New Delhi: At a time when US financial markets are reeling, Asian financial institutions seem to have escaped deep trouble. However, there are many lessons to be learnt from the crisis, says Masahiro Kawai, dean and chief executive of the Asian Development Bank Institute, a think tank and a subsidiary of the Asian Development Bank (ADB). Kawai calls for greater vigilance on asset prices and stricter regulation of financial institutions in the region. Kawai was in New Delhi to release the ADB report, Emerging Asian Regionalism: A Partnership for Shared Prosperity. Edited excerpts from an interview:
What are the lessons for Asia, and particularly India, from the current financial crisis in the US?
Lessons from US: Dean and chief executive of the Asian Development Bank Institute, Masahiro Kawai, says a key need for India is creating a fine balance between inflation, asset price and growth rate.
I don’t know much about India, but perhaps some lessons are quite universal. One general lesson is any excessive boom without being checked could be quite dangerous, particularly in the asset market. Such boom is followed by a bust and can put a great strain on domestic financial institutions. In boom time, financial institutions overextend their investments in the real estate sector. Till the boom lasts, everything is fine. Once it fails, that causes tremendous damage. In Asia, it happened in Thailand and Japan in the 1980s and 1990s. So a country should try to avoid this boom-and-bust cycle in the asset market.
What measures do you suggest to avoid such a cycle?
Well, monetary policy is quite important. Monetary policy has been paying attention to inflation in goods prices. But perhaps it should also pay attention to asset prices and asset markets. But monetary policy may not be just enough. Financial regulators and supervisors have to monitor financial institutions and their investment behaviour. And when a bubble-like situation arises, monetary policy has to be very cautious. Even if underlying inflation rate is all right, there may be a case for tightening monetary policy.
How would you rate the Indian monetary policy and the kind of policy tightening that we have been doing for sometime now?
Given the inflationary pressure, I think monetary tightening is appropriate. I don’t have a very strong view about the direction of the monetary policy for India, because I don’t know enough. But despite India’s high inflation and monetary policy (tightening) and recent slowdown in growth rate, still India enjoys one of the fastest growth rates in the world.
How badly are we placed today?
I cannot say how badly we are placed. But what I can say is that there are several channels through which the US financial crisis can affect the Indian economy as well as some other Asian economies.
One is through the financial channel. Many countries, including India, have seen very rapid decline in equity prices. In some countries, real estate prices are going down. At least the growth rate of real estate price is decelerating. Usually, that generates negative wealth effect. People holding equity, stock and real estate tend to consume less as their wealth has shrunken. This phase may have just started but I don’t think this negative wealth effect is that strong.
But as time goes on, this may change. Auto sales in many Asian economies are now declining. Some auto producers have started adjusting their auto production. This may be due to the collapse of the stock market and the tight monetary policy also. As interest rate goes up, demand for consumer durables and auto goes down.
Another channel is slow economic growth or even a recession in the US and the rest of the world, through trade channels. This may affect Indian export to the US market and European markets. Until the first half of this year, we had not seen a great deal of export deceleration in many Asian countries. But in the past few months, we are now beginning to see it.
I don’t think many Asian banks have exposure to subprime-related instruments. So any direct impact is virtually not there. Japan has some exposure to subprime-related products, but Japanese banks are doing fine. I am sure Indian banks are okay. But this indirect channel, caused by this nervousness in the global market, dampening stock prices, may be setting in. But we are yet to see how serious this negative wealth effect is going to be.
There are economies that are still booming, because of high prices of oil, food and other commodities. These are producers, particularly the Middle East and resources-rich countries. So there are offsetting factors. For the global economy as a whole, what’s going to happen to a country like India depends on many things.
But, the Indian growth rate is still high. ADB has projected a growth rate of 7.4% for 2008 and 7% for the next year. Which may be lower than 9% growth rate of 2007, but that is a healthy growth rate. I don’t think that is bad. So what is important for a country like India is to sustain this growth rate. Just to make sure that inflation does not go out of control. Once it gets out of control, the policymakers have to really tighten the monetary policy, which could force the economy to go down much more sharply. So the most important lesson for a country like India is to create a fine balance between inflation, asset price and growth rate.
So in view of this financial market crisis, do you think India should follow a more cautious path towards financial sector reforms?
Yes, definitely. India should make steady progress in terms of financial sector reforms, including capital account opening. But always that has to be very cautious.
What is really important is to increase the effectiveness of financial sector supervisors and regulators. Unless they have sufficient capacity to monitor, supervise and regulate, then financial institutions can do anything they like just like many investment banks which failed in the US. The ability of the regulators and supervisors to monitor the market and institutions is very important. So reforms and liberalizations have to be accompanied by that capacity.
How do you look at the clichéd India-China comparison? And in which areas you think India should pick up to become a global superpower?
Well, India is already a global superpower. It is going to sign the nuclear deal with the US. But when compared with China, may be India can invest more in manufacturing. India cannot simply rely on the services sector. For that purpose, infrastructure investment is absolutely important.
I hear a lot of stories from Japanese firms sending autos from their factories (in India) to ports. Transport conditions are so bad, (and) by the time the cargo reaches the port, the new cars become old cars because of the bumpy roads. Infrastructure is weak compared with China.
Also, further trade linkage with global market in order to link Indian economy with other dynamically growing economies is quite important. China has been doing it.
China is in the middle of a production network of various products. It imports intermediate inputs from various countries and exports products to various regions like North America and Europe. India can also do that. It has the human capacity, high quality labour. In terms of human resource, India is in a very, very strong position.
How far is Asia from a single market and a single currency?
In terms of single currency, maybe many decades away. In the areas of electronics products, tariffs are very low. For many other manufacturing items, tariffs are coming down. Particularly, Asean (Association of Southeast Asian Nations) and East Asia are getting much closer through elimination of barriers to trade. Investments within the Asean and even among emerging market economies are also taking place. Services have yet to be liberalized.
People’s movement is also a big challenge. But the direction is towards greater integration. In that sense, a single market for goods and services is not an unrealistic case. A single market for investment is also not unrealistic from a medium-term perspective. A single market for professional workforce is also not unrealistic. Short-term capital flows may take a bit more time. But step by step, Asia is moving towards an integrated market.