For a relatively brief period in the aftermath of the Southeast Asian financial crisis, Indian policy makers did look to the region to extract some lessons for the Indian government's own plans regarding capital account liberalisation. Unfortunately, that period was all too brief. The apparent economic recovery in the region beginning in 1999, and the effective abandonment at the multilateral level of any serious discussion of reform of the international financial regime, both served to create a sense of complacency and to mute discussions of alternative trajectories.
In India, the process of financial
liberalisation, which had halted to some extent over 1998, was renewed
with much enthusiasm by the BJP-led government especially from last
year. And the obsession with stock market development and with the perceived
need to attract significant amounts of foreign portfolio capital, which
was a feature of the Congress government of the early 1990s, appears
to be even more marked in the current government. In the process, little
attention is paid to the actual post-crisis experience of the Southeast
Asian economies. In fact, even serious analysis of the processes leading
up to that crisis are no longer given much significance.
This blinkered amnesia is
more than just a pity; it could actually be extremely dangerous. Many
of the recent tendencies and events in the Indian economy, and most
especially in the capital markets, appear almost like an action replay
of the pre-crisis Southeast Asian experience, albeit in somewhat slower
motion. An excellent new book on the Malaysian economy (K.S. Jomo, edited,
Malaysian Eclipse : Economic Crisis and Recovery, London, Zed
Books 2001) shows both that the nature of the crisis and recovery have
been quite different from the standard interpretation, and that there
are still very pertinent lessons from Malaysia relating to capital market
strategies in particular.
While the book provides a
sober and analytical assessment of the earlier development strategy
and the nature of the response to crisis, including the temporary capital
controls, its prime usefulness in terms of policy implications for other
countries lies in its assessment of the type of financial system. Unlike
the three worst-affected economies of the region (Thailand, South Korea
and Indonesia) the Malaysian financial system was less bank-based and
provided a greater role for the capital market.
In fact, the banking reforms
of the late 1980s contained the most dangerous consequences of sequential
financial liberalisation that affected several other countries. Strict
prudential regulation and very limited exposure to short-term credit
from abroad protected the banking system, which was in consequence much
less adversely hit, and Malaysia managed to avoid the forced closure
of banks and non-bank financial institutions that became commonplace
in other crisis-affected economies of the region.
This meant that for the Malaysian
economy, the stock market played a much larger role in worsening the
crisis than elsewhere in the region. Capital inflows into Malaysia increased
substantially in the mid-1990s, with foreign portfolio flows dominating
and creating much volatility. The authors point to need to distinguish
even within these portfolio flows, suggesting that the investment behaviour
(and even investment duration) of pension funds, mutual funds and hedge
funds can be quite different.
It was capital flight by portfolio
investors that drove the crisis in Malaysia. The authors point out that
while the introduction of capital controls 14 months after the onset
of crisis was bold and certainly not the recipe for disaster that monetarist
critics claimed it would be, it actually amounted to closing the stable
doors long after the horses had bolted. They argue that a more differentiated
set of capital control instruments should instead have been in place
well before the crisis, which would also have prevented or at least
reduced the speculative boom that preceded the crisis.
The Malaysian experience thus
points quite directly to the role played by a liberalised financial
system which promotes reversible short-term capital inflows, in creating
the conditions for crisis. In the mid 1990s, the unsustainable "virtuous"
cycle of assets price inflation (which the authors argue may have boosted
growth slightly through the wealth effect and its limited multipliers
in Malaysia's very open economy) quite easily turned into its antithesis,
a vicious cycle of asset price deflation which in turn added to deflationary
tendencies.
Not only that, but the speculative
capital inflows also operated to shift producers' incentives away from
tradeable to non-tradeable sectors in the economy, thereby contributing
to the creation of the current account deficits which they were then
used to finance. So , instead of accelerating the pace of economic growth,
such inflows were important to finance the import of financial services,
the payment of investment income payments abroad, growing imports for
consumption, speculative activity in regional stock markets, and output
of non-tradeables, especially real estate. Thus the inflows contributed
directly and indirectly to the asset price bubbles whose inevitable
deflation was dramatised by the onset of contagion from Thailand.There
is another very important point made in this book which is rarely noted
in analyses of the Southeast Asian rapid growth process. The dominance
of multinational companies, especially in more sophisticated, dynamic
and export-oriented activities, meant the subordination of domestic
industrial capital in the region. This allowed finance capital - both
foreign and domestic - to become more influential in the entire Southeast
Asian region.
Indeed, Jomo argues that "finance
capital developed a complex symbiotic relationship with politically
influential rentiers, now dubbed 'cronies'... In these and other ways,
transnational dominance of Southeast Asian industrialisation facilitated
the ascendance and consolidation of financial interests and politically
influential rentiers. This increasingly powerful alliance was primarily
responsible for promoting financial liberalisation in the region, both
externally and internally."
Jomo and co-authors point
out that the recent recovery, in Malaysia as elsewhere in the region,
has been due primarily to Keynesian style reflationary policies. This
shows that the prior necessity of corporate governance reforms, as demanded
by the IMF and others, is not a precondition for economic recovery.
But they also note that the basic conditions which allowed for the crisis,
in terms of a financial system open to reversible short-term flows,
still persist. And there has been no reform of the international financial
system, which is the basic precondition for preventing future such crises.
A lot of the description of
the pre-crisis Malaysian economy, as well as the nature of unfolding
of the crisis, will appear eerily familiar to readers of recent editions
of Indian newspapers. In fact, even the political economy processes
that are described bear some relation to the political economy pressures
at work in India at the moment. This suggests that those who wish to
avoid a similar asset deflation process, even if it is less intense
and more prolonged, would do well to heed the lessons of the Malaysian
experience.