Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

Why India’s crisis could be a good thing

I recall telling some Indian policy makers in the late 1990s that it was unfortunate that India had not fallen victim to the Asian Crisis. I need hardly add that the rest of the conversation was not very pleasant. However, one of the great privileges of living in a democracy is that one get away with saying such things – policy makers do not have firing squads at their disposal (at least not yet).

Now we seem to be getting a crisis of the kind which I have been expecting for several months now (see my blog posts here, here and here). This is a good time to reflect on the aftermath of the Asian Crisis to understand how (under the right conditions) a lot of good can come out of our crisis.

Like in East Asia of 1997, the Indian corporate sector has come to be dominated by a rent seeking kleptocracy that resembles the Russian oligarchs. Unlike the businesses that came to prominence in the first decade after the 1991 reforms, many of the business group that have emerged in the last decade have been tainted by all kinds of unsavoury conduct. For the country to reestablish itself on the path of high growth and economic transformation, many of these unproductive businesses have to be swept away. In 1997, the bankruptcy of the Daewoo Group was important in reforming the Chaebol and getting Korea back on the track again. We need to see something similar happen in India. A useful analogy is that of a forest fire that clears all the deadwood and allows fresh shoots to grow and rejuvenate the forest.

One of the wonderful things about a financial crisis is that the capital allocation function shifts decisively from those who think like short term lenders to those who think like owners. In a debt restructuring for example, erstwhile lenders are forced to think like equity holders, and they end up allocating capital much better that they did when they were just chasing yields while floating on the high tide of liquidity. They have to stop worrying about sunk costs and focus more on future prospects.

A very good example is what the Asian Crisis did to Samsung. At the time of the crisis, Samsung was an also-ran Chaebol whose head was obsessed with building a car business like Daewoo or Hyundai. In the consumer electronics business, it was well behind Sony. The crisis forced Samsung to abandon its car making dreams under enormous pressure from the financial markets. As it focused on what it knew better, Samsung has created a world beating business while Sony ensconced in its cosy world in a country which largely escaped the Asian Crisis has simply gone downhill.

Even at the level of countries, one can see how a country like Malaysia that changed least in response to the crisis has been in relative decline as compared to its peers. I cannot help speculating that in the emerging crisis, China’s large reserves will allow that country the luxury of behaving like the Malaysia of 1997. If by chance, India responds like the Korea of 1997, Asia’s economic landscape in the next decade will be very interesting.

Another interesting parallel is that in 1997/1998, several of the crisis affected countries faced elections at the height of the crisis or had a change of government by other means (Indonesia). Far from leading to political confusion, these elections helped to legitimize decisive action at the political level. Nothing concentrates a politician’s mind more than a bankrupt treasury. We saw that in 1991 (another case of an election at the time of crisis). We could see that once again in 2014.

Of course, nothing is preordained. We can blow our chances. But to those who think that 1991 was the best thing that ever happened to this country, there is at last reason to hope that we will get another 1991. In these bleak times, all that one can do is to be optimistic in a pragmatic way.

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