Fixing Global Finance A Developing Country Perspective on Global Financial Reforms Kavaljit Singh 1 Fixing Global Finance 2 Fixing Global Finance Fixing Global Finance A Developing Country Perspective on Global Financial Reforms Kavaljit Singh 3 Fixing Global Finance Fixing Global Finance was first published in 2010 by Madhyam and SOMO. Madhyam 148, Maitri Apartments Plot No.28 Patparganj Delhi: 110092 India Phone: 91-11-43036919 Email: madhyamdelhi@gmail.com Website: www.madhyam.org.in Stichting Onderzoek Multinationale Ondernemingen Centre for Research on Multinational Corporations Sarphatistraat 30 1018 GL Amsterdam The Netherlands Phone: 31-20-6391291 Fax: 31-20-6391321 Email: info@somo.nl Website: www.somo.nl ISBN: 81 86816 21 6 (PDF) ISBN: 81 86816 22 4 (EPUB) Cover Photos: Hayden Bird (www.haydenbphotography.co.uk) Copyright © Kavaljit Singh 2010. Since this publication is meant for non-profit, research and educational purposes, you are welcome to reproduce it provided the source is acknowledged. We will appreciate if a copy of reproduced materials is sent to us. 4 Fixing Global Finance Contents Acronyms 6-7 Data Notes 8 1. The Unfolding of Global Financial Crisis 9 2. The Global Financial Crisis and Developing Countries 22 3. Recent Trends in International Finance and Developmental Implications 30 4. The Rise of New Global Players 36 5. Financial Derivatives and the Globalization of Risk 55 6. Global Financial Crisis and India 59 7. Guiding Principles for Building a Stable Global Financial System 75 8. Global Financial Reforms and Developing Countries 101 9. Global Financial Reforms and Civil Society: A Bottom up Approach 114 Glossary 121-124 Bibliography 125-127 5 Fixing Global Finance List of Boxes 1. Understanding the Sub-Prime Mortgage Crisis 11-13 2. The Revival of International Monetary Fund 16-17 3. The Collapse of Trade Finance 26 4. The Foreign Exchange Market in India 62 5. Exotic Currency Derivatives Trap Small Exporters in India 72-73 6. Capital Controls Gain Credence 88-89 7. Basel III 92 8. Securities Transaction Tax in India 96 9. Key Policy Proposals 109 List of Tables 1. Global GDP Growth 15 2. The Relationships between Bailout Banks and Hedge Funds 50-51 3. Trends in Capital Flows to India 61 4. Key Indicators of Openness of the Indian Economy 64 6 Fixing Global Finance Acronyms ASEAN The Association of Southeast Asian Nations ATMs Automated Teller Machines BCBS Basel Committee on Banking Supervision BIS Bank for International Settlements BoP Balance of Payments CAR Capital Adequacy Ratio CDOs Credit Default Obligations CDS Credit Default Swap CECA Comprehensive Economic Cooperation Agreement CIS Commonwealth of Independent States CRAs Credit Rating Agencies ECA Europe and Central Asia ECB European Central Bank EU European Union FDI Foreign Direct Investment FII Foreign Institutional Investor FOREX Foreign Exchange FTA Free Trade Agreement GATS General Agreement on Trade in Services GCC Gulf Cooperation Council GDP Gross Domestic Product HNWI High Net Worth Individual HSBC The Hongkong and Shanghai Banking Corporation IFSL International Financial Services, London ILO International Labour Organization IMF International Monetary Fund IOSCO International Organization of Securities Commissions IPO Initial Public Offer LIBOR London Inter-Bank Offer Rate 7 Fixing Global Finance LBO Leveraged Buyout L/C Letter of Credit LTCM Long-Term Capital Management (US based hedge fund) M&As Mergers and Acquisitions MFIs Micro Finance Institutions MSE Micro and Small Enterprise NAFTA North American Free Trade Agreement NBFCs Non-Banking Financial Companies NGOs Non-Governmental Organizations NIM Net Interest Margin NPAs Non-Performing Assets NPL Non-Performing Loan OBE Off-Balance Sheet Exposures OFCs Offshore Financial Centers OTC Over The Counter PE Private Equity RBI Reserve Bank of India RoA Return on Assets RoE Return on Equity SEC Securities and Exchange Commission SIVs Structured Investment Vehicles SME Small and Medium Enterprise SPV Special Purpose Vehicle SWFs Sovereign Wealth Funds TNCs Transnational Corporations UK United Kingdom UN United Nations UNCTAD United Nations Conference on Trade and Development US United States of America WOS Wholly Owned Subsidiary WTO World Trade Organization 8 Fixing Global Finance Data Notes Million is 1,000,000. Billion is 1,000 million. Trillion is 1,000 billion. Dollars are US dollars unless otherwise specified. 1 US Dollar ($) = Indian Rupees (Rs.) 45 (As on September 30, 2010). Indian Financial Year: April-March. 9 Fixing Global Finance 1 The Unfolding of Global Financial Crisis Since 2008, the world economy is in the midst of a severe crisis. The housing market meltdown which was triggered by sub-prime mortgage crisis in the US quickly snowballed into a global financial crisis affecting large international banks and other financial institutions. The sub-prime mortgage crisis is discussed in details in Box 1. Due to financial interconnectedness, the turmoil that began in September 2008 with the collapse of Lehman Brothers and other Wall Street banks quickly spread to other developed economies including Germany, the UK and Japan. Post-Lehman collapse, many markets became dysfunctional and several big banks on both sides of the Atlantic had to be rescued from bankruptcy. In most developed countries, the economic growth reversed. International trade and investment flows declined sharply during the current crisis. The turmoil in the financial sector rapidly spiraled into the real sector, thereby leading to a global economic crisis. Given the scale and extent of the present crisis, many economists have called it “the worst financial crisis since the Great Depression of the 1930s.” Some have compared it to the Great Depression. Undeniably, both originated in the US and were global in scope. Some even argue that net impact of current crisis in terms of declines in output, trade volumes and stock markets has been much severe than that of the Great Depression. What Caused the Financial Crisis? There are plenty of hypotheses about what caused the global financial crisis, ranging from greed to fraud to regulatory failures. Some analysts have explained the crisis by Hyman Minsky’s Financial Instability Hypothesis while others view it as a structural crisis of global capitalism. [...]... Crisis, Finance, and Growth, 2010, p 25 2 For details, see Kavaljit Singh, The Changing Landscape of Export Credit Agencies in the Context of the Global Financial Crisis, FERN, March 2010 (http:// www.fern.org/changinglandscape) 3 World Bank, op cit., p 32 4 Ibid 30 3 Fixing Global Finance Recent Trends in International Finance and Developmental Implications The starting point in any discussion on global. .. impacts of crisis were felt through trade channels given the fact that African exporters rely heavily on external trade finance Those African countries which largely rely on export and tourism for 26 Fixing Global Finance Box 3 The Collapse of Trade Finance The global market for trade finance (both credit and insurance) began deteriorating in mid-2008, with the squeeze in liquidity and growing concerns... meet a number of MDGs due to enormous economic constraints put by the crisis Is the Financial Crisis Over? Despite massive bank bailouts and fiscal stimulus packages announced by governments, the global economy recovery is still not in sight with faltering demand and falling production, a squeeze in credit markets and growing 20 Fixing Global Finance job losses In the US and Europe, the main macroeconomic... across countries The deterioration in the global economy began in early 2008 with most developed countries experiencing a sharp contraction (Table 1) Among the developed economies, Japan was severely hit by the financial crisis It’s GDP growth contracted by 5.4 percent in 2009 As the crisis unfolded, domestic bank lending contracted in the major 15 Fixing Global Finance developed economies Likewise, internationally... Furthermore, Islamic finance is fast emerging in the Asia and the Gulf region The revival of G20 also signals the growing influence of big developing economies in international policy making Nevertheless, it remains to be seen how far a new global economic order would emerge with the rise of new financial centers from the developing world? Fixing Global Finance 29 Notes 1 World Bank, Global Economic Prospects:... workers The jobs crisis is unlikely to be resolved soon due to sluggish and jobless 18 Fixing Global Finance recovery Unlike bailing out big banks, the strong political will to protect and create jobs is squarely lacking at both national and global levels By and large, fiscal stimulus and other measures announced by governments lack focus on employment generation and social protection The developed... serve the real economy But in the last two decades, the global financial sector has Fixing Global Finance 31 become so big that has led to a tail (financial sector) wagging the dog (real economy) kind of situation Financial Innovation, Deregulation and Globalization Financial innovation played an important role in changing the dynamics between finance and real economy It facilitated the introduction... 34 Fixing Global Finance the value of annual world trade and output, much of global finance capital is moving in search of quick profits from speculative activities rather than contributing to the real economy Every day, trillions of dollars move in the world’s financial markets in search of profit making opportunities from speculative investments These flows are largely liquid and are attracted by. .. concern for global policymakers Financial speculation is now well recognized as one of the major contributors in extreme price volatility in commodity and agricultural markets A study by SOMO found the growing influence of “non-traditional” institutional investors (such as hedge funds) in agricultural markets.7 The sharp rise in global food prices during 2006-08 and subsequent Fixing Global Finance 35... stability Paid by those whose securities and financial products they assess, they are subject to a crippling conflict of interest that resulted in their giving top ratings to RMBS despite the decline in lending standards and a slowdown in the housing market 14 Fixing Global Finance Even though the crisis originated in the US, banks and financial institutions in Europe were more severely affected by losses . Fixing Global Finance A Developing Country Perspective on Global Financial Reforms Kavaljit Singh 1 Fixing Global Finance 2 Fixing Global Finance Fixing Global Finance A Developing. Finance A Developing Country Perspective on Global Financial Reforms Kavaljit Singh 3 Fixing Global Finance Fixing Global Finance was first published in 2010 by Madhyam and SOMO. Madhyam 148, Maitri. severely hit by the financial crisis. It’s GDP growth contracted by 5.4 percent in 2009. As the crisis unfolded, domestic bank lending contracted in the major 15 Fixing Global Finance Table 1: Global