a poor, backward and often violent nation, saddled with an inefficient bureaucracy and, though officially nonaligned, friendly to the Soviet Union. Suddenly the country seems to be not only a "roaring capitalist success story" but also, according to Foreign Affairs, an "emerging strategic partner of the United States." To what extent is this wishful thinking rather than an accurate estimate of India's strengths?

Looking for new friends and partners in a rapidly changing world, the Bush administration clearly hopes that India, a fellow democracy, will be a reliable counterweight against China as well as Iran. But trade and cooperation between India and China is growing; and, though grateful for American generosity on the nuclear issue, India is too dependent on Iran for oil (it is also exploring developing a gas pipeline to Iran) to wholeheartedly support the United States in its efforts to prevent the Islamic Republic from acquiring a nuclear weapon. The world, more interdependent now than during the cold war, may no longer be divided up into strategic blocs and alliances.

Nevertheless, there are much better reasons to expect that India will in fact vindicate the twin American ideals of free markets and democracy that neither Latin America nor post-communist countries — nor, indeed, Iraq — have fulfilled.

Since the early 1990's, when the Indian economy was liberalized, India has emerged as the world leader in information technology and business outsourcing, with an average growth of about 6 percent a year. Growing foreign investment and easy credit have fueled a consumer revolution in urban areas. With their Starbucks-style coffee bars, Blackberry-wielding young professionals, and shopping malls selling luxury brand names, large parts of Indian cities strive to resemble Manhattan.

Indian business tycoons are increasingly trying to control marquee names like Taittinger Champagne and the Carlyle Hotel in New York. "India Everywhere" was the slogan of the Indian business leaders at the World Economic Forum in Davos, Switzerland, this year.

But the increasingly common, business-centric view of India suppresses more facts than it reveals. Recent accounts of the alleged rise of India barely mention the fact that the country's $728 per capita gross domestic product is just slightly higher than that of sub-Saharan Africa and that, as the 2005 United Nations Human Development Report puts it, even if it sustains its current high growth rates, India will not catch up with high-income countries until 2106.

Nor is India rising very fast on the report's Human Development index, where it ranks 127, just two rungs above Myanmar and more than 70 below Cuba and Mexico. Despite a recent reduction in poverty levels, nearly 380 million Indians still live on less than a dollar a day.

Malnutrition affects half of all children in India, and there is little sign that they are being helped by the country's market reforms, which have focused on creating private wealth rather than expanding access to health care and education. Despite the country's growing economy, 2.5 million Indian children die annually, accounting for one out of every five child deaths worldwide; and facilities for primary education have collapsed in large parts of the country (the official literacy rate of 61 percent includes many who can barely write their names). In the countryside, where 70 percent of India's population lives, the government has reported that about 100,000 farmers committed suicide between 1993 and 2003.

Feeding on the resentment of those left behind by the urban-oriented economic growth, communist insurgencies (unrelated to India's parliamentary communist parties) have erupted in some of the most populous and poorest parts of north and central India. The Indian government no longer effectively controls many of the districts where communists battle landlords and police, imposing a harsh form of justice on a largely hapless rural population.

The potential for conflict — among castes as well as classes — also grows in urban areas, where India's cruel social and economic disparities are as evident as its new prosperity. The main reason for this is that India's economic growth has been largely jobless. Only 1.3 million out of a working population of 400 million are employed in the information technology and business processing industries that make up the so-called new economy.

No labor-intensive manufacturing boom of the kind that powered the economic growth of almost every developed and developing country in the world has yet occurred in India. Unlike China, India still imports more than it exports. This means that as 70 million more people enter the work force in the next five years, most of them without the skills required for the new economy, unemployment and inequality could provoke even more social instability than they have already.

For decades now, India's underprivileged have used elections to register their protests against joblessness, inequality and corruption. In the 2004 general elections, they voted out a central government that claimed that India was "shining," bewildering not only most foreign journalists but also those in India who had predicted an easy victory for the ruling coalition.

Among the politicians whom voters rejected was Chandrababu Naidu, the technocratic chief minister of one of India's poorest states, whose forward-sounding policies, like providing Internet access to villages, prompted Time magazine to declare him "South Asian of The Year" and a "beacon of hope."

But the anti-India insurgency in Kashmir, which has claimed some 80,000 lives in the last decade and a half, and the strength of violent communist militants across India, hint that regular elections may not be enough to contain the frustration and rage of millions of have-nots, or to shield them from the temptations of religious and ideological extremism.

Many serious problems confront India. They are unlikely to be solved as long as the wealthy, both inside and outside the country, choose to believe their own complacent myths.

Pankaj Mishra is the author of "Temptations of the West: How to Be Modern in India, Pakistan, Tibet and Beyond."

Friday, June 09, 2006

It's Hard Out There For... An Indian-American Chick-Lit Author?

It's Hard Out There For... An Indian-American Chick-Lit Author?
New America Media, Commentary, Sandip Roy, May 04, 2006

Editor's Note: When a 19-year-old Harvard student and novelist was accused of plagiarism recently, one fellow Indian-American felt strangely... relieved. Sandip Roy is an editor for New America Media and host of "UpFront," a NAM weekly radio program on KALW-91.7 FM, San Francisco.

SAN FRANCISCO--Dear Kaavya Viswanathan,

I know this must come as small consolation to you these days, as dreams of book deals, film projects and maybe even Ivy League futures seem to wither on the vine. But as one Indian-American to another, I say thank you. I have to confess to a sneaking sense of relief when Opal Mehta's life came crashing down around you. It's not schadenfreude. It's just this relief that finally we can fail, that we can screw up spectacularly and live to tell the tale.

Only we Indian-Americans know it's hard out there for an overachieving Indian-American. It was bad enough that we were the anointed model minority. (Did you know our median income is higher than any other ethnic group in the United States? That we have 200,000 millionaires and 41,000 doctors?) Now we are expected to excel at everything we do. We are the first-class first minority. "Doesn't anyone's kid ever come second in anything anymore?" wondered a friend bemusedly listening to a group of Indian mothers at a potluck.

It isn't just first-class first. It's first-class first at the first attempt. Jhumpa Lahiri writes her first book. It wins a Pulitzer. Arundhati Roy writes her first book and wins the Booker. Salman Rushdie wins the Booker of Bookers. When an Indian kid writes a good essay in school and brings it home, his fond aunt doesn't say, "Well done." She says, "Mark my words, my little nephew will win the Nobel Prize one day."

What was wrong with aiming first for the neighborhood Rotary club essay competition?

There's nothing wrong with a quest for excellence. And I kind of believe you, Kaavya, when you say you had a photographic memory. We do. I don't know whether its genetic or because we have to memorize so much history (the Guptas, the Mauryas, the Tughlaqs, the Khiljis, the Mughals, the Brits), but we do imbibe facts like pictures. We remember things. That's why we are so good at spelling bees.

I mean, we don't just win spelling bees. We do a clean sweep. Last year, all four finalists were our people. Our Bollywood actress Aishwariya Rai can't just be beautiful, she has to be the MOST beautiful woman in the whole world. That's why it was such a relief to see a stoner South Asian in that film "Harold and Kumar." Except Kumar wasn't just a pothead; when push came to shove he was also a medical whiz.

It would be funny, this race to the top, if it wasn't also a race to conformity. And it left very little room for someone who didn't fit into this shiny brown prototype. No battered wives, homosexuals (and other unmarried types) and illegal immigrants, please -- we are Indian Americans. When I quit working in a "goodjob" (for us it's always one word) in software programming to be a journalist, I imagined a kind of hush that could be sensed worldwide -- or at least all the way from my neighborhood in Calcutta to that yahoogroup for the alumni of my old college. "His poor mother," I could almost hear it say.

Your Opal's parents made master plans with handy acronyms for their progeny -- HOWGIH (How Opal Will Get Into Harvard) followed by HOWGAL (How Opal Will Get A Life). And you, Kaavya, wanted to write bestselling chick-lit about Opal and win the Booker and try investment banking. Why, Kaavya, why? We have over a billion Indians in the world. Why can't we leave some things for them to achieve? Instead we just keep setting the bar ever higher. When I was a kid and won prizes at school I would be sent over to the neighbors to display them on some kind of tacky victory tour. It was the most excruciating experience ever -- I felt like some wicked Red Riding Hood bearing grief rather than goodies. There I was bringing shiny trophies to display to the neighboring moms, who would then no doubt berate their less worthy children who had only managed to come in second in the English Grammar test.

But like a demented magpie I couldn't resist the lure of those shiny achievements. More, more, more, shinier, shinier, shinier. Then one year I almost flunked my mathematics exam. It was the best thing that could have happened to me. Paradise Lost. Earth Regained.

Dear Kaavya, it might not seem so now. But one day you might thank Opal Mehta for setting you free. Just call 1-800-HOWGAL-ASK (How Opal Will Get A Life -- And Save Kaavya).

Best Wishes,


Friday, August 19, 2005

Real Estate's Wall of Worry

Barry L. Ritholtz recently wrote a piece on Housing Bubble..

The way information moved in earlier times was lot slower than what today is. The mere fact that you are able to pick up on an obscure story of Bubble T-Shirt means that information flows faster and hence slows down the reaction time. The new media has also brought down the "Experts" from their Castle closer to the "Commoner" hence dissipating the value of their analysis faster and to wider audience.

It also created pseudo and obscure experts to the forefront which might explain the amount of "Housing Noise"

I think rational thinking proves that there is Housing Bubble only questions are about Why it is going up? How long this can last? I don't think we will be able to answer that till we are way past the bubble. Then we might gather together and certainly analyze the posts/blogs to see who and how many were right (Another powerful feature of this new media)