Articles by C P Chandrasekhar

The financial crisis has made clear that the accumulation of risk and the occurrence of crises are almost inevitable in a self-regulated financial system governed by a framework of the Basel kind. One solution is to monitor investment banks and hedge funds and subject them to regulation while seeking an institutional solution that would protect the core of the financial structure, the banking system. The bail out implemented in the US and some of the west European countries has been forced to take a form that perhaps provides the basis for such a transformation. Governments have opted for state ownership and direct influence over decision-making. Will this be temporary or a new form of banking regulation?

Is India heading towards its own sub-prime crisis? There have been a number of developments that suggest such an eventuality is possible. Bank credit has been growing very rapidly in recent years, the retail exposure of banks in the form of personal loans has increased sharply, exposure to the "sensitive" sectors (especially by the new private banks) has exploded, and securitisation of loans (during which diligence can slacken) has also risen. If the economic environment takes a turn for the worse - as has already happened - then the danger of bank loans turning bad increases manifold.

India's experience with private equity is illustrative of the rush of this form of finance to the developing world. The acquisition of shares through the foreign institutional investor route today paves the way for the sale of those shares to foreign players interested in acquiring companies as and when the demand arises and/or FDI norms are relaxed. This trend of transfer of ownership from Indian to foreign hands would now be aggravated by the private equity boom. Private equity firms can seek out appropriate investment targets and persuade domestic firms to part with a significant share of equity using valuations that would be substantial by domestic wealth standards.

The Indian experience with reform in the financial sector indicates that, inter alia, there are three important outcomes of such liberalisation. First, there is increased financial fragility, which the "irrational boom" in India's stock market epitomises. Second, there is a deflationary macroeconomic stance, which adversely affects public capital formation and the objectives of promoting employment and reducing poverty. Finally, there is a credit squeeze for the commodity producing sectors and a decline in credit delivery to rural India and small-scale industry. The belief that the financial deepening that results from liberalisation would in myriad ways neutralise these effects has not been realised.

Burdened with rising interest payments, the government finds itself increasingly short of funds for investment and development purposes. In the circumstances the Planning Commission's foreign exchange for infrastructure scheme which is an implicit advocacy of a monetised deficit is indeed welcome. But to strengthen its own case, the commission should possibly be more explicit and advocate both the repeal of the FRBM Act and the restoration of the practice of monetising a part of the deficit. In the short run, while efforts to raise the tax-GDP ratio are underway, these are the only ways of garnering resources for faster and more egalitarian development.