FREE - MARKETS IDEALS SURVIVE THE CRUNCH / THE FINANCIAL TIMES ( VERY HIGHLY RECOMMENDED READING )

Free-market ideals survive the crunch

By Alan Beattie in London and Geoff Dyer in Beijing

Published: November 26 2009 17:57

The global crisis prompted more than the loss of a string of financial institutions. It also inflicted collateral damage to the economic ideology that had sustained the rich world, or at least the US – that of finance capitalism.

For much of the 20 years since the end of the cold war, the US – with sporadic support from industrialised countries, such as the UK, and institutions, including the International Monetary Fund – had propagated the gospel of economic liberalisation and financial deregulation. Having evoked scepticism among its audience, particularly after episodes such as the 1997-8 Asian crisis, the global financial crunch might have been expected to bury that message for good.

But reactions have been measured among the so-called Bric (Brazil, Russia, India and China) countries and other key emerging markets.

Few are hurtling headlong into more financial deregulation – as one Chinese official says: “We used to see the US as our teacher but now we realise that our teacher keeps making mistakes and we’ve decided to quit the class.” Yet the dominant reaction appears to be a pause to consider rather than an immediate clampdown. And paradoxically, the fact that restrictions have protected the financial sectors from the worst of the downturn seems to have kept the prospect of more liberalisation on the table.

John Cooke, chairman of the liberalisation committee at industry group International Financial Services London, says: “The likes of China and India have made statements congratulating themselves for escaping the worst of the crisis by keeping their financial sectors relatively closed. But while they have drawn strength from that position, they have not, on the whole, put up new barriers”.

China has spent the past year quietly pushing through financial reforms that are building the foundations for a more active domestic capital market. “We have actually seen more in the way of financial reform since the collapse of Lehman Brothers than we have in the preceding three years,” says Arthur Kroeber, managing director of the Dragonomics consultancy in Beijing.

China has engineered a major expansion in its domestic bond market and launched a stock market in Shenzhen for small companies. It has also taken steps to encourage greater international use of the renminbi, allowing selected companies to use the currency to settle trade transactions and issuing the first renminbi government bond.

If anything, the crisis has enhanced the credibility of many of those who had pushed for a gradual opening of the system, including Zhou Xiaochuan, governor of the People’s Bank of China, and Liu Mingkang, head of the Chinese banking regulator. Both have seen their reputation enhanced by the way the economy survived the crisis. By publicly suggesting that the US dollar should eventually be replaced as the global reserve currency, Mr Zhou also has won some nationalist credentials.

In India, which has strict controls on how foreign banks and investors operate in the country and imposes limits on domestic businesses borrowing abroad, the crisis generated suspicion of reform, and the opposition Bharatiya Janata party attacked deregulation as irresponsible.

But with the liberalising instincts of Manmohan Singh, prime minister, to the fore, the government is gently pushing forward with some reforms, including reducing government stakes in banks and raising the limit for foreign investment in insurers.

Montek Singh Ahluwalia, deputy chairman of India’s Planning Commission and a close economic adviser to Mr Singh, said that with India needing to attract foreign capital to fund investment and growth, “it would be a great mistake to stop financial sector reforms”.

In fact, managing flows of capital is providing emerging market policymakers their most immediate test in what to regulate and what to leave alone. With a flood of money into higher-yielding assets and commodity currencies in particular, many countries in Asia and Latin America are having to cope with an influx of cash, which is pushing their currencies up against the dollar.

Brazil raised some eyebrows by imposing a tax on capital inflows to prevent destabilising speculation, prompting debate about other countries following suit. But economists say it will take more evidence to justify a wholesale recourse to capital controls across the emerging market world.

Gerard Lyons, chief economist at Standard Chartered, says: “If Brazil shows it is possible to stop the inflow of short-term capital without affecting the international view of your country, it might be a template.”

More generally, he says, the crisis has reinforced a philosophy of eclectic pragmatism rather than provoking a wholesale retreat into government intervention. “The real message ...  from both the Asian crisis and the past two years is that countries will deregulate at a speed overwhelmingly determined by domestic economic conditions.”

Additional reporting by Jamil Anderlini in Beijing

Copyright The Financial Times Limited 2009