Quick-fix for crisis? Sorry, won’t work

by Sudip Bandyopadhyay*

Financial crisis have, by and large, exhibited a repetitive pattern, demonstrating the inability, or unwillingness, of financial market participants to learn.

Charles Mackay, in his book Extraordinary Popular Delusions and the Madness of the Crowds, says that while episodes of panic and disasters have their own distinctive features, they exhibit a common feature – that they are all preceded by a period of apparent prosperity when it is possible to rapidly acquire fortunes ‘otherwise than by the road of plodding”. In their study of 18 financial crises in the US, economists Carmen Reinhart and Kenneth Rogoff of Harvard Business School found that there were ‘stunning qualitative and quantitative parallels across a number of standard financial crisis indicators’. Ahead of each big financial shock, house prices rose rapidly, as did equity prices; current account deficits ballooned; and capital inflows accelerated.

Financial crises, either global or domestic, transform ‘something close to universal trust into something akin to universal suspicion’ as Galbraith remarked in his book The Great Depression. Under these conditions, it becomes difficult for regulators and legislators to make the wisest decisions or take the best measures. Regulations originating in a crisis tend to be extreme and such measures often lead to expensive regulation. The Sarbanes Oxley Act is one such example. The question is: if the financial crisis could not be detected despite the expensive disclosures and risk management requirements of this act and NYSE rules, are such rules serving the purpose? The recent banning of short sales in the US, Europe and Australia is another example. Banning of short sales is an extreme measure which has not worked in any market. It does little to arrest the decline in prices; on the contrary, when the ban is removed, a flood of pent up sales push the market down further. This was tried in India too on a couple of occasions, and with little effect. We ought to refrain from taking any quick-fix regulatory measure – either as a precautionary or prophylactic step or for lifting the market sentiment. Market sentiments cannot be talked up or down and when fear grips the market it would be futile to try and impact the prices by comforting statements for example, the famous Greenspan speak of ‘irrational exuberance’ had affected markets only for half a day. Markets are known to respond to the casual market-reviving measures only casually, as they did to the recent SEBI Participatory Note-related policy changes. What works are measures that ensure that liquidity never dries up. That is the responsibility of the central banker.
*CEO & Director, Reliance Money

India will emerger stronger: PM

 

TOKYO: Prime Minister Dr. Manmohan Singh today said that India would emerge stronger from the current “great turbulence in the world economy”.

 

“The short-term outlook is somewhat cloudy but I am confident that the Indian economy has the resilience to sustain its growth momentum in the medium run. We hope to build on India’s many inherent strengths as an emerging market economy that is now ready for rapid and sustained growth,” he said addressing the Business Luncheon hosted by Nippon Keidanren in Tokyo today.

 

“Over the past four years, we have averaged 9% GDP growth per year.  It looks like  slowing down in the current year because of conditions in the global economy. But, once normalcy returns, we can and we are determined to regain the 9% growth trajectory.  We have a tradition of a high rate of domestic savings averaging 35% of our GDP. This is like most Asian countries, and we also have a strong and a dynamic private sector,” he said. 

 

Speaking on “India-Japan Economic Relations  in the 21st Century”, the Prime Minister said: “We meet at a time of great turbulence in the world economy. The international financial crisis, which still continues, has revealed the extra-ordinary vulnerability of the global financial system even in the industrialized world. The crisis has choked credit flows and predictably spilled over to the stock market. We have to prevent the liquidity crisis from becoming a crisis of confidence in the international monetary and financial system.” 

 

He pointed out that the Governments and central banks of the major economies have taken strong and even innovative steps to deal with the crisis. The global nature of the crisis calls for a coordinated global response. Developing countries like India are also affected by the crisis and have to be part of the solution. “We cannot afford to risk the gains we have made in the last few years. Nor do we wish to remain vulnerable to infirmities in international surveillance, supervision and regulatory mechanisms in the future,” he said.  

 

The government has taken several measures in India in the last few weeks to ensure adequate liquidity and confidence in our financial system. The fundamentals of Indian economy have been and continue to be strong.  The country’s banking system is well capitalized. “But, we have experienced a shrinking of liquidity and we are responding by injecting additional liquidity to ensure that the rhythm of economic activity is not disrupted. The Reserve Bank of India stands ready to respond quickly to address the emerging needs of our economy,” Dr Singh said.