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Print This Pa Euro zone will survive, says expert Andrew Sheng, one of the rare financial wizards, has served as policy maker and regulator in several countries including China, Hong Kong and Malaysia. A Chinese Malaysian by birth he was assistant governor at the Malaysian Central Bank in the 80s. In the 90s he served the Hong Kong Government as head of the Reserves Management and then chairman of the Securities and Futures Commission in Hong Kong. Currently, he is chief advisor to the China Banking Regulatory Commission. Also, he is board member of the Qatar Financial Center Regulatory Authority. From the rise of Malaysia as an economic power to making policy in Hong Kong during the Asian crisis to helping China develop a modern banking system, there is hardly a problem in the financial sector which Dr Sheng hasnt handled. In an interview with CNBC-TV18s Latha Venkatesh, Sheng says, Euro zone will survive. It doesnt mean that there may not be one or two casualties. Everybody recognises that the cost of joining a Euro zone can be expensive, but it is unraveling could be even more expensive for everybody, he adds. He further says, he is very optimistic about the Indian economy. Below is the edited transcript of his interview on CNBC-TV18. Also watch the accompanying videos. Q: How would you look at the European situation at this point in time? Clearly, there are policy struggles between the supranational forces and the national forces. How might Europe end, more integration or one or two countries walking out? A: The first thing you remember about crisis is that it is very difficult to predict the trigger and almost impossible to predict what will develop. Europe is going exactly through that phase at the moment. A crisis has many different origins. Then you have to go in to do some damage control. Europe is exactly in the second part, which is still evolving, of loss allocation. Who is going to pay for the losses of the entire sovereign debt crisis and also the banking problems? The structural issue of the integration is necessary. You can have a central bank, one currency, but if you dont have a centralised ministry of finance or fiscal mechanism to distribute the gains and losses of a fixed exchange rate system for the whole region then problems will occur. And thats exactly where things are going. I think there are three scenarios. One, a muddling through scenario, which is happening to some extent, you solve it this week and next week the things seems to unravel and then you have to solve it again. The second one is further integration. And then the third one is whether you bring in an outsider like the IMF to help you resolve this problem. Q: Your short answer would be that Europe may lean on the side of allowing little bit of its sovereignty to be sacrificed to a central authority. Is that the more likely outcome? A: My own thinking is that the Euro zone will survive. It doesnt mean that there may not be one or two casualties. Everybody recognises that the cost of joining a Euro zone can be expensive, but it is unraveling could be even more expensive for everybody. So, with that understanding, I think there is now increasingly political awareness that some kind of concession of national sovereignty towards a more central fiscal mechanism is necessary. Q: Let me come to the other issue that bothers us in India. The rapidity with which the US dollar depreciated against many currencies that depreciation has kind of plateaued a bit only because Euro zone went into problem. So, the dollar couldnt weaken beyond a point. What is the sense you are getting from hereon? Does the dollar continue with its depreciation because of its inherent instability? Will that be one of the big themes of 2012? Will it revisit as a big theme, the weakening of the dollar and hence more expense of commodities? A: Dont expect any major currency to go one way. I personally think that the US economy is much stronger than most people think. I am a great believer in the real economy. If you really look at the United States, it is very strong militarily. Its corporate sector is extremely strong. They have very strong balance sheet. They are totally global. They dont borrow too much.

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Their corporate governance compared with their competitors in Europe or in Asia or anywhere is much stronger. So, my fundamental belief is that the US maybe going through a difficult patch. The difficulty, at this point of time, is somewhat similar to that in Europe and that is the very large fiscal overhang. But if there is bipartisan recognition that something needs to be done. And if that is stabilised, there is no reason why the US economy cannot continue to grow. Ofcourse everything is relative. Will the growth be as strong as in the first decade of the 21st century? Probably not. There will be some slowing down because the other sectors such as finance, government and the household sector will need to deleverage. Now that doesnt mean that there are some further risks. We all hope that the property market will not continue to tank. We all hope that the unemployment numbers will not continue to increase. But my basic scenario is that relative to the others the US economy is doing much better than many outsiders would claim. Now how does that compare with the emerging markets? I personally think that because the United States dollar is the global reserve currency, its role will not change very drastically. We have seen this whenever there are some problems with the euro, the yen or the major market currencies, there is a flight back to the dollar. So, I would caution people not to say that well there is only one direction it will go. _PAGEBREAK_ Q: Several questions face the Indian economic policy makers, central bankers and capital market regulators. Do you think going by the fact that we have had nearly 24 months of near double digit inflation or 8% plus inflation it is time that Indian policy makers took a leaf out of Chinese authorities and stopped trying to aim for double digit growth? Is it time they did that? A: I cannot comment on the Indian situation because I am not the expert here. In my view, there is no doubt Indias growth will strengthen, at what level is not my place to say. All I can say from the East Asian experience is that growth very often is a demographic endowment. If you have a very large young population and they are growing older or they become mature, growth will naturally strengthen. Now, whether it is sustainable depends upon the quality of governance. East Asian experience has been that if you have stable government and reasonably low inflation and good investment in infrastructure, growth can be sustained for decades. And that is why personally I am very optimistic about the Indian economy. I think the Indian economy growth will continue, but its not easy for me to comment whether it will be at this level or that level. So, let me not comment the level of the growth, just the direction of the growth. Q: We have recently had lot of discussion in the last couple of years on how market intermediaries should be owned, for instance, Stock Exchanges or for that matter Depository Companies which hold shares in electronic form. A committee, headed by a former central banker, said that these exchanges at the current juncture should not be profit driven, should be widely held and should probably not aim for more than a 10-year bond yield. What would be your thought? Is that the way Indian authorities should plan market intermediaries or there are privately held exchanges which can do a good job? A: My own experience was to push for the privatisation. The public listing of the Hong Kong stock exchange, it is now today one of the most successful listings of a formerly a mutual institution. It was run like a club, it was owned by the brokers. That has been a great success. It depends up on case by case situation. I think in cases where the institutions are mutual, the dangers of being it owned only by members, for example, is that they may not take into consideration the needs of the market and look after their own interest. In lot of instances around the world this has been known to happen. On the other hand, when the exchanges become publicly listed, they may become so commercial that sometimes they lose sight of the public interest. That is the downside of it. Other things being equal, assuming that the governance of the financial intuitions of the particular institution you are talking about is alright. Q: Would you think that exchanges should be privately held? You were telling me that in Hong Kong it was successfully publically listed. But there could be a downside that these institutions only think of profit and not

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public interest. Therefore, what do you think authorities should watch out for? A: I think in Hong Kong, for the HKEx, a Risk Management Committee is created, in which the Hong Kong Monetary Authority and The Securities and Futures Commission are represented. They represent the public interest. They make sure that the HKEx would look after the public sector interest and risks in the event another shock comes. In the Indian case, my personal view is that today a mutual type institution is not a bad solution. That means it is actual owned not by just the intermediaries, but it should be owned by the users. And this could be mutual. But it should also have public sector representatives to make sure that the objectives of such institutions are for the public good and also for the market efficiency. What does this mean? It means that there is no reason why the salaries of this organisation could not be market based, but their targets or their measures of performance. _PAGEBREAK_ Q: The other issue we are grappling with is ownership of banks. There is a move now to allow the private sector or rather corporate houses, business houses to own banks. A discussion paper and some draft guidelines are already in place. Whats your sense ownership of banks by corporate houses is a good idea? A: I am personally very much prudent on this issue. I believe that the borrowers who also own banks is fundamentally a conflict of interest. It is not a good idea. The reason is twofold. The first one is that if a borrower owns a bank, he could actually influence the direction of laws or maybe to his or her interest. Now that obviously is a conflict of interest. Secondly, the real problem which is being my banking experience is that those people who like to own banks forget that actually any deposit they put in that bank is actually completely illiquid, if the bank gets into trouble. If anything, the shareholder has to put even more money into the bank when the bank suffers a liquidity run of some kind. So, in my view, the bank ownership should be as widely held as possible. I have nothing against state-owned banking systems. But if the banks are publicly listed, highly transparent and the governance is of good quality, public ownership is not a bad idea. Q: India has not been able to evolve a corporate bond market. The government bond market is reasonably active, but the corporate bond market is stillborn. There is lot of issuances which is held to maturity, but secondary market trading is very rare, very scanty. Whats your experience in looking at other countries Malaysia, China? A: This is a very common problem in Asia. Firstly, government debt markets are the anchor of a capital market. They are the anchor because the government is considered to be the best quality credit risk and its U-curve is the benchmark U-curve. The corporate bond market is much more difficult to get involved. There are several reasons for this. The first one is that it is very difficult for outsiders and even credit rating agencies dont have too good a track record on this to be able to evaluate what is the true credit risk. If a bank has difficulty monitoring the credit quality of its borrower, do you think a market can evaluate it much, much better? Now, particularly if the retail investors in corporate bonds are not that sophisticated. So, from the issuer point of view, companies have been very reluctant to issue because the issuing costs are high. From the investor point of view, they dont think, particularly in the East Asian experience, that the yields are attractive enough for them to invest in these corporate bonds. So, to a large extent, corporate bonds, particularly in East Asia, have not taken off as strongly as the government bond market. Q: Repeatedly the desire for bond markets or the demand for bond markets from government in particular is that there is no other way to fund infrastructure in a country like India. Like you mentioned we have to get the infrastructure piece right. At the moment, its largely bank financed and banks by the very nature have short-term deposits. So, there is an asset-liability mismatch. There is a problem of exposure to one particular group or one particular project prudentially it cant be too much. Is there any experience of successful funding of infrastructure by bond markets in Asian countries? A: Yes and no. I think yes in a sense that countries like Malaysia has been reasonably successful in issuing bonds,

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particularly the tied to infrastructure. The secret really lies not in the bond side, the funding side. The secret lies in the design of the infrastructure project and the management of that project. The secret is not the funding side. The secret really is the governance and the infrastructure management side. If you define the project well, particularly through public private partnerships, the project is conceived well, its managed well. The managers have credibility. They deliver a reasonable rate of return. There is no interference over the utility prices, for example, water or electricity. Then the project can find good funding and everybody wins. Its only when you dont have very sophisticated and good corporate governance and the management of a product that you cant get the project off the road, then the project fails, the funding fails and everybody loses. Q: Another big demand that constantly surfaces every now and then is to use Indias foreign exchange reserves to loan them to infrastructure companies. This surfaces even in other countries. You have so much of FX reserves, why dont you lend it? Is that a good idea? Wouldnt it mean more liquidity, wouldnt it mean endangering? Where do you stand on that issue? A: I am very clear on that issue. Central bank reserves should be for central banking purposes, it is not to be used for commercial credit. I think commercial credits can be used for whatever commercial purposes they want. If they want to borrow foreign exchange, there is no reason why they cant. If the project is very good, there is no reason why they cant borrow on their own standing. You dont need central banks to be involved in that regard.

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