SYNOPSIS: Looks carefully at Krugman's call for Capital Controls and at Asian problems
At a time when the Asian crisis is being
dissected for possible lessons, Paul Krugman, MIT's celebrated Ford International
Professor of Economics, has surprised policy-makers and
economists alike by recommending imposition of capital
controls as a last resort. The suggestion can be said to
have a special relevance to the Indian economy, which is
as yet only partially open.
In Calcutta to attend the three-day convention organised
by the All-India Management Association (AIMA), Krugman
underscored the need for prudent capital controls for
emerging economies as a measure of abundant caution. He
outlined lessons for India: Adequately capitalising
banks, closing down weak ones and leaving the
convertibility programme where it is. Krugman believes
that by not being flavour of the month, India has avoided
the worst. An interview with Saurav Majumdar.
Business Standard:
Assuming you were at the helm of
India's finances at this point, what would you be doing
to steer the economy?
Paul
Krugman:
Well,
I'd probably be advocating pressing ahead with reform...
imports need to be liberalised. India should stop talking
of disinvestment and start talking privatisation. They
should deregulate as many remaining areas as possible.
You see, India has had incomplete reform so far.
It's much more than what was there earlier, by far, but
that's still only half way there. I would go for a
strengthening of the banking system. Close the weak banks
and impose serious capital requirements on the strong
ones. Leave currency convertibility where it is. It's an
extremely dangerous world out there. The risks of getting
caught in the pinball game are too high. But what I'm not
clear on is the Budget and the macro position. I don't
know enough about these to make any specific comment.
You made the point
about closing down weak banks. But in India, the social
costs of this move could be disastrous...
You see, it may sound hard-hearted, but you cannot keep
unsound financial institutions operating simply because
they provide jobs. There can be a huge amount of damage a
bad bank can create. There is a cruelty to our market
system, but that cruelty cannot be eliminated. The
alternative is fraught with danger, that of carrying on
with the weak banks.
How do you think
India has fared against the background of the Asian
turmoil. Why, if at all, is the situation here not that
bad?
India has avoided the worst. The answer is partly in the
fact that the restrictions discouraged both inflows and
outflows of short-term capital. The answer can also be
attributed to the fact that India did not become flavour
of the month too soon, or too long ahead of the crisis
and was a relatively late entrant. For instance, among
the troubled Asian economies, the ones which have been
saved are the late entrants like the Phillippines.
No developing country with large-scale mobility in
short-term capital is immune to these crises. India,
fortunately, did not make the same mistakes. Had the
crisis come, there would have been economic devastation,
and the crisis would have fed on itself.
Look at Brazil. Just a
few months ago, there was talk of the significant
progress there. And now, there's a crisis. But you see,
there is another aspect. I've travelled to a number of
countries recently, and I have told a number of them that
the crisis won't hit them, only to find later that it
had. So, when I say that the crisis won't happen in
India, I might just be wrong.
What is the one
issue which is the basic cause of crises like these?
There's no one issue, really. Take a look at the affected
countries --- you have the whole arc of east Asia, then
you have Brazil and Mexico. The diversities of their
policies and economies is enormous. But after going
through all these things, with great hesitation I have
arrived at this conclusion that there is no other
plausible answer other than temporary capital controls.
Otherwise, staying the course looks impossible.
Debt moratoria, which is one of the suggestions which
have come, looks to be too strong and at the same time
too inadequate. It is not really that external debt is a
crushing burden --- it's not that big an issue. But the
flight of capital has been major. If some variant of the
current policies could work...structural reforms or the
like, that's a judgement call. But it seems to be that
there's little alternative.
When do you think
is the time to impose such controls? I mean, when exactly
should these be brought on?
I would say these should be brought about with an
announcement of an intention to remove them after a point
of time --- say, three years or so. Of course, if it is
found that after the three years, the situation is still
dangerous, then there could be a political price to pay
for continuing with the controls. The controls can be
lifted when it's safe again --- when emerging markets
become popular again.
But I would much want to maintain, for the long term,
prudential inward capital controls. Outward controls are
all right, but inward controls are useful for the long
term.
There's also the
point about crony capitalism...
No, crony capitalism is not the only problem. It's not as
if all the economies suffered simply because there were
corrupt politicians who helped out their cronies and
created rent. There's more to it. Look at Hong Kong. It's
suffering because its exports are now hurt. But there's
nothing wrong with the financial structure. The downturn
in the stock prices has put Hong Kong's banks in some
threat of being underwater. The natural policy answer for
Hong Kong, the financial capital of the region, is to
have its currency devalued, but they don't dare let it go
for fear of a speculative reaction.
How do you read
India's currency management?
I'm a little unwilling to stick my neck out on India,
since I don't know too much about it. Maybe, if I do some
in-depth research on India over two weeks, we can talk
more fruitfully. But yes, the rupee is heavily managed.
Smaller economies cannot have a benign neglect of the
foreign exchange rate.
Unlike the United
States, which ignores the exchange rate. We let it fall
where it goes. To me, India looks a bit like Brazil.
There's a large fiscal deficit, sluggish growth,
unemployment. But on the other hand, it doesn't appear
that the Indian government will raise interest rates to
50 per cent. And the government finances are also not
such that it would get reflected on interest rates paid
on government debt.
For those economies which are already in a crisis, there
is a need for that extra degree of freedom. There is a
need for outward capital controls. It's a bad policy, but
better than the alternative --- that of economic
devastation.
How do you look at
the Malaysian controls?
The Malaysian economy is shrinking. I feel Mahathir
Mohammad's policy is excessive and badly implemented.
It's almost as if these controls are a permanent
solution. But there's room to have some small growth. I
feel Malaysia will see some growth next year. The crisis
situation seems to me a bit like the 1930s. The countries
that broke the rules did better.
There's a perverse, but relevant, point here. Properly
instituted controls may actually end up being welcomed by
investors. See, what are investors really afraid of? All
they are afraid of is each other. It's like I'll keep in
if you keep in. They don't want to stay on unless they
are assured that the other investors, both domestic and
foreign, will stay on. But when I talk of the 1930s, the
comparison is only qualitative and not quantitative. This
crisis has affected a very small percentage of global
GDP.
When will we see
the end of the crisis?
I think there will be a recovery relatively quickly.
Argentina had problems. But it came out of those problems
quickly because the changes were major. Following the
1930s crisis, there was a good recovery. In fact, very
soon, there was a situation near to full employment.
I think there's going to be a pretty good recovery...I
hope so. Not too far away. I think it'll happen pretty
soon.