On Sunday, at the Chennai airport, I ran into a friend who has a very faint link to the world of finance. I showed her the cover of the book The Rise Of Finance: Causes, Consequences And Fearsthat Gulzar Natarajan and I have co-written. It became available in the market last week. She asked me about the book, and I said that it was about how finance messed up our lives. That was the shortest non-technical introduction I could give about the book and its subject of “financialization”—how finance came to dominate and influence economic outcomes, rather than the other way around. Some of you might wonder if it is true of India, even if it was true of the western world.
Y.V. Reddy, former governor of the Reserve Bank of India (RBI), in his foreword for our book, has written that while financialization is a problem in the West, in India, the problem was the politicization of finance ever since banks came under government ownership. Not that he was approving of the state of affairs that prevailed before bank nationalization. It was an objective statement. Banks had become an instrument of state policies and, by extension, politics. Businesses influence the government. The government influences banks and, ergo, businesses control finance. In other words, it is the capture of finance rather than the capture by finance that should worry Indians.
It comes through sadly, but vividly, in a recent article by Andy Mukherjee in Bloomberg. In his piece Save Indian Capitalism From Indian Capitalists, published on 24 April, he writes about the culpability of many arms of the Indian financial system that reads eerily similar to what happened with Enron in the US in the early years of the new millennium. In the case of Enron, accounting, auditing and credit-rating agencies did not cover themselves with glory. Similarly, “in the case of the now-bankrupt infrastructure financier-operator IL&FS Group, it was the auditors and credit rating agencies that led even small pension plans like that of the American Embassy School staff in New Delhi into trouble”. Next, he talks about how the mutual fund industry had compromised the interests of investors through its lending to the promoter of Zee Entertainment against the collateral of his shares in the company. The funds did not sell the shares to recover their dues, and now investors have to wait until the promoter finds a buyer.
So, it is not just about government-business-public sector banks’ nexus. Private sector behaviour is also not consistent with the requirements of a sound financial system. In this environment, is further financial liberalization likely to help or hurt the Indian economy? In 2013, Joe Studwell published his book How Asia Works. The book is an attempt to trace the ingredients of successful economic development based on the success of Northeast Asian economies of Japan, South Korea, Taiwan and China. The last one is still a work-in-progress. The book contrasts the experience of Northeast and Southeast Asian economies.
It is not that Northeast Asian economies got everything right. Cronyism was there. Tariffs were used to protect domestic industry and additional concessions were offered. Banks were nationalized and loans were directed. However, the emphasis on infant industry protection went hand in hand with external benchmarking through export performance. There were special privileges for local businesses, but there was accountability for export performance. That is how scale, productivity, efficiency and rapid economic growth were achieved. Studwell repeatedly says that Korea punished non-performers more than helping performers, citing that as the crucial difference between the economic transformation of Korea and that of, say, the Philippines and Malaysia.
He notes, from the experience of many Southeast Asian economies, premature liberalization—whereby interest rate ceilings on deposits and loans are removed—actually results in a lot of real estate and consumer lending but not enough for capital formation in manufacturing and technology upgrading. Even now, anecdotal evidence indicates that banks demand abundant collateral for industrial loans, but throw money (loans, of course) at consumers, stuffing them with loans that they don’t need. India’s credit card outstanding is growing at more than 26% per annum, according to the latest RBI data. Loans to small and medium industries are growing rather tepidly, if at all. Basel norms for risk-weighting assign a lower risk weight to real estate loans because they are collateralized. That is why bank loans for real estate outpace loans for productive purposes far easily, globally. In India too, housing loans to consumers are growing at nearly 19% a year.
India is under pressure to undertake financial liberalization. However, financial markets are not central to economic growth. A sound banking system with a competitive manufacturing sector are more essential. India’s agricultural sector is an unfinished agenda, and its industrial sector is globally competitive in parts. Cronyism combined with financial liberalization will harm the Indian economy. That is the message of our book The Rise Of Finance and that is also the lesson from the experience of Southeast Asia.