145;India shouldn146;t worry about sovereign 038; hedge funds146;

Your latest book uses the 1907 crash to demonstrate the typical factors that precipitate panic and crises in financial markets. Can you explain?

Mark Twain said, 8220;History doesn8217;t repeat itself, but it rhymes.8221; People say each financial crisis is unique in itself. But I compare them to cyclones 8212; each cyclone is unique but we do know enough about what climactic conditions trigger them off. Similarly, financial crises are caused by a convergence of many factors that would only need a spark to blow up. Today we are seeing rapid global growth, growing complexity in financial markets, reduction in safety buffers, growing scarcity of natural resources and constraints of labour and leadership. These factors set the stage in 1907 and the same pattern has been seen in many crises since. This gives us confidence to forewarn decision makers that we are in the midst of another crisis.

Are the global implications of the sub-prime crisis not yet fully understood?

Investors in Asia are very confident that the crisis has passed them by, while those in Europe, Australia and America think otherwise. With each passing week, we learn of more losses, more CEOs being fired; this will take time to wash through the system 8212; maybe another 18 to 24 months. I find it hard to believe that Asia will escape completely, though economies like India and China expect their large reserves and high growth rates to cushion them from the worst effects of the crisis. If it passes India by completely, I would be really surprised.

First, it was hedge funds, now it8217;s the recently launched Chinese sovereign fund that is looking to invest here. The Indian authorities are concerned about security implications. Should they be?

In the late 19808217;s, the US was very worried about Japanese investors buying up companies and real estate. There was talk about restricting those capital flows. But in retrospect, if they had intervened, the US would have been worse off and the capital would have gone elsewhere. We can draw a parallel between Japan and today8217;s China. The long-run benefits of free trade are so enormous that it8217;s worth absorbing the inflows and the concerns about potential control of domestic markets by FIIs. At the rate India is growing, it8217;s unlikely that these sovereign funds would have any significant influence on capital markets. China, Singapore, Korea and other emerging economies have something capital to give India for its expansion. I would counsel the Government and the regulatory community to think liberally.

And the favourite regulatory bugbear the world over 8212; hedge funds?

Hedge funds must be viewed liberally as well. They may bring some volatility, but they do bring liquidity and help distribute risks across global markets. The lack of transparency is something that the US Securities Exchange Commission SEC and other regulators are worrying about. But the SEC8217;s attempts to get them to disclose holdings and strategies periodically hasn8217;t worked as hedge funds have argued that revealing their trading strategy would dissipate their opportunities and destroy their very reason to be. The formula for their success is to discover new trading strategies and they should be applauded as a marvel of modern financial markets. Rather than get them to reveal their secrets, regulators must rely on intermediaries to bring better judgement to the market.

Whether it was analysts abandoning logic during the dotcom boom or credit rating agencies being lax while rating securities backed by sub-prime mortgages, intermediaries seem to be key players in triggering crises.

Indeed, whether it is the sub-prime loans or Enron or dotcoms, we have learnt that key intermediaries either fail to perform or under-perform their vital functions. A solution can be found only if we can construct their incentives properly. Incredible periods of growth lead to very rapid innovation in design of institutions as well as instruments. Regulators, journalists, academics find it difficult to keep pace and it8217;s only after a crash that we discover what went wrong and change accordingly.