High deficits will lead to crisis 8212; Rangarajan

BHUBANESWAR, MAY 15: Countries with high current account deficits, even if accompanied by high growth, are vulnerable to the economic cri...

BHUBANESWAR, MAY 15: Countries with high current account deficits, even if accompanied by high growth, are vulnerable to the economic crisis which engulfed several east Asian countries recently, according to the Orissa governor, Dr C Rangarajan.

If the capital inflows are affected or if exports fail to grow, these countries come under heavy stress, Rangarajan said while delivering a lecture on quot;East Asian crisis 8211; what lessons?quot; at the Nabakrushna Choudhury Centre for developmental studies here yesterday. Rangarajan, a former governor of the Reserve Bank of India RBI, said that though some economists contended that the size of the current account deficit was irrelevant, the Asian experience clearly pointed out the danger of countries running very high levels of current account deficit.

In fact, the higher the level of current account deficit, the greater was the benefit from capital flows but also higher the risk to which they were exposed, he said.

Stating that the very high level of current accountdeficit made these countries vulnerable to external shocks, he said that so long as the capital inflows filled up the current account deficit, the economies performed well. However, once the sentiment changed and capital inflows were replaced by capital outflows, it had severe consequences. Rangarajan, whose speech was part of the Kalinga lecture series, said that the east Asian crisis emphasised the need for a watch on volatile flows which had destabilising effects.

The economic crisis in East Asia was the result of the failure of the respective governments and the market, he said. Markets in these countries had failed to detect some of the weaknesses in the functioning of the system, he said. A major factor in triggering the crisis related to weaknesses in the financial sector with banks not being subjected to effective prudential regulation and supervision or asset liability management, he said.

This coupled with poor governance and lack of internal controls resulted in excessive leverage andexcessive credit expansion directed to unproductive investments while financial reporting and disclosure norms in these countries were far from satisfactory, he added.

The governor also pointed to lack of transparency which delayed public realisation of the magnitude of the problem. The crisis mainly hit the countries of south Korea, Thailand, Malaysia, Indonesia and the Philippines while the reverberations were felt by many countries including India, he said.

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Detailing the lessons India should learn from the crisis, Rangarajan said it emphasised the need for a watch on volatile flows which had destabilising effects on the economy. However, the real concern was over short term flows which were sometimes described as hot money, he said adding that short term debt as a proportion of total external debt had to be kept within reasonable levels. Some restrictions on short term flows through market based instruments were now accepted as necessary, he said. Rangarajan said when the capital account was open, theexposures of private sector needed to be monitored. While some effort was made normally to monitor the short term exposure of banks, not enough information, very often, was available to the countries regarding exposure of corporates.