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Government Greed and Damaging Financial Inflows by S L Rao
The UPA government has taken foreign exchange inflows and reserves as the principal
indicator of GDP growth. It has therefore not only continued with the special treatment of
investments coming from Mauritius that started when Manmohan Singh was Finance
Minister. It created the device of participatory notes. This has enabled anonymous
inflows, round tripping (i.e., Indians sending money out and returning through Mauritius)
of inflows, and inflows coming in for IPO’s using borrowed funds overseas compensated
for by backdoor means from India.
Excessive freedom by the US regulators to American financial institutions resulted in
the inevitable collapse of companies like Bear Stearns. They had overextended
themselves, along with other banks, merchant bankers, hedge funds, private equity
investors and a score of other respectably labeled organizations. They speculated on
currencies, interest rates, securities, weak loans, mortgages, foreign exchange derivatives
and other such instruments. They packaged strong instruments with weak ones. The
purchasing institutions did not know what they were buying. The Regulators also had no
clue since these transactions were not covered by their rules. The crises started with the
“sub-primes”, packages that were not worth the advances given against them. The loss of
confidence made all such packages and the institutions themselves suspect.
These transactions resulted in financial instruments becoming the purpose and not the
lubricant for economic activity. Financial transactions are now many times the actual
trade in goods and services. Managers of these institutions are not accountable to anyone.
But when they collapse like Bear Stearns, governments as in the USA and UK, rescue
them with public money to prevent unraveling the whole economy,
The greed of nations and their shortsighted economic managers as in India helps these
modern pirates. India opened up financial markets long before the manufacturing base
was strong, industries competitive and regulatory frameworks sufficiently educated,
strong and quick to act. Few foreign investors were interested in building production
capacities in India. India opted for financial investors into stock markets instead. They
were helped to enter and exit at will. Taxes on their short term gains from speculation
were waived.
China had a flood of foreign direct investment first, along with buoyant exports and
fund inflows from overseas Chinese. Only in recent years has China opened its financial
markets to foreign investment.
India also allowed anonymous foreign ‘investors’ to invest in Indian stock markets.
“Participatory Notes” enabled them to conceal their identities so that even Indian money
could round trip to India, or come in with borrowings abroad that were used (against
Indian laws) to buy stock in Indian markets.
Indian stock markets have witnessed an unprecedented degree of volatility, with prices
moving up and down every day by extremely high numbers. Instead of taking corrective
auction we said that Indian markets were now betting on the future performance.
Government joined this chorus.
The SENSEX at 21000 had no relationship even to foreseeable future performance of
companies. It went into free fall when the American economy soured and the Greenspan
bad-aids of reducing interest rates could not prevent American recession. Fiscal
mismanagement by the Bush administration was compounded by financial managers
packaging synthetic financial instruments whose real values were not known to anyone.
Overstretched credit card loans, housing mortgages, derivatives, and many other high risk
instruments created a bubble. We are also in it. When it was pricked, overextended
institutions liquidated investments at fractions of face values. Indian financial institutions
have also created such a bubble which might be pricked any day.
The American economy must learn to live within its means. The foreign exchange
surplus economies like China, OPEC countries, Russia and even India, must not place
most of their exchange surpluses in the USA as they have done, financing its profligacy.
Fortunately, other currencies and economies provide options. We need an independent
global body to regulate global financial flows.
India must reduce its greed for foreign money. We must reduce the Mauritius route to
a trickle and regulate it tightly. SEBI must now ban anonymous participatory notes.
Speculative ventures in derivatives will diminish now that the Institute of Chartered
Accountants requires companies to immediately account for derivatives losses, and
possibly exclude such losses from set-off for income tax. RBI must closely scrutinize the
stability of the banks and institutions that have grown by offering loans to all and sundry,
with little security, enabling an explosion of credit cards issued, housing loans and
borrowing for consumer durables. We must encourage foreign direct investments that can
build productive capacities. All this demands a far stronger and sophisticated regulation
of financial markets, banks and other such institutions.
The India ‘growth’ story like the earlier India ‘shining’ story was a three year wonder.
India’s macro economic fundamentals cannot support a consistent annual GDP growth of
10%. The real economy has to strengthen, particularly agriculture and manufacturing.
With commodity prices rising due to the weak dollar, and high rates of inflation, the new
‘Hindu’ rate of growth will be less than the hoped for 10%. Rising inflationary pressures
will force liquidity constraints through higher cash reserve ratios and further affect
growth. (841)