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Ghosts in the Corridor

The shadow of foreign capital, which in recent years has driven the stock market, investment in the private corporate sector and the financial sector in general in India, now hangs over the economy. The exit of foreign capital and the drying up of external funds for the corporate sector have created a turbulence the Indian economy is not used to.

COMMENTARYEconomic & Political Weekly EPW November 8, 200819Ghosts in the CorridorK SubramanianThe Liquidity Adjustment Facility (LAF), otherwise known as the liquidity corridor, has thus far pro-vided safe passage for growth and finan-cial stability of the Indian economy. It has evolved over the years and the latest version has been in place since 2004.The LAF has received global acclaim. Y V Reddy, the previous governor of the Reserve Bank of India (RBI), has eloquently and persuasively set out in several of his speeches and articles how theLAF was calibrated over the years. He has explained how it reconciles conflicting objectives even when confronting the “Impossible Trinity”. Even a year after the financial turmoil broke out, the LAF was managed deftly and guarded against “tail risks”. The concerns of the RBI have been macro-economic and it has kept in view the needto withstand tightening financing conditions abroad.TheRBI’s record of monetary manage-ment has led to false comfort among many. Politicians and ministers repeat ad nauseam the cliché how our banks are safe and insulated from the crisis. The banks are indeed safe; but, unwittingly, the real economy is feeling the pain. Banks are safe as foreign capital was kept out of them as a measure of policy and no credit is given to the Left partners who had re-sisted the efforts of the “reformers”. Sadly, foreign capital has entered other sectors through other ways in high volumes. With the onset of the crisis, especially since January this year, the economy is grap-pling with the second and third order effects of those flows, especially when they have begun to flee from the country.October has been the cruellest month when the ripples have been the most pow-erful. The Governor of the RBI, D Subba Rao, has described it as “an inferno”. There was a sudden liquidity collapse threatening to run the economy aground.The RBI took extraordinary measures such as to reduce the cash reserve ratio (CRR) by 1.5% in less than a week, a step it had not done any time in its history. It pro-vided liquidity of the order of Rs 135,000 crore. It relaxed norms for the external commercial borrowings (ECBs). Again, un-expectedly, on 20 October, it reduced the repo rate by 1% even though the mid-term review was due four days late. In making these efforts, theRBI seems to mimic the United States Federal Reserve.These measures did suggest panic and theRBI going out of the way to assuage the markets. The mid-term review narrated, rather blandly, the circumstances attached to those steps. One of the triggers was the precipitous fall in the stock values which took the BSE index well below 10,000; and the other was the call rate crossing 23%. The stock market responded with ferocity and beat the World Bank, and WTO, plus representa-tives ofUN agencies, members of civil society, and private sector organisations. It would provide the opportunity for a holistic and serious cross-ministerial, cross-institutional, public and private sector discussion of global economic and financial concerns. A form of the Galvez idea was endorsed by the Rio Group of 20 Latin American countries, although in a proposal that was too elaborate and precise to win consen-sus support. The question now, as time is short, is to figure out if a working group somehow convoked by the UN with the collaboration of IMF, the World Bank and WTO, and in consultation with official and non-governmental stakeholders, could be charged to draft a proposal for considera-tion in early 2009. In fact, the draft text of the Doha outcome document prepared by the Norwegian and EgyptianUN ambassadors as co-chairs of the prepara-tory discussions for Doha included the beginnings of such a proposal for a new international process. They did not speci-fy who would develop it, but proposed that it be discussed in the nextFFD meet-ing of the UN Economic and Social Coun-cil with the major international financial and trade institutions, due to take place in April 2009. As October ended, the views of govern-ments were far apart on the follow-up pro-posal and it is not clear how close they can come to a consensus in the time remain-ing before going to Doha. If they can come to an agreement, the world body can cre-ate a forum that allows all relevant stake-holders to make inputs, that allows small countries access to the discussions as well as big countries, that brings the leadership of the major international institutions into dialogue with their shareholders and cus-tomers in a way not possible in their own institutions when money or trade conces-sions may be held in the balance. I think they should try for it.K Subramanian ( is a former official of the government of India who retired from the finance ministry.The shadow of foreign capital, which in recent years has driven the stock market, investment in the private corporate sector and the financial sector in general in India, now hangs over the economy. The exit of foreign capital and the drying up of external funds for the corporate sector have created a turbulence the Indian economy is not usedto.
COMMENTARYNovember 8, 2008 EPW Economic & Political Weekly20stock values further down – below9,000 before it recovered brieflyearlier this week. The money market showed appar-ent stability for a while and the call rates were close to the repo. And yet, an un-easy gloom pervaded the market and bank lending remained sluggish.The past week saw further develop-ments. As call rates zoomed past 20% again, theRBI (unfairly pilloried for a do-nothing monetary review) cut the repo by 50 basis points and the CRR by 100. Our finance minister went to overdrive asking the public sector banks to cut rates and lend more. Recent developments suggest that theLAF may be cracking. Unbe-knownst to the RBI and to those in North Block, it is theLAF dependent on foreign inflows. When they are on the upswing, even if volatile, theLAF absorbs the excess (securitises the inflows) and modulates the liquidity required with an eye on growth and inflation. When they are on a downward loop, it is unable to operate in the reverse gear. The instruments at its command appear helpless, especially when there are “sudden stops” in capital flows and other hiccups.The liquidity trap was discernible from the earlier quarters of the year and reached its nadir around August-September. Intui-tively, this can be related to the collapse of investment banks like Bear Stearns, Leh-man Brothers, etc. Even in the US many economists and analysts attack the US Treasury and Hank Paulson for having allowed Lehman Brothers to collapse creating mayhem in the markets globally. The foremost impact was the flight of foreign institutional investor/participatory note (FII/PN) capital, an outflow estimated around $13 billion since January this year. This has received very wide publicity. The first order impact was on stock values which have more than halved. Surveys showed that FIIs held 40% of the paid-up capital of all the companies listed in the Sensex. In some likeHDFC, Tata Steel, Reliance Industries, BHEL, ICICI, etc, their holding has been allowed to exceed the caps substantially.The fall in share values would have hit the balance sheets and credit standing ofcompanies. The other impact is on their American Depository Receipts (ADRs), Global Depository Receipts (GDRs) and foreign currency convertible bonds (FCCB). TheADRs have lost around 26% andFCCB redemptions would shake the finances of even respectable companies. Incidentally, these exotic instruments were floated abroad with the consanguineous relations that existed betweenFIIs and their breth-ren in Wall Street. Indian banks also drew comfort from them and provided back-to-back guarantees. With the demise of in-vestment banks, the alliances ceased and, at our end, got transformed into a liquidity crunch. Liquidity, as many economists have analysed, has more to do with trust and confidence than with mere provision of cash.A more serious impact was on the mutual funds (MFs). The MFs had grown at an annual rate of 26% for 10 years. Last year they had grown at 60%. As of Sep-tember 2008, their assets were valued at Rs 5.29 lakh crore. They rode on the crest of phenomenally rising stocks and invest-ment by corporates on the back of tax concessions. Banks began to cosy up to mutual funds through issue of certificates of deposits (CDs). India was awash with liquidity and it seemed there would be no shortage. The honeymoon came to a grievous end when stock values crashed and led to a rush for redemptions. By mid-October, 20% of the assets had been pulled out and redemptions exceeded new subscriptions. The banks could not rescue them due to trouble in their own tills. MFs were driven to the RBI which, in turn, created a new (unconventional!) line of credit of Rs 20,000 crore. The credit line is not moving asMFs are unable to produce collateral other thanCDs. The RBI, like the FED, is diluting the collaterals to facilitate lending. Unfortunately,RBI’s credit line cannot cure the malaise afflicting theMFs. It is the collateral damage caused by the flight ofFIIs and fall in share values. It is systemic and cannot be cured by injec-tion of liquidity. Another area causing anxiety stems from the entry of private equity (PE), espe-cially in real estate. When policy changes were announced in February 2005, per-mitting foreign investment up to 100% in construction projects, there was jubilation among investment banks in Wall Street. Big ticket operators like Goldman Sachs, CalPERS began to target India and were joined by others like J P Morgan, Warburg Pincus, Morgan Stanley, Merrill Lynch, Lehman Brothers, etc. They set up India-oriented funds. Even small town realtors were wearing PE hats. In a press release (January 30, 2008) Assocham gave an estimate of $48 billion of new funds for the year and described how around 400 firms were operating in Centre for Women’s Development Studies, New Delhi (an ICSSR Supported Institute) invites applications for Faculty positions (Professor, Reader, Senior Lecturer and Lecturer’s grade). The Centre is looking for persons with a demonstrated capacity to initiate research and analysis in thefields of women and gender studies, as well as to participate in a new teaching programme offering an M.Phil/Ph.D. in Women’s Studies. Candidates with backgrounds in the social sciences and humanities combined with an understanding of gender issues are eligible to apply.Qualifications: A Ph.D. or equivalent published work, Master’s degree with at least 55% marks (5% relaxation available to SC/ST candidates).Experience: In Research/Teaching, a minimum of 10 and 5 years for the posts of Professor/Reader respectively, 3 years for the post of Senior Lecturer and 2 years for the post of Lecturer.Suitable applicants wishing to join on deputation may also apply through proper channel.Scales of Pay: As per UGC norms.Last date for receipt of Applications: One month from the date of Advertisement. Apply with full details including details of published work and specifying the post applied for to the Director, Centre for Women’s Development Studies, 25 Bhai Vir Singh Marg, New Delhi 110 001 (Tel: 23345530, 23365541, 23366930, Fax: 23346044,;;
COMMENTARYEconomic & Political Weekly EPW November 8, 200821the market. PE comprised the largest com-ponent of FDI in the country and much of it was in real estate, especially high value malls, luxury apartments and gated condos. The collapse of private equity has put paid to this saga. Projects are being abandoned, sold off or held by bankrupt-cy courts. Highly leveraged companies, prime movers in the sector, can no longer hope to draw on vanishing hedge funds. These developments are reflected in banks’ liquidity tantrums. Earlier,PE partners would forge arrangements with banks and institutions, Indian or foreign, through any means. With their brand image and clout, they could arrange or guarantee large value loans and could even get them counter-guaranteed by affiliates abroad. These links have snapped. In the absence of PE alliances, Indian contractors and subcontractors have lost their credit standing with banks. Down the line, contractors and sub-contractors in areas like steel, cement, ma-chinery, electrical, etc, who service the real estate sector have lost their standing. In the past, PE firms stood guarantee for them. The mid-term review draws atten-tion to the deceleration (from 7.1 to 3.4%) in infrastructure in all sectors except coal. In large measure, it may be traced to the black hole created by the exit of PE. There is an assumption that our economic growth is driven by domestic demand. RBI refers to this in the mid-termreview. It may seem so but super-ficially. However, as narrated here, domestic demand itself has been driven in recent years by the shadow of foreign capital. When the shadow recedes, the impact will not be restricted to banks but will go deeper into the real economy. Much more than bank liquidity is required to lift the economy from its present state. The liquid-ity corridor lacks the flexibility to operate when the flows are in reverse gear and it is stalked by ghosts.ISRO’s Deep Space VenturePallava BaglaThe Indian Space Research Organisation’s moon mission marks the first venture into “deep space” for an indigenous satellite. India now joins a select club of nations which have achieved this “milestone”.On a rainy October morning as most of India slept, and the sun had barely peeped out from beh-ind the ominous cloud bank at India’s space port, an apparatus weighing 316 tonnes, spewing fire, leapt up from the coast of the Bay of Bengal. The launch of a mission to the moon has been heralded as a new dawn for India’s space research agency, the Indian Space Research Organisation (ISRO).The country’s first-ever mission to the moon lifted off successfully from the Satish Dhawan Space Centre (SDSc) at Sriharikotaat 6.22 am on 22 October. It was a flawless launch for the mission – titled Chandrayaan-1. The event catapulted India into a small clutch of space-faring nations across the world. Calling it a historic moment achieved against tremendous odds, G Madhavan Nair, chairman of the ISRO, said “today what we have charted is a remarkable journey for an Indian space-craft to go to the moon and try to unravel the mysteries of the Earth’s closest celestial body and its only natural satellite”.Chandrayaan-1 was launched into an elliptical transfer orbit using the indige-nously built rocket, Polar Satellite Launch Vehicle-C11 (PSLV-C11). This was the 14th flight fromSDSC for the PSLV workhorse. Thirteen of the launches have been con-secutively successful – an enviable track record since rocket launches around the world are notorious for failures. The suc-cess of the launch finally allayed prior concerns about lightning bursts that were occurring in the vicinity due to rain and stormy weather and a fuel leak on the launch pad also caused some concerns. Making of HistoryChandrayaan-1 is an Indian mission with international partners. With six scientific instruments from the United States, the European Space Agency and Bulgaria, Chandrayaan-1 stands out from all its other Asian counterparts in its payload. There is a clear signal going out – inter-national collaboration is certainly critical in the modern, global ethos of space research. The five Indian instruments will map the lunar resources through remote sensing. India’s first unmanned satellite to the moon is the cheapest lunar mission among the Asian lunar missions, with Chan-drayaan-1 costing Rs 386 crore – almost a quarter of what the Japanese mission Kaguya cost and half the overall cost of the latest Chinese moon mission Chang’e-1. Incidentally, despite the low costs, the Indian mission has double the lifetime of all the current lunar missions. This is the first time in the history of the nearly 50-year-old Indian space pro- gramme that an Indian space mission is attempting to move beyond the earth’s orbit. It is but obvious that the journey into Pallava Bagla ( is co-author of the book Destination Moon and is science editor for the news channel, NDTV.

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