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Friday, February 27, 2009

Institutional change as a tool for dealing with fiscal stress

Ila Patnaik has an article in Indian Express about the usefulness of a Debt Management Office in these difficult times.


  1. One of the topics of interest in India, even to school students in good institutions has been - how to solve the problem of poverty in India? Even today there are several schools of thought and professionals devoted to this objective.
    The immediate task of building India's economy is to set up a workable public infrastructure, and that requires a tremendous amount of financing. I differ with your assessment as to why Standard & Poor has downgraded India's Sovereign debt, while they have not done the same either for the UK, or the US Government, both of which are on much more of an unsustainable fiscal path than India is.
    The simple and straight explanation for it is corruption, nepotism, and favoritism - something that shouldn't be too strange for Indians to recognize, though.The US total public debt exceeds $ 10 trillion, and there is little doubt in investors' minds that the US Treasury is inexorably headed for a sovereign default. The only question that remains is how many years more that will take. Though the US and UK governments are plainly insolvent, Standard & Poor wants to keep millions of rural Indians in a financial state their nom de plume suggests - standard and poor.
    However I agree with your policy advocay of fiscal prudence for the incoming Government. China is exhibiting several signs of inching towards independence from a net positive external sector as their primary growth driver. People's Bank of China now has a $2.4 trillion forex reserve. Imports of natural resources, such a oil,minerals and commodities from Africa and South America can be financed on advantageous terms using this reserve. Also, there are reports that PBoC has moved to ensure settlement of trade with the Hongkong and Macao Special Administrative Regions, as well as with ASEAN countries in Renminbi. This will reduce China's dependence on a US-centric external sector to finance imports from these nations. With a very low risk of a balance of payments crisis, China is now in a much better situation to engage in massive fiscal stimulus spending in railway infrastrucuture, health care, and sops for people to move away from big cities and set up small businesses in rural areas.
    Despite the geopolitical challenges, (mainly, threatening the US Dollar global hegemony) China's model is infinitely more attractive and practicable to achieve genuine economic freedom for India.

  2. Credit Rating Agencies do not operate in a competitive environment. There is also lack of adequate regulation of these agencies. There has been ample evidence to show that these agencies have failed miserably to forewarn the ensuing crisis. International Credit Rating Agencies are also like the Bretton Woods twin, who continue to articulate their master's voice. They are not the innocent messengers, who forewarn the impending crisis; rather they create the crisis, by sending wrong signals to foreign investors. They execute the economic strategy of the first world of executing the financial systems of the emerging super-powers, who are still clocking decent growth rates keeping the price-line under check.

    In India too, the priority should be to create decent competition among credit rating agencies and put in place effective regulation of these agencies, before we try to market mandatory use of their services for say, capital mobilisation.

    Parveen Singhal

  3. Ajay, any inputs from you on a strategy to ensure India's solvency from an external financing crisis would be greatly appreciated. The INR/USD closed at a high of 51.65 or somthing like that recently. This shows that the current administration has relented from defending the Rupee by spending from the depleting forex reserves.
    The liberalization of ECB norms has led to higher external debt and higher imports, mainly of capital equipment. The fiscal stimulus also leads to some higher requirements for imports. As exports fall in double digit percentages, and imports grow, what should the strategy of the incoming government be to ensure India's insularity from another balance of payments crisis?
    There is little hope for major expansion of either the merchandise exports, or the IT/BPO exports. We'll be lucky if there's no major further contraction of exports. The external sector has been making a net negative contribution to GDP the last few years. And the trade deficit is growing.
    The bulk of our imports are crude, constituting something like a third of our import bill. This needs to be paid in US dollars. Where will we continue to get foreign exchange earnings from, to fund increasing imports of oil, fertilizers,capital equipment, etc; even as our exports collapse? And if the situation continues, who will bail us out with an external financing loan?
    We have antagonized China by making a ban on import of toys from China. We have not been too close to Iran, because of vacillation over the proposed Iran Pakistan India pipeline. Other than a bailout loan from China, or an agreement with Iran to receive favorable terms for crude imports; we have no choice but to depend on the United States for external financing.
    Private US lobbies will extract a pound of flesh from growing India's heart if we go them bowl in hand. What are the strengths, geopolitical, or economic, from which we can negotiate our external financing situation?
    The incumbent administration has been lauded in the US mainly because they have not built a large forex reserve, unlike China.Past surplus from our exports was utilized for fiscal spending in the following way. Our state owned oil companies paid the international crude price in dollars. Next, they sold oil at subsidized prices by dictat. The consumer price was maintained at higher than the international price by levying state and central taxes on oil sales to India consumers. The revenue from these taxes was utilized for fiscal spending.
    China, on the other hand has built up a 2+ trillion forex reserve, which is made up of something like $1350 billion at least in USD.
    Now, we're in a fix.

  4. I thought it somewhat funny that the article begins, by way of the Reliance vs. Infy example, as if to make the case that that a DMO would be beneficial to the borrower, i.e., GoI and then goes on to make a very strong case that it does the exact opposite, i.e., that it benefits the lenders by providing transparency, removing conflicts of interest etc. I don't mean to suggest that the DMO is a bad idea, but only that the example didn't seem too apposite.


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