No one like us

Indian Express, 31 August 2009

In recent months many people have been heard saying that the India escaped unscathed in the crisis, and that the world should learn from India how to do financial sector regulation. In fact, each time the global financial system experiences problems, there is a resurgence of calls in India to block financial sector development and capital account liberalisation. Policy makers take pride in India's license-permit raj, through which, it is argued, India was undisturbed through the crisis. This "let us block development" chorus sprang up after the Asian crisis in 1997, and has sprung up again after the global financial crisis in 2008.

First, is their view of what happened in the crisis, correct? Let us start with the claim that India got off lightly in the global crisis. While India did not have a financial crisis of the dimensions that the US did, the real economy did not go unscathed. IIP growth crashed from a pre-crisis peak of 15% annualised to a bottom of -5% annualised. India was hit hard by the global downturn. India's business cycle downturn is not out of line with what has been seen in the rest of Asia. The extent to which Indian growth dropped, compared with the high Indian trend growth is comparable with the extent to which growth dropped in other countries, compared with their lower trend growth. India did as badly, or as well as most of the other countries. India got off lightly compared to the US, which was at the epicentre of the crisis. But then so did many other countries.

Let us turn to who else 'escaped' the global financial crisis. Was it only other countries who had blocked financial sector development? A look around the world shows that most countries did not have a financial crisis. Even countries close to the US, like Canada or Mexico, which should have been badly affected, came out fine. All over Latin America, the macroeconomic and micro-prudential frameworks that were built in the 1990s fared fairly well. All over East Asia, financial systems that are more sophisticated than India's, and more connected to the world, fared well. There is no evidence to support the claim that an Indian style license-permit raj, coupled with Indian-style capital controls, was the essence of avoiding a financial crisis in 2008.

It is also interesting to look around at the world from the point of view of what happened after the Asian crisis. If we were correct in blocking financial progress and capital account integration, then did the countries hard hit by the Asian crisis turn their backs on financial progress and capital account integration? The evidence shows one country -- Malaysia -- which introduced substantial capital controls. Apart from that, Asia did not turn its back on financial progress and capital account integration. Even South Korea, where there was widespread resentment against the terms of the IMF package, did not turn its back on financial progress and capital account integration. Today, South Korea is an open capital account -- more open than it was prior to the Asian crisis.

The next question we need to ask ourselves, in today's context, before patting ourselves on our backs, is how are other countries responding to the crisis? If a systematic effort by government agencies at preventing progress in finance (backed by a detailed system of capital controls) is a good thing, are we seeing any other countries (rich or poor) moving in this direction? Once again, the answer is no. Paulson and Geithner have released proposals for reform of financial sector policy in the US. None of the things that they are envisaging are comparable with the intrusive system of central planning manned by RBI. The idea of the US importing ideas from RBI is a bit like the idea of Lalu Prasad Yadav making Japan more like Bihar. There are no financial reforms on the anvil elsewhere in the developing world which will give them Indian-style financial and monetary policy making.

Some individuals from the Indian establishment have spoken in various international meetings, praising India's achievements, and suggesting that the world now turn towards India's path. In response, there is quite a bit of amusement in the room, and there are no takers. A licence system, where RBI specifies every tiny detail about financial products and market processes, is not how finance functions anywhere else in the world. It is nobody's model of how finance should function. A license-permit raj, where the activities that make up 90% of the ordinary life of global financial firms are banned in India, is nobody's model of how finance should function.

It is important to recognise that India is a very poor country. We know very little about how to establish institutions or regulate markets that can support a sophisticated economy where a billion people can enjoy high productivity. Nobody in the world wants Indian-style monetary or financial policymaking. Our path ahead lies in learning how fiscal, financial and monetary institutions work in countries where per capita GDP is many times bigger than what we have in India. Our hope for making progress lies in learning these things with an open mind, and demanding a pace of change in India so that we can become more like an OECD country. A villager with no roads may foolishly boast of having no accidents, but he cannot teach people how to regulate traffic on busy intersections. It is important for policy makers to remember that India has no lessons to offer to regulators operating in the sophisticated world of finance, and proposals suggesting that they should learn our style of regulation only makes us look foolish.

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