Last week in these columns we discussed the warning for India in US financial crisis. This week let us examine the prospects for India in the emerging global financial architecture.
In the last three weeks the world of American finance came down crumbling marking perhaps the end of Wall Street as we know it. The two fastest growing economies of China and India have largely been insulated from the crisis. This is also because India and China were not the beneficiaries of the huge financial gains of the free market economy that according to The Economist, increased the share of total American corporate profits from 10 per cent in 1980s to 40 per cent at its peak last year. ?By one calculation profits in the past decade amounted to $1.2 trillion more than you would have expected. This industry will not be able to make money after the boom unless it is far smaller?and it will be hard to make money while it shrinks. No wonder investors are scarce.?
The big meltdown has forced the US Federal Reserve and the Treasury, ?nationalize the economy faster than Hugo Chavez.? India and China will continue to thrive for various reasons, the most important being that they had no part in the big gains made by few in the freewheeling financial system that is now in a shamble. The system that has collapsed has no use for India though in India its lobbyists have become shriller after the collapse. When it worked it benefited a few thousand operators in the financial centres. The cost of which is now being borne by the US taxpayer.
The US government had to rescue the American International Group (AIG) through an $85 billion loan at punitive interest rates though AIG was a safe, well-run insurer. But its financial products division, which accounted for just a fraction of its revenues, wrote enough derivatives contracts to destroy the firm and shake the world. This has exposed the real culprit in the mystery of the collapse of banks and investors. This is the disconnect between the stock markets and the real economy, accentuated by the derivatives market, which according to Prof. R. Vaidyanathan of the Indian Institute of Management, Bangalore, is like the tail beginning to wag the dog. Prof. Vaidyanathan says, decline of the West is a pre-requisite for the emergence of India as a global power.
It is time to develop a thinking where India is at the centre of the economic architecture. This was not possible as long as the peak in the US financial system continued. The decline of the global financial institutions has changed the situation to our advantage for a fresh thinking. India'sgrowth is mainly because of our domestic saving. The FDI-FII component is only eight per cent in relation to our gross savings in the last decade. And 80 per cent of our 35 per cent domestic saving comes from household savings. In comparison the US household savings is meagre or negative. In India these days companies spent more on advertising than on production to promote consumerism, spendthrift and artificial demand creation. In other words to create shopoholics
The restructuring of the architecture of the global financial system, some economists believe is the beginning of the end of the economic order built on laissez-faire. Indian economic thinking has to become more nationalist and east-ward looking. It might even take a decade for the US to come out of the mess in its financial market.
Consider the reform being forced on Goldman Sachs and Morgan Stanley who have to either raise more capital or shrink their balance sheets. For long they played on loan on the high street of world finance. These were investment banks highly leveraged with barely 3 per cent of capital adequacy ratio. It is amazing that if the financial crisis had not taken place they would have been still lecturing the world arrogantly about the virtues of unbridled capitalism and the need to integrate with the US economy.
They made fat profits because they violated rules, overleveraged businesses and took huge risks.
Enron, another big American firm that went bust a couple of years ago after enticing a whole bunch of economic journalists and politicians in India, was run by top Harvard business experts and McKinsey was its market adviser. The American rating agencies which in recent years have become the soothsayers for India'sinvestment climate, and theirs was the last word for the country'sbusiness media, are now under close scrutiny. Reports say that these agencies were doing brisk business with the investment banks proffering convenient ratings and making big money in the process. So they went soft on their ratings of investment banks and misled the markets. We have finally got to see what was really inside these big Wall Street sharks. Evaluation is easier than passing the test. This has been the lesson in the failure of the American rating agencies which used to certify and rate the health and prospects of economies all over the world. But they could not fathom their own investment companies going downhill.
This is not the time for India to debate if remaining set of finance sector reforms should be put on hold or accelerated to go and extend solidarity with the US. Some experts think that a more liberal domestic environment would have made the domestic financial system vulnerable to the global crisis. Other view is that the reform should not suffer and held hostage to the current crisis. This is also an opportunity for a more efficient and sustainable balance between growth, reform and risk, they say. The unfortunate side is that the economists who formulate the national policy are more loyal to the West.
The huge foreign exchange buffer that developing economies have built up to protect themselves against a 1997-type market volatility is the new target. The exchange rate is the first casualty of sudden and large portfolio movement. But there are NRI experts who suggest that the $300 billion reserves India has got is repressing the economy. These advocates of full financial integration with the US dismiss Indian financial system as relatively primitive. This is the kind of advise the UPA government is getting from its two experts committees? on Making Mumbai an International Financial Centre and the Committee on Finance Sector Reforms? both headed by World Bank economists. Both are US citizens and their first loyalty is not to India. Why is it that India'seconomic policy is always formulated by foreigners? Is there a dearth of truly Indian economic genius?
Should India tag along to a failed financial system under America or think of itself as one of the emerging four largest economic centres of the world? There are some who believe that the decline of the West is an inevitable consequence of the unrealistic, high spending, credit-driven model they have adopted. They were sustained by exploitation of colonies subservient to them. The World Bank, WTO and the latest high sounding idea being propounded by the West, stateless multinationals?as seamlessly integrated across time zones and cultures? are all instruments of perpetuating their hegemony. Our experts and the media are only debating on the Indian economy as to how the US will impact on it. So they are obsessed with the IMF-inspired reports and the impact of US meltdown on India. It is understandable that the experts on IMF-World Bank payroll think in those lines because as they say their stand depends on where they sit.
(The views expressed in this column are personal. The writer can be contacted at [email protected])