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| Learning Curve |
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| A Re-look at Meltdown |
Ajit Ranade, Group Chief Economist of the Aditya Birla Group,
was invited to the ISB as a Guest Speaker during a CEE custom
designed programme. He addressed issues on the current financial
crisis, focusing on policy and sectoral issues, analysing and
forecasting domestic and global economic trends and policies.
We present here excerpts from his address at the ISB
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How we got there
As a prelude, I would like to discuss a little about how we got
here. In Hindu mythology, there was a character called Jabala.
Once he went to a learned man to receive knowledge. The learned
man asked him, “Where do you come from? Who is your father?” The
child did not know who his father was. He only knew about his
mother. So he answered, “It is not important where you come
from, it is important where you are going.”
In the same spirit, we will talk a little about how we got
here, about the financial meltdown, but essentially we will talk
about the future. Incidentally it is not easy to predict the
future, especially in these times, and in India sometimes you
need to predict the past. And economists are very good at analysing the past
The role of the financial sector is simply to connect the
savers to investors. The overall financial sector includes
banking systems, insurance, capital markets, stock and bond
markets etc. The fundamental purpose of the financial sector is
to ensure that household savings eventually find a productive
use. Economic growth depends on that capital, on that funding.
The role of the financial sector is simply to connect the two.
It is like matchmaking or brokering a marriage.
How important should the financial sector be? In India the
financial services industry is something like 7 percent of the
total GDP. But unfortunately, in recent times, it has become the
tail that wags the dog. Today it has gone up to 50 percent. In
recent years, almost half of all corporates accounted in the US
are in the finance sector.
Mother of All Crises
The sub-prime crisis happened because everybody assumed that
house prices would keep going up. Nobody looked at the
possibility that house prices could actually go down. There was
a big crisis in the US in the 1980s called the savings and loans
crisis, but it was mostly confined to Texas and Florida. Then
there was of course the Japan banking crisis in the 1990s, which
is still continuing, and then there was the Asian crisis of
1997. But this one is the mother of all crises, in terms of
magnitude and this is the first crisis that was manufactured and
made in a developed country. This is the first time it got made
in New York, it started there.
There is a huge recession going on in the developed world and if
you are in Singapore or in Taiwan or Korea you are exposed to is
effects. China is suffering because China has a huge exposure to
what is going on in the developed world - whether it is toys or
clothes, everything is made in China.
Outlook of Indian Banks
How does this financial crisis connect to the real economy? In
recent times we saw falling real estate prices, a stop in
construction work, job losses, lower credit availability,
because people are now liquidating assets. What happened is that
we had the sub prime crisis, and then we
had leveraging and liquidation of that, and the third aspect was
the credit squeeze. So this was the scheme of things. The
sequence is that banks are panicking, their loans are failing ,
they are recalling assets.In India banks have enough liquidity,
they have enough funds, but the banks are not willing to lend
money, not even working capital. I think in India the situation
is that there is enough liquidity in the banking system to meet
the needs of corporates, but the banks are not aware of the real
economic outlook. The problem is that we have enough funds to
loan in the system and yet these transactions are not happening.
In India, 83 percent of our spending is domestic spending (if
you take consumer spending plus government spending). Already
the budget this year was expansionary in the fiscal sense
because there was some income tax cut, an excise cut, farm
waiver loans, and then there was a Pay Commission. India’s
saving rate is still at 33- 35 percent, but banks are influenced
by what is going on around the world.
It is generally believed that the daily transactions in banks
have totally dried up because no bank is willing to believe
other banks. So, this is one of the major reasons for the lack
of liquidity in banks, and this has affected the Indian money
market also. In India there is a huge inter-bank market and that
market has simply withered away. I need to add here that
inter-bank is not based on collateral. It is my word against
your word. Here in India, I don’t see why this should be
applicable because here we have public sector banks and they can
lend to each other.
The Problem of Confidence and Greed
One of the solutions to the financial crisis has been
nationalisation of banks. The biggest bank in the UK, RBS, is
almost 56 per cent nationalised. In comparison, in India 75
percent of Indian banks are already nationalised. Secondly, the
capital adequacy ratio is at 13 percent, and NPA levels are at
less than 1 or 2 percent. So where is the problem? Unfortunately
it is a problem of confidence or of greed. Next, there is a
confusion between managing the risk and timing the market. Once
you are into risk management, you are not in the game of timing
the market. There is also a reluctance to report a clear picture
or position. Commodities risks are less readily appreciated. We
only discuss currency risk. Often we actually have an economic
risk. To give you an example - we produce half a million tones
of aluminium, it is actually going up to 1.5 million tonnes. And
guess what? 80 per cent of our sales is to Indians. But
unfortunately the aluminium rate is determined in global market.
India’s trade tariff barriers are minimal. We actually operate
on a dollar balance sheet. So, our customers are going to pay a
price which is determined by the dollar price of aluminium. We
actually have an exposure to dollar whether we like it or not.
That is called economic exposure and the RBI allows you to hedge
on economic exposure. I would strongly recommend that you have a
risk management frame work, a risk management committee and have
an approach to risk management which incorporates to these
issues.
Also, in India the rich are getting richer and the poor are also
getting richer. It is not that the rich are getting richer and
the poor are getting poorer, but it is just that the rich are
getting richer much more than the poor. This social inequality
is a problem in India to reckon with.
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