Euphoria, mad rush, and ............. crisis ?

The biggest-ever initial public offering completed recently by ICBC, China's largest bank, has brought into focus the problems facing the Chinese banking system, as the euphoria evaporates. According to analysts, reforms in the banking system are a long way from completion and Chinese lenders may be headed towards a crisis if a culture of risk management is not ingrained into the lending practices. A Bloomberg story titled "China's IPO Revolution May Be Long March to Doom" highlights the problems of large bad debts and compares the mad rush for Chinese banks' IPOs with the dotcom era. Here are some excerpts from the story:

Nothing underscores China's financial rise in this century more than this month's share sale by Industrial & Commercial Bank of China Ltd. Those who got a piece of the deal may fancy themselves as winners. They now have a pivotal stake in the China-growth story. Looking under the surface, though, it's hard not to wonder what some of these buyers are thinking. Just as investors who had rushed indiscriminately into dot-com shares in the 1990s regretted it, so may those betting on Chinese banks.

Much of the euphoria surrounds China's efforts to clean up banks saddled with bad debt. The Beijing-based bank, China's largest, faces the challenge of balancing rapid growth against proper risk-screening after a $141 billion government bailout of bad loans. Chinese bank lending jumped almost 50 percent in the first half in a nation that is likely to expand more than 10 percent this year.

Loan growth is impressive, but those new loans are not seasoned yet. Nobody can tell whether there will be another massive bad-loan problem in the future. The question isn't whether China is reducing the bad loans of the past; it's whether sufficient steps are being taken to keep loans made today, tomorrow or next year from going bad.

Why are Chinese banks hot?

The huge interest shown by overseas investors in the initial public offering of the Industrial and Commercial Bank of China (ICBC) highlights the scramble to gain a foothold into the Chinese banking system. ICBC is the largest bank of China and its IPO is all set to become the world's biggest IPO. ICBC plans to debut in Hong Kong and Shanghai on Oct. 27 - the first IPO to be simultaneously listed on both stock exchanges.

The degree of interest in ICBC stock can be gauged from the fact that the entire order book meant for institutional investors had been filled within an hour of the formal solicitation of bids. By the end of the first day investors had placed bids for three times the number of shares on offer and it was nine times subscribed by the close of the next day.

If priced near the top of the range (which is almost certain), the issue will garner US$22 billion, beating the record of $18.4 billion set in 1998 by a Japanese mobile-telecoms operator. The sale will also place ICBC among the ten most highly valued banks in the world, with a market capitalisation close to $130 billion.

ICBC is the latest in a series of massive IPOs launched by Chinese banks during the past year. Bank of China, the country’s second largest lender, raised US$11.2 billion with an IPO that was the fourth-largest on record. China Construction Bank, the mainland's no. 3 bank, raised US$8 billion in October 2005. It’s the strong growth recorded by these banks in the sizzling Chinese economy that is luring the institutional investors. There is a scramble among the financial powerhouses of the world like Goldman Sachs, Morgan Stanley and Citigroup to gain a foothold into the Chinese banking system.

For the investors, these banks are a sort of a proxy for China itself: vast, diverse, growing fast, and with extraordinary scope for internal restructuring. Economist terms the ICBC IPO as a single transaction that could sum up the knowns and unknowns surrounding China's red-hot economy. According to an Economist article, “…ICBC, however valuable, also reflects the murkier side of life in the Chinese economy. Political considerations often come first, information is unreliable, and openness in the banking system is questionable, despite conditions tied to China's entry into the World Trade Organisation.”

Future of Internet – Towards Balkanisation?

Experts have warned that internet could one day be broken up into separate networks around the world. According to a BBC report, Nitin Desai, ‘a leading light in the development of the net’ and chairman of the Internet Governance Forum (IGF), warned that concerns over the net's future could lead to separation and a 'Balkanisation' of the net. He was speaking at a conference in London organised to discuss the development of internet. The conference had been organised by Nominet, the UK body in charge of .uk domain names, ahead of the first-ever Internet Governance Forum to be held in Athens, Greece later this month.

Mr. Desai said there were tensions about the future regulation of the net and over specific issues such as international domain names. Five years from now, there will be many more internet users in Asia than Europe or America and there will be more Chinese web pages than English pages, according to him. People are concerned about whether the system we have now will also work five years from now.

Other speakers at the conference also echoed the concern. Professor Howard Williams of World Bank said the debate around future regulation of the web rested on the assumption that there would be a single web in the future. "Why would the technology we have at the moment be the ubiquitous technology across the world in the future?" he asked, while saying that 'Balkanisation' was already happening. The BBC report titled "Warning over 'broken up' internet" can be accessed at http://news.bbc.co.uk/2/hi/technology/6037345.stm.

The debate on various issues related to internet governance is expected to generate more heat in the coming months. The issues will figure prominently at the forthcoming IGF Athens 2006, the inaugural meeting of the IGF (30th October – 2nd November). IGF is a body set up by the UN to accommodate multi-stakeholder policy dialogue in the field of internet governance. It seeks to bring together all stakeholders - states, private sector and civil society. Inaugural Meeting of the Forum will focus on the overall theme of “Internet Governance for Development” and the sub-themes of “Openness” (freedom of expression, free flow of information, ideas and knowledge), “Security” (creating trust and confidence through collaboration), “Diversity” (promoting multilingualism and local content) and “Access”(internet connectivity: policy and cost).

THE ABC OF SEZ
What is Special about SEZs, China's experience, the Indian experiment, the politics and the economics ...

A Special Economic Zone (SEZ) is a geographical region where economic laws are more liberal than a country's typical economic laws. SEZs are set up with a view to increasing investments – typically foreign investments - and promoting exports, by offering privileged trading terms. Usually an SEZ is designated as a duty free enclave and treated as foreign territory for the purpose of trade operations, duties and tariffs.

SEZs have been established in many countries like China, India, Philippines, Russia, Iran, Jordan, Poland, Kazakhstan and North Korea at varying scales and with varying degrees of success. In India, the government’s big bang approach to push through a large number of SEZs has generated lot of heat and triggered a nation-wide debate on the costs and benefits of SEZs, including the issues like social displacement caused by large-scale conversion of agricultural hinterland into industrial belts.

International experience with SEZs has shown that by offering various incentives, SEZs can attract investment and foreign exchange on a large-scale, generate employment and boost infrastructure and technological development. However, critics claim that SEZs attract investments only by offering distortionary incentives rather than building underlying competitive conditions. These incentives create a fiscal burden on the taxpayer and hurt environmental and labor standards. In addition, critics argue that the direct and indirect costs of maintaining zone privileges do not benefit the rest of the economy and, instead, lead to “out-of-bound” enclaves of prosperity. It has been widely recognized that promotion of SEZs in the context of an overall strategy to promote economic development, active linkage programs and adequate social and environmental safeguards are necessary to reap the maximum benefits from SEZs at the minimum cost to the society.

China's Experience
The Chinese model of SEZs has been very successful and SEZs there have been considered as remarkable contributors to the miraculous economic growth of the country. The dragon’s success story has inspired many other countries, including the other Asian giant India, in their pursuit of foreign investment and export-led growth. A brief on how China did it.

China started the SEZ experiment as early as 1980s as part of the broader economic reforms and opening-up policy. The first group of SEZs was set up in Shenzhen, Zhuhai & Shantou in Guangdong province and Xiamen in Fujian province - all located in costal areas of Southeast China. This was followed by other 10 costal cities, Hainan Province and Pudong area in Shanghai. To further build on the success of these SEZs, China went on to establish “Economic and Technological Development Zones” (ETDZ) on similar lines. Compared to SEZs which were developed in the whole city (sometimes whole province), ETDZs are developed on relatively small geographical areas earmarked in coastal and other open cities. The overall development of SEZs in China has moved along the following 3 dimensions: extending from SEZs to ETDZs; stretching from east costal region to inland middle and west region; upgrading from fundamental industries to hi-tech industries..

The Indian Experiment
Government of India embarked on the path of economic liberalisation way back in 1991, with foreign investment as one of the foundations of economic policy. However, it was only in 2000 that a policy on SEZs was formulated.

The objective of the policy is to facilitate setting up of SEZs, with a view to providing an internationally competitive and hassle free environment for exports. The policy provides for setting up of SEZs in the public, private or joint sector and envisages a lead role for the state governments, in line with the general trend of decentralization in governance and policy implementation. SEZ units may be for manufacturing, trading or service activities.

The SEZs are designated as a “duty free enclave” and will be treated as foreign territory for trade operations and duties and tariffs. The privileges include no license requirement for imports, exemption from customs duty on import of capital goods, raw materials, consumables, spares, etc., exemption from central excise duty on procurement of capital goods, raw materials, consumables, spares, etc. from the domestic market, reimbursement of central sales tax paid on domestic purchases, 100% income tax exemption for a block of five years, 50% tax exemptions for two years and upto 50% of the profits ploughed back for next 3 years, and 100% foreign direct investment allowed in manufacturing sector through automatic route barring a few sectors.

SEZs currently operating in India are located at Kandla and Surat in Gujarat, Cochin in Kerala, Santa Cruz (Mumbai) in Maharashtra, Falta and Manikanchan - Salt Lake in West Bengal, Chennai in Tamil Nadu, Visakhapatnam in Andhra Pradesh, Noida in Uttar Pradesh, Indore in Madhya Pradesh, and Jaipur in Rajasthan. In addition, numerous SEZs are at various stages on development in various parts of the country.

The current debate on the potential revenue loss, the accusations of “land grab” by real estate operators in connivance with politicians and middlemen and the sharp political divides on the issue (there are differences even within the government) are likely to slow down the development of SEZs in the near term. This may actually be an occasion to look at the issues afresh and tighten the policies so as to harmonise the whole process with the broad goals of economic development.

Putting people into economic models

American economist Edmund S. Phelps has won this year’s Nobel Prize in Economics for his work on the trade-offs between unemployment and inflation. The prize represents a return to a more traditional economic approach, after last year's award to game theorists Thomas Schelling and Robert Aumann.

The Royal Swedish Academy of Sciences said his work had "deepened our understanding of the relation between short-run and long-run effects of economic policy." In its citation announcing the award, the Academy said that Phelps had advanced the understanding of the trade-offs between full employment, stable pricing and rapid growth, all of which are the central goals of any sound economic policy. "He has emphasized that not only the issue of savings and capital formation but also the balance between inflation and unemployment are fundamentally issues about the distribution of welfare over time," the academy said. "Phelps' analyses have had a profound impact on economic theory as well as on macroeconomic policy."

In his research, Phelps showed how low inflation today leads to expectations of low inflation in the future, thereby influencing future policy decisions by corporate and government leaders. His research suggested that inflation was not a cause of unemployment but there was a base level of unemployment in the economy that helped keep prices steady. Phelps' framework helped central banks shift their focus towards using inflation expectations to set monetary policy rather than concentrating on money supply and demand.

Professor Phelps said of his work: "I tried to put the people back into our economic model and in particular to take into account their expectations about what other economic actors are doing at the same time and in the future."

Who is afraid of SEZs?

It’s not just Sonia Gandhi who is worried about the development of Special Economic Zones (SEZs) in India and its immediate political fallout. The debate on SEZs is getting hotter and hotter with criticism coming in from various quarters, including the Finance Ministry and the Reserve Bank of India. Even Prime Minister Manmohan Singh recently asked the states, without mentioning SEZs, to go slow on offering sops to drive industrial development. “The jury is still out on whether these policies (incentives) really promote industrial growth” said the Prime Minister.

The ever-growing list of powerful people questioning the way SEZs are conceived and being developed in the country has turned the focus on the whole range of issues from the long-term social and economic consequences to revenue implications, uneven development and sacrifice of prime agricultural land to boost industrial growth. Although SEZs are expected to boost investments, industrialization and exports in a big way, the costs and benefits need to be weighed carefully.

Finance Minister has expressed concerns over the loss of tax revenue due to the sops offered to the SEZs. RBI has also cautioned the government on potential revenue loss saying that the incentives may be justified only if the SEZ units ensure forward & backward linkages with domestic economy – and this is a big ‘if’. Acting on its view, RBI has already announced guidelines to banks that will make it difficult for them to lend to the SEZs in a big way. Financing of SEZs will be treated like commercial real estate lending, attracting higher risk weight for the purpose of capital adequacy. This means banks will have to set aside a larger capital for such lendings as compared to other assets.

Another worry is that the mushrooming of SEZs would aggravate the widening inequality in India - both in terms of individual income levels and national infrastructure. The IMF Chief Economist Raghuram Rajan has warned: “Not only will [the SEZs] ... make the government forgo revenue it can ill afford to lose, they also offer firms an incentive to shift existing production to the new zones at substantial cost to society.” Given the way large corporates are rushing to grab the 'sweetheart' deals offered by the state governments, the ‘land grab’ in the name of SEZs is going to badly affect the livelihood of a large number of farmers. Swathes of prime agricultural lands will be converted into ‘islands of prosperity’ and the affected farmers will definitely not be in a position to transition to the jobs created in these ‘islands'.

The issue of “land grab” has turned out to be the most controversial aspect of the SEZs, also politically the most sensitive one and perhaps the last straw on the proverbial camel’s back. This is the issue that has caused sharp political divides and forced a re-look at the entire gamut of the planning and development of SEZs. The international experience with SEZs has shown that only large SEZs are likely to succeed and that for every successful SEZ ('Shenzen’ is the name that comes to mind immediately) there are numerous failures. Clearer guidelines are needed for land acquisition and compensation to farmers. The possibility of using barren and wasteland - of which we have plenty - for setting up of SEZs, rather than fertile agricultural land, should be explored.

Bangkok Bomb - the Coup and the Road Ahead

As the newly ‘appointed’ prime minister, retired Army General Surayud Chulanont has assumed office in Thailand, the world is eagerly watching as to what lies ahead for the young Asian democracy. General Surayud replaces Thaksin Shinawatra, who was ousted in absentia in a bloodless coup over charges of corruption, shady business deals and abuse of power. The coup, led by General Sonthi Boonyaratglin and endorsed by the country's beloved monarch is the first in fifteen years and sets the clock back on evolution of democracy in a country that has a long history of military coups. The coup leaders, however, portray themselves as democracy-friendly, have pledged to return power to the people and say Thaksin's ouster was necessary to rid the country of the political uncertainties that had come to paralyse it since the beginning of this year.

Thaksin, a billionaire-business-tycoon-turned-politician, had a strong political mandate and enjoys immense popularity among the rural masses primarily due to his successful social welfare and health care schemes. Having won a landslide re-election in February 2005, he was forced to dissolve the Parliament only a year later in view of protest rallies triggered by the controversial sale of his family-owned telecom company to a group led by Singapore's Temasek Holdings. There has been no respite for the beleaguered ‘hero’ since then. The snap polls held in April this year were invalidated by the courts on grounds of electoral fraud. Although Thaksin's Thai Ruk Thai party was widely expected to win the fresh elections scheduled for October 15 owing to his rural support base, the political climate was increasingly getting divisive and it's in this context that the coup has been seen in Bangkok as a relief.

A major criticism against the ousted prime minister has been his approach in handling the sectarian violence in the restive south. The predominantly Muslim provinces of Narathiwat, Pattani and Yala have been affected by insurgent movements for “independence”. Thaksin Shinawatra adopted a confrontational approach – to fight the insurgency by force and refused any talks with the local Muslim leaders on any kind of political settlement.

Gen. Sonthi, belongs to the Muslim community in Buddhist-majority Thailand and this puts on him a responsibility to bring his fellow-Muslims into Thailand's mainstream and to find a credible political settlement of the problem of "Muslim insurgency" acceptable to the country as a whole.

General Surayud Chulanont is a respected figure, known for his integrity. He has been chosen for his ability to work with all sections of society, to ensure that the political situation is stabilised. General Surayud has said he will focus on national reconciliation and people's happiness.

Going ahead, the interim Prime Minister faces the challenge of promoting reconciliation with Thaksin supporters and reaching out to democracy advocates, while keeping the support of the military. Putting Thailand's democracy back on track and strengthening of political institutions will be a daunting task for him. It needs to be seen how much independence he will have in dealing with the tasks ahead. On the economic front, General Surayud has said he puts healing social divisions before boosting economic growth and indicators of people's happiness are more important than GDP numbers. But he can ill-afford to ignore the realities and challenges of the global economy.

There are considerable powers in the hands of the coup leaders in terms of the interim arrangement now in force. General Sonthi will have the power to appoint or sack the government. He will also appoint the members of the People’s Assembly that will start work on a new constitution. It will be important for revival of democracy that the process of drafting the new constitution is transparent and representative.