After the 2008 global financial crisis, notable among many who complimented India for its handling of its external sector was economist and Nobel laureate Joseph E Stiglitz, who was quoted as saying that “if America had a central bank chief like Y V Reddy, the US economy would not have been such a mess”.
Yaga Venugopal Reddy, who was RBI governor during that period, may have had his share of critics who reckon that his conservative stance stunted the growth of the financial sector in India. But Reddy, a former IAS officer with a grounding in economics and more than an academic interest in macro economics, has consistently stood his ground during his stint as deputy governor in the RBI and later as governor.
He was joint secretary in the finance ministry, handling balance of payments and foreign borrowings during the 1991 crisis and was among those who engaged in fire-fighting then and operationalising some of the reform measures later. He was also chairman of the 14th Finance Commission which recommended a record sharing of proceeds, 42%, to states last year, signalling a new co-operative fiscal federalism. Reddy was also India’s executive director on the board of the IMF.
In an interview to The Indian Express, Reddy says that financial sector reform is just one element of economic reform.
How did your role play out during the 1991 economic reform programme and the crisis that preceded it?
My association with reforms had a modest beginning. It started with the handling of the external sector — both the intellectual framework under C Rangarajan’s leadership and operationalising of this framework in the ministry of finance. I was joint secretary from 1990 to 1993 in the ministry of finance, dealing with balance of payments or BoP. Over the next 25 years, I was continuously involved in matters relating to finance and the financial sector. Indeed, I grew with the reforms, working with the government and the RBI, as the country progressed.
What are the lessons from that economic crisis of 1990-91?
The first lesson is that we should avoid the mistakes we committed during the ’70s and ’80s. While discussing reforms, we should realise that part of the reform was about correcting our mistakes and part of it was to improve our systems and policies. The second lesson from crisis management is that the central bank has to play a critical role in a crisis, especially when there is political uncertainty. My experience after seeing (RBI governor) S Venkitaramanan and the functioning of RBI during that period from the other side, the ministry of finance, is that the stature of the RBI governor and the central bank matter.
What was the biggest challenge you faced then or later in your various roles?
The biggest challenge for me professionally was to manage a situation of plenty as governor of the Reserve Bank, especially during the 2006-08 period. We in India have never had to deal with a problem of plenty in the past. Global liquidity was high during this period. The belief, including among the political leadership, was in favour of global finance. The belief was also in favour of finance leading to development and being of great benefit to all. The risks of global finance were being underestimated then. Therefore, we had to convince everyone about the challenges involved in development of the financial sector and integration with the global economy. RBI as a professional body commanded respect globally and was able to gain the trust of the government. The combination of intellectual opinion, especially from the IMF, interests of global financial conglomerates and the inclination of the political leadership in favour of the prevailing beliefs had to be countered with all professional resources in RBI and the personal trust reposed in me. However, the government and the RBI still worked together to bring about significant legislative changes and a structural transformation while undertaking counter cyclical operations. The outcomes in terms of GDP growth, inflation and the soundness of the financial sector and the strength of the external sector reflect the co-ordinated policies during this period. They show that the challenge has been met successfully by all of us.
What was the level of political support during those days?
No important or major economic reform has been reversed by the political leadership since 1991. That is a positive. There are always political economy considerations in economic reforms. Any reform means re-ordering of benefits and costs among various sections of the population. Those issues are essentially social and political. We have to convince the political leadership to gather political support for the desirable economic reforms. The issue is not merely political support for economic reforms but convincing the political leadership and assisting them to gather political support for economic reforms. Still, it is a tribute to our political leadership that compared to many developing countries, there has not been any reversal of any major reforms.
What is still to be opened up after 25 years?
There is an impression that economic reform means opening up. In fact, in my view, there is an issue of the tyranny of the 10% in our policy focus. What I mean is that 10% of our investment is funded by foreign savings and the attention paid to that in our policy debate is 90%. When the discussion is on the work force, it is focused on the organised work force, which is less than 10%. Similarly, the large private corporate sector dominates policy discussions disproportionate to its criticality to our economy. Opening up is one element of the financial sector reform. Financial sector reform is one element of economic reform, the real issue for us is one of efficient financial intermediation in our economy. We have to improve financial intermediation in banking, which dominates the financial sector. As long as there is no genuine reform in public sector banking, financial intermediation will continue to be inefficient.
Now, when it comes to capital markets, they are essentially being driven by foreign investors reflecting more of inherent volatile global conditions than relatively more stable domestic growth. My position on Participatory Notes being an unhealthy element in the Indian financial sector is well known. In India, households still depend on banks. The capital markets are yet to command the trust and confidence of households. In my view, the mutual fund business is being driven by bank money and institutional sources. Mutual funds should ideally not have the participation of anything other than household money. And they should not be a pass-through vehicle for corporates and institutions who have the capacity to take independent financial decisions unlike households.
In brief, the real immediate priority for reform of our financial sector is to improve the efficiency of the the domestic banking system and to enhance the integrity and relevance of the capital markets to Indian households.
What should be on the agenda for the next 25 years?
One of the first things we should do is to fix the judicial process. The bad loans mess is in some ways a reflection of the fact that banks could not enforce their rights in a timely manner. The judicial process involves huge delays affecting the enforcement of rights of lenders in India. Unless we fix the legal framework and the judicial process, we can never become a middle income country. The second thing is to focus on law and order and enforcement of criminal justice. Filing an FIR is a major challenge for a common person. The delays in dispensation of justice in criminal matters make the process a captive of the rich and the powerful. Economic reforms cannot afford to underestimate the criticality of reforms in institutions performing basic functions of the government such as the judiciary and the law and order machinery.
Having been RBI governor and having seen conflicts between the institution and the government, how can the relationship between the two evolve? Do you think there is a need for a longer, fixed tenure for an RBI governor, considering that you had a straight five-year term?
We should distinguish between the length of the tenure and the security of tenure of an RBI governor. The relevant provision of the RBI Act says that the governor can be removed, just as the deputy governors and members of the central board can be removed. My understanding is that there is no prescribed procedure for removal of the RBI governor. In most other countries, there is a prescribed process for the removal of the governor and that assures security of tenure.
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