Scientists as monsters

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, director of the London School of Economics and Political Science, has advocated caution on full convertibility of the rupee.

The former head of Confederation of British Industry, deputy governor of the Bank of England and head of the Financial Services Authority in the UK, said in a telephonic interview with Business Standard from London, "In present circumstances given the significant imbalances in exchange rates, I'd say that it would be a rather dangerous time. I would advocate caution at the moment."

He will be in Mumbai next week for a seminar on "Challenges and Opportunities for Managing Liberalisation in India" to be hosted by the London School of Economics and Political Science and CII.

Davies felt that there is a need for an upward adjustment for Asian currencies, but India cannot do this unilaterally.

According to him, the Reserve Bank of India's (RBI) plan of floating market stabilisiation bonds to sterilise the dollar flow is quite a sensible short-term approach.

"In the longer term, there is probably need to be some more currency adjustment but in Asia as a whole and not just in India," he said.

Referring to the RBI's foreign exchange management policy, Davies said: "They have allowed rupee to appreciate a bit and this is sensible. I think it will be difficult for them to do it unilaterally... There is probably need over time for general adjustment of Asian currencies. But I certainly would think that it will be dangerous for India to do this all on their own."

Davies also felt that the time is not ripe for a pan south Asian currency as has been proposed by Indian Prime Minister.

"While currency zones are in principle attractive because they promote trade but they also imply a major transfer of monetary sovereignty. I personally do not think that the political relationships between Asian countries are yet in that sort which will make that a realistic possibility," he said.

According to him, the advocates of currency zones must ask themselves whether they are prepared to see control over their own monetary policy passed to somebody else. They also need to answer economic and political questions.

"Are you prepared to accept binding constraints on your public borrowings set by somebody else? Are you prepared in Mumbai to see that your interest rates are fixed in Bangkok or Hong Kong or wherever the Asian central bank will be," Davies asked. Excerpts from the interview:

Does India need such a huge (over $108 billion) foreign exchange reserves? Should the RBI stop mopping up dollars from the market and allow the rupee to appreciate?

Let me first say that I am not coming to India to reorganise the Indian economy. I am primarily coming to develop the London School of Economics. My view is that the Indian authorities at the moment are in quite a difficult position...

The other Asian economies with which they compete have been intervening very heavily though their currencies are down against the dollar...

In those circumstances, it's very difficult for India to adopt a radically different policy. The authorities have allowed the rupee to appreciate somewhat against the dollar. This is sensible because it takes the pressure off...

But I think the growth of reserves is really part of a broader problem in Asia... India has over $100 billion, Japan has got $750 billion and China over $400 billion.

To my mind it's a little unfair on the Indian authorities to single them out for criticism. This is a general Asian trend. The idea of floating market stabilisation bonds to sterilise the dollar flow is quite a sensible short-term approach.

In the longer term, there is probably need to be some more currency adjustment but in Asia as a whole and not just in India...

There is always a cost of holding reserves but personally I have some sympathy with the authorities at the moment. I think they are part of a generalised trend between US dollar and Asian currencies...But obviously, as Alan Greenspan said, this could not carry on for ever. He must be right. There is indeed a need for some adjustment.

Aren't you saying that the government should allow the rupee to appreciate against the dollar?

No, I am not saying that. They have allowed rupee to appreciate a bit and this is sensible. I think it will be difficult for them to do it unilaterally.

If the Chinese and Japanese (central banks) are intervening very heavily to hold the currencies down, I think there probably need over time for general adjustment of Asian currencies. But I certainly would think that it will be dangerous for India to do this all on their own.

On hindsight, did India do the right thing by being very cautious in opening up the capital account?

Probably yes. I am one of those people who is more certain about the end point than about the means to get there. In the long run, it will be good for India to have a liberalised capital account.

But of course the experience of the Asian crisis in the late 1990s has shown that if you liberalise before you have strengthened your domestic financial system, then you can run significant dangers. In retrospect, one would have to say probably that the Indian cautious approach has been quite sensible.

Should India step up the opening up process now? Is the time ripe for the rupee to go full float?

In the present circumstances, given the significant imbalances in exchange rates, I would say that it would be a rather dangerous time. I would advocate caution at the moment.

The Indian Prime Minister had sometime back floated the idea of a pan-south Asian currency on the line of euro. Is this a feasible idea?

Look at the Eurozone. You need to have an awful lot of preparatory work before you get there. You will also have to answer a question "" partly economic and partly political. Are you prepared to accept binding constraints on your public borrowings set by somebody else? Are you prepared in Mumbai to see that your interest rates are fixed in Bangkok or Hong Kong or wherever the Asian central bank will be?

I think people who proposed currency zones have to ask themselves very carefully whether they are prepared to see control over their own monetary policy passed to somebody else.

While currency zones are in principle attractive because they promote trade but they also imply a major transfer of monetary sovereignty. I personally do not think that the political relationships between Asian countries are yet in that sort which will make that a realistic possibility.

That's the lesson from your UK experience?

Well, I am in principle in favour of the euro. The debate has shown that the people here are not yet happy with the idea of control over their interest rates should be handed over to European institutions. You must take them seriously... You can't move where the people don't want to go..

What's your view on FDI in India. Why the flow is not that good?

What India needs to do is what it is doing and carry on doing it. The problem is that looking at India over the last 60 years there have been good times and bad times for foreign investors... They came in and then kicked out again entered and expropriated and asked to come back.. I am afraid that India still suffers from an ancestry of policy changes. Now we have started seeing positive signs. You have to carry on with this.

It seems that the entire world is buying the Indian Shining story. How genuine is this?

It looks pretty good. I was somewhat cautious in the past. But I think you now have a sustained period of growth and people now do talk about India in the same sentence as China. The Goldman Sachs BRICS report has been very influential ... It has been calling people to think about India in the same way about China in particular. As long as the inflation rate is reasonably contained, I think the prospects are pretty good.

How do you feel about the global imbalances "" burgeoning current account deficit in US and continuous appreciation of the rupee? Is the time right for hard landing of the greenback?

There was a need for a dollar adjustment. Because the US current account deficit was too large and was going into wrong direction... Therefore, in general, the dollar depreciation in the last year has been welcome.

The problem is that it has been an unbalanced depreciation with a very large depreciation against the Euro and very little against most Asian currencies. The big trade deficit is between US and Asia, not between US and Europe.

I think the profile of the depreciation has not been appropriate... Overtime, there will be need for an upward adjustment for Asian currencies generally in order to correct this imbalance.

That is very unpopular in some countries and difficult to achieve and certainly dangerous for any one country. But my analysis would say that at some point the adjustment would need to take place.

There are too many regulators for the financial sector in India. Do you think India should shift from the existing system of multiple regulators to a super-regulator?

The key issue here is that the regulatory structure should follow market structure, not the other way round. The reason why FSA makes excellent sense in the UK is that we allowed banks to buy insurance comEx-FSA chief calls for caution on convertibility open banks... We allowed them all to trade securities... In this market, there is no clear distinction between banks and insurance and you cannot regulate effectively without an integrated regulator.

In the Indian case, the issue is more a question of how you want your financial market to evolve. At the moment, insurance companies are separate from banks. The case in India for a single regulator is not particularly strong as the markets are fragmented.

That's true about China as well. You have to first decide what kind of market would you like to have. If you decide for an integrated market, then the regulator has to be in place appropriately... At the moment your regulation is appropriate for the market structure.

Given the rising opportunities for China and India in terms of outsourcing, infotech and manufacturing and backlash in the US and UK, do you believe that globalisation is at risk?

From the UK perspective, I would say no because the UK is probably the most instinctively free trading country of the world. We have our big argument about free trade versus protection in 1830 and ever since then this country has basically chosen free trade.

While there is concern about outsourcing, it does not have a very high level of intensity....partly because our unemployment rate is very low.

It is becoming an issue in the US presidential elections. But the candidates who are the most protectionists like Richard Gephardt fell out of the race right at the start.

It's a theme in the elections which could be dangerous but at the moment I would say the democrats have chosen more or less on the free trade side of the argument. (John) Kerry is not an out and out protectionist.

I was encouraged by the failure of Gephardt because he was the most protectionist of all the candidates and he lost. I think that's an optimistic sign.

So, your sympathy is with Bush?

No, Neither.. On the trade issue, Bush's record is mix. He has been liberal in some areas and illiberal in some other fields....

What's your assessment of the Indian financial system?

The financial system improves through competition primarily. Compassion usually brings in greater discipline than good regulations. What the Indian financial system needs is more varied competition.

In insurance you probably need more foreign competition. You need skills to be brought in by foreign companies. The watchword must be competition.

A number universities are coming to India. Particularly, Australian universities have been setting up offshore campuses here. Does LSE have any plan to set shop here?

We have just set up a small Indian office which is not a campus but an office. Our approach is more likely to be through partnerships with Indian institutions than through setting up an offshore campus.

There are two reasons for that. One, of course, we already have a lot of students working on LSE degrees in India through the University of London external programmes.

In effect, we have LSE campuses in India. But they are in different colleges where people are studying LSE degrees. We already have an outreach programme in India for Indian students who can't afford to come to UK.

In addition to that, we would like to develop research links with Indian universities. We do a lot of work on development studies, deveoopment economics, anthropology, sociological studies and we would like to find ways of developing links with Indian universities on research projects.

We would like to make finical support available for Indian students. We would like raise more money to pay for poorer Indian students.