How Well Has South Asia Coped With the Global Financial Crisis: Monetary Management, Regulation and Market Discipline
D. M. Nachane and M. Shahidul Islam
The global financial crisis affected most economies primarily through three channels– declining trade volumes, exchange rate pressure and asset deflation. The paper focuses on the impact of the crisis in the four major economies of South Asia viz. Bangladesh, India, Pakistan and Sri Lanka and how by a combination of swift actions on the monetary, fiscal and exchange rate fronts the worst consequences of the crisis were averted. The regulatory and supervisory systems in these four economies are then benchmarked against certain desirable norms, which have emerged out of post-crisis international deliberations. It is felt that South Asian regulatory systems perform fairly well vis-à-vis these norms. The paper also discusses three major unresolved issues on the regulatory and supervisory dimensions. With regard to the Principles versus Rules-based regulation controversy, it recommends that a more promising and safer course of action would be to make the existing (rules-based) system more flexible and dynamic. Secondly, with a view to strengthening market discipline, several new initiatives seem to be in order, the most important being the switchover to a risk-based premium of deposit insurance. Finally, the paper discusses the crucial issue of independence of regulators and supervisors from official (government) interference and
1 D. M. Nachane is Professor Emeritus and former Director of the Indira Gandhi Institute of Development Research, Mumbai. He is also an Honorary Senior Fellow at the Institute of South Asian Studies (ISAS), an autonomous research institute at the National University of Singapore. M. Shahidul Islam is Research Associate at ISAS. D.M. Nachane can be contacted at email@example.com and M. Shahidul Islam at firstname.lastname@example.org. The views expressed are those of the authors and do not necessarily reflect the views of the Institute. market “noise”, in executing their mandate of financial stability. The authors are of the view that the future success of financial reforms in South Asia will be crucially contingent upon how successfully the regulatory architecture adapts to the twin dictates of financial development and financial stability, the extent to which market discipline can be usefully deployed as a pillar to support this architecture; and the degree to which regulatory and supervisory independence is not compromised.
Introduction:In recent years, there has been a marked shift in attitude towards financial development among economic growth theorists. The earlier scepticism on the role of financial development for economic growth2 has given way to a growing realisation that financial markets and institutions play a defining role in the economic evolution of societies. Empirical evidence based on both cross-country as well as micro-level studies lends support to the view that financial development crucially affects the speed and pattern of economic development. The financial system is traditionally viewed as performing the following five functions (see Levine (1997), Archer (2006), etc.)3: (i) allocating resources; (ii) mobilising savings; (iii) expanding goods and services markets; (iv) facilitating risk pooling, hedging and diversification; and (v) monitoring managers and exercising corporate control. To this list one must append an extra function, which has assumed a great deal of importance in recent years in least developed countries (LDCs) and emerging market economies (EMEs), viz., (vi) providing credit to the informal sector (rural as well as urban) via microfinance institutions. However, even within the broad consensus of recognising the role of financial systems for economic development, important areas of disagreement persist, viz., the type of financial system most conducive to growth, private versus public ownership of financial institutions, the degree of regulation and supervision, the role of financial innovations and the pace and extent of financial liberalisation. The Latin American crises of the 1980s and 1990s, the Asian financial crisis of the late 1990s and the current global recession have once again brought the critical role of financial institutions under the scanner, and introduced important caveats to the consensus. The present paper aims to take stock of some of these issues in the South Asian context. While it is certainly not being claimed that the South Asian experience is representative of EMEs in general, it is nevertheless felt that some of the lessons drawn here would have some relevance transcending their immediate context.