US/Europe Debt Crisis 2011: React or Ignore?

The past few months have been a roller coaster ride for the global investor community. Gold touched US1900/oz, a historical high indicating lack of faith in the stock market and other global currencies. Rumour has it that it may go much higher in 2012. Is the world going to face another recession?

Yes or no. It depends on whom you ask.

Numerous debates are going on. IMF chief Christine Lagarde recently commented that 40 million people could be put back into poverty if we don’t succeed, but 20 million jobs could be created if crisis is averted. Some industry veterans are more positive. During his recent visit to Singapore, Citi chief Vikram Pandit commented that “The chances of another financial crisis hitting the global economy are slim.” He is bullish about Asia and expressed his faith in the banking system here.

These observations point us in one direction. We are entering unchartered waters, and nobody is sure what will happen next.

In Asia, countries like China and India who have large domestic demand fared much better during the 2008 crisis, compared to smaller export-led economies. Even so, India and China did not emerge unscathed. The Indian IT industry, which depended very much on US demand, was badly hit. In China, several factory workers were laid off after the manufacturing sector lost millions of dollars in orders from the US.

The impact may be worse next time. As some Indian fund advisers have commented, “None of the problems since September 2008 in the global financial sector have been resolved in the real sense by the governments all across the world.” They have just been swept under the carpet by politicians.

Whatever is the cause of the current turmoil, India—which is witnessing strong macroeconomic growth, as well as growth in banking and financial services—can’t afford to lose momentum now. India has a very dynamic banking environment that is growing rapidly. RBI (Central Bank) is also in the process of opening up the sector by allowing entry of new banks, NBFCs, credit bureaus and others to compete.

In India and other markets keen on maintaining momentum through economic turmoil, bankers can’t assume that this time the market mechanisms will work, and things will automatically correct themselves. There is no “happily ever after.”

How should banks and financial institutions manage risk in such an increasingly risky world? Lenders need game-changing, proactive strategies. Regulators have long suggested that banking strategies should incorporate long-term macroeconomic indicators for day-to-day decision making. Strategies should not only consider local indicators, but the indicators of foreign economies to which the local economy is tied.

Sounds logical, right? Yet many lenders today don’t or can’t.

In Asia, the data-capturing process for these macroeconomic indicators often lags, and accuracy is questionable. Even if data is captured, there is a lack of initiative in using them for day-to-day decisions via predictive science and forecasting methodologies, often because the process of mathematical linking is complex.

We can’t let this stand in our way. Proper data collection needs to become institutionalized. With good data comes the ability to model macroeconomic factors. With this type of proactive approach, risk in the banking system will be completely attuned to the volatility in the market. Risk policies will be changed dynamically. In the end, we’ll be able to weather economic storms much better.

Asia is extremely fortunate not to have the serious debt crisis that West is facing today. Let us not blow it up by ignoring the value of quality data, the warnings that economic indicators provide and the power of predictive science.