Moody's Report

Asian Crisis - Lessons Learnt and Not Learnt

The Asian crisis, which broke out a decade ago, taught observers many lessons but also raised questions that either have uncertain answers or have yet to be answered at all, says Moody's Investors Service in a new report as part of its "International Policy Perspectives" series. The report, entitled "The Asian crisis: what we know, what we think we know and what we do not know", presents Moody's perspective on how the crisis has added to global knowledge of economics and where it has not allowed firm conclusions to be drawn.

"Ten years after the Asian crisis, there are at least three key issues on which we still do not know enough. The understanding of these issues has improved, but not to the point of providing full comfort in terms of risk assessment," says Pierre Cailleteau, Chief International Policy Analyst at Moody's and author of the report. "Probably the most critical issue is the difficulty of disentangling structural from cyclical factors. This stems from the fact that the world economy is undergoing a dramatic change -- probably one of the most important in its history."

Mr Cailleteau also argues that contagion dynamics remain largely undecipherable. This is an issue that interests investors, because of potentially unexpected portfolio correlations, as much as policymakers. In a way, the reflection on contagion prompted a look at the demand side of the capital market -- who finances what and on which basis -- in addition to the more traditional approach based on the supply side -- i.e. the issuer of financial claims such as governments.

The third issue flagged in the Moody's report as one where knowledge is currently insufficient is political risk. "A final lesson is that we don't know how to anticipate political crises. More precisely, while the risk of political turbulence can be foreseen, the unfolding scenario of a political crisis is unpredictable," advises Mr Cailleteau, who notes that this is more a constant in history than a product of globalisation.Moody's new report cites the "lessons that we think we know" as the realisation (i) that current account imbalances raise concerns, although they do not always end in disaster; (ii) that periods of boisterous financial liberalisation often, but not always, lead to problems; and (iii) that local currency debt is generally "better" than foreign currency debt.

"All in all, the situation of emerging market economies has improved considerably since the 1997 crisis, spurred by a strengthening of liquidity positions, the diffusion of a risk management culture -- practices have improved, broadened and converged across the financial industry and the public sector -- and an intensification in trade integration," says Mr Cailleteau. "These are the three lessons that have been learnt. The repeat of an Asian crisis is thus very unlikely and it will require more imagination to determine how and when risks will coalesce and degenerate into the next crisis.

Source - Asian Banker

What can IT Industry do for India?

IT industry's contribution to the resurgence of India as a major economic power on the global stage need not be over-emphasised. What can it do for the transformation of Indian society? And, why should we burden the industry with a 'social obligation' ? Why should it be expected to do more than what happens automatically from its normal business operations ?

These are some of the questions which Amartya Sen dwelt upon in his Keynote Address at the NASSCOM 2007 India Leadership Forum in Mumbai earlier this month on "I.T. and India". He talked about the possibility of the IT industry to reach out beyond its traditional domain. While acknowledging the enormous contributions made by the industry, the nobel laureate emphasised that it can do even more, indeed in some ways, much more.

"This is partly because the reach of information is so wide and all-inclusive, but also because the prosperity and commanding stature of the IT leaders and activists give them voice, power and ability to help the direction of Indian economic and social development."

Full text of the address is available at The Hindu website. This is a must read for all Indian IT professionals. I am highlighlighting some important points from the lecture.

Amartya Sen has elaboarted on the connections between the success of IT in India and some particular features of India's past - intellectual traditions of Indian society that have tended to support the pursuit of specialized excellence, a general attitude of openness influences from far and near, etc.

Social obligations of the IT industry go beyond the very obvious charitable activities such as building hospitals, research centres and other social institutions which have traditionally been performed by Indian industry, including many of the major IT leaders. As information is key to societal change, the IT industry can take a central role in this regard and make a big difference.

"As it happens the key to the success of IT, namely accessability, systematization and use of information is also very central to social evaluation and societal change. There is, in fact, a very foundational connection between information and social obligation, since the moral - and of course the political - need to pay attention to others depends greatly on our knowledge and information about them."

........"This foundational connection also gives the information industry a huge opportunity to help India by trying to make its contribution to the systematization, digestion and dissemination of diverse clusters of information in India about the lives of the underdogs of society - those who do not have realistic opportunity of getting basic schooling, essential health care, elementary nutritional entitlements, and rudimentary equality across the barriers of class and gender. This can also be said about problems of underdeveloped physical infrastructure (water, electricity, roads, etc.), as well as social infrastructure, that restrain the broad mass of Indians from moving ahead. There are particular causal connections also here: an enterprise that hugely depends on the excellence of education for its success - as the IT sector clearly does - has good reason to consider its broad responsibility to Indian education in general."

Strong Q4 Growth in Japan, Doubts Still Persist

Japan's economy has posted better than expected growth in the last three months of 2006. The annual rate of 4.8% recorded in the quarter is the fastest rate in almost three years and has been driven by resurgent consumer spending and capital investment in factories and equipment. Consumption, which makes up more than half of Japan's gross domestic product, rose 1.1% from the previous quarter, rebounding from an equal drop in the July-September period. For the whole of 2006, Japan's GDP grew 2.2%, up from 1.9% in 2005 and down from 2.7% in 2004. Private consumption in the year increased 0.9 percent, down from the 1.6 percent rise in the previous year.

However, doubts still persist regarding strength of the economic recovery. The economy is witnessing its longest expansion since second world war after stagnating in the 1990s. The 5-year expansion seems to be losing steam as growth rates have been stuck in low gear. The Bank of Japan's policy board meets on 20-21 February and the opinion is divided on whether or not it will go for a rate hike.

The country's central bank is waiting for stronger signs of growth and particularly a rise in inflation. The Bank of Japan raised interest rates by a quarter percentage point last July ending the long period of zero rates and would like to raise them further to a more normal level, but signs of strong growth and inflation have proved elusive on one hand and the govenement has shown an inclination for cotinuance of low interest rates, on the other, to keep the economic recovery on track. Meanwhile, Japan's trading partners, notably European nations, have shown concern on the continued weakness of the Japanese curency Yen and would like to see Japanese interest rates being raised to counter this and protect their trade interests.

Related Posts

Bank of Japan's Assessment of Economic & Financial Developments (Jan 2007)

Politics and Economics of Interest Rates (Jan 2007)
Japan Interest Rates on Hold - for Now (Nov 2007)
Japan's Growth Beats Forecasts, Rate Hike May Come Sooner (Nov 2006)

The Surging Inflation - Other Views

India growth story is hot. And, so are the debates on soaring prices and overheating. As the government is trying its best to dowse the inflation and the political heat it has generated (and RBI doing its part on the monetary side), I decided to check out what the blogging community is saying on this. Are rising prices a necessary side-effect of high growth which we must learn to live with or are they symptoms of a deeper malaise? Why has the government not succeeded in containing the prices despite a series of measures over last few months? What should be done immediately? What should be done in the longer run? How to address the supply bottlenecks?

I came across some very good pieces on the subject. The common thread running through most of the discussions on the blogosphere is about supply side constraints especially those relating to agriculture commodities. It's interesting that many of them refer to onions. The ubiquitous onion seems to have become a symbol of price rise affecting common man and having a potential to affect electoral politics.

I am prividing links to two of the blog articles that I found interesting.

The first one is Inflation + Price of Onions. Kamla Bhatt in this post says that infrastructure bottlenecks should be adressed, as lack of food is not an issue as much as lack of an effective distribution channel.

"Inflation is on the rise and you can see it all around you. Price of onions, wheat, oil have all been climbing northwards and have hit the pocket book of many consumers. The economy is overheated and there is no question about that. ...There is no question that infrastructure is one of primary bottlenecks in India. If the infrastructure bottleneck is addressed it will lead to swifter movement of goods and reduce the transportation costs and the overall cost of products."

The second post is from "chutney spears" How to solve inflation in India? The author Shivaji Das talks about the signs of high prices as experienced in an Indian city. In a lighter vein, he offers some suggestions for controlling inflation, including putting curbs on the Bacchan family’s visits to temples to pray for happy marital life for Aishwary-Abhishek and firing the people publishing such high inflation numbers.

Please give your opinion on this.

Inflation defies monetary and fiscal measures, uptick continues

The annual wholesale price index-based inflation continued its upward march, touching 6.73 per cent for the week ended February 3, up from the previous week's 6.58 per cent. The contributory factors remain the same - pulses, cereals, vegetables and non-vegetarian food articles within primary articles, besides Manufactured Products including cement, steel and machinery items. The inflation estimate for the week ended Dec. 9 has also been revised to 5.63 percent from 5.32 percent. The government revises the inflation rate with a lag of two months on additional price data.

The continued 'pincer movement' - the strategy adopted by the government and monetary authorities to fight inflation from both supply side and demand side - has so far not delivered desired results and we may be approaching a stage where all the weapons in the armoury are exhausted.

To tackle the demand side (i.e. inflation arising from rapid growth and credit expansion), the central bank has been tightening the monetary policy. The most recent monetary policy measures include hike in repo rate and cash reserve ratio in quick succession. The Indian economy is expected to expand at a record 9.2 percent in the year ending March 31, following a 9 percent growth last year. Bank loans increased more than 30 percent in each of the past two fiscal years, outpacing the 23 percent growth in deposits.

The central govenrment, on the other hand, has taken a series of steps to address the supply side constraints. These include ban on export of items wheat and milk powder, lifting restrictions on import, reduction in customs duties, invoking restrictive storage laws and delisting a couple of essential commodities from the futures trading exchanges. The latest one is a cut in petrol and diesel prices.

Though all these fiscal and monetary measures will act with a time lag and may help contain the spiralling prices, these may be 'too late, too little' - especially the fiscal measures, monetary tightening measures beyond a point are not desirable as they will hurt the economic growth. On fiscal side, more needs to be done in the immediate term. And, much more on a long-term basis to improve the farm output.

Business Line editorials on the suject

De-fuelling inflation

Weaponless in price war

Related posts on AKT on Markets

War on inflation intensifies - CRR raised again

RBI raises repo rate

THE NEW HINDU RATE OF GROWTH
Indian economy is on a high growth trajectory
CSO has upped the FY07 growth forecast to 9.2%


Indian economy is expected to grow by 9.2% in the current financial year ending March 2007, driven by robust growth in manufacturing and services sectors.

This will be the fastest rate in 18 years and follows a strong 9% growth in the previous year, according to the Central Statistical Organisation (CSO). The highest-ever growth rate of 10.5% was recoded in 1988-89, but it was preceded by two low-growth years on account of drought (3.8% and 4.3%). The current boom marks the best-ever growth phase in recorded history. The growth story is largely being led by industry (more specifically, manufacturing) and services. While industry as a whole is expected to grow by 9.9%, the corresponding rate for manufacturing is 11.3%. The services sector is set to expand by 11.2%,

Agriculture languishing
While industry and services sectors are booming, the agriculture sector remains an area of concern. The sector which employs about 60% of the population is expected to expand by a mere 2.7 % on top of the 6% growth last year. Agriculture's share in the economy has been consistently declining – it would account for about 18.5% of GDP, down from the 23.9% in 2000-01 and 32.2% in 1990-91.

The past four years of sustained high growth have generated a great deal of euphoria and optimism on one hand and fears of overheating on the other hand as the economy moves into unchartered territory. Raising the farm output will be key to sustaining the high level of growth and spreading the benefits of economic boom to different sections of the society.

Impact of rating upgrade by S&P

S&P has raised India's sovereign debt rating to investment grade in view of the country's strong economic outlook, its rising foreign exchange reserves and the depth of financial markets.

The Indian economy has registered an average growth of over 8 percent in the past three years and is expected to grow at a record 9 percent in the current fiscal year ending March 2007. The rating upgrade from BB+ to BBB- is an acknowledgement of the improved fundamentals of the economy. According to S&P, gradual reforms and consistent monetary and fiscal policy stances have sustained macroeconomic stability and India's huge foreign-exchange reserves provide a buffer against changes in investor confidence.

Although the rating upgrade should attract more overseas funds into the economy and enable corporates to raise funds at better terms, it is largely seen as a (long overdue) affirmation of what has already been factored in by global investors. The bullishness on the Indian economy has been attracting large capital inflows in the equity market pushing the market to record highs. Hence it may not have a dramatic effect on the level of capital inflows.

The information on which this is based has been known and factored in, still the rating upgrade lends credibility to the continuance of the India story. Now that all three major rating agencies S&P, Moody’s and Fitch have an investment grade rating on India, more long-term and stable money such as pension funds can invest in Indian markets with greater confidence. Many such funds have the mandate to invest only in investment grade papers. On the other hand, medium-sized companies will benefit from the improved rating and they will be able to borrow abroad at lower rates (bigger companies already enjoy good pricing power in respect of their global bond issuances).

ABC of SEZ

The controversies surrounding the special economic zones refuse to go, as the land acquisition and rehabilitation issues continue to haunt. Government has now decided to put on hold clearances for new SEZs until new a rehabilitation policy is in place. A Times of India editorial on the subject (Jan 20, 2007).

The Centre has been forced to put on hold clearances for new special economic zones (SEZs). The SEZ policy has attracted controversy since it was first announced in 2005. The government's reason for the present pause is that it would wait for the national rehabilitation policy to be in place before allowing new SEZs. On the face of it, it is a sensible decision since large tracts of land are expected to be acquired by the government for SEZs. This is bound to force thousands of people out of their homes and present livelihoods. In the absence of a proper rehabilitation policy, resettlement of SEZ oustees would become a tardy affair. Already, the government is facing the heat in places where land has been acquired.

The opposition to SEZs is taking the shape of a loose coalition of disparate outfits ranging from grass-roots activists, including Medha Patkar and former prime minister V P Singh, to NGOs and even Left extremists. Sections of the political mainstream, including those within the Congress, are worried about the SEZ policy. The groundswell against land acquisition has been exploited by opposition parties at the local level to target the party in office. It is obvious that the Centre would not like the SEZ policy to become a magnet for opposition parties prior to assembly elections in Punjab and Uttarakhand, which have Congress governments.

That some of the vocal opponents of the SEZ policy have been valuable allies of the UPA during the 2004 elections would add to Congress's discomfort. The trouble over the SEZ policy is another indication of the flawed nature of Indian democracy. Policies are announced by the government without carefully studying their implications. In the case of the SEZ policy, the government should have worked out a consensus with all the political parties and civil society organisations. A top-down approach to development is fraught with the danger of alienating the state from even the intended beneficiaries. It is not too late to change. In the case of projects that are land-intensive, a dialogue with people who reside and live off that land is essential. The government needs to look at them as stakeholders in the project and treat them as venture capitalists, their capital being land. Fears of home and livelihood loss have to be addressed at various levels if the necessary, and inevitable, industrialisation of the Indian economy has to happen. Before setting out to implement the SEZ policy, the government should have followed the ABC of governance; it ought to have gained the trust of the people.

China’s red hot growth continues

China's economy expanded by 10.7% in 2006, topping the 10.4% growth recorded a year earlier and marking the fastest growth since 1995 and fourth consecutive year of double digit growth. The stronger-than-expected growth was largely fuelled by booming exports, stronger retail sales, a manufacturing boom and huge investments in new buildings, roads and cities. There are concerns that the blistering pace of growth may be unsustainable. Government has taken a series of measures to cool the economy like raising interest rates and pressuring banks to temper lending. Given the continued growth, further interest rate hikes may be on the cards. Slowing down over-investment in certain sectors of the economy like real estate and preventing stock market bubble are major challenges which the Chinese economy has been grappling with. China is also under intense pressure to allow its currency to appreciate more quickly against the dollar in the hopes of easing the country's mammoth trade surplus with the United States. The Yuan has been steadily appreciating against the dollar, strengthening to 7.77 yuan to the dollar from 8.26 in 2005. Besides the economic challenges, the enormous economic growth has also given rise to growing inequality and simmering social unrest.

BRIC by BRIC – Tier II Emerging Markets

Emerging markets have been the darling of portfolio and foreign direct investors in recent times, with the whole world recognising their growing importance in the global economy. Particularly, the so-called BRIC economies - Brazil, Russia, India and China – have attracted the lion’s share of investment inflows. The term BRICs which caught the imagination of the world was coined by Goldman Sachs in a 2003 report, which predicted that these four rapidaly developing economies will eclipse most of the current richest countries of the world by the year 2050.

The BRICs economies having established themselves as the future superstars, the search for more emerging stars is on as a larger part of the earth’s population is getting involved in the mainstream of the global economy. Investors and multinational firms are seeking opportunities in a number of smaller investment destinations that offer just as much, if not more, opportunity. Economist Intelligence Unit, in a recent study focused on tier II emerging markets, observed that more and more companies are including the second tier emerging markets in their corporate strategy.

The second tier emerging markets include countries of South-East Asia, such as Vietnam and Indonesia; those of Eastern Europe, such as Poland and Romania; those of Latin America, such as Mexico and Venezuela; and countries of Africa, such as South Africa and Nigeria. Here are some of the major findings of the Economist study.

• Second-tier emerging markets are becoming an established part of corporate strategy.
• Companies see these markets as sources of growth. Access to low-cost labour and resources is also an attraction.
• Poor rule of law remains a significant barrier to investment. Dealing with governments and regulators, poor rule of law and weak regulatory regime were identified as a significant challenge, poor infrastructure being another problem.
• Asia-Pacific is seen as the greatest source of opportunity.
• Improving relationships with local governments seen as the best way to manage risk.

Who are the hottest of them all?
Top five countries which are perceived as offering the best investment opportunites are Vietnam, Mexico, Indonesia, Poland and Romania. A brief about what makes these attractive and what are the risks and challenges.

Currently, investment in Vietnam is centred around heavy industry. Light industry, construction, hotels and tourism, and transport and telecommunications are also important sectors and with rising cost of labour in China and India, companies are looking to Vietnam as an outsourcing destination for IT services. Vietnam’s attractiveness as an investment destination is expected to increase with its entry into WTO.

In Mexico, NAFTA has been a major driver of foreign investment and electronics, computer and automotive industries have traditionally received the majority of FDI. Going ahead, substantial progress will be required on fiscal reform, labour reform and liberalisation of sectors such as telecommunications and energy, in order to realize the country’s potential as an investment destination.

Indonesia’s wealth of natural resources, particularly in the extractive sectors, has provided the main attraction for foreign investors. While mining and hydrocarbons sectors have been the largest recipients of FDI, pulp and paper, chemicals and financial sectors have also received significant inflows. In order to maintain its attractiveness, Indonesia will need to move fast on the financial, legal, regulatory and bureaucratic reforms, labour reforms and improvement in infrastructure.

Most of the foreign investment in Poland has come from companies headquartered in EU member countries. Manufacturing and financial sectors have the major beneficiaries. The attractiveness of Poland as an investment destination looks set to increase over the near term, with improvement in macroeconomic environment, relatively slow growth in wages and rapid growth in productivity.

Romania’s advantages as a location for investment include a domestic market of about 22m consumers and the potential—partly owing to a good geographical position at a crossroads of traditional trade routes—to emerge as a regional hub. It has a comparatively cheap and skilled workforce and a diversified industrial structure that allows intermediate inputs to be bought locally. The main concerns for foreign investors in Romania are the legal and regulatory systems, which remain unpredictable; excessive red tape; and the state's failure to ensure the uniform enforcement of the law.

Hong Kong is the world's freest economy

Hong Kong has been ranked as the world's freest economy for 13th year in a row by the Heritage Foundation because of its low taxes, openness to investment and lack of trade tariffs. The Asia–Pacific region is home to the top three economies on the index of economic freedom, with Singapore and Australia occupying the second and third positions respectively. United States, New Zealand, United Kingdom, Ireland, Luxembourg, Switzerland and Canada come next on the list. Burma, Zimbabwe, Libya, Cuba and North Korea are at the bottom of the list that covers 157 countries. The economic powerhouses of tommorrow - the so-called BRICs countries fare poorly on economic freedom, with Brazil at 70, India ao 104, China 119 and Russia 120.

The Heritage Foundation, a conservative Washington-based public policy research and advocacy group, produces the index of economic freedom in conjunction with the Wall Street Journal. The index, which measures 10 categories of economic variables, gives an indication of the level of governments' intervention in their country's economies. The 10 categories covered in the index are business freedom, trade freedom, fiscal freedom, freedom from government, monetary freedom, investment freedom, financial freedom, property rights, freedom from corruption and labor freedom. The average score (0 equals repressed, 100 equals free) was 60.6%, down slightly from last year but the second-highest since the survey began in 1995.

The report can be accessed at http://www.heritage.org/research/features/index/

Bank of Japan's assessment of economic & financial developments

The Bank of Japan’s policy board in its two-day meeting that concluded on 18th January decided, in a 6-3 vote, to keep its benchmark interest rate steady at 0.25 percent. This was seen as an apparent about-turn from the recent public remarks made by the bank authorities giving the impression that a rate hike was imminent. The decision has generated intense media scrutiny with concerns that the central bank may have caved in to political pressure to move slowly on monetary tightening. The political establishment has expressed concerns that raising rates too quickly might choke off the nascent recovery, as the economy faces weak consumer spending and no clear signs of inflation.

In its Monthly Report of Recent Economic and Financial Developments January 2007 released on 18th January, BoJ has said that the economic developments so far have deviated slightly downward from the expectations as outlined in the bank’s outlook presented in October 2006, mainly due to weaker-than-expected private consumption. Looking ahead, the bank expects that the economy will develop broadly in line with the outlook, as a virtuous circle of production, income, and spending is likely to remain intact. Here's the text of the report.

Japan's economy is expanding moderately. Exports have continued to increase, while public investment has been on a downtrend. Business fixed investment has continued to increase against the background of high corporate profits. Household income has also continued rising moderately. In this situation, private consumption has been on an increasing trend, although the pace of increase has been only modest. Housing investment has been increasing moderately with some fluctuations. With the rise in demand both at home and abroad, production has also been increasing.

Japan's economy is expected to continue expanding moderately. Exports are expected to continue rising against the background of the expansion of overseas economies. Domestic private demand is likely to continue increasing against the background of high corporate profits and the moderate rise in household income. In light of these increases in demand both at home and abroad, production is also expected to follow an increasing trend. Public investment, meanwhile, is projected to remain on a downtrend.

On the price front, domestic corporate goods prices have recently been somewhat lower than their levels of three months earlier, due to the drop in international commodity prices. The year-on-year rate of change in consumer prices (excluding fresh food) has been on a positive trend.

Domestic corporate goods prices are expected to be somewhat weak or stay flat in the immediate future, due to the drop in international commodity prices. The year-on-year rate of change in consumer prices is projected to continue to follow a positive trend, as the output gap continues to be positive.

As for the financial environment, the environment for corporate finance is accommodative. The issuing environment for CP and corporate bonds is favorable. Also, the lending attitudes of private banks have continued to be accommodative. Credit demand in the private sector has been increasing. Under these circumstances, the amount outstanding of lending by private banks has been increasing. The amount outstanding of CP and corporate bonds issued is slightly below the previous year's level. Funding costs for firms have risen slightly. Meanwhile, the year-on-year rate of change in the money stock is at the 0.0-1.0 percent level. As for developments in financial markets, in the money markets, the overnight call rate has been at around 0.25 percent, and interest rates on term instruments have been around the same level as last month. In the foreign exchange and capital markets, stock prices have risen compared with last month, while the yen's exchange rate against the U.S. dollar has fallen compared with last month. Meanwhile, long-term interest rates have been around the same level as last month.

Developments in Japan's economy have so far deviated slightly downward from the outlook presented in the Outlook for Economic Activity and Prices (the Outlook Report) released in October 2006, mainly due to weaker-than-expected private consumption caused partly by temporary downward pressure stemming from the unfavorable weather conditions. Looking ahead, however, the economy is expected to develop broadly in line with the outlook, as a virtuous circle of production, income, and spending is likely to remain intact. As for prices, domestic corporate goods prices are expected to deviate slightly downward from the expected trajectory, reflecting the drop in crude oil prices. Consumer prices have so far deviated slightly downward from the projection, partly reflecting the drop in crude oil prices, but they are expected to develop broadly in line with the projection.

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.”

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.

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.