'I don't see India emerging as a global demand engine. Until India sorts out its domestic problems, nothing much is likely to happen in India.'
Image: People look at a large screen displaying India's benchmark share index, on the facade of the Bombay Stock Exchange building in Mumbai. Photograph: Arko Datta/Reuters
India-born Satyajit Das wears many hats: An avid cricketer, a bird watcher, a banker, a consultant, an author, and most importantly the man who was one of the first persons to warn the world about 'The Coming Credit Crash' in his 2006 book, Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives.
He spoke to Prasanna D Zore/Rediff.com
- Part I of the interview: The Interview Narendra Modi Must Read!
You mentioned that world leaders have learned nothing from the economic meltdown of 2008.
Could you elaborate on the lessons not learned and how it could once again take us towards a 2008-like recession?
Will it be more severe than what the world witnessed in 2008?
We just got to go back to the real basics. Ask yourself: What caused the crisis (of 2008)?
In my view, there are four inter-related factors: High levels of debt, financial imbalances in terms of savings and investments and current account surpluses and current account deficits; the third is related to some extent to the first, entitlement programmes and the welfare States which were generally unfunded, and the final one is financialisation of the economy, which is related to debt. But there are other elements to it too.
In the period leading up to 2008, in the United States of America, you needed five dollars of debt to create one dollar of GDP. In comparison, in the 1950s you needed one to two dollars of debt to create one dollar of GDP.
What happens is, over time, like the heroin addict, you need stronger and stronger doses to get the same high.
Once the problems occurred, the sensible, intelligent response should have been to tackle the four problems I mentioned individually. We didn't do any of that and the debt is now higher and though the imbalances have come down a bit, they have come down because of lower growth and not because we actually dealt with them.
As you can see in Europe, winding back entitlements other than in the direst circumstances like Greece, is pretty difficult. The Germans are the classic example. (German Chancellor ) Angela Merkel put up the retirement age from 65 to 67. In the last election she brought it back from 67 to 65 to satisfy her coalition partners.
So, there isn't any willingness to tackle any of these real issues.
The most ridiculous thing is we haven't dealt with financialisation. That's what got us into trouble. We haven't dealt with it. All those (complex derivative) products, derivative volumes are still the same. CDOs (Collateralised Debt Obligation, a complex derivative product that led to collapse of many investment banks during the 2008 financial meltdown), is back to the same volumes.
What is even worse, the central banks and governments are now using finacialisation to deal with the problems it caused in the first place.
If a government sells its debt to a central bank (purchases bonds by printing money and gives it to the government) to finance itself, it's paying interest to the central bank. The central bank pays for the bonds by creating reserves which costs them nothing.
If I was to do that in a company I would be locked up by the regulator!
You look at the European Union proposal for their infrastructure spending. It is basically a gigantic CDO where the EU takes the first loss. We have learned absolutely nothing.
In the film Matrix, one of the characters in the film called Morpheus (Laurence Fishburne) offers Neo (Keanu Reeves) the choice between a blue pill or red pill. The blue pill lets you continue to believe in a surreal world which you live in and the red pill helps you understand reality with all its pain.
The world (the central banks) keeps swallowing blue pills. We keep pretending, we keep believing that our central bankers are saving us. But they don't know what they are doing.
Everybody is into this popping up of the blue pill. The US did it for five years and now they have unwounded it. Then the Chinese did it, the Japanese too and now the European Union is pondering over its own QE programme.
The question is who will pay the price for it and what price would it be?
Look, what can't go on, won't go on and there will be a tipping point. It will unwind. And it will unwind horribly. People have borrowed and can never pay back their debt. If it can't be paid back, it won't be paid back.
In Greece, they are talking about issuing zero coupon bonds with 100-year maturity. What's the difference if you as well write it off? This whole thing is nonsense!
Eventually, we will have to take a hit and wipe out a whole lot of wealth. It's inevitable.
In the meantime, the policies keep creating more and more asset price bubbles -- equities, bonds, property, emerging markets etc. In the end, when it (the loose monetary policies adopted by central banks across the world) unwinds it will be horrible.
We all know it will be horrible. It is going to make 2008 look like a picnic.
This time there is going to be nothing to back-stop us because all the balance sheets of the government are weaker as a result of the last crisis. If you have already got the interest rates at zero, and you have been pumping massive amounts of money in, then essentially what's left?
Japan shows you very clearly that once you get into this position, you can't get out. Japan has been trying for 25 years to get out of this, but haven't. They are up to QE IX; they are up to the fifteenth fiscal stimulus package.
In a sense, India is a closed economy. Can India insulate itself from this contagion reaching its shores?
In this (inter-connected) world you (India) cannot avoid (the financial) contagion. There are two channels by which India gets hit.
India still needs to export and foreign capital is very important for India to finance its current account deficit. These two lines will get hit no matter what happens.
This is like a large fire blowing through your neighbourhood and, if you have a house sitting there, then it is unlikely you are going to go out unscathed.
Is the crash in oil prices good for India? And do you see the crash in oil prices cascading down to global banks given their exposure -- some estimates say almost two trillion dollars -- to oil drillers and producers?
It is good for India in the short run. But I don't think the fall in oil prices is an unmitigated good. At its heart, fundamentally, this crash is just a transfer of money from producers to consumers.
The whole assumption that the oil price crash is good for global growth assumes that producers are actually not going to spend it (the petro dollars they earn by exporting oil) and consumers will spend (the money saved because of falling crude prices).
All these petrol-exporting countries have massive spending programmes. They are just going to wind back their spending proogrammes.
I don't think the consumers who get the money are going to spend. The multiplier that people are assuming is wildly exaggerated. People don't seem to be focusing on why oil prices are actually going down. There are certainly supply factors, but one of the reasons is weak demand because of weak growth.
Oil prices are going down is because the US dollar is going up. Real interest rates in US dollar terms are also going up which is terrible news for borrowers around the world.
There is a massive winding back of investments which is negative. There could be perhaps one trillion or two trillion dollars of investments which won't take place.
The United States has done pretty well in the last couple of years, in a relative sense. Energy has been part of that. A lot of the good jobs were in the energy or allied industries. But that may now reverse because of the fall in oil prices. The average American may save 500 to 600 dollars on his gasoline bills, but if he doesn't have a job in the first place it is meaningless. How does that help?
This whole boom in the energy prices led to massive investment and lending by banks and investors into this (exploration and drilling of oil) sector. Now that oil and gas prices have crashed, these companies won't have enough money to service the huge debt levels on their books.
People forget that Petrobras in Brazil, Pemex in Mexico, Gazprom and Rosneft in Russia are very big borrowers. If oil prices go down, how are they going to service their loans? And in the case of emerging markets if their dollar revenues go down, and if they have got dollar debt, then they have a growing currency mismatch.
In this gloomy economic environment, do you see India and the US emerging as the demand engine for the global economy considering that many economists are betting on strong economic revival in these two countries?
The US could, but India cannot if you put things into perspective. In size, India's absolute GDP is a fraction of the US's. There are investment banks that are proposing that India will be growing quicker than China.
As of now, I don't see India emerging as a global demand engine. Until India sorts out its domestic problems, nothing much is likely to happen in India.
I can see the Indian economy puttering along anywhere between three-and-a-half to six-and-a-half (percent GDP growth) depending on what happens.
There is so much that is outside India's control. The monsoons are still extremely significant to growth. Depending on how monsoons fare in India it can have enormous effect on the Indian economy. You have to be very, very careful.
What kind of reforms do you want to see happen in the Indian banking space?
While little regulation of banks in the West led to the economic meltdown of 2008-09, banking in India is excessively regulated/misused, especially the PSU banks. Do you think in these conditions Indian PSU banks can emerge stronger?
Already, most of the top PSU banks are loaded with NPAs (non-performing assets/ loans gone bad), a result some allege, of the political-corporate nexus and doles given as subsidies to even those who don't need it?
The real problem in India is of mobilisation of capital. India has lot of savings. If these savings are mobilised efficiently some of the problems of infrastructure funding can be eased. The intermediation process needs to be more efficient.
We all know that it is necessary to break what you politely call the political-corporate nexus. This is very, very difficult.
Indian banks need to fix their non-performing loans first. You need to set up a bad bank, where you can move all those bad debts. But that costs money -- a lot of it.
Then essentially, start to modernise banks, reduce public sector ownership, bring external capital in, bring better non-political professional management in and then get them to focus on what needs to be done.
Banking is very simple. There are three things you need to do: One, provide an efficient payment system. As we know, the payment system in India is still not what it could be; it is getting better but still there are issues.
Second, you provide a safe-haven for savings in the form of deposits, allowing banks to provide efficiently priced loans. A key is to provide better access to finance for small and medium sized business.
In India, a large fundamentally bankrupt company has better access to money than a small start up or small business with excellent prospects. That's got to change.
The last is to provide very simple risk management tools. If you start this today, it is going to take you five years to get these systems in place.
The Union Budget will be unveiled soon. What is your wish-list for India's finance minister?
- Get some funds to get infrastructure kick-started.
- Fix the financial system. Improve the taxation system.
- Start on a clean chit and get rid of many, many little taxes and have simple, sensible tax administration and collecting of taxes, broadening the tax base. Probably Mission Impossible!
