Satyajit Das: Double-edged Dollar

Satyajit Das
An expert on financial derivatives and risk management, Satyajit Das, has worked on both the sell and buy sides of the derivatives business for over 30 years. He is the author of a number of key reference works on these subjects. He is also the author of “Traders, Guns and Money: Knowns and Unknowns in the Dazzling World of Derivatives”. It has been described by the Financial Times, London as “fascinating reading ... explaining not only the high-minded theory behind the business and its various products but the sometimes sordid reality of the industry”.


Winston Churchill famously observed that “We shape our buildings; thereafter they shape us”. Global finance, a human creation generally assumed to be a munificent agent of prosperity, has shaped the age of capital.

Historically, emerging countries, like India, were colonial properties. ‘El-Dorado economics’, as practised by developed nations, emphasised conquest and exploitation of natural resources of their colonies. Following decolonisation, emerging countries gained independence but remain, for the most part, sources of cheap resources, labour and (in some cases) capital or markets for Western goods. This is ‘El-Dollardo economics’, the world of globalised trade and capital flows, which shapes India in ways that are complex and not always beneficial.

Economic Sovereignty
Integration into the global financial system reduces a country’s economic sovereignty, increasing vulnerability to external developments and the effects of policy decisions of foreign nations outside its control.

A key element is reliance on global capital flows for financing. These flows are notoriously fickle as the Asian monetary crisis of 1997/1998 demonstrated. The crisis encouraged countries like China and India to build large foreign exchange reserves as protection against the destabilising volatility of short-term foreign capital flows. But the build-up of foreign reserves became a liquidity creation scheme, where the money was lent back to developed countries. Purchase of government securities, primarily US treasury bonds, helped keep US interest rates low, encouraging debt fuelled consumption, contributing to housing and stock market bubbles. Foreign currency reserves of emerging nations, a large proportion denominated in dollars, now have limited value as they cannot be liquidated or mobilised without large losses.

In the aftermath of the global financial crisis, the US and other developed nations issued massive amounts of debt and followed policies to weaken their currencies. The resultant fall in the value of Treasury bonds and the dollar has reduced the purchasing power of hard earned savings and reserves of emerging economies illustrating another side of global finance.

The low dollar and zero interest rate policies pursued by developed nations have led to rise in commodity prices creating inflation, which, in turn, has destabilised emerging economies.

Killing You Slowly or Quickly
Motivated by high profit margins, global financiers introduce complex products into local market settings. The inadequate expertise and experience of local corporations, investors and regulators results in entry into inappropriate transactions that create unknown risks.

Complex currency derivatives, supposedly ‘hedges’, have led to substantial losses. IMF estimates suggest that as many as 50,000 companies in at least 12 countries lost as much as $530 billion. Many Indian companies, including small and medium sized businesses, together with firms in Korea, Taiwan, China, Philippines, India, Eastern Europe and Latin America, have suffered large losses.

Asian investors also suffered large losses from complex investment products created and sold by international financial institutions, often through local banks. Investors found that equity accumulators (known to dealers as ‘I will kill you later’) kill sooner not later. Minibonds, created and sold by Lehman Brothers, have generated minimum returns and maximum losses.

Global finance requires emerging nations to become ‘embedded’, adopting uniform banking regulations and allowing institutions to freely enter into transactions.

Regulations developed for and influenced by large financial institutions are rarely appropriate for the needs of smaller, less financialised nations. Such regulations inevitably promote the interests of large multinational banks, which have significantly competitive advantages over smaller, less sophisticated local institutions.

During crises, identical regulatory regimes, standard risk metrics, similar business models and complex links between financial institutions can transmit shocks rapidly, destabilising emerging economics, not directly affected by the problems.

Breaking the Circuit
Insulating a country from such risks necessitates an unfashionable medieval strategy — the castle and the moat. India must seek to become a strong, self-sufficient economy. It must build a wide and effective moat to protect itself from the effects of an increasingly uncertain and volatile external environment. Drawbridges can be lowered to allow trade and commerce with external parties but can be raised when needed. Foreigners who want to enter the castle can do so but on India’s terms.

The strategy requires building a more efficient domestic capital market to encourage and mobilise domestic savings to finance growth. A dangerous reliance on foreign funding must be controlled. Foreign investment should be welcome but must entail long-term commitments, preferably in the form of equity.

Short-term capital flows should be strictly controlled. Marriage rather than one-night-stands will provide both the stable capital and technology transfer India needs.

Regulation of financial institutions should ensure the availability of finance for the real economy, simple, efficient investment products and means to hedge financial risks. Financial innovation should be measured by its ability to support growth and bring the majority of India’s vast population some amenities of the 20th if not the 21st century.

Rather than slavish compliance to international standards, the focus should be on developing specific rules that fit India’s environment. If necessary, rules governing specific products and transactions, including prohibitions on specific products or activities, should be used to complement broad principle-based regulation, such as capital, reserve and liquidity requirements. Enforcement and compliance should be strengthened.

Foreign institutions operating in India must be required to separately capitalise their local operations and fully subject themselves to India’s regulatory regime. This should apply when dealing in the domestic market, in India’s currency or with Indian firms. Currently, foreign institutions use a variety of strategies to avoid many regulatory controls.

India needs its own strong well-capitalised financial institutions and flexible markets that serve its economic objectives. An emphasis on improving financial hardware (market infrastructure such as clearing and settlement) and financial software (expertise and knowledge) is essential.

The by-words should be ‘simplicity’ and ‘transparency’ rather ‘complex innovation’ in the pursuit of faux modernity.

Only Self Interest
Global finance’s skillful salesmen will argue that anything less than the adoption of financialisation and free markets will marginalise India and impede its economic development. This is simply wrong.

In developed countries, financialisation was a form of economic Viagra, designed to boost flagging growth and cover up deep seated economic problems, ultimately with disastrous results. India is in a different stage of economic development and has ample traditional growth prospects, without resorting to aggressive financialisation. The threat that India will become an international ‘pariah’ is hollow as her large economy and vast markets will inevitably attract overseas interest.

India’s interests may be served by guarded engagement with global finance, with its risk of excessive debt and speculation. As John Maynard Keynes warned: “When the capital development of a country becomes a byproduct of the activities of a casino, the job is likely to be ill done.”