Trading in the world currency and related markets has reached staggering proportions, with the average daily turnover crossing $4 trillion by December 2010. World GDP stands at around $65 trillion. The Bank for International Settlements estimated that the daily trading reached $3.98 trillion in April 2010, up from $1.7 trillion in 1998. The turnover grew by 20 per cent between April 2007 and April 2010, and doubled since 2004. The prognosis is mind-boggling, if we are still left with one.
It is in this background that the recent observations of the Basel Committee on Banking Supervision assume importance. These are as follows — banks are underestimating the risk that their trading partners in the foreign exchange market may fail to honour their commitments; such risks may have a low impact during normal market conditions, but they can be serious when markets are stressed; while banks and other financial institutions dealing in the currency markets have taken steps to make trading more robust, substantial settlement risks still remain. Banks get away with such risk-taking because financial markets have managed to build a myth that if they are disturbed the world economy would collapse. This fear psychosis created with the connivance of the media, which are privately owned and controlled, is a malaise of present- day capitalism. To curb such speculation — betting on exchange rate fluctuations in the global currency markets — a transactions tax was proposed, a minimal tax, say, .01 per cent on the value of each transaction, which would have significantly reduced short-term and ultra short-term transactions.
This issue was raised more than once in the G20 meetings but had to be dropped because of bitter opposition from the United States of America and Britain. They contend that the tax would eliminate any profit potential for currency markets. Proponents say that the tax would help stabilize currency and interest rates because the central banks of many countries do not have the foreign exchange reserves needed to balance a currency sell-off. The culprit is the condition of full capital account convertibility, which allows foreign funds to flow in and out freely. The International Monetary Fund imposed this condition for disbursing its loans. This is the terrible price debtor countries, especially the developing ones, have to pay for the IMF’s dollars.
There are instances when sovereign nations have stood up against the international financial institutions and markets. The Southeast Asian crisis began when the Foreign Institutional Investors started pulling out their funds and the economies in the region fell one by one. FIIs could do this thanks to full CAC. This proved beneficial for these economies during the boom. But the opposite happened when the boom was followed by the inevitable bust, and the FIIs withdrew their funds causing currencies to crash, inflation to soar and the nations to face riots. IMF offered easy credit to these economies but insisted on free float of currencies. Everyone agreed, except for Mahathir Mohamad of Malaysia who refused the IMF’s credit and its diktat, imposed high taxes on the exit of foreign funds and set the exchange rate at a low level. There was uproar in the world financial markets and in the IMF. Even threats were issued, but he stood firm with the nation behind him and steered it to stability within a year.
Nearer home, the Reserve Bank of India under Bimal Jalan stood firm against full CAC and the combined onslaught of the IMF, the World Bank and the finance ministry. This saved India from the fate of its Southeast Asian neighbours. After Jalan, Y.V. Reddy withstood such pressures and permitted only partial and calibrated CAC, and India was saved from the financial tsunami of September 2008.