Sunday, February 27, 2011

2008 crisis has changed the debate about financial flows in global markets

There is much naive talk among media's economic pundits about ushering in big package economic reforms, especially in the Budget for 2011-2012 that finance minister Pranab Mukherjee unveils on February 28. First, the budget could reflect the reformist thinking of the government but it is not strictly speaking for implementing reforms. The budget is all about management of government revenue and expenditure, of which taxation is a key instrument.

In a market economy, the government's budget exercise would not be a central factor. The fact that captains of industry and business and economists debate with such passion – a good thing for the media, of course – the budget measures should raise the basic question whether India is as yet fully liberalised.

The other thing about the pundits is that they are talking of bringing in new liberalisation measures and they seem to be blithely unaware that in the wake of the 2008 global financial meltdown, market economy is still in the dock. Many of the experts in the western world are rethinking their assumptions about it. Anti-globalisation icon and Nobel laureate Joseph Stiglitz is not the only Cassandra crying out in the wilderness. India's market enthusiasts choose to ignore the crisis facing market economy.

Most experts are arguing the need to let in foreign direct investment (FDI) in retail and in insurance, the two issues that are very much on the government agenda and for which there is resistance from not just ante-diluvian socialists but from domestic businesses as well. It is really a clash of interests, and the government will have to weigh its policy options with much care.

More importantly, there is a debate on about financial flows in the global market which has gone unnoticed. That is why, the experts seem to have missed what US Federal Reserve chairman Ben Bernanke said in Paris while the G20 meeting was on in early February in the French capital. He argued, and he had done it earlier too, that there is a 'savings glut' in the emerging markets – he is thinking of China – and that funds should be flowing into developed economies from Asia and not the other way round. Bernanke was also hinting at creating mechanisms for regulating fund flow. Mukherjee at the G20 meet responded by saying that fund flows should be left to market forces and there cannot be any regulation of which way funds should go.

Immediately after opening up the economy in the 1990s, India had to woo foreign funds and it continued even into the early part of this decade. On his first visit to the US in 2004 after taking over as prime minister, Manmohan Singh had explained that India needs about US$150 billion for its infrastructure development over a period of time.

The 2008 crisis has changed the terms of debate. The western economies reeling under recession had to lower interest rates in the first place to stimulate spending. But funds last year moved to Asian markets because the interest rates as well as investment opportunities were better in this part of the world. As a matter of fact, there was much apprehension last year about this brisk flow of foreign funds, that it would end up heating the economy and by implication fuel inflation. The Reserve Bank of India had assured that the country can absorb foreign funds and it would have no deleterious effect on the domestic market.

There is no doubt that India needs FDI and quite a bit of it as well. It is not yet in a position to finance its own growth demand. India's savings rate is hovering at 34 per cent of the GDP, and the investment rate is at 37 per cent. But FDI is not there for the asking. It is not sufficient for governments to lower and even remove limits to be able to attract all the invetsment that is needed. There is the lingering danger that foreign funds in India could take perverse turn as they did in the US housing mortgage sector. There is need for clear rules to manage FDI in the country.

It is time to end the starry-eyed talk about an open economy. The developed markets are looking for ways to deal with a delinquent market. India cannot ignore the problem and it has to find ways to cope with it.

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