Now there are twenty

Indian Express, 4 April 2009

The April 2, 2009 G20 Summit has got a positive reaction from markets and economists around the world. The main outcome of the Summit is a Communique which expresses the intentions of the leaders present. These included additional support to the IMF, blocking protectionism, regulation of credit rating agencies, expansionary monetary policy and international cooperation in improving international financial regulation. The communique goes after problems which were unrelated to the global crisis -- tax havens and hedge funds -- but this seems to have been caused by some negotiations between the Americans and the Europeans. Among the items that were important in today's crisis but missing from the Communique were fiscal expansion, questions about whether the dollar should remain a reserve currency and a coordinated attempt at cleaning up bank balance sheets. Like any such Communique, this one is also only the beginning of a long process of negotiations. However, if the leaders present are genuine about their intentions, then even though the outcome may be able to help the world out of the current crisis only to a limited extent, it will help in making the world a safer place in the future.

The increased resources for the IMF, Multilateral Development Banks and for trade credit to the tune of a trillion dollars is one decision that will help both in the short and long run. Though it not clear who will be putting the additional money into these institutions, when the money becomes available to nations in trouble, it will surely be of immense help. It will also help in the long run as it may prevent more countries from building up large dollar reserves, which was one of the main causes of the present financial crisis.

Further, the Summit was successful in the sense that the Comminque contains nothing that will harm markets or finance. Even though there were many things the nations present could clearly not agree upon and as a result these have been kept out of the statement, even if they could implement those that have agreed on, that will be big progress. It is also to be seen what the G20 countries present in London do when they go back home. One of the first questions that will come up and test their resolve will be protectionism. Countries have agreed that they will not be protectionist especially in the flow of capital towards developing countries. When unemployment rises, keeping such promises will be increasingly difficult. If the US and countries of Europe like France and Germany are able to resist the pressure to be protectionist, it will help ensure that the Great Recession does not turn into a Great Depression.

A regulatory structure with greater international coordination is a desirable goal but this is going to be the hardest to achieve. As of now, there is little consensus on what the steps to avoiding another such crisis are. So for example, while some in India believe that banning sophisticaed financial instruments like derivatives is the best way to protect the financial system, countries like the US and UK prefer better regulation to banning. The liberal view has won out at the G-20 meeting. The G20 appear to be committed to modern financial systems. The Communique has said that hedge funds which have implications for systemic risk would be required to register and disclose information to regulators. The mood does not appear to be to ban hedge funds. Nor are there suggestions that private banks are dangerous and banks have to remain in the public sector forever to remain safe. The tone is one where there is an understanding that failures in regulation, in compensation packages, in the conflicts of interest and lack of regulation of credit rating agencies and in international coordination among regulators were at the bottom of the problem and these will need to be strengthened to prevent such problems. There is no mood to throw the baby out with the bathwater.

It is clearly in India's interest that the declarations made at the Summit are successful. It will reduce the damage India has to experience when things in other parts of the world go wrong. The question is what is the role that India can play to strengthen the decisions taken at the Summit. While on issues such as protectionism, expansionary monetary policy, treaties with tax havens etc. India can do the things that have been decided by the G20 and can lead the world by example, India has to follow an entirely different path on its approach towards financial markets and regulation. On some fronts, such as focusing the derivatives business (including credit default swaps) on exchanges with central clearing counterparties, subject to effective regulation and supervision, India is in the position to obtain a leadership role, on most other fronts this is not the case.

In fact, India is many years behind in the way modern finance is regulated. India's approach continues to be to ban products that the senior staff of our regulators do not understand. The approach in the UK is to ask how to improve the quality of the staff, the procedures the regulator follows, the powers of the enforcement division and so on, so that government does not become a bottleneck to the progress of markets. Not only does India not try to address the more difficult question about how to improve regulation, rather then destroy the market for the product which was to be regulated, there is often visible support for such a system of control from some elements in academia and left-wing political parties. The two approaches -- that of India and of the G20 are so divergent that it is difficult to reconcile the two. Thanks to this, today India has little to contribute to the G-20, either by example, or by intellectual inputs. We have to go a long way -- first unbanning finance, then learning how to regulate it, before we encounter problems like the developed world did and are able to meaningfully participate in these discussions. asm

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