Leave Convertibility Alone: Krugman

Superstar American economist Paul Krugman says India should close down its weak banks, impose serious capital requirements on the strong ones and leave the currency convertibility programme where it is.

In the course of an interview with Business Standard, Krugman, MIT's Ford International Professor of Economics, said he saw similarities between India and Brazil in the sense that both had a large fiscal deficit, a sluggish economy and high unemployment.

"But perhaps the similarities are only till that point, since it doesn't appear that the Indian government will raise interest rates to 50 per cent. And the government finances are not such that it would get reflected on the interest rates paid on government debt", he said.

Krugman was careful not to comment in too much detail on India as he "did not know too much about it." Besides, as he ruefully pointed out, there were several countries where he had said a crisis wouldn't occur, only to be proved wrong.

However, he was still willing to offer some advice. India, he said, would have to stop talking about divestment and start talking privatisation. "The reforms here are more than earlier by far, but only half-way there", he said.

On the social costs of closing down weak banks in India, Krugman, an advocate of extreme caution in the banking system, said it made no sense to keep unsound financial institutions running only to protect some jobs. "There is a cruelty to our market system. But the cruelties cannot be eliminated."

Krugman recently sparked off a controversy by advocating capital controls as a last resort for crisis-ridden economies. Clearly, he has not changed his views. On capital account convertibility, he said: "It's an extremely dangerous world out there. The risks of getting caught in the pinball game are too high".

India, he said, had "avoided the worst" of the Asian crisis, partly because the existing restrictions discouraged inflows and outflows of short term capital. "The advantage was also because India did not become a flavour of the month long ahead of the crisis and was a relatively late entrant into the global scenario. "Had the crisis come to India, it would have fed on itself," Krugman said.

He added that the rupee was indeed heavily managed and pointed out that smaller economies cannot afford a benign neglect of the foreign exchange rate. "There is a perverse, but relevant point here. Actually, properly instituted controls may end up being welcomed", he said, pointing out that investors were more afraid of the other pulling out first. "It's something like I'll keep in if you keep in", he said.

So, having advocated capital controls as a last, but temporary resort, how does Krugman reckon these controls can be lifted, and when? "I would say that these have to be imposed alongwith an announcement to lift them after, say, three years.

He said he would much rather continue, on the long term, with prudential inward capital controls. Over the short term, however, the crisis-ridden economies need to impose outward capital controls. "It's a bad policy, but still better than the alternative". Commenting on Mahathir Mohammad's Malaysian capital controls policy, he said it had been "badly implemented" and was excessive. Besides, Malaysia was seeking to offer controls as a permanent solution.

Comparing the current crisis to that of the 1930s, Krugman, however, said the 30s analogy was qualitative and not quantitative, since this time, a very small percentage of global GDP was affected. "I think there will be a pretty good recovery pretty soon".