HVK Archives: The triumph of pragmatic liberalism
The triumph of pragmatic liberalism - The Observer
Virendra Parekh
()
September 19, 1998
Title: The triumph of pragmatic liberalism
Author: Virendra Parekh
Publication: The Observer
Date: September 19, 1998
It is unusual for us Indians to be regarded as role models in, of
all things, economic policies. And yet, that is precisely what
the crisis in southeast Asian countries might do.
Things have turned a full circle. As countries like Japan, South
Korea, Indonesia, Thailand, Malaysia and Taiwan find themselves
mired in an economic mess, India and China, long regarded as
laggards, have come to be viewed in some circles as role models
of successful reforms.
Relatively closed economies and restrictions on capital account
convertibility no longer seem very bad ideas. There is no doubt
that compared with most southeast Asian countries, we have done
better. Indonesia's economy is expected to contract by more than
15 per cent this year, Thailand's by seven per cent, South
Korea's by about five per cent.
Malaysia and Hong Kong have both reported negative growth (that
is economic contraction) in the first half of the year. In
contrast, Indian economy is likely to grow by at least five per
cent this year by cautious estimates and by 6.5 per cent if we
believe the Reserve Bank of India's annual report. It is in a
much better shape than her neighbours.
Inflation, though on the rise recently, has been well-managed.
The rupee has depreciated, but in an orderly manner. Foreign
institutional investors have been sellers on bourses, but more in
view of their losses in southeast Asian countries than any
inherent weakness in Indian conditions. The 'opportunity' has
been seized by ideologues and interested lobbies to mount a
renewed pressure to go slow on economic reforms. The limited
opening up of the economy begun in early 90's has already begun
to produce some winners and losers.
Many new names like Infosys, Wipro, Nirma, Zee TV, Jet Airways,
unknown ten years ago, are now on the top. On the other hand, big
names and industries of the past have declined in importance.
This falling stars of yesteryears lobbying hard for protection
under evocative slogan of Swadeshi. They want greater protection
>from foreign competition, though they call it level playing
field. They want interest rates to be pushed down, without
caring about inflation.
They have requested banks to relax norms for non-performing
assets. They want foreign capital to go only in infrastructure
and not in their own industries.
Their efforts seem to have succeeded in some measure. Import
duties have been raised. Foreign institutional investment is
sought to be controlled. Witness the nonchalant manner in which
the government reacted to the withdrawal by the Tatas of their
proposal to set up a new airline.
The Reserve Bank, which was until recently avowedly moving
towards greater reliance on market instruments and more open
forex market has now warned banks not to arbitrage between the
money market and forex market. A move is afoot to ask banks to
direct more credit to small industries.
The issue is not so much the wisdom of individual measures, as
their collective tilt away from an open market-based economy,
with which we are so familiar.
There is a temptation, in this climate, to regard India's
relative success in avoiding pitfalls of its southeast Asian
neighbours as an endorsement of the slow and tardy course of
economic reforms.
Proponents of slow reforms and greater control may cite better
shape of Indian economy, introduction of exchange controls in
several countries and a plea for exchange controls by leading
economists.
It would be dangerous to succumb to their line of thinking. The
relatively better condition of Indian economy at present is no
reason for complacency. It is no consolation for a poor man to
know that even the rich people have financial problems.
The fact remains that despite their difficulties, southeast Asian
countries which were as poor as India in the 60's are today far
richer than India. We should find out how they managed to surge
ahead, while avoiding the mistakes they made.
Capital account convertibility is a tricky issue and cannot be
discussed here even summarily. Still, a couple of points can be
made to put in perspective its role in the Asian crisis. It must
be grasped clearly that most of the problems of southeast Asian
countries car! be traced to lack of rather than excess of capital
account liberalisation.
None of the countries in east Asia had a freely floating market-
determined exchange rate. Their central banks often intervened in
the market to restrict movement of capital and hold exchange rate
in an implicit or explicit band.
In this regime of managed fixed exchange rate, banks often
deliberately neglected hedging on expectations that the local
currency may appreciate, or exchange rate might depreciate faster
than interest rate differential or that smart money would exit
early. So the banks borrowed short abroad, lent long at home and
money went progressively into assets like real estate and stock
market.
When these markets collapsed and when short term lenders pressed
for repayments, they found that they had gone bust.
This is not to deny the havoc speculators played with their
currencies at a later stage. But the point is that if the
exchange rates had been free, large capital inflows would have
led to an appreciation of currencies and corrected excesses in
time. That was not allowed to happen.
It is response to this situation that countries like Malaysia
took measures contrary to their past policies. Malaysia imposed
exchange and stock market controls.
Taiwan banned hedge funds, restricted operations of foreign banks
in local currencies and stipulated strong monitoring requirements
for capital transactions abroad. Hong Kong authorities
intervened in the stock market to hit at the bear operators.
Against this backdrop, one is surprised to see leading economists
>from prestigeous institutions (Paul Krugman from Massachusetts
Institute of Technology, Jeffrey Sachs from Harvard and Josheph
Stiglitz from World Bank) expounding desirability and efficacy of
foreign exchange controls.
In a recent article in Fortune magazine, Krugman has advocated
controls that are intelligent, well-meaning, consistent with
macroeconomic objectives and are temporary.
With due respect for his seniority, we must point out that the
plea is naive. The learned economist is preaching what we in
India have practised for decades - with disastrous consequences.
If he really thinks that controllers would stop at a level he
considered optimal, he has no clue as to how (and why) controls
are designed and implemented.
In the 60's, free-marketers like Milton Firedman, and Hayek were
ridiculed by those who saw all the virtues in a planned economy
based on quantity signals, as contrasted with a market economy
based on price signals. It is history repeating itself as a
farce.
Politicians and bureaucrats always distrust market because it is
the only institution which can call their bluff. True to style,
we Indians have reduced market to a slogan, as we did to
socialism earlier. Unfortunately, market is a fastidious godess.
There is a vast ground to cover and no time to waste. The main
challenge is to replace a regime that runs on bureaucratic
discretion with one that is based on transparent and liberal
rules.
Policies on foreign competition, public sector autonomy,
privatisation, introduction of independent regulatory
authorities, gradual reduction of import duties to international
levels, tight norms for financial sector reforms and
rationalisation of excise duties and sales tax are just some of
the areas that need urgent attention. It will be a tragedy if we
allow reforms to be halted or derailed by drawing wrong lessons
>from failures of our neighbours.
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