Former RBI Governor Dr Y V Reddy’s latest book, India and the Global Financial Crisis, makes for a useful and timely reading, and is a reminder of how pragmatic risk management by a central bank can limit the potential economic damage from shocks. The book is a collection of speeches that Dr Reddy gave during his five-year term as Governor that began in September 2003.
The speeches have been padded effectively with a helpful introduction that offers the relevant context around each speech, and an epilogue that offers more insights on the current crisis. The book has a user-friendly grouping of the twenty-three speeches under eight thematic chapters, each covering an important issue.
Particularly striking is the inclusion of a speech about what the RBI means to the common person in a book about the global financial crisis. But that only shows the relative importance of communicating with the public rather than only with financial market participants.
Dr Reddy’s tenure as RBI Governor coincided with the unexpected surge in India’s economic growth that caught the government and the private sector (including us, market economists) off-guard. The destabilising large volume of capital inflows—which partly contributed to the surge in India’s growth—made matters more difficult for the central bank. India was largely closed financially and hence did not experience the sting from the Asian financial crisis, but last year’s global credit crisis was different — it almost broke the economy’s back.
There is no doubt in my mind that had it not been for the deft handling by Dr Reddy, India could have been a mini version of Iceland, with the economy buckling under overseas borrowing by Indian companies. Indeed, if that scary scenario had played out, we’d be dealing with a far more serious triple whammy—corporate, banking, and fiscal crises triggered by the reversal in capital flows and currency crisis.
The key areas where things began to clash were when the government seemed to go public about some of its preferences but without being prepared for the consequences of its actions. Thus, the opening of the banking and financial sector was being compromised not by the RBI but by the government’s inability to fix its own finances and cut its ownership in state-owned banks. The government signalled greater opening up of the capital account of the balance of payments when the RBI was already having difficulty with managing the emerging complications from capital inflows especially. At the same time, the government was unable to move quickly and effectively to increase the absorptive capacity of the economy to foreign capital, and was also ill prepared for living with rupee appreciation.
But nothing brought the differences between the ministry of finance (MoF) and the RBI as clearly as the public comments by the finance ministry on the interest rate outlook. Read page 30 of the book carefully, and you’ll have the answer about how the RBI felt compelled to hike rates in June 2008 once expectations had been built in financial markets around the government’s preferences (probably indicated via more active media comments by MoF officials). As Dr Reddy notes, “…the RBI had to fulfil those expectations as far as possible to avoid giving the impression of serious differences.” Quite frankly, he should have stuck to his guns, again.
One of my favourite speeches in the book is “Management of the capital account in India: Some perspectives” that was delivered in January 2008. It is exhaustive in its treatment of the topic and offers several valuable insights from a practitioner.
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One speech that is conspicuous by its absence is the one delivered at the National Institute of Public Finance and Policy (NIPFP) in May 2008. This is the speech where the analytical reasons for introducing the innovative market stabilisation scheme (MSS) were highlighted. Obviously, as events have shown, those who were against the MSS had no idea what they were talking about. Separately, it is in this speech that Dr Reddy indicates the need over time for reducing the SLR and CRR. The speech clearly indicates that the issue at hand is not only of desirable goals but also of negotiating the path in an optimal manner given the backdrop of liquidity management and the changing fiscal pressure.
The book is a refreshing reminder of how the RBI under Dr Reddy navigated India through uncharted waters, ducked almost all the guns pointed at them, and had the foresight to adopt unconventional measures well before they became fashionable to ensure financial stability during an exceptionally trying period.
Dr Reddy is part of a disappearing breed of civil servants who not only know what they are doing but are also willing to make timely decisions, and accept the responsibility for them. Too bad for his detractors that he knew macroeconomics well, which is far more than what can be said about some of those who wasted ink by attempting to pre-judge his approach.
The author is head of India and ASEAN economics at Macquarie Capital Securities, Singapore. The views expressed are personal.
INDIA AND THE GLOBAL FINANCIAL CRISIS
Dr Yaga Venugopal Reddy
Orient Blackswan
368pp; Rs 595
