The Hindu Business Line : ‘Economic winter’ is far from over, warns Unctad report

Even as the world’s financial system is privy to the worst meltdown in recent times, following the exposure of financial institutions in advanced countries to risky and innovative financial instruments, the leverage-led or credit-linked crisis bears important lessons to all stakeholders.

Loss in real economy

This is the nub of the Trade and Development Report (TDR) of the UN Conference on Trade & Development (UNCTAD), released worldwide on Monday. The crisis has also hit developing countries but what kept the banking industry there resilient is that their policies sought to “keep private sector indebtedness and the degree of leverage of the banking sector relatively low,” Unctad succinctly sums up.

The world might prematurely gloat over “green shoots” but the spring is far away as the “economic winter” is far from over, the manifestations of malaise include tumbling profits in the real economy, previous over-investment in real estate and rising unemployment, it said. These negative signs would continue to constrain private consumption and investment for the foreseeable future.

Upper-hand of finance

The report is not off the mark when it contends that an upturn in financial indicators in the first half of 2009 is more likely to signal a temporary rebound from abnormally low levels of prices of financial assets and commodities, following a downward overshooting that was “as irrational as the previously bullish exuberance!”

Unctad diagnosed that the current crisis is due to the predominance of finance over those productive sectors of the economy where real wealth is created, based on the benign belief over the efficiency of free markets. This euphoria led to excessive deregulation, an underestimation of risk and inordinate leveraging in the years before the crisis. Amplifying this, it said in the US, the share of the financial industry in GDP grew from 5 per cent to 8 per cent between 1983 and 2007, while its share in total corporate profits went up from 7.5 per cent to 40 per cent.

Securitisation and other financial ‘innovations’ have broken the traditional relationship between lenders, particularly banks and borrowers, besides weakening the capacity and willingness of financial institutions to manage risk and favouring the development of a non-transparent, poor regulated and under-capitalised shadow financial system. Hence Unctad pitches for the need to develop a new regulatory system that systematically discriminates between financial services for productive investment and betting or gambling in zero-sum games.

Financial regualtion

For developing countries, Unctad report offers a suggestion, asking them to ensure the process of financial development to go hand-in-hand with “better and broader” financial regulation and supervision. “As regulatory reforms cannot be implemented overnight, developing countries should proceed with caution and avoid big-bang processes of financial reform,” Unctad counsels.

Commenting on the monetary policy response and the flurry of financial rescue operations in advanced countries, the UN report rightly argues that such policy intervention to rescue banks with humongous amounts of assets of uncertain value is not "without problems."

Presumably so, it implies subsidising shareholders and providing a form of insurance for banks without appropriate recompense by the beneficiaries, the report quips.

While rigorous monetary easing and large bailout packages might have precluded a meltdown of other financial system, they were "insufficient to revive aggregate demand and halt rising unemployment", it reasoned.

Unctad said the public resources deployed in such `fiscal packages' signify an average of some 3.7 per cent of GDP in the advanced economies, whereas the size of such packages in developing countries was larger than that: 4.7 per cent of GDP in developing countries and 5.8 per cent in transition economies, extending over a span of one to three years.

For both developed and developing countries, Unctad has a word of caution, pointing out that in order to be truly countercyclical, an expansionary fiscal policy in a recession needs to be combined with fiscal consolidation when recovery sets in and output growth accelerates.

Finally, the report pertinently plumps for reducing vulnerability to external financial shocks at the country level, it said assertions that capital controls are ineffective or injurious have been disproved by the actual experience of emerging market economies. It cautioned countries against perceiving surging capital inflows as a sign of strength but instead treating them as a potential source of dis-equilibrium with "grave repercussions for macro-economic stability and trade, a point Indian authorities must reckon and ponder as FIIs rushed-out of India only recently after contributing substantially in the euphoric growth phases, a couple of years ago.

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