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'Deceleration due to domestic factors, not Asian crisis'

The deceleration of the overall growth rate of Indian economy in 1997-98 was mainly due to domestic factors like decline in agricultural production and slow growth in industrial output and not due to the economic crisis in east Asia, according to Dr Tarun Das, economic adviser, Union finance ministry.

Presenting a paper on "East Asian Economic Crisis and Lessons for Debt Management" at an international conference in Thiruvananthapuram, he said external factors had only marginal impact on the country's growth rate as the dependence of gross domestic product on external trade was very limited.

The Indian economy had demonstrably withstood the firestorm of capital flight from emerging economies because of its sound macro-economic management, strict fiscal prudence and monetary discipline, liberal policy of foreign direct investment and firm control on short-term external borrowings, he added.

Dr Das said the Asian crisis had highlighted the importance of a sound macro-economic policy framework and the dangers of unsustainable large current account deficits. The basic lesson from the crisis was that, the sooner the problems were identified, recognised and properly treated, the better the chances for being successful and the smaller the economic and social costs involved.

Dr Das said the odds for the occurrence of a financial crisis could be reduced by better macro-economic fundamentals, complemented by appropriate legal, regulatory and institutional set-up for effective prudential regulation, monitoring, surveillance and supervision of the financial system and improved corporate governance. These entail structural reforms with an unavoidably long-time scale.

The main responsibility for taking appropriate measures to contain the economic damage lies with the countries directly affected. Hesitation in the implementation of required adjustments and reform measures could only worsen the crisis, cause markets to overshoot even further and exacerbate contagion effects.

He said the crises occur due to the weak banking and financial system, which has constrained the monetary authority in conducting monetary policy and banking supervision as well as facilitating payments system.

A few lessons for the financial sector reforms were now evident. First, worst time to reform a financial system was in the middle of a crisis. Second, when currency turmoil was associated with financial difficulties, raising interest rates over an extended period might simply worsen the situation by bringing about widespread corporate and bank insolvency. Third, currencies should not be left to sink while funds were used to bail out the international creditors, he added.

Dr Das said monetary policies need to be kept sufficiently firm to resist excessive exchange rate depreciation through adequate increase in interest rates, its inflationary consequences and downward pressures on partner countries' currencies.

For economies with large amounts of short-term external debt, it was particularly important that monetary conditions provide adequate incentives for the private sector to roll over short-term foreign loans in the face of the increase in risk premium.

Generally, a tight monetary policy was required to defend a currency which is under severe downward pressure. Higher interest rates not only raise return on investment from assets denominated in foreign currency thus encouraging inflow of foreign currency assets, but also reduce speculative demand for foreign currency by making it more expensive. Tight monetary policy also reduces domestic demand and expectations of future inflation and helps to support the exchange rate.

He said, however, tight monetary policies increase the debt burden in domestic currency and the fiscal deficit, which may put downward pressure on the exchange rate when foreign lenders and investors perceive greater credit risks.

Therefore, a tight monetary policy might be avoided as far as possible or might be used only temporarily in an economy with relatively large domestic debt burden. Short periods of relatively high interest rates were, however, might be needed to stabilise wide exchange rate fluctuations when speculative demand was high and confidence lacking.

Dr Das said fiscal policies need to contribute to the mobilisation of domestic savings and encourage the flow of non-debt creating financial flows, thereby reducing the country's excessive reliance on foreign debt.

More effective structures for orderly debt workouts, including better bankruptcy laws at the national level and better ways at the international level of associating private sector creditors and investors with official efforts were needed to help resolve sovereign and private debt problems.

Fiscal policy needs to strike a balance between different objectives such as growth with stability and economic justice. It should protect the interest of the vulnerable sections of the society, expand the social safety net, accommodate costs of financial sector restructuring and relieve the burden of the current account adjustment on the private sector.

He said international economic and financial cooperation was essential to contain the crisis. The major advanced economies should seek to maintain supportive conditions in international financial markets. Particularly, in Europe and North America, there might be a need for timely monetary easing to arrest an escalating downturn.

Collaboration and consultation at the regional and bilateral levels would also contribute to the prevention of financial crisis. Their potential role was particularly important with respect to the prevention of currency disorders and contagion effects, he added.

UNI

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