Give them credit

Why did the government and RBI choose to do a “self-assessment” when more than two-thirds of IMF / World Bank member countries chose independent expert assessments through FSAPs? India’s actions raise a number of questions. How are these actions consistent with our position that there should be greater international supervision of financial systems in countries whose regulators and governments did not alert the world to the problems in their financial systems? If countries with sophisticated regulatory systems need independent assessments,why doesn’t India?

Though the FSAP is intended to help increase the effectiveness of efforts to promote the soundness of financial systems,it plays an important role of providing an independent assessment of that soundness. This role is being emphasised by many countries,including India,at the G-20 forum — especially after the regulatory failures in the US in the current financial crisis.

This consideration is part of the history of FSAP. Prior to the East Asian crisis,global financial markets believed a lot of what East Asian governments were saying about their domestic financial systems. The governments steadily put out reports claiming that their financial systems were sound. Then came the crisis and the reality turned out to be very different.

Global financial firms reacted in an extreme fashion. They went from trusting almost anything in East Asia to trusting nothing in East Asia. Prior to the crisis,global financial firms believed the government’s propaganda,and money kept pouring into East Asia. When the crisis broke out,global financial firms disbelieved everything that these governments said and just took money out. This contributed to the severity of the crisis.

In response to these events,the World Bank and the IMF jointly came up with a proposal on how developing countries could better engage with the global financial system. Under an FSAP,a team of well-respected international experts would write a report about the strengths and weaknesses of the financial system of a country. This would be an independent review and not propaganda: it would not be like speeches given by civil servants or reports released by central banks.

The FSAP process has been running for roughly a decade now,and roughly two-thirds of countries have done an FSAP. Many countries choose to release these reports so as to feed them back into the information arteries of the global financial system. These reports can be found on the website of the IMF.

Let us remember the benefits India gets by undertaking such an exercise. For a foreigner,Indian finance is difficult to comprehend. On the one hand are some world-class elements,such as the index derivatives trading at NSE. Side by side with this are problems such the malfunctioning bond-currency-derivatives nexus,or the political influences in Indian finance,with features such as SEBI being prevented from questioning Raju for so long. Global finance has to struggle when making investment decisions in India. The reduction of fuzziness that FSAP provides would help. The FSAP gains legitimacy through three instruments: independence from the government,the use of internationally respected experts,and the stamp of the World Bank and the IMF. A “self-assessment”,executed by civil servants and their friends,by definition,offers none of these benefits.

This is evident when we look at what the report has to say about accounting standards. The International Auditing Standards (ISAs) are widely accepted in India. Some gaps need to be addressed in areas relating to convergence with the ISAs,implementation of auditing standards,strengthening peer review,access to working papers and independence of auditors. Given the state of auditing and accounting standards in India,especially given the loss of confidence after the Satyam scandal,the government would only undermine its own credibility were it to release a report that points to access to working papers as one of the major gaps.

The right thing for the government of India is to immediately request an FSAP. Anything less,especially a self-assessment that paints a rosy picture,sounds too much like propaganda and sends out wrong signals. The FSAP should then be publicly released. It would give an independent expert perspective on what is right and what is wrong in Indian finance. It would reduce the asymmetric information between global finance and the realities of India,and thus help stabilise foreign capital in India by helping investors to form realistic expectations about Indian finance.

The writer is senior fellow,National Institute of Public Finance and Policy,Delhi

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