Transcript Slide 1

Economic Modernization and
Finance
Panelist
Hrishikesh D. Vinod
[email protected]
Open Economy & Financial Burden
of Corruption
Hrishikesh D. Vinod
Professor of Economics,
Fordham University,
Director: Institute of Ethics
and Economic Policy
E-Mail: [email protected]
Web page:
http://www.fordham.edu/econ
omics/vinod
Joke
• How many Chicago economists does it
take to change a light bulb?
• None
• If the bulb needed changing, market would
have already done it.
• As long as the Govt. leaves the light bulb
alone, it would screw itself in the socket.
But democracy and free markets don’t
always help reduce corruption
Open Economy Corrup Burden
• (i) Economic Modernization, Financing
Infra structure (energy, Enron in India)
• (ii) International Financial Flows and
Economic Volatility. Comments on
downside risk of international investment.
• (iii) a study of new tools including “value at
risk” and how they might adversely affect
foreign direct investment (FDI) in India.
Infrastr: Water, Energy, Comm, Ins.
Modernization of India needs capital.
Tapping domestic savings for K and FDI
Sunshine is the best disinfectant, India has
plenty of it, yet corruption no trust in K
markets, hurts K-formation for infrastr. Use
e-government, all Gov. trans on Internet.
Enron in India used corruption and wrong
techn. (LiqNGas) cancel energy projects
Modernization by Improved Infra
• Telecommunications is very important for
IT sector exports, but the telecom sector is
in trouble in US due to governance issues
including fraud and corruption by CEOs
• Internet can be used to fight corruption.
Despite digital divide, it can reach millions
as other media report on it (Tehelka).
Vinod (1999) J Asian Ec micro econ paper
Corruption hurts infrastr
• 1) direct destruction. 1993 Stock Exch. Attack
possible due to RDX brought in India using
corrupt customs officers
• 2) Goodwill is hurt (e.g. Bank of NY, Russian
mob connection or Jack Welch GE perks.)
• 3) hurts ordinary investors. Rs 680 crore ONGC
corporate funds were credited in Harshad
Mehta's account (no 1028 with the UCO Bank,
Hanuman Street, Mumbai) by a corrupt official
Two Cows joke update for Enron
• Under feudalism, you have two cows. Your lord
takes some of the milk. Under fascism, you have
two cows. The government seizes both, hires
you to take care of them and sells you the milk.
Under communism, you have two cows. You
must take care of them, but the government
owns all the milk. Under capitalism, you have
two cows. You sell one and buy a bull. Your herd
multiples; you sell out, invest the money and
retire on the income.
2 Cows joke update for Enron2
• You borrow 80% of the forward value of the two
cows from your bank, then buy another cow with
5% down and the rest financed by the seller on a
note, bearing interest at twice the prime, callable
if the market cap of your publicly listed company,
whose stock you've put up as collateral, goes
below $20 billion. You sell the three cows to your
publicly listed company, using letters of credit
opened by your brother-in-law at a second bank,
then execute a debt/equity swap with an
associated unit, so that you get four cows back,
plus a tax exemption for five cows.
2 Cows joke update for Enron3
• Transfer milk rights of six cows (via
intermediary) to a Cayman Islands
(secretly owned by the majority
shareholder) who sells the rights to seven
cows back to you. Annual report trumpets:
company owns eight cows, with an option
on one more. All transactions cheerfully
blessed by your independent auditors,
who, of course, served as consultants.
Sad end & how to de Enronize
• Big Press Release and conference call
with analysts: Enron will begin trading
cows over the Web. Analysts proclaim
Enron the prototypical New Economy
Company, shares ↑ enabling insiders to
sell and got out before bankruptcy.
• A company can de-Enronize itself by
better disclosure (Sarbanes-Oxley Act)
International financial distress and
volatility is increased by corruption
• Banking distress, collapse of the Thai Baht
in 1997LossesRebalancing portfolios
Rapid worldwide transmission stock
/currency markets. This is facilitated by
corruption, fraud, money laundering
havens, crony capitalism & enronitis.
• Modern tools of managing risk unavailable
in India. (interest swaps)
Financial Flows & Econ Volatility 2
• Undeveloped ‘derivative securities’
markets make the risk from stress-induced
volatility difficult to manage for Indian firms
• Asymmetry of ‘home bias’ (Americans fail
to diversify abroad, but Indians do invest
abroad if allowed) and the effect of
corruption on the value at risk (VaR)
(Worst case scenario 1 percentile
becomes worse with corruption)
Home Bias
• E (excess return) =
• [JWWW/JW ]E2 + [JWF/JW ]E(covar’ce),
where [JWWW/JW ] measures risk using
constant relative risk aversion CRRA. The
covariance term hedge component.
India corruption is so high that home bias
does not work. There is foreigner bias.
Joke
• What do you get when you cross a
Godfather with an economist?
An offer you cannot understand
My full paper is accepted for publication by J
of Asian Ec. Contact [email protected].
Here I give nontechnical highlights
Incomplete Insurance Available
• (i) Credit risk refers to the ability of the
borrower to generate revenue to pay back
the debt. (ii) Default risk is with reference
to collecting when default occurs. (iii)
Transaction risk (currency devaluation),
(iv) corruption risk
• Very limited insurance available to Indian
entrepreneurs to manage these risks.
S&P, Moody’s grade India Low
A positive contribution of private rating
agencies and hot money transfers is that
they create a countervailing power to
government propaganda. But daily $1Trill
transfers cause volatility, hard to manage.
Ordinary investors need to be convinced
that investment in India will yield profits.
Socialism and mistrust of profits hurts.
VaR tools make corruption seem worse.
Our theory predicts:
Corrupt countries with low CPI (corrup. perception
purity index) by Transparency International have
• (i) extra capital flight controls, (IMF data)
• (ii) low foreign direct investment (FDI).
• (iii) high cost of capital (Price-Waterhosue Data)
All are supported by Asian data, forthcoming paper
in J of Asian Econ. E.g.,Corr(CPI, FDI/GDP)
=0.6, FDI goes to purer (less corrupt) countries.
Correlation Results: New Measures
• Correlation between CPI and (Trade/GDP
ratio) is even higher at 0.7341
• Corr(CPI,“capital flow control index”)
0.7522,(New data from IMF reports)
• Corr(CPI,“cost of capital % penalty”)
0.827. New ‘cost of capital’ measure
from Price-Waterhouse-Coopers’ data.
Isolation of India w.r.t. FDI
• Indian Rupee was largely immune to the
volatility induced by the contagion due to
India’s capital controls (cause corruption).
Mexico controls < Indian. K-flight to US
problem, Peso fluctuates more than Indian
Rupee, but FDI is much more in Mexico
than in India. Cost of K is high for India.
• China gets many times more FDI
Conclusion
• India needs infrastructure (+insurance) but
Corruption hurts India’s microeconomy
• Open Economy Burden of Corruption is also
High (VaR worsens it) High cost of K hurts.
• Corruption can be reduced if everyone
understands the burden and tries to reduce it.
China has death penalty.
• Hopeful signs: CVC, Internet, IT sector
• Discouraging signs: ban criminal MPs, supreme
court decision overturned by all parties