Archive for November 27th, 2007

4 theories of capital flows

November 27, 2007

I have written a number of posts on the capital flows (the allocation puzzle, capital controls, IMF’s analysis, Rogoff’s view etc). These papers have a single viewpoint and they provide evidence on the same.

However, this excellent paper from Barry Eichengreen summarises all on capital flows in form of 4 schools:

1. Neoclassical school: It believes in basic economics argument that capital flows from low return avenues to high returns. However, what we find is opposite as capital flows from emerging markets (where returns are high) to developed (where returns are low)? So, people believing/criticising this school explain why this happens.

2. Corollary School: It believes capital flows may not have direct benefits but indirect ones like it leads to better corporate governance, deepening of financial markets, better institutions etc. I have discussed this view here.

3. Anti capital Flows: This believes capital flows are damaging to an economy and should at best be restricted. The other way of looking at this school is that it is important to get the sequencing of reforms in fin sector right

4. Asian view:This school believes managing capital flows is tough and looks at possible ways to minimise the problems from capital flows.

He then summarises the key findings in each school and suggests policies for Asian countries that are experiencing huge capital flows. The advice is common – get sequencing right, flexible exchange rates, fiscal prudence etc.

Overall a very good read.

Trichet disappoints

November 27, 2007

I was keenly looking forward to this year’s LK Jha memorial lecture. After all, the lecture was to be delivered by Jean Claude Trichet (President, ECB). The lecture was held y’day and was a sheer disappointment.

The title was pretty good – “The growing importance of emerging economies in the globalised world and its implications for the international financial architecture” and I was expecting some insights from the great speaker. He does not offer any different insights and simply speaks on predicted patterns- Emerging economies are important, their role is expanding etc etc.

Anyways, let’s wait for his future speeches.

Why are foreign banks in India unhappy?

November 27, 2007

Today’s newspapers are buzzing with the speech given by RBI’s Deputy Governor, Mr. V. Leeladhar ( his brief profile is here). He gave the speech at BANCON-2007 (Annual Banker’s Conference in India).

It is an excellent speech and seldom you come across a speech where a Central banker clarifies the position of the Central Bank so clearly.

The speech begins with an excellent history of Indian Banking system and the reasons for  their establishment.

The three Presidency Banks, as these were then known, were amalgamated in January 1921 to form the Imperial Bank of India, which acquired the three-fold role: of a commercial bank, of a banker’s bank and of a banker to the government.

Then he discusses how Commercial banks came under RBI’s purview and why banks are special entities that need to be regulated properly.

However, it is towards the middle the speech gets really interesting where he says the thought that branch expansion and foreign ownership of Banks in India is basically a myth.

He points out to evidence that RBI has been granting higher permissions to set up branches every year compared to previous year but the banks are not utilising their permissions

For instance, as against the a total of 881, 1125 and 1259 authorisations given by the RBI under the old policy regime during 2003-04, 2004-05 and 2005-06, respectively, the number of authorisations issued under the new policy during 2006-07 was 2028.

Even though the banks were granted authorisations to the extent of 97 per cent and 62 per cent of the authorisations sought by them for the years 2004-05 (April-March) and 2005-06, respectively, as at end-March 2007, as much as 30 per cent and 38 per cent of the authorisations granted for those years had still not been utilised, even after more than a year or two of grant of the authorisations. As on that date, the extent of non-utilisation for the year 2006-07 was much higher at 61 per cent when only 69 per cent of the authorisations sought had been granted.

His take on foreign banks ownership is even more interesting. He says that foreign banks enjoy all the privileges which Indian banks enjoy (deposit insurance cover etc) unlike many other countries which discriminate against foreign banks.

Infact, some Indian banks contend that certain amount of positive discrimination exists in favour of foreign banks by way of lower Priority Sector lending requirement at 32 per cent of the adjusted net bank credit as against a level of 40 per cent required for the Indian banks.

He adds under WTO agreements:

licences for new foreign banks may be denied when the share of foreign banks’ assets in India, including both on- as well as off-balance-sheet items, in the total assets (including both on- and off-balance-sheet items) of the banking system exceeds 15 per cent

And in India the share of foreign banks in on and off balance sheet activities is 49%!! This one adds cream to the cake:

Besides the foreign banks, there are also two large Indian private sector banks in which the non-resident ownership is very close to 74 per cent permitted, which could, therefore, be considered as incorporated in India but predominantly foreign owned banks. These banks together with the foreign banks, have a combined market share in the country in the deposits, advances and off-balance-sheet business of 17.46, 18.65 and 76.63 per cent, respectively, which, by no means, are insignificant levels.

He doesn’t name the two banks but media is intelligent and has already analysed (check this and this). He mentions foreign banks have been making more money than the Indian Banks. He also points that foreign trade in goods and services is based on reciprocity and foreign shores have not been very kind to Indian Banks despite well-proven expertise. So why do foreign bankers continue to complaint?

He then also speaks on securitization norms (which most believe has not kicked off in India because of RBI) and principles based regulation. All points are well debated.

I am sure there would be some counter-views from the foreign bankers in some days to come. Keep posted for further developments.

Update: ET Edit criticises RBI after the sppech. I have covered it in seperate post here

Assorted Links

November 27, 2007

1. WSJ Blog says ECB might lower its growth forecasts for next year.

2. Rodrik writes to economics of sweatshops.

3. MR looks at possible reasons on why American kids don’t respect their parents more.

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