Financial sector reforms
C. T. KURIEN
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“Premature capital account liberalisation is counterproductive”
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MONEY, FINANCE, POLITICAL ECONOMY— Getting it Right: Deena Khatkhate; Academic Foundation, 4772-73/23 Bharat Ram Road (23 Ansari Road), Daryaganj, New Delhi-110002. Rs. 995.
This volume is a collection of selected professional writings of one of India’s distinguished economists. The author was a senior official of the Reserve Bank of India and then of the International Monetary Fund. His writings have appeared in several professional journals of international repute as also in publications that cater to a larger readership such as the well-known and widely read Economic and Political Weekly (EPW).
Money and finance
The volume consists of 27 pieces written over the period 1964-2006, the majority of them during the 1990s and the present decade. As the title suggests they deal with a wide range of issues, and they have been divided into five sections — Money, Finance, National Economy, Governance, and International Economy. Practically all the pieces, other than those in the last section, deal with the Indian situation and initially appeared in the EPW.
Mr. Khatkhate’s professional work has been largely in the broad areas of money and finance and, naturally, financial sector reforms constitute the major theme of the writings. They convey the author’s scholarship, his incisive analysis and his firm convictions, sometimes going against conventional wisdom. A topic dealt with in a couple of papers is the process of financial liberalisation with examples taken from South Korea, Malaysia, Indonesia, the Philippines and Sri Lanka in Asia, and Chile, Argentina and Uruguay in Latin America.
A point that is brought out and that needs to be emphasised is that financial reforms in these countries did not follow a uniform pattern. Also the beneficial impacts of financial liberalisation have come for different reasons. If there is a single issue to be focussed on, it is competition. “It is the presence of competition, be it in regard to lending or borrowing, which should constitute the main core of financial liberalisation policies,” says the author. And with reference to South Korea, it is pointed out that this does not necessarily mean the withdrawal of government. On the contrary, government intervention was purposively used to achieve market-orientation. Of equal importance “is the need to set up well-planned financial infrastructure with provision for information flow, legal and accounting systems and an appropriate regulatory system to monitor it carefully and continuously.”
Capital convertibility
What the author has to say on capital convertibility is also worth noting. “A hasty capital account liberalisation ahead of complete liberalisation of interest rates, elimination of direct credit, high liquidity ratios, and credit ceilings tend to increase the spread between deposit and lending rates… Premature capital account liberalisation or placing it ahead of other domestic financial reforms is counterproductive and slows the pace of financial sector reforms and other structural forms of the real economy.”
Another set of papers address issues connected with international economy. They include an analysis of the East Asian financial crisis of 1997-98 and a discussion of how the IMF is to be restructured. The context of the latter is the situation arising from the giving up of the fixed exchange regime that prevailed from the end of the Second World War till 1971 when the U.S. formally withdrew from the obligation to convert the dollar into gold.
Relevant
All these pieces must have appeared as words of wisdom in their particular contexts and may have some relevance even today. It is no fault of the author that those contexts have changed, and changed drastically. But it appears a little strange that a perceptive observer like Khatkhate did not have even an inkling of the catastrophe that has overcome the world of finance fairly soon after he penned the ‘Prelude’ to this volume, possibly in mid-2008. Perhaps it is not altogether surprising.
The financial intermediation that Khatkhate deals with refers only to “the process by which savings of the scattered economic units in an economy are garnered by institutions, often by banks in the initial stages of economic development, to make them available to other investing units in the economy.” That, surely, is the basic role of financial intermediation and the institutions that perform it. What Khatkhate ignores is the fact that financial intermediation does not stay confined to that role. Financial intermediation has the built-in propensity to generate more intermediation, each step taking it further and further away from its initial task and from the real economy. This process of continuing intermediation leads to new “products,” combination of products, new “assets,” and of course, new institutions — together constituting what a contemporary author aptly refers to as “Planet Finance,” and Planet Finance is distinctly different from Planet Earth. Khatkhate’s writings are about financial intermediation on Planet Earth. With the appearance of Planet Finance, they appear rather unreal, even when they are sound.
The essays dealing directly with the Indian experience in economic and social development are largely polemics justifying and defending the reform process started in 1991. One of them also deals with “the decline and fall of the Indian intellectuals in post-independent India.”
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