The opportunity in the crisis
In today’s DNA, Mukul Asher & Azad Singh Bali argue that it is an opportune moment for India to make a serious play in developing international financial services:
It may seem odd to stress the need for developing international financial services (IFS) during the fragile recovery from the global financial and economic crisis. The Reserve Bank of India (RBI) has argued with considerable justification that its conservative approach to liberalisation of the financial sector has significantly contributed to mitigating the macroeconomic impact of the current global crisis.
Nevertheless, diminished prospects of the current providers of IFS due to the crisis and subsequent rethinking of the appropriate role of finance; India’s own growth prospects; and its vision of emerging as a major economic power strongly suggest that this is an opportune time to develop IFS in India.
…The development of IFS in India primarily for domestic needs should be the first priority. This phase may last perhaps a decade. As India’s financial and capital markets acquire greater depth and size, in the subsequent phases, India could consider serving the needs of international clients and become a global financial centre. It is therefore clear that the policymakers and the stakeholders need to sustain their efforts and focus over a long term, and plan sequencing of this process carefully.[DNA]
And the risks of a hard landing for India
Nouriel Roubini issues a dire warning (linkthanks Ananth)
The US and advanced economies’ financial system is now headed towards a near-term systemic financial meltdown as day after day stock markets are in free fall, money markets have shut down while their spreads are skyrocketing, and credit spreads are surging through the roof. There is now the beginning of a generalized run on the banking system of these economies; a collapse of the shadow banking system, i.e. those non-banks (broker dealers, non-bank mortgage lenders, SIV and conduits, hedge funds, money market funds, private equity firms) that, like banks, borrow short and liquid, are highly leveraged and lend and invest long and illiquid and are thus at risk of a run on their short-term liabilities; and now a roll-off of the short term liabilities of the corporate sectors that may lead to widespread bankruptcies of solvent but illiquid financial and non-financial firms.
On the real economic side all the advanced economies representing 55% of global GDP (US, Eurozone, UK, other smaller European countries, Canada, Japan, Australia, New Zealand, Japan) entered a recession even before the massive financial shocks that started in the late summer made the liquidity and credit crunch even more virulent and will thus cause an even more severe recession than the one that started in the spring. So we have a severe recession, a severe financial crisis and a severe banking crisis in advanced economies…
Countries with large current account deficit and/or large fiscal deficits and with large short term foreign currency liabilities and borrowings have been the most fragile. But even the better performing ones – like the BRICs club of Brazil, Russia, India and China – are now at risk of a hard landing. Trade and financial and currency and confidence channels are now leading to a massive slowdown of growth in emerging markets with many of them now at risk not only of a recession but also of a severe financial crisis. [RGE]
Offering a list of policy measures and calling for “radical and coordinated actions” he argues that
central banks that are usually supposed to be the “lenders of last resort” need to become the “lenders of first and only resort” as, under conditions of panic and total loss of confidence, no one in the private sector is lending to anyone else since counterparty risk is extreme. And fiscal authorities that usually are spenders and insurers of last resort need to temporarily become the spenders and insurers of first resort. The fiscal costs of these actions will be large but the economic and fiscal costs of inaction would be of a much larger and severe magnitude. [RGE]
Ajay Shah describes the reasons for the crisis, and the current panic…
Once a financial panic starts, only government intervention can solve it. Once trust is lost, only governments, with the power to print money and pay off debt through future taxes, can offer credible financial guarantees, and get the financial sector to work again.
An ideal big government effort at resolving these problems would involve three elements. It would involve stemming the bleeding of housing-related securities that are available at fire sale prices and are very illiquid. It would involve a government induced and policy supported mechanism for financial firms to raise fresh equity capital, going beyond the hundreds of billions of dollars that financial firms have raised by themselves. And, I think it would have to involve some mechanism through which the top 20 financial firms would get a detailed look at each others internals, so that they can start trusting each other and the money market can sputter to life.
The Paulson plan which has obtained support from lawmakers in the US is explicit about the first element: the US government will buy something like $700 billion of housing-related securities. This is a step in the right direction. But the other two problems remain : financial firms are low on equity capital and don’t trust each other. We continue to live without a money market. [Ajay Shah/FE]
…and what might solve it.
One of the most promising elements of a policy response has come from the UK on Tuesday. This involves three elements: liquidity injection to compensate for the collapse of the money market, guarantees for medium financing of banks, and equity injections into eight banks. Key design features of this package, and the magnitudes of resources involved, appear to have improvements compared with the American efforts. If this leads to a revival of the money market in London, this would mark a major step forward in resolving the crisis.
Related Links: Niranjan Rajadhyaksha on how the crisis might affect the Indian economy, and what the Indian government should do about the global crisis.
Wall Street woes
By V Anantha Nageswaran
In the last few months, financial markets had got used to the idea of the authorities conjuring up some solutions to problems in the US financial industry over the weekend and announcing it on Monday morning (Asian time) in time for the Asian stocks to open higher. This routine worked initially but when problems did not go away, the impact became rather muted.
Unfortunately for Lehman Brothers such a weekend solution did not arrive. Late on Sunday evening in the US it announced that it was going to declare bankruptcy. Wanting to avoid that fate, Merrill Lynch sold itself to Bank of America. Some called it tectonic shifts on Wall Street. Alan Greenspan, former chairman of the Federal Reserve said that America was facing once-in-a-century financial crisis. He should know better because he played no small role in creating it. Continue reading By Invitation: Buy lots of mattresses