An interesting experiment is going on in Malaysia. The administration of Prime Minister Najib Razak has embarked on an economic transformation plan that marks a clear departure from the development plans of Malaysia’s past.

In years past Malaysia’s development plans, while ostensibly focusing on economic growth and structural changes, had been in actuality little more than budget priorities for the federal government. While economic issues were usually correctly identified, there was an underlying and unspoken premise that ‘we’ll solve the problem if we throw enough money at it’. Results were often not in line with the money spent, and occasionally not achieved at all. While one hesitates to give too much credit to public spending as a driver of the economy, the fact remains that Malaysia’s performance, post-Asian crisis, has fallen behind that of its regional peers.

Starting with the New Economic Model (NEM) report of 2010, the budget-based approach has changed. While the Tenth Malaysia Plan continues the traditional top-down assessment of the economy and government budget priorities for the period 2011–2015, the Plan is largely superseded in the public eye by two new and radically different programs — the Government Transformation Plan (GTP) and the Economic Transformation Plan (ETP). The former aims at improving the efficiency of the public service delivery system, particularly in matters directly affecting citizens, such as licensing and taxes. The latter aims at improving the competitiveness of the economy and increasing private investment to meet the stated target of Malaysia achieving high-income status (as defined by the World Bank) by 2020.

What differentiates these programs is less their content and aims and more their implementation. Rather than the historical approach which entrusted planning and action to different government ministries, the GTP and ETP were formulated through extensive collaboration between interested stakeholders, with a goal of coming up with specific policies with detailed implementation plans and, more importantly, measurable objectives. In the past, the assessment of success or failure in development was often presented as a matter of the ratio of the budget utilised. Now success is measured against the impact on the agreed upon target variable. The government has also invested in a comprehensive communication strategy, explaining the programs and their benefits to the public in a variety of mediums and platforms. In the short space of less than a year, both programs have made remarkable and impressive progress.

More recently, the more structurally-oriented reforms detailed in the NEM document have also been given shape and form through six Strategic Reform Initiatives (SRIs). These have followed the implementation blueprint already established by the GTP and ETP — extensive consultation and collaboration, followed by detailed action plans.

Critics maintain that these programs — the ETP, GTP and NEM — are little more than public relations exercises, and leave fundamental gaps in addressing the real problems and issues that Malaysians care about. There is some truth in this. For example, some of the highly publicised foreign and private investment projects touted under the ETP probably would have been made with or without the ETP. The focus on headline GNI, including encouraging domestic investment abroad to improve factor payments, does not obviously benefit the incomes of domestic workers. Some key human development indicators remain unaddressed, like the very poor record in pre-natal care for women. Affirmative action policies to address the economic insecurity and fear of the politically dominant (but economically backward) Malay community have been but lightly tampered with, to the dissatisfaction of both Malays and non-Malays.

Just as important is the question of how relevant the ETP and NEM would be in meeting the challenge of achieving the stated objective of transforming Malaysia into a high income economy. It is nearly impossible to prove the counterfactual, that is, what would Malaysia’s economy be like in 2020 without these programs? But the answer is probably that it would not be that much different. There are in fact enough fundamental economic trends, particularly Malaysia’s highly favourable demographic profile and a hands-off central bank allowing an appreciating currency, to ensure that the target will be reached within the required time frame. But if this is so, why bother with these programs at all?

The answer must be that the GTP, ETP and NEM are not needed so much for economic growth alone but to transform the Malaysian economy and society into one that can reasonably sustain high income status. A more productive, value-adding private sector, coupled with a more efficient public sector, will be far better able to support and nourish a high income, more equitable society. The 9 July demonstrations in Kuala Lumpur demonstrate the increasing political and social activism and awareness of Malaysian society. The alphabet soup of economic programs currently under way will help Malaysia achieve a matching economic maturity.

Nurhisham Hussein is an economist at a large fund management company in Malaysia. He writes a blog on the Malaysian economy at Economics Malaysia.

1. Economic and political developments in Malaysia: new players new game?
2. Vietnam: the beginning of another economic transformation?
3. Can Malaysia graduate?

The removal of Muhammad Yunus as Managing Director of Grameen Bank now seems irrevocable.

The Bangladesh Finance Ministry is reported to have prepared a ‘14 point plan’ that will ‘transform the Nobel winning micro-lender into another state-owned bank’, with the government likely looking to increase its equity stake in Grameen (currently less than 4 per cent of paid capital) to restructure the board and ‘establish control over its lucrative sister firms’.

The removal of Yunus, and Grameen Bank’s takeover, is heavily politicised, and justifications citing Yunus’ retirement age are little more than a pretext. After all, Grameen’s board raised the issue of compliance with statutory retirement rules with Bangladesh Bank (the central bank) in the past and the matter had been ‘nodded through’ without demur.

It seems clear that the intention of Prime Minister Sheikh Hasina’s government is nothing less than a seizure of Grameen and its associated ‘social enterprise’ companies, whose activities include mobile telephony, solar energy, textiles and yoghurt. This has been assisted by carefully nurtured public doubt over Yunus’ integrity, including damaging allegations (later disproved) about Grameen’s management of foreign aid funds in a hostile Norwegian TV documentary. Senior members of the Awami League (the governing party) have also accused Yunus of corruption, while Prime Minister Sheik Hasina has described the bank as ‘sucking out money from the people after giving them loans’, though Grameen’s relatively high deposit rates were not subject to similar invective.

Official sources now label Grameen a ‘government bank’ by virtue of its creation under an official ordinance. From this flows a tendentious definition of Yunus and his fellow directors as ‘public servants’, used to support the government’s takeover as the proper course of action. The stakes are high; the telecommunications interests alone are valued at more than US$1 billion, while the bank holds assets of some US$1.5 billion.

The activities of Grameen Bank have been a standing rebuke to successive Bangladeshi governments over many years. Grameen, and many other voluntary entities, emerged in the early days of Bangladeshi independence from a governmental vacuum, created by the weakness and incapacity of the state in meeting the poor’s needs. The growing achievements of Yunus and Grameen attracted the attention of donors and, at least partly in deference to their requirements, the Grameen Bank Ordinance 1983 was enacted (although Grameen itself was not constituted as a regulated bank). This ordinance has been the legal battleground for the present struggle.

Sheik Hasina’s motives appear to include a degree of resentment for Yunus’ and Grameen’s joint achievement of the Nobel Peace Prize (for which Hasina herself appears to have harboured a shy hope). The formation of a rival political party by Yunus in 2007 (politically ill-judged as it was) may also have continued to rankle in government circles. Though the attempt was soon abandoned, it drew attention to the potential for Grameen Bank — with more than 8 million members/shareholders — to serve as a platform for mass mobilisation, if under the control of a more adept political operator than Yunus.

An extraordinary series of external interventions on behalf of Yunus has also raised the stakes. These included visits by former World Bank President James Wolfensohn and by the US Assistant Secretary of State for South Asia, the World Bank’s and IMF’s reprogramming of loan tranches in an apparent rebuke to the Bangladeshi government, and the communication by US Secretary of State Hillary Clinton to Sheik Hasina of Washington’s concern.

These external reactions may have been counter-productive, hardening the Hasina government’s position. Further, the government is not without support. Jagdish Bhagwati recently claimed that ‘Yunus is suspected of covering up losses at Grameen with huge sums of money from abroad’. Yunus’ defence — that Grameen has not accepted foreign grants since 1995 and that lending is financed more than adequately by deposits (which amount to about 150 per cent of loan portfolio) — carried little weight.

The government’s plans could have serious implications internationally and domestically.

First, moves to assert control over Grameen ‘family’ firms with foreign capital stakes could negatively affect foreign investor perceptions of political risk.

Second, the viability of Grameen Bank as a financial institution is at risk. There is abundant evidence from Bangladesh’s political history that governments will interfere in the operations of state banks for political ends. The real possibility exists that Grameen could become a vehicle for politicised lending, or that it might suffer from government-imposed ‘loan forgiveness’ related to the electoral cycle. Under Yunus, Grameen resisted such politicisation and established an enviable credit culture among its members, as well as earning their trust (evidenced by Grameen’s outstanding performance in deposit-mobilisation). But the balance sheet equilibrium is fragile — hostage to any changes in the political environment causing loss of confidence among Grameen’s constituency. This would be a tragedy for the bank, for Bangladesh and for other non-state microfinance service providers which might be caught up in the turmoil.

Finally, there is another international dimension to all this. Yunus’ voice has stood in lonely protest against the current pernicious trend towards the financialisation of microcredit. This trend, so far as it has contributed to reckless lending in Andhra Pradesh and elsewhere, has led to the current international crisis of legitimacy in microfinance. The fallout from Yunus’ removal could include a loss of his considerable moral authority. This in turn could diminish his capacity to resist the ‘barbarians at the gate’ of microfinance, whose resort to financial engineering and the single bottom-line threaten this significant social movement.

John D. Conroy is Visiting Fellow at the Crawford School of Economics and Government, Australian National University, a Special Consultant at the Foundation for Development Cooperation, and a participant in the Advisory Group on APEC Financial Sector Capacity-Building.

1. Why Grameen Bank and Muhammad Yunus need a closer look
2. The revival of the World Bank’s bank
3. Private Chinese firms don’t get bank loans? Think again

China’s exports have resumed their robust growth since last year. The World Bank predicts a 3.5 per cent growth rate for the world economy this year, and most analysts also predict that the US economy will grow at a similar rate.

As a result, external demand for China’s exports will be strong. While there was a trade deficit in February, this was transitory, likely caused by the spring festival holidays, and China will continue to accumulate large reserves of foreign exchanges this year.

China is moving back toward what happened between 2004 and 2008 where inflationary pressures were high due to large trade surpluses. It is predictable that the Chinese authorities will now deploy a combination of tools to stabilise domestic prices.

The bank reserve ratio is already 19.5 per cent and unlikely to be raised by a large margin. Most likely, interest rates will be jacked up step by step. The benchmark annual lending rate reached 7.47 per cent in August 2008 after five years on an upward trajectory. There is presently still a lot of room before that level is reached as the current lending rate is still only 5.56 per cent.

International observers are more willing to see the yuan’s value rise. Revaluation will discourage the inflow of foreign capital. On the other hand, revaluation might raise people’s expectations of further appreciation and thus invite more foreign capital to flow in. Revaluation will help China only if it brings China’s trade surplus down, and the experience of 2004–2008 suggests that that is not going to happen for only moderate revaluations. That is why some people believe that China should take the bolder step of large revaluation. For the Chinese government this is out of the question because of the heavy risk of unemployment — a cost the government will make every effort to avoid because of its concern about social stability and, in the final analysis, the very legitimacy of the government.

The Chinese authorities will also introduce quantitative controls on bank lending. But the effect of this kind of measure is beginning to have a diminishing effect because banks and other financial institutions have a range of ways of circumventing it. A more effective strategy is for the central bank to expand its sterilisation operations, absorbing the inflationary effect of current account surpluses. In theory, the central bank can sterilise any amount of money supply caused by the inflow of foreign reserves simply by issuing larger amounts of central bank bonds. In practice, it faces two kinds of cost.

The first kind is a direct accounting cost. The interest rate will inevitably increase when more central bank bonds are issued. On the other hand, the interest rate paid on the central bank’s foreign reserves, mostly in US dollars, is low. As a result, the central bank incurs accounting losses when it issues more sterilisation bonds.

The second cost is implicit but potentially has more substantial effects. Sterilisation bonds absorb potential investment and consumption implied by the trade surplus in the current period. But the induced effect is to drive down domestic investment and consumption in subsequent periods. This is because sterilisation bonds are forced savings and are deflationary — they deter further investment and consumption. For example, banks would draw back mortgage lending in response to higher rates paid on the sterilisation bonds. Hence, consumers have to save more in order to buy houses and other goods.

This line of thinking suggests that the central bank’s sterilisation operations are likely to be self-defeating in the long run: it sterilises the money supply caused by today’s trade surplus but is the source of more current account surpluses in the future.

The Chinese authorities have to find new ways to take care of its external imbalances problem directly. One is to increase consumer imports. Right now, only 2.3 per cent of China’s imports are consumer goods. Consumer goods are subject to relatively high tariffs and have value-added or sales taxes levied on them at customs. In addition, customs procedures are complicated and slow. Lowering tariffs on consumer goods and simplifying custom procedures would improve the flow of consumer imports and, because potential consumer imports do not compete that much with domestic products, also have minimal harm on the domestic industry. Take potential imports from the US as an example. They are mostly likely to be brand-name products, furniture, high-end cars and land-intensive agricultural products (such as beef) — in none of which China has comparative advantage.

Opposite to the case of exports, imports have a deflationary effect and help China deal with inflationary pressure. More imports will reduce China’s trade surplus and help balance China’s external payments. Increasing imports is a policy strategy that achieves multiple goals and will be welcomed by the international community. There is no reason why the Chinese authorities should shy away from it.

Yang Yao is Director of the China Center for Economic Research at Peking University.

1. China’s exchange rate policy, its current account surplus, and the global imbalances
2. Fixing China’s current account surplus
3. Factor market distortion and the current account surplus in China

The big financial news in the run-up to Chinese President Hu Jintao’s recently concluded visit to the United States was Beijing’s decision to allow the state-controlled Bank of China to offer renminbi-denominated bank accounts and currency conversion services in New York.

Some observers hailed this as an important step in positioning the renminbi to become a true international currency. Others dismissed it as a mere publicity stunt designed to deflect attention away from China’s refusal to let its currency appreciate against the dollar.

My view is that this is another small but significant step in the internationalisation of the renminbi, even if President Hu’s visit explains the timing. There has been an important shift in Chinese strategy and rhetoric since March 2009 when PBOC Governor Zhou made some much-commented-on remarks calling for an enhanced role for the IMF’s Special Drawing Rights, or SDRs, as an alternative to the dollar in the international sphere. Chinese officials speak now not of an international monetary system centred on SDRs but on a system that rests on a handful of existing currencies: the dollar, the euro, and the renminbi.

What are Chinese officials after?  They want to give their companies the security of being able to invoice and settle their cross-border transactions in their own currency, thereby eliminating the risk that comes with doing business in other people’s money. They want their companies to be able to raise funds abroad by issuing bonds in renminbi. They want to be sure that Chinese banks get a slice of the global foreign exchange market. This means making the Bank of China a platform for renminbi-trading in New York, further liberalising renminbi transactions in Hong Kong, and transforming Shanghai into an international financial centre. These are not alternatives. China is intent on pursuing all three.

Moving in this direction will be a good thing not just for China, but for the world. One way of understanding our recent financial problems is in terms of the imbalance between the real and financial economies.  On the real side – that is, in terms of trade and production – the era of US dominance is now over. We are moving toward a more multi-polar world dominated by three large economies: the US, Euroland and China. But on the monetary and financial side, the dollar still dominates international transactions. When the residents of other countries need more international liquidity, they have virtually no choice but to accumulate dollars. This allows the US to finance its twin deficits more freely than otherwise. And that in turn means that when we in the US succumb to financial excesses – when we engage in frenzied real estate speculation, for example – foreigners give us more rope. It is no coincidence, in other words, that the recent financial crisis originated in the United States or that it coincided with the widening of global imbalances.

This kind of external finance will be less freely available to the United States when there exist attractive – that is to say, stable and liquid – alternatives to the dollar. The resulting intensification of external discipline on the US will make the world a safer financial place. One potential alternative to the dollar, namely the euro, is already here, although its stability and liquidity obviously leave something to be desired. But I remain convinced that when European leaders find themselves with their backs to the wall, not too long from now, they will undertake the necessary reforms. They will fix Europe’s banking system. They will restructure the unsustainable debts of the European periphery.

Part of this will entail issuing ‘e-bonds’:  bonds backed by the full-faith and credit of Euroland countries as a group.   e-bond issuances may be limited at first, but the very fact of their creation will be an important step toward developing an integrated market in standardized euro assets attractive to international investors.

The other potential alternative to the dollar, the renminbi, is coming faster than many observers realize. The last year has seen a quadrupling of the share of bank deposits in Hong Kong denominated in renminbi. 70,000 Chinese companies are doing their cross-border settlements in renminbi.  Dozens of foreign companies have now issued renminbi-denominated ‘dim sum’ bonds in Hong Kong.  And then there is the decision to allow the Bank of China to provide renminbi-deposits to foreign investors in New York. To be sure, Hong Kong and New York are not the same as Shanghai. But practices that are successfully test driven in Hong Kong and New York will be licensed in Shanghai next.

China has a long way to go, admittedly, in order to internationalise the renminbi. It will have to make its financial markets more liquid. To create a bond market of the requisite size, it will have to ‘overfund’ its debt, issuing more sovereign debt securities than would be necessary otherwise. To gain the confidence of foreign investors, it will have to make its financial markets more transparent and strengthen rule of law. To accommodate a larger volume of capital inflows and outflows, it will need a more flexible exchange rate. Above all, it will have to avoid serious financial problems.

Merely listing these perquisites makes them sound daunting. But then, who 10 years ago who would have thought that China would be as open to foreign direct investment as it is today?

The Chinese have set 2020 as the target date by which Shanghai should be transformed into a true international financial centre and, by implication, the renminbi into a true international currency.  I wouldn’t bet against them.

Barry Eichengreen is the George C. Pardee and Helen N. Pardee Professor of Economics and Political Science at the University of California, Berkeley.  His new book, Exorbitant Privilege: The Rise and Fall of the Dollar and the Future of the International Monetary System, will be available in Australia in February through Oxford University Press.

1. China moves slowly to internationalise the renminbi
2. Why is China attempting to internationalise the renminbi?
3. Panda Bonds could help China avoid the risks of US Treasury Bonds

The recent developments in the Indian microfinance sector, particularly in Andhra Pradesh (AP), have been disconcerting. Within a relatively short period, a sector heralded as representing a commercially viable solution to the problems of financial inclusion, poverty reduction and female empowerment is now being accused of various improprieties. Microfinance institutions (MFIs) are now being criticised as detrimental to improving the lives of low income individuals.

Recent developments involve some of the borrowers from MFIs being over-extended, resulting in repayment problems; including coercive collection methods in some cases. There have also been well publicised episodes of poor governance practices and an alleged overemphasis on profit rather than social objectives by some MFIs in the country.

Indeed, some sensational reports portray the Indian microfinance sector as nearly on the verge of collapse.

Just as it was unrealistic to view microfinance as revolutionary in mitigating poverty and advancing financial inclusion, its current characterisation, as a contributor to worsening the lives of millions of sector participants, is also unwarranted.

It is therefore even more essential that the policymakers in India, and particularly in AP, let good economics and sound regulation, aided by empirical evidence based on robust data and analysis, be good politics.

Unfortunately, the government of AP hastily passed a controversial ordinance. This resulted in bringing all microfinance repayments to a halt in AP, the state which ironically led the microfinance revolution in the country.

The Microfinance Institutions Network (MFIN), an association of MFIs accounting for more than 85 per cent of the MFI portfolio in the country, challenged the AP ordinance; however, the ordinance has subsequently been passed by the AP State Assembly and, effective from 1 January 2011, is now an Act.

As many large MFIs in the country have outstanding loans in AP, this has led to concerns on the part of their investors and lenders. Due to the microfinance sector’s priority sector status, most banks have loan exposure to MFIs and these portfolios are now being rapidly downgraded by credit analysts.

In principle, there is little to suggest why a microfinance provider of loans to low income individuals at their doorstep, without insistence on collateral or prior credit history, should cause harm. However, in practice there are instances when it has apparently done so. While this needs to be addressed, ill-conceived regulation, with low implementation capacity, and immature and irresponsible political leadership, could make the situation worse for low income households, particularly in the medium term.

While a combination of factors may have contributed to the above situation, multiple lending and coercive collection practices are frequently being cited by analysts as the causes of the crisis. These may be the proximate causes, but there are other underlying reasons. These include a lack of financial education of microfinance customers, the nature of incentives offered to field staff by microfinance institutions (MFIs) and the lack of a uniform code of conduct for the sector. The widespread politicisation of microfinance in AP is an additional contributing factor.

First, lack of financial education is an important factor behind why some MFI borrowers find themselves in difficult debt repayment situations. While microfinance providers claim that they train borrowers, what they impart is usually product knowledge, aimed at ensuring compliance of the borrowers to the terms of lending.

Imparting financial education empowering the borrower to make financial decisions such as ascertaining the effective cost of loans, and the extent of debt they can handle, rightfully needs to precede provision of financial services. Currently, such education is not being routinely made available to all microfinance borrowers by any stakeholder, government or non-government bodies.

With increasing pressure on MFIs to reduce interest rates, it is unrealistic to expect them to incur additional transaction costs on financial education and so this will necessarily need to be addressed by socially-oriented donor or state funded bodies. It is also desirable that financial education be imparted by an independent entity.

Second, the incentives of the field staff are typically directly linked to the number of new loans and the volume of ‘on-time’ loan collections. Considering that often field staff come from relatively low income segments, these have the potential to lead to unethical actions.

Third, while there are shortcomings in the operating models of MFIs, the state has also contributed to the current crisis due to the long delay in introducing microfinance regulation, discussions which have been ongoing since 2007. A uniform nation-wide code of conduct for all MFIs urgently needs to be established.

One option is that an independent oversight board reporting to the Reserve Bank of India (RBI), with representation from various sector stakeholders, could oversee the implementation of the code of conduct.

Recent reports suggest that the RBI-appointed committee will submit a report on microfinance regulation in January 2011. Its recommendations will inform the Microfinance Bill to be introduced in the budget session of the Parliament. It is hoped that the Bill will include all sector participants in its scope; provide a uniform code of conduct; facilitate construction and maintenance of data bases; and not impose interest rate ceilings.

All the stakeholders need to acknowledge that the MFI sector is based on collateral free loans, and so by its very nature is prone to volatility in repayment. This is the reason why this segment of borrowers has been neglected for many decades in the past. By politicising the sector, its volatility is only being enhanced.

It is believed in some quarters that the success of MFIs may have adversely impacted state-supported, subsidised microfinance programs whose objectives included developing political constituencies for certain parties. Once the perception takes hold that public policies are not being designed with broader public interest in mind, but to serve narrow sectional or political interests, even good policies become harder to implement.

A useful contribution of the microfinance sector has been to show that India’s low income individuals are credit worthy. It is important to build on this contribution by sustaining the repayment culture inculcated by Indian MFIs, even while introducing adequate safeguards and providing supplementary support mechanisms through civil society and the state.

The microfinance sector is at a stage where it needs decisive policy direction from the government to restore the confidence of stakeholders. The policy course adopted should let good economics and sound regulation be good politics.

The coming weeks will determine whether a promising avenue for enhancing financial inclusion for low income groups, particularly women, will progress towards a more mature phase or flounder in the country.

Savita Shankar is a research scholar at the Lee Kuan Yew School of Public Policy at the National University of Singapore.

Mukul G. Asher is Professor of Public Policy at the National University of Singapore.

1. Protecting consumers of microfinance in Pakistan
2. Financing the expansion of higher education in East Asia
3. The Great Crash of 2008 and getting financial regulation right

There are a lot of global architecture, theoretical, and micro-institutional incentives issues that Asia must address in the wake of the GFC.

Conventional wisdom is not helping to solve the dilemma of a global market that is still regulated at national levels.

There has been a significant shift from the Asian crisis era idea that ‘all evil is local’ – crony capitalism and bad policy on a local level being to blame for the crisis – to the notion that ‘all evil is global’. Asia has come back from extreme imbalances to the Golden Mean, and Dr. Goh’s famous quote, which is actually paraphrased Confucius — that financial regulation, like ruling a country, is like frying small fish — it must not be overdone.

In this highly distorted, politically charged and still Western dominated global architecture, Asia must steer a steady ship. There must be no deviation from the long-term goals of social development, social equity and environmental sustainability.

If Asia is to shoulder global responsibilities then Asian mindsets, institutions, knowledge and modus operandi will have to be vastly different from today. But the new approach must overcome five major problems before Asia can even begin to compete with the West in the global financial arena. These are the global financial architecture problem, the moral high ground question, the issue of financial and accounting standards, the Too Big to Fail problem and the need for regional and global cooperation.

Global Financial Architecture

In terms of the global architecture, the dollar and the euro will remain as global reserve currencies within the next two decades at the very minimum. This is because it will be difficult to achieve Asian consensus on what the right currency arrangement is for Asia. Perhaps the right step forward for global architecture is to impose both financial turnover tax and financial services tax, both of which the European Commission has adopted to recommend to its members.

At the regional level, the financial turnover tax on foreign exchange transactions (the Tobin tax) will be a good way to slow down speculation in foreign exchange when the market gets too frothy. Having common levels of such tax would avoid the problem of racing to the bottom in terms of tax arbitrage and would fund some of the costs of resolving financial failure when they do occur. Having a common tax base would also foster institutional arrangements for better regional cooperation.

The Moral High Ground

The second problem is that Western money has reigned supreme because they commanded the moral high ground. That high ground has been shaved a notch or two by this crisis. Let me say that I used to think that we should build Wall Street in Asia. I now think that is exactly what we should not do. I am still a firm believer that finance must be at the service of the real economy, not the other way around. I still believe that finance must look after the interests of the public first and foremost before its own interests. We change these beliefs at our peril.

Financial and Accounting standards

The third issue is the question of regulatory and accounting standards that were shown to be flawed. They are too complicated to be understood by the layman, which is exactly why the current system is too complex, non-transparent and can easily be gamed at the expense of the public. Asia has to go back to basics and challenge these rules and standards at the fundamental level. This will take a lot of research and resources.

The biggest challenge within Asia is not the lack of rules, but effective implementation of the Basel, IOSCO and Insurance Principles. What changes market behaviour is enforcement. We have to identify what bad incentives are driving faulty markets and then fix them, not pretend that we are not guided by theory or we do not have the powers to deal with these problems. It is the public which has paid for such ideological fallacies.

In other words, a strong global network must begin with strong and resilient domestic networks.

Currently, Asia does not have the intellectual firepower and institutions to conduct a strong dialogue with the West. We need more discourse, and institutionalisation of think tanks and research institutions. We need the work of our research institutes to feed the debate that will be ongoing in the coming decades. The intellectual battle for the right finance model will be as important as the battle for market share.

The Too Big to Fail Issue

Fourthly, we must address the issue of Too Big to Fail, or what has really emerged, Too Powerful to Fail, because the largest complex financial institutions have become even more concentrated, connected and powerful than before.

Asia’s solution to this problem is state-ownership, because in the largest countries the commercial banking system has been largely state-owned or guided. This has solved the power problem without solving the innovation problem.

How do we make financial institutions more innovative to help fund and foster growth within Asia?

If we are to deal with the question of Too Big to Fail, we have to deal with leverage, incentives and the political economy of who is bigger, the state or financial institutions that can hold countries to ransom. As I said earlier, this problem cannot be solved with zero interest rates, because low or negative real interest rates are at the heart of the leverage and incentive distortion problem.

Regional and global cooperation

The institutionalisation of Asian regional and global cooperation will be challenging, given that it is a geographically vast, culturally diverse, economically disparate and politically complex region. Nevertheless, there is increasing awareness that many of the problems that Asia and individual economies face cannot be solved by national action alone. The interdependence and interconnectivity are such that there must be greater national, regional and global dialogue and policy research. Given the disparate levels of financial development and understanding of the issues, convergence towards global standards will inevitably take time.

My personal conclusion from this brief survey is that there is unlikely to be a ‘Big Bang’ in Asian financial sector reforms, even as the current financial crisis evolves, until Asian financial sector actors appreciate that the current Wall Street financial model is irretrievably broken. I am not sure that many Asian bankers agree with that view. If we do not find a viable alternative model, we may be paying for quite a lot of the costs of that failure. However, within Asia, there is a gradual realisation that its financial markets must change rapidly in response to fundamental changes in our demographics, consumer behaviour and industrial structure. This analysis is urgent and must be of the highest priority. How these will impact on the global regulatory architecture will be an interactive debate between Asia and the rest of the world.

Andrew Sheng is Adjunct Professor at the University of Malaya and Tsinghua University, Beijing.

1. East Asia and the global financial crisis
2. The Asia Pacific Community: objectives, not institutions
3. The financial crisis and East Asia

The G20 includes more Asian countries than any other global grouping, and it is expected to be a good forum for Asian countries to press their agenda.

The G20 Summit was created out of the chaos of the global financial crisis. After Lehman Brothers  collapsed in September 2008, global financial markets went into a tailspin. Securities markets were frozen as buyers disappeared. European governments, and the United States, had to de facto nationalise large, systemically- important financial institutions.

The G20 is now regarded as the ‘steering committee’ of the world economy, replacing the G8.  It was first created as the finance ministers  and central bank Governors’ meeting in 1999, in the aftermath of the Asian crisis; hence the increased Asian participation.

In the midst of financial panic following the Lehman Brothers’ failure, leaders of major countries called for a framework to discuss important financial issues among concerned countries. Leaders of France and Germany, and Britain, were quite vocal in pushing for the creation of a summit that would involve not only the G8 but also large emerging market economies. Some leaders called for G8 plus BRICs, while others called for an even broader grouping. Due to lack of negotiating time, leaders grabbed the existing G20 grouping, transforming it into a leaders-level Summit.

At first, it was not clear whether this would be a permanent institution. After three meetings, it was decided to make the G20 Summit permanent. It is often advertised as a grouping that comprises 85 per cent of world GDP.

In the G8, Japan was the only Asian country, whereas China, Japan, indonesia, Korea, Australia and India all participate in the G20. On the one hand, having six Asian countries is a good start for pushing the Asian agenda at the conference. on the other hand, the group of 20 countries may be too big to act in a timely way. Voices as well as votes are important. Whether the G20 continues to be an important ‘steering committee’ on international financial issues is still unclear, and the Korean G20 Summit will set an important precedent for perceptions of Asian capabilities.

The G20 Summit has been effective in crisis management  and building new financial architecture. Several agreements on monetary and fiscal policy commitment, and an agreement on anti-protectionism, were made. for example, coordinated fiscal stimulus and monetary stimulus, in the face of decline in aggregate demand, were encouraged at the Washington Summit, although a quantitative target was not adopted. in addition to growth and employment, recommendations also included reform agendas for international financial architecture, including an International Monetary Fund quota adjustment; resources large emerging market economies, like (loans) for the IMF; tripling Special Drawing Rights (SDR) allocations; and transforming the Financial Stability Forum into the Financial Stability Board.

The membership of the original G20—that is, the finance ministers and central bank Governors meeting—was chosen to reflect GDP size rankings, with some consideration for regional representation.  In response to the criticism of Asian countries regarding their low representation when the G20 was originally created in 1999, European countries were given less emphasis and countries from Asia and other regions were chosen. European countries, like Spain, the Netherlands, Poland, Sweden, Switzerland and Belgium, were not chosen, while Korea, Indonesia, Turkey, Saudi Arabia, Argentina, and South Africa were.

The contrast with G8 and G10 membership is clear; the G20 has more Asian countries and emerging market economies. in this sense, the G20 is closer to a balanced representation than the IMF quota or the General Agreements to Borrow. The list of countries participating in the NAB is broadly similar to the G20 list, with the notable exception of emerging market economies, namely the BRICs and Mexico.

Because the G20 acted in crisis mode, its decisions were quick. Also, the composition of membership—less weight on European countries—may have contributed to faster decisions.

China seems to have recognised the importance of voicing concerns and disseminating ideas about how new international financial architecture should be shaped. for example, Governor Zhou Xiaochuan of the People’s bank of China gave three speeches in late march 2009. They were titled: ‘Reform the International Monetary System’, ‘on Savings Ratio’, and ‘changing Pro-cyclicality for Financial and Economic Stability’.

The timing was clearly chosen for the G20 meeting in London that April. The first speech stirred debates in international finance circles, and in the third Governor Zhou argued that SDR should be used more extensively, as a liquidity provision in case of crisis, and that SDR composition should revised. While he was not explicit, it would not be surprising if China requests consideration  for the RMB to be included in the last session for the year.

This has produced the impression that China is effectively using the G20 to press its own agenda. It remains to be seen how Korea will use its chair position to push its own agenda.

Japan has been conspicuously absent from hot debates regarding reforming global financial architecture, and agenda-setting in the G20 Summit process. Perhaps Japan is absorbed by its internal political mess, and does not have the time or capacity to contribute to global leadership.

Asia collectively is not pushing its agenda, if there is one. An Asian G20 caucus does not exist. So far Asia remains fragmented despite the opportunity increased membership presents. After so many years of under-representation in the IMF, Asia has not coordinated to maximise its effectiveness. but, one may wonder, is there a common agenda for Asia?

Asian leaders should examine whether Asia collectively has anything to contribute to the global agenda, or an Asian agenda to press. ASEAN also demands that the ASEAN Secretariat be granted permanent observer status, if not full G20 membership.

Asian countries should think carefully how ASEAN, ASEAN+3, ASEAN+6 and otherAsian meetings should be used to give input that can be advocated by Asian members in the G20.  If Asia fails to conduct preparatory meetings and coordinate its agenda, Asian voices risk falling upon deaf ears.

The G20 Summit will most likely continue as the premier institution of global governance concerning financial markets. Financial markets will repeat boom and bust cycles in the future too. If a crisis in Asia should occur again in the future, Asian voices should prevent a repeat of the mistakes of the Asian financial crisis of 1997-98. Asian economies will continue to grow, and their collective economic weight continues to increase. So why not coordinate a collective voice? This is the challenge that Asian leaders will face.

Takatoshi Ito is a Professor at the Graduate School of Economics, University of Tokyo, and has served as a member of the Prime Minister’s Council of Economic and Fiscal Policy.

This is an article from the most recent edition of the East Asia Forum Quarterly, ‘Asia and the G20′.

1. International financial stability architecture for the 21st century
2. Indonesia’s strong balance sheets—key to weathering the global financial crisis
3. The sub-prime crisis and East Asian financial cooperation

Change is afoot in the area of Indian financial regulation. A Delhi-based body (the proposed Financial Stability and Development Council) is set to supplant existing the existing regulator, the High-Level Coordination Committee. This follows a series of committee reports that sought to shift power away from Reserve Bank of India (the RBI) towards market development.

These twin shifts are a mistake. They ignore the performance of the RBI during the global financial crisis. They also place greater power in the hands of elected officials, which is problematic.

Dealing first with India’s central bank, the RBI’s current role is an appropriate one.  So much is apparent from a consideration of two aspects of India’s financial architecture; currency options and the role of market participants other than banks.

Currently, participating currency options traders must be registered with the Securities and Exchange Board of India (SEBI) and follow its guidelines for position limits, margins, surveillance and disclosures. At the same time, the RBI retains the power to modify eligibility, limits, and margins, or take any action required to ensure the stable and orderly development of the foreign exchange markets.

In the case of market participants other than banks, the 2006 amendments to the RBI Act empowered the RBI to give directions to market participants other than banks. But the amendment did not touch trading procedures; regulation of these remains with SEBI.

Both aspects of India’s financial sector have been successful. In both cases, SEBI (the sectoral regulator) retains oversight of the details of a sector, and the RBI has general oversight of the system.  This dual regulation allows flexibility, but also allows the RBI to act as a macro safety net. India’s strong performance during the global financial crisis is testament to the effectiveness of this system.

Thus, by devolving power away from the RBI, India is brushing aside the lessons of the crisis. But this devolution of power has another serious consequence; it places more power in the hands of elected officials. Specifically, although the Financial Stability and Development Council would theoretically be an independent body, the make-up of the council means that it would effectively be government-controlled.

Giving more power to politicians may seem to fulfil democratic objectives.  But in fact, this transfer of power will distort India’s financial sector, as the financial sector will be forced into funding the inefficient government sector. In addition, the average politician has poor organising ability and sees foreign transactions as an opportunity to make money. This short-termism would slow down the functioning of the Indian economy.

At the same time, the current Indian regulatory structure is not perfect. The current focus on stability comes at the expense of development, which proceeds slowly.

But there is a solution; convert the Financial Stability and Development Council into a strengthened HLCC (High Level Coordination Committee).

The idea of a strengthened HLCC has several advantages.  First, the legislature would be able to assign responsibility to a single regulator, and could impose clear time lines so as to fulfil the twin objectives of stability and development. But this assignation of responsibility would not come at the expense of the independence of the markets, who would retain their freedom to design products.

Second, a strengthened HLCC would strengthen sectoral regulation, which would in turn aid a focus on development. For instance, trading would remain the primary responsibility of SEBI.  Where policy or systemic issues arose, RBI involvement would be needed.  But the reinforcement of the HLCC would mean that the RBI could intervene with a specific mandate for market development.

Third, a strengthened HLCC would assist in the development of liquid markets, and deep liquid markets would improve the transmission of monetary policy. Specifically, strengthening the HLCC would allow SEBI  to become involved in the regulation of exchange procedures. Although the Clearing Corporation of India Limited was floated by the RBI, and performs many exchange related functions, involving SEBI in regulation of its trading procedures will help homogenise standards across exchanges, and will thus encourage the development of liquid markets.

Ultimately, regulators must be accountable to Parliament, but their technical knowledge and decisions must be respected. The RBI’s role should be retained, the HLCC’s role developed, and politicians should become involved only as a last and rare resort.

Ashima Goyal is Professor of Economics, Indira Gandhi Institute of Development Research (IGIDR), New Delhi.

This essay is edited from an article first published here at The Hindu Business Line.

1. Contentious reforms to India’s financial sector
2. Regulating financial stability In India
3. Financial reforms after crisis

Low-income earners in Pakistan have been offered financing opportunities for the first time, thanks to a recent surge in the activity of microfinance institutions (MFIs).

Microfinance theoretically involves the provision of loans or other financial services to lower-income-bracket borrowers, with little or no collateral required. These borrowers are able to take out small loans from MFIs to improve their businesses or living conditions. In Pakistan alone, the potential market for microfinance is an astounding US$27 million, with active borrowers and national gross loan portfolio size increasing in every financial quarter.

Despite the benefits that accompany the growth of MFIs, one aspect of microfinance lending that must be addressed is consumer protection, or the right of the consumer to make autonomous, well-informed decisions. In Pakistan, such protection is especially vital.

Not only does almost 56 per cent of the population have no access or experience with formal finance, but the majority of the individuals targeted by these institutions have extremely low literacy levels. The lower literacy factor, be it financial or otherwise, disadvantages most consumers by obstructing their understanding of the complexities of loan transactions. This lack of understanding can lead consumers to believe that access to finance is more essential than the appropriateness of the product’s costs or risks. This is sharpened by the fact that, for many lower-income people in Pakistan, microfinance is the only financing option available.

The MFI sector in Pakistan is highly differentiated and largely unregulated. Where some MFIs have a strictly non-profit social motive such as poverty alleviation or female empowerment, others may cater to slightly higher-income-bracket individuals and thus may become for-profit organisations.

The unregulated environment effectively means that MFIs do not have to observe adequate financial assessment before passing on a loan. In a poorly regulated developing nation, MFIs often justify higher costs by virtue of the added expense of providing individuals with basic levels of financial literacy, and the higher cost of enforcing compliance. This is often used as an excuse for not opting for responsible financial practices. For close-knit communities, such as those found in most rural areas of Pakistan, the ‘trust’ factor plays a major role in decision-making. A lack of alternatives causes lower-income-bracket individuals to rely faithfully on the MFIs for their financial needs. This should serve these institutions well, as often these individuals become long-term customers with the ability to make better financial decisions and fewer missteps in terms of unmanageable debt or repayment issues. This trust factor is a product of transparency in, and dependability on, the words and actions of the MFIs and cannot be stressed enough.

To achieve greater consumer protection within the MFI industry in Pakistan, there must be greater regulation. MFIs must develop transparent, unbiased, and nondiscriminatory ways of dealing with consumers.

While this need could be addressed by greater governmental regulation and policies, the adoption of self-regulatory methods by the MFI industry of Pakistan could better serve the institutions as well as the customers. Self-regulation means enforcing and adhering to self-proclaimed codes of ethics and practices and avoids the costs incurred due to governmental regulation—which ultimately makes credit more costly and limits the accessibility of microfinance. Ultimately, customers are more likely to use the financial services of a trustworthy institution, while the government is less likely to have to enforce regulation on a sector which adheres to general standards of customer protection.

Ayesha Zara Naeem recently graduated with a Bachelor of Science (Honours) in Economics from the Lahore University of Management Sciences.

This article is a finalist in the recent EAF Emerging Scholars competition.

1. Indian microfinance: Let good economics and sound regulation be good politics
2. Consumer over-indebtedness in Japan, Australia and the US
3. Financialised microcredit: Another kind of subprime

One of the major criticisms of the Hatoyama administration’s postal reform plan has centred on the proposal to maintain more than a third of Japan Post Bank shares in government hands and to raise the cap on individual savings deposits from ¥10 million to ¥20 million. This will make it harder for private sector financial institutions, particularly small and medium-sized institutions in regional areas, such as regional banks and credit unions, to compete with Japan Post Bank because of the implicit government guarantee on postal deposits. Under these conditions, people will inevitably shift their savings into Japan Post Bank.

It is not often that Japan’s agricultural cooperative organisation (JA, or Japan Agriculture) is on the side of free and fair competition, but on this issue its message to the government has been loud and clear. In its sights is not only the lifting of the limit on postal savings deposits but also the raising of the limit on life insurance coverage from ¥13 million to ¥25 million.

On the 25^th February and again on the 9^th of March, representatives of JA’s key national organisations (the National Central Union, the National JA Insurance Federation, and the Central Bank for Agriculture and Forestry) visited the Financial Services Agency and directly put their case to Kamei Shizuka, Minister of Financial Services and Postal Reform. The JA representatives made strong statements, viz., ‘If the limits on postal savings and postal life insurance are raised, pressure on the management of commercial financial institutions is unavoidable’, and ‘If you raise the limit, the influence on JA management will be profound’. They demanded that the new institutional arrangements for Japan Post not steal business from the private sector, arguing that JA’s management, which was doing its best to operate successfully as a private sector enterprise, would be squeezed by the plan.

They were speaking from experience. In 1991 when post offices raised the minimum deposit limit from ¥7 million to ¥10 million, there were serious repercussions for private financial institutions. In the space of one year, the level of postal savings increased by about ¥20 trillion, which was more than a 14.2 per cent rise. On the other hand, the rate of increase in JA and fisheries cooperatives’ savings declined from 7.7 per cent in 1991 to 3.7 per cent. According to the Central Bank for Agriculture and Forestry’s calculation about current prospects, if JA savings decrease by ¥10 trillion, the gross profits from JA’s trust business will decline by ¥100 billion.

Kamei responded by saying that he wanted to revive the level of postal savings at Japan Post Bank, which had declined. The outstanding balance of these savings has fallen from a high of ¥260 trillion when the 10-year postal privatisation process began in October 2007 to a current level of ¥170 trillion owing largely to the lower interest rates on postal savings deposits compared with the commercial banks .

The current outlook for a number of JA’s businesses is negative in terms of profits, market share and volume of business. JA’s share of rice sales (by far the most important agricultural commodity it trades) has fallen to 50-60 per cent. The operations of many local co-ops are unprofitable because they are dependent on the patronage of small-scale, part-time farmers owning tiny plots, whose input demands and output sales are very small. The local agricultural co-ops that run up operational deficits traditionally rely on profitable credit and insurance businesses to make up the shortfall. However, even JA’s financial businesses are in difficulties.

Not only has competition in the savings and loans market increased recently, but investments of the Central Bank for Agriculture and Forestry were hard-hit by the global financial crisis with well over ¥1 trillion in unrealised losses. The question JA now faces is whether its financial businesses are in a position any longer to cover losses in its agricultural businesses. If savings flow out of JA into Japan Post Bank, it will push many local cooperatives into the red.

It also raises questions about the implicit contradictions in government policy. To the charge that Japan Post would end up using its massive surge in funds merely to buy more government bonds, Hatoyama has said that the group ‘should not become merely an institution to buy government bonds. It has to be one that can contribute to the revitalisation of regional economies’. What he has agreed to, however, is a policy that will undercut the financial and economic strength of the biggest economic organisation in regional areas – JA.

Minister Kamei himself also represents interests that attach great importance to maintaining services in rural areas, yet in this case, his interests seem to be narrowly institutional rather than broadly regional. His main desire reportedly centres on transferring anywhere from 70,000 to 100,000 non-regular workers into regular jobs in Japan Post, which will require a big expansion in earnings growth from its savings business, in order to create a loyal constituency for his own party . While this move is likely to increase postal votes for Kamei’s People’s New Party, for the DPJ as a whole, votes are more likely to decline overall despite a certain hardening of the postal vote.

Other vested interests should also be factored into the equation. In a situation where 80 per cent of postal savings are invested in government bonds, raising the deposit cap makes it easier to sell government bonds, and for this reason it is likely to be welcomed by Japan’s Ministry of Finance (MOF). The MOF probably sees postal savings as a storehouse of strong national bonds until the raising of the consumption tax rate can be realised. This may explain why MOF Minister Kan Naoto, who had been expected to weigh in on the deposit cap issue, failed to do so, leaving National Strategy Minister Sengoku Yoshito out to dry.

1. Reversing reform: How special interests rule in Japan
2. Japan: Is the DPJ the party of economic reform?
3. Economic reform in Japan on hold