28 March, 2006
Capital Account Convertability
Technically, this is not my first blog. I've written blogs many a times before. However this is my first post on footnotes2marx. However, I must confess that it's been a year and a half before I have writen any political commentary ..so my articulation might have become a little rusty. However, I'm confident that my analysis has become more mature (just as vintage wine), so that gives me the confidence to hit the keyboard once again!!
In , India PM Singh has announced his desire to introduce full capital account convertibility. The whole world knows Manmohan Singh as an erudite person and an economist par excellence. Then why is the same person doing the same mistakes that created the Asian financial crises not too long ago--whether countries like Thailand and Malyasia almost went to the dogs? What has he learnt from their crises and also that of Argentina , Russia and many other places in the world?
Ok , demystifying the economic jargon--what exactly is capital account convertibility? Put simply, you can transform the rupees you hold into dollars or euro (or any other currency) at your free sweet will. Is there anything wrong, you might ask? Not when you are converting your hard earned Rs. 20K into dollars--but something goes wrong when the "hot money" flows in like the tsunami waters.
"Hot money" refers to the large amount of foreign capital (say billions of dollars) which flow into the country as "portfolio investment" (read money pumped into the stock market). This is an age old trick of the large western investors. Pump in huge amount of money--and artificially jack up the markets. The sensex goes up , up and away. And then suddenly (with some concerted mainpulation amongst the large investors), these investors pull out (sell everything) and move out--just in flash.
Well, our large FII friends made a lot of profits. But the stock markets always are a zero-sum game. You don't make profit unless somebody bears the loss. So when these large FIIs sell out--the ordinary retail investor--our "desi bhaiya" (with a little greed) bears losses. Millions of small investors lose money, and as a ripple effect the entire economy comes down with a thud.
Does PM Singh not know that? Oh yes , he does. Then why does he do all that. Elementary, dear Watson--he represents his class interests, that of the big bourgeoisie who funds him into that chair. He may be the leader of Indian masses, but his loyalty is tied to the classes.
So long for today.
And before I forget, do send your brickbats and bouquets (read comments).
Regards,
Charvaka Acharya
Read more:
Against my views:
http://www.thehindubusinessline.com/2004/03/30/stories/2004033000180800.htm
For my views:
http://www.thehindubusinessline.com/2004/03/27/stories/2004032700030800.htm
Comments:
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Hi Charvaka, U surely don’t write rusty. It is crisp writing. Loved it.
But what is leftist about it? The conclusion that the Indian decision to go for full capital account convertibility is an evidence of the prime Minister’s class interest? An attempt to placate the wealthy bourgeoisie?
I think u missed a point. For India, full capital account convertibility is “within a transparent framework”.[ http://us.rediff.com/money/2006/mar/18asoc.htm]The Prime Minister also expressed his awareness of the skewed priorities of the WTO, the agricultural subsidies in Europe. But then that the world outside is corrupt does not justify your remaining hidden [and protected]– like an ostrich digging its head in the sand [or isn’t that the burqa logic – hide from the big bad world?]
Well, your analysis of what capital account convertibility is or how “hot money” wrecks an economy is just right. But not your comments on Dr. Singh’s understanding of Asian financial crisis.
Let me try to explain.
I grant that the IMF led West had a hand in a s much as it forced these countries to have full account convertibility prematurely. What happened was this.Full Account Convertibility can result in two things – huge inflow of capital and also huge outflow of capital. When the exchange rate is favourable the chamces of inflow exchanges and when it is not here is a danger of outflow.
The East Asian “miracle” turned into a mirage not overnight after being role model to developing countries for over two decades. Among the most important factors contributing to the crisis were –
• Thai policy of fixed exchange rate defined in terms of single currency, the US dollar, in spite of massive current account deficit[currency pegged to dollar giving an impression that there can never be depreciation of Us $ and hence of their currency too]
• High asset prices
• Heavy exposure to international financial markets
• Weak Banking systems
Now what I think contributed to these were –
• What u called “hot money” and a sensex shooting up high resulted in increase of price of assets.
• Explicit or implicit guarantees of the liabilities of financial intermediaries without the creation of a system of financial regulation and supervision .
Banking deregulation [LED TO] domestic banks borrowing short term from foreign banks and lending to financial institutions long term.[LED TO] reckless lending by banks[LED TO]boom in investment in unproductive areas like construction , real estate, golf courses, shopping plazas[LED TO]lopsided development .
Since early 1997 some Korean and Thai companies collapsed due to huge debt.[LED TO]fall in propert market[LED TO]reluctance of foreign banks to give short term debts any more[LED TO] collapse of exchange rate due to massive outflow[LED TO]further withdrawal[LED TO]banking system no more has foreign short term loans plus it became burdened with non – performing loans [LED TO]banks insolvency
If the creditors of financial intermediaries believe they have no need to check the solvency of those to whom they are entrusting their assets, while the owners of the financial institutions believe that their losses will be socialized while they will reap the full benefits of the profits the institutions may make, they will have an incentive to undertake investments that are excessively risky from a social point of view.
• Then a mojor policy error was premature liberalization of the capital account of the balance of payments. It was this which allowed foreign as well as domestic wealth-holders to respond to the attractive (because presumed to be largely risk-free) returns offered by financial intermediaries, and thus provide the financial resources that in many cases powered asset price booms—booms that for a long time seemed to validate the excessively risky lending that was being undertaken.
• And I concede that a part of the blame for the East Asian crisis can legitimately be laid at the door of those in the West (including in the international organizations) who pushed for rapid, unconditional, and complete liberalization of capital account transactions.
• There is surely a third factor that contributed to the weakening of the banking systems in most or all of the victim countries. This is "crony capitalism". One of the ways in which the cronies received favors was in terms of access to credit. This weakened the banks when the cronies either were unable to repay or chose not to repay because they knew that their political patrons would defend them against the sanctions that are normally imposed on defaulters.
• First, while it is probably undesirable to avoid all guarantees of bank liabilities, it is quite essential that these be accompanied by good regulations (requiring transparent accounting, capital requirements at least up to the international norm, prohibitions on connected lending, a legal system that exacts sanctions if loans are not serviced conscientiously, etc.) which are enforced by a competent and motivated body of supervisors.
• Second, it suggests that countries should eschew dogmatic commitments to capital account convertibility, and retain some ability to require financial actors to maintain a reasonably balanced currency position, and to make it expensive for domestic agents to borrow abroad short-term (as Chile and Colombia do).
• Third, it argues the need to abandon crony capitalism once and for all.
• I take the East Asian meltdown as decisive evidence showing the wisdom of the Tarrapore Committee (1997) on whose recommendations this policy decision is made. It recommended that in having argued that Indian capital account convertibility needs to be preceded by the establishment of a liberalized, well-supervised, domestic financial system.
Summing up, beyond any ideological predilection, capital account convertibility has its good and bad. And intelligent use with strict vigil and monitoring can be beneficial, which does not make sense to shun it totally.
That is my amateurish understanding of the issue
But what is leftist about it? The conclusion that the Indian decision to go for full capital account convertibility is an evidence of the prime Minister’s class interest? An attempt to placate the wealthy bourgeoisie?
I think u missed a point. For India, full capital account convertibility is “within a transparent framework”.[ http://us.rediff.com/money/2006/mar/18asoc.htm]The Prime Minister also expressed his awareness of the skewed priorities of the WTO, the agricultural subsidies in Europe. But then that the world outside is corrupt does not justify your remaining hidden [and protected]– like an ostrich digging its head in the sand [or isn’t that the burqa logic – hide from the big bad world?]
Well, your analysis of what capital account convertibility is or how “hot money” wrecks an economy is just right. But not your comments on Dr. Singh’s understanding of Asian financial crisis.
Let me try to explain.
I grant that the IMF led West had a hand in a s much as it forced these countries to have full account convertibility prematurely. What happened was this.Full Account Convertibility can result in two things – huge inflow of capital and also huge outflow of capital. When the exchange rate is favourable the chamces of inflow exchanges and when it is not here is a danger of outflow.
The East Asian “miracle” turned into a mirage not overnight after being role model to developing countries for over two decades. Among the most important factors contributing to the crisis were –
• Thai policy of fixed exchange rate defined in terms of single currency, the US dollar, in spite of massive current account deficit[currency pegged to dollar giving an impression that there can never be depreciation of Us $ and hence of their currency too]
• High asset prices
• Heavy exposure to international financial markets
• Weak Banking systems
Now what I think contributed to these were –
• What u called “hot money” and a sensex shooting up high resulted in increase of price of assets.
• Explicit or implicit guarantees of the liabilities of financial intermediaries without the creation of a system of financial regulation and supervision .
Banking deregulation [LED TO] domestic banks borrowing short term from foreign banks and lending to financial institutions long term.[LED TO] reckless lending by banks[LED TO]boom in investment in unproductive areas like construction , real estate, golf courses, shopping plazas[LED TO]lopsided development .
Since early 1997 some Korean and Thai companies collapsed due to huge debt.[LED TO]fall in propert market[LED TO]reluctance of foreign banks to give short term debts any more[LED TO] collapse of exchange rate due to massive outflow[LED TO]further withdrawal[LED TO]banking system no more has foreign short term loans plus it became burdened with non – performing loans [LED TO]banks insolvency
If the creditors of financial intermediaries believe they have no need to check the solvency of those to whom they are entrusting their assets, while the owners of the financial institutions believe that their losses will be socialized while they will reap the full benefits of the profits the institutions may make, they will have an incentive to undertake investments that are excessively risky from a social point of view.
• Then a mojor policy error was premature liberalization of the capital account of the balance of payments. It was this which allowed foreign as well as domestic wealth-holders to respond to the attractive (because presumed to be largely risk-free) returns offered by financial intermediaries, and thus provide the financial resources that in many cases powered asset price booms—booms that for a long time seemed to validate the excessively risky lending that was being undertaken.
• And I concede that a part of the blame for the East Asian crisis can legitimately be laid at the door of those in the West (including in the international organizations) who pushed for rapid, unconditional, and complete liberalization of capital account transactions.
• There is surely a third factor that contributed to the weakening of the banking systems in most or all of the victim countries. This is "crony capitalism". One of the ways in which the cronies received favors was in terms of access to credit. This weakened the banks when the cronies either were unable to repay or chose not to repay because they knew that their political patrons would defend them against the sanctions that are normally imposed on defaulters.
• First, while it is probably undesirable to avoid all guarantees of bank liabilities, it is quite essential that these be accompanied by good regulations (requiring transparent accounting, capital requirements at least up to the international norm, prohibitions on connected lending, a legal system that exacts sanctions if loans are not serviced conscientiously, etc.) which are enforced by a competent and motivated body of supervisors.
• Second, it suggests that countries should eschew dogmatic commitments to capital account convertibility, and retain some ability to require financial actors to maintain a reasonably balanced currency position, and to make it expensive for domestic agents to borrow abroad short-term (as Chile and Colombia do).
• Third, it argues the need to abandon crony capitalism once and for all.
• I take the East Asian meltdown as decisive evidence showing the wisdom of the Tarrapore Committee (1997) on whose recommendations this policy decision is made. It recommended that in having argued that Indian capital account convertibility needs to be preceded by the establishment of a liberalized, well-supervised, domestic financial system.
Summing up, beyond any ideological predilection, capital account convertibility has its good and bad. And intelligent use with strict vigil and monitoring can be beneficial, which does not make sense to shun it totally.
That is my amateurish understanding of the issue
# posted by 
: 1:12 AM
: 1:12 AM
Gayatree,
Thank you for your comments. I appreciate it. I would like to see more such comments in the near future for my other posts.
Thanks,
Charvaka
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Thank you for your comments. I appreciate it. I would like to see more such comments in the near future for my other posts.
Thanks,
Charvaka
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