Financial markets are in turmoil. In his co-edited book, Capture and Exclude: Developing Economies and the Poor in Global Finance, Amiya Kumar Bagchi describes how financial institutions in developed countries have an adverse impact on developing countries and poor people. We are experiencing this in India today. There have been suggestions that a global regulatory institution, and not merely national ones, must regulate cross-border financial flows. These flows are many multiples of the value of international trade in goods and services.

Banks, merchant bankers, hedge funds, private equity investors and a score of other respectably labelled organizations speculate on currencies, interest rates, securities, weak loans, mortgages, foreign exchange derivatives and other such instruments. They package strong instruments with weak ones. The purchasing institutions do not know what they are buying. When a loss of confidence occurs, all such packages become suspect. Managers of these institutions are the buccaneers of this century, engaging in esoteric games that few understand (perhaps not even themselves). Greed is their driver. Their wealth reaps them respect. In the process, they often destroy productive companies, economies and individuals who might have entrusted their moneys to ‘safe’ financial institutions and ‘safe’ instruments meant to minimize risk. There is nobody to hold them to account. When they collapse, governments, as in the United States of America and the United Kingdom, rescue them with public money (as with Bear Stearns). Leaving them to their fate could unravel the whole economy,

Financial buccaneers are helped by the greed of nations and their shortsighted economic managers. India opened up financial markets long before the manufacturing base was strong, industries competitive, and regulatory frameworks sufficiently educated, strong and quick to act. Few foreign investors invested in building production capacities in India. So India opted to invite them into financial markets instead. India helped them to come in and withdraw quickly, waiving taxes on their profits from speculation. Indian stock markets became a great casino for speculative investors looking to manipulate the markets for quick profits.

China did it the opposite way. It first saw a flood of foreign direct investment, buoyant exports and fund inflows from overseas Chinese. Only many years afterwards were its financial markets opened to foreign investment. Even today they are not as open as they are in India.

India allowed anonymous foreign ‘investors’ to invest in its stock markets through a variety of ways. Registration in Mauritius saved investors from Indian short-term capital gains taxes. Participatory Notes enabled them to conceal their identities so that even Indian money could fund a round trip to India, or come in with borrowings abroad that were used (against Indian laws) to buy stock in Indian markets.

Many other means were used by foreign parties to play the Indian stock markets. Their funds became the primary influence on stock price movements. They could come in, sell at high prices, and move their gains free of tax through the Mauritius route, saving on short- term capital gains taxes, and then come back to buy and sell again. Indian stock markets have witnessed an unprecedented degree of volatility, with prices moving up and down every day by extremely high numbers. This extent of volatility is no cyclical movement. It should have rung alarm bells long ago. But the government was keen to accumulate foreign exchange reserves, so trumpeting the India growth story.

When the sensitive index reached 21,000, Indian stocks were wildly over-priced. Their market value had no relationship to their present or foreseeable future performance. Stock prices were ruled by the amount of finance (mostly foreign) that was ready to be invested in the market, pushing up prices, and selling to book profits. This was no uptrend as in the Japan of the Sixties, backed by a production economy on a continuous upward spiral.

High stock prices in India were bound to fall. The concomitant souring of the American economy and a hyped-up ‘India Growth story’ made people believe that India had entered a decade of consistent and long-term rise in stock prices. Our stock prices collapsed when the same investors were caught by the crisis they had created in the US with synthetic financial instruments whose real values were not known to anyone. These were junk bonds raised to the nth level, not just bonds of weaker companies. Overstretched credit card loans, housing mortgages, derivatives, and many other high-risk instruments created a bubble. When it was pricked, an overextended institution like Bear Stearns had overvalued assets and was illiquid. It reported itself as hours away from bankruptcy. Others are not much better. As they liquidated investments to become liquid and shore up their credibility, they also liquidated Indian stock- market investments. The Indian stock-market values, ruled by their money, collapsed.

As an old-fashioned manager and economist, I am suspicious of markets and prices that are not firmly based on a production process of goods and services. The world financial markets, like those of India, had moved too far away from this real world. The fall was inevitable, helped by an excessively indebted American economy.

The US economy must learn to live within its means. The foreign exchange surplus economies like China, the Opec countries, Russia and even India, must not place most of their exchange surpluses in the US as they have done, financing its profligacy. Fortunately, other currencies and economies provide options. When American companies can have such devastating effect on other countries, they need to be regulated in the US and also globally.

India must reduce its greed for foreign money, and not encourage inflows at the cost of internal stability. We must reduce the Mauritius route to a trickle and regulate it tightly. The cautious attempt by the securities and exchange board to eliminate anonymous P-notes must be replaced by an outright ban on them. Speculative ventures in derivatives must cease. We must closely scrutinize the stability of the new banks and institutions that have grown by offering loans to all and sundry, with little security, enabling an explosion of credit cards issued, housing loans and borrowing for consumer durables. We must rein in volatile foreign fund inflows and instead encourage foreign direct investments that will build productive capacities. This demands strong, sophisticated regulation of financial markets, banks and other such institutions.

The ‘India growth’ story, like the earlier ‘India shining’ story, was a three-year wonder. India’s macro- economic fundamentals cannot support a consistent annual gross domestic product growth of nine to 10 per cent. The real economy has to become stronger, particularly agriculture and manufacturing. With commodity prices rising because of the weak dollar, and high rates of inflation, the new ‘Hindu’ rate of growth may be seven per cent. Rising inflationary pressures will force liquidity constraints through higher cash reserve ratios. Interest rates may not fall but might even increase, hurting industrial growth.

Governments must improve the efficiency of their spending; invest effectively in agriculture, infrastructure and social services. There must be a revolution in administrative structure and systems as suggested by the administrative reforms commission and the pay commission. The financial regulatory framework must become speedier, tougher and uncompromising. The new accounting standard requiring companies to immediately account for derivative losses, and the possible exclusion of such losses from set-off for income tax, is a good step.