India and international financial services

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]

The Gold Standard – a new blog on The Indian National Interest

Perspectives on finance, economics and policy

V Anantha Nageswaran joins us on INI, with The Gold Standard, where he intends to “improve the information to noise ratio in the world of finance and economics while having some fun and learning in the process.” The blog will cover issues such as “if all currencies have some highly urgent reason to remain weak or be devalued, what happens? Who bears the brunt?”

Do make The Gold Standard a part of your regular reading. (And in case you haven’t done so already, subscribe to our combined RSS feed.)

By invitation: How can we be sure Dr Singh has answers?

V Anantha Nageswaran

TN Ninan’s weekend rumination on Manmohan Singh’s purported successes on the external front is disappointing for two reasons: it does not make any useful point and it is misleading. The ongoing global financial and economic crisis is neither about global financial regulation nor its architecture.

In all fairness—whether or not Dr Singh was and is a great economist is beside the point—his tenure this time around, even after the Communists left the alliance, has not exactly been inspiring. He might not have been able to carry the day with his proposals. But he could have, at least, articulated the change, the vision and the blueprint that India needs, thus helping whoever comes after him (or himself) when conditions turn more propitious. The only thing we know is that he missed the Communists in his coalition. Continue reading By invitation: How can we be sure Dr Singh has answers?

Safe under the carpet

Whose wealth was kept out of the financial system?

Al-Qaeda’s. (Sunday Levity. Yes, this joke is on the rest of us)

The Associated Press reports that

Al-Qaida, which gets its money from the drug trade in Afghanistan and sympathizers in the oil-rich Gulf states, is likely to escape the effects of the global financial crisis.

One reason is that al-Qaida and other Islamic terrorists have been forced to avoid using banks, relying instead on less-efficient ways to move their cash around the world, analysts said. [AP]

Because it was forced to keep its money under mattresses (okay, carpets) it might have escaped the dramatic losses due to the global financial crisis. Not entirely though. Unless they managed to cash out in time, terrorist financiers must have lost some money in the stock market, which they were alleged to be milking.

Intimations of a severe global depression

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]

Understanding the global financial crisis

Credit asphyxiation

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.
[Ajay Shah/FE]

Related Links: Niranjan Rajadhyaksha on how the crisis might affect the Indian economy, and what the Indian government should do about the global crisis.

Pakistan awaits a bailout

And on the kindness of friends

Pakistan’s effective foreign exchange resources are down to US$3 billion—sufficient to cover about a month’s worth of essential imports. And other than a tranche of US$500m from the Asian Development Bank, it has received few firm promises. After Standard & Poor’s cut the country’s sovereign long-term foreign-currency rating to CCC+, with a negative outlook, it has become “the world’s riskiest borrower according to credit-default swap prices from CMA Datavision.”

The Friends of Pakistan, perhaps too preoccupied with the global financial crisis, have postponed this month’s scheduled meeting. Pakistan is sending a team to the United States, seeking US$10 billion of emergency assistance—at a particularly inopportune time. Even the Saudis—Pakistan’s traditional bailors—have stalled announcing the US$6 billion oil credit facility. The Saudis are very likely trying to teach the PPP government a lesson (even as they remain thick with Nawaz Sharif). There are no reports of China providing direct financial assistance. It is a member of the Friends of Pakistan group, and might lend through that channel.

The Pakistani government is attempting measures like securitising future remittances, but given its credit rating and the mood of the global financial markets, the success and the efficacy of such moes is likely to be limited. That leaves approaching the International Monetary Fund. But an IMF loan will come with the condition of an “intensive economic reform programme”. In Pakistan’s current political climate, trying to implement the kind of programme that the IMF will demand is a recipe for disaster.

The Post-Paulson Plan world

A few notches down

Commenting on his piece in Mint, V Anantha Nageswaran says (in an email) that at the time he wrote it, he had expected the US Congress to approve Treasury Secretary Henry Paulson’s $700 billion bailout plan. In the event, the lower house voted it down, but he expects Mr Paulson to come back with a new version.

Four conditions must be met in any government rescue:

(a) Those who need to be bailed out, get bailed out and no one else.
(b) They must be bailed out of their losses but if they make gains, they go to the supplier of the bailout.
(c) Those who created the conditions that brought about the bailout should be punished and removed and their privileges—golden parachutes, bonuses and suchlike—stripped.
(d) Others who took the risk of investing in such an enterprise with such management share the pain and contribute to the bailout. Risk-taking means bearing losses too.

Unfortunately, the Paulson Plan failed the test.

In the end, the rejection of the vote is a positive. It rejected a flawed plan. It could now become slightly better. Unfortunately, because it was a flawed product to start with, it won’t get a lot better. That is why sometimes the slate needs to be wiped clean. [V Anantha Nageswaran]

In his Mint piece, he contemplates a new international exchange rate regime.

The problems that the US and the rest of the world face today with credit destruction and crisis were caused by the “Bretton Woods II” exchange rate regime. In that regime, many countries kept their exchange rates in a quasi-peg to the dollar and lent to US households, which borrowed heavily. That has to be played out all over again for the bailout plan to work. In other words, the US is expecting to repeat Bretton Woods II to solve the problems created by Bretton Woods II. That does not sound like much of a solution but more like the creation of a new, bigger problem. [Mint]

By Invitation: Buy lots of mattresses

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

A debtor’s capacity to project military power

…hinges on the support of its creditors

Lending money to governments to fight wars has a very long history, giving creditors a degree of influence over debtor monarchs or governments. But at least four factors make the situation in the early twenty-first century different. First, the global economy—and not least global financial markets—are connected in an intricate sense. Second, the creditors are not only sovereign but in several instances also from countries where the state-owned companies are entrenched economic players in their own right. Third, the individual and combined size of the sovereign wealth holdings is unprecedented. And finally, the geopolitical relationships between the principal debtors and creditors is competitive and adversarial, if not antagonistic.

In this light, the Council on Foreign Relations has published a special report by Brad Setser on the sovereign wealth and sovereign power. It argues “that the United States’ current reliance on other governments for financing represents an underappreciated strategic vulnerability.”

The willingness of foreign central banks—which remain a far more important source of financing for the United States than sovereign wealth funds (SWFs)—to build up dollar reserves has long provided a stable, but limited, source of external financing. But the United States increasingly relies on financing from central banks that already hold far more reserves than are needed to assure their own financial stability. It is true that foreign central banks have an interest in keeping the dollar strong. But the United States might have more to lose from a disruption of this relationship: financial flows create mutual interdependence, but the interdependence is asymmetric. The longer the United States relies on central banks and sovereign funds to support large external deficits, the greater the risk that the United States’ need for external credit will constrain its policy options. [CFR]

While much of the recent analysis on sovereign wealth has been from an economic standpoint, Dr Setser’s report provides directions for a realist appreciation of the issue. To the extent that they give rise to a balance of terror, it is possible to see excess foreign reserves holdings of central banks and large sovereign wealth funds as strategic weapons. How these ‘weapons’ work, how they might be employed and how they might be deterred or defeated are all questions that should concern geopolitical strategists.