145;Indian banking system is stable, sound, functioning146;

8226;What are some of these signs?

When the crisis began you know six weeks ago the real concern was the stability of the banking system. Will there be a payment8217;s crisis? People fearing the safety of their deposits. In an economic situation, the stability of the banking system is absolutely the top priority and I think it will be absolutely fair to say that the actions that the govt has taken have restored calm. I mean nobody should be worried about their bank deposits. The Indian banking system is stable, sound and functioning. Infact there was a lot of concern about two week ago that the banking system didn8217;t have enough liquidity. We took very quick action. The reserve bank I think in about ten days. There was 250 basis point reduction in CRR, a new 50 basis points window in the SLR as an additional window plus putting money into the banks because of these agricultural advances. Its made a big difference. Banks today are liquid. Now the 2nd stage of the concern is where they are liquid but are they lending enough. And I think this is important.

8226;Or are they going back and lending to the government?

Well you know when banks are over liquid they just use what is called the reverse repo. They put the money back in the reserve bank through that window and I think over the last few days that has been the concern. Theres no danger of liquidity shortage. The concern is are the banks lending.

8226;Ya because you know you get the feeling because if you look at the figure 37,500 crores in reverse repo, that means banks are not lending.

Well they are not lending all the liquidity that they have got. There are two issues here. I think the total growth of credit in the banking system has actually been quite good. I know that some of it is locked up in these oil fertilizer bonds. But my guess is even if you adjust for that the growth has been good. The real problem is that non bank credit has shrunk. Many of our cooperates that used to borrow abroad lets say external commercial borrowing because of the choking of credit in the rest of the world they are not able to roll over their external commercial borrowings. All of a sudden they have to come and get the money in the domestic market. Secondly trade credit, suppliers credit8211; people who are financing imports. Availability of credit there has really shrunk. So what you have got is banks are I think in quantitative terms doing pretty much what they are supposed to. But non bank system is choked. Infact the PM when he intervened in parliament made that point that although banks are lending as per their original targets, infact may be a little more than the target because of these oil bonds etc. what has actually happened is that other sources of credit dried up. Therefore the banks have to lend more. He said that in parliament that banks should.

8226;Particularly the corporate debt market is frozen.

The corporate debt market is frozen. the corporate debt market used to operate through these liquid debt mutual funds and the NDFCs. These have really felt the brunt of the liquidity shortage. Now what we have said is we have encouraged banks to lend to them directly. There are other ways of providing liquidity to these funds which I amsure this liquidity group that has been set up under the finance secretary will be looking at these.

8226;Because certainly these are all the dominoes you have to watch because if one liquid fund goes down, one large NBFC goes down, confidence will again get shaken.

I think the govt and I am sure the reserve bank have the same view on this. I think all over the world infact what you have learnt from the crisis in the US is that its not just banks, its non banks, shadow banks, this new sort of spectrum that has come in which produces liquidity but isn8217;t in the same category as banks. Now we have the same issue. They are not anywhere near the scale that they are in america. I mean relative to the banking system, debt, mutual funds and also NBFCs are still relatively small. But I think they are now systematically significant and that8217;s why govt has said to public sector banks that they should be willing to lend to debt, mutual funds and NBFCs. PM in his speech in parliament has made the point that they are an important part of the system. So they are not an aberration that you don8217;t have to worry about.

8226;And they are not outsiders who have to be left to fend for themselves

No absolutely. I mean there is some feeling around the world because there is segmentation of supervision. For example, debt mutual funds play a major role in intermediating credit but they are not supervised by the RBI. On the other hand NBFCs are supervised a little bit by the RBI.

8226;So maybe the time has come to look at the possibility of debt mutual funds being supervised by the RBI.

Well I don8217;t know if they should be supervised by RBI but internationally one of the things that has been done. I mean they have done it foe example in US, they have created a window in the federal reserve where non banks can go and get liquidity by directly pledging relevant collatoral. We are doing something similar. We are expecting commercial banking system to provide that liquidity and giving all the signals necessary. I am sure this liquidity committee will look at what other countries are doing.

8226;Maybe we could look at a fresh regulator for debt mutual funds.

Well they are regulated by SEBI. I wouldn8217;t say that having a single regulator is necessarily the solution. But financial regulation has to be closely coordinated. Now there is a mechanism in the govt which does that what is the high level committee on capital markets. Governor of reserve bank chairs the committee. And chairman SEBI, the insurance regulator are all a part of it. So the mechanism exists it just has to be operated.

8226;Montek, you have been closely involved with fire fighting, damage control, planning ahead, this entire exercise, when is it when we actullay to use the expression spooked, when we said this is actually bigger than we thought.

We were concerned throughout that the growth was going to be slower this year. Many govt spokesmen repeatedly said that its not going to be possible to repeat last year8217;s 9 per cent performance. But I think the sense of the crisis as located in the financial sector and maybe causing systematic problems is only about 2 or 3 weeks old. I mean that8217;s what happened internationally also.

8226;That was the week when call rates went to 22 .

Yes there was a period when they shot up lots of complaints about lack of liquidity and more than that people were looking at what was happening elsewhere. When you8217;ve got stories of bank failure in Europe, when you got stories that banks had lost confidence in Europe and America. Inter bank lending had stopped. Secondly I think the international community suddenly began to take action which was highly unorthodox. You can call it unorthodox or innovative. Both may be relevant. I think then people began to realise that this is not an ordinary crisis. It could create problems elsewhere also.

8226;When did the PM actually get directly involved in this?

Well I think he being involved before, there have been meetings at centrally govt level where 2 or 3 of us have participated. In a way, I am not in a position to tell. Its possible he was involved right at the start. But I know in the last 3 weeks there have been meetings where 3 or 4 of us have sat together and looked at the situation.

8226;3 or 4 of us.. you, chidambram

Well PM, FM, I have been involved in some of those meetings and you also in some areas, commerce and industry ministers is directly concerned also.

8226;So would you say Montek now we don8217;t know what is going to happen tomorrow, day after, or a few weeks from now. Do you feel reasonably confident now that we are on top of the situation now that nothing major could slip through?

Well I am absolutely confident that the issue of the stability of the banking system is pucca. I think in terms of banks getting to lend that issue is also under control. You know, there are procedural problems. I mean you inject liquidity, you give signals. Banks have their own procedures. It can take a few days, but I think banks will infact do what the both reserve bank governor, PM and others have said that they must lend. Now you come to the other two sides, one is the stock market and the other is the slowing down of the economy. I think the stock market is reflecting a number of global developments, so in my view our stock market will get back to normal when globally there is restoration of financial stability which I expect will happen.

8226;Have you begun to see signs of that globally.

I would say that is a little disappointing because globally I wouldn8217;t say that financial situation hasn8217;t yet stabilized. Atleast nobody in the global environment says it has stabilized.

8226;Flyboards coming down, if that8217;s an indication.

Interest rates yes. But still to get back to normal needs a little bit more. I think the good news there is in every govt, and across the globe in major economies, this is being viewed as most important single thing for global coordination. You know president bush has convened a summit of leaders. You know our PM is also invited on November 15.

8226;I hope he will be going?

I don8217;t know. I assume he would. What this indicates to markets is it is very important that this is not just being left to markets. Nobody is saying that whats happening is normal and financial ,markets do get spooked. When they get spooked, it is very important for everybody who has any role in it who has any role in it, whether govt regulators etc to come out and take responsibility and say we will work together to fix it.

8226;This is not a crisis which has shaken your basic beliefs in the markets, in the amount of regulation that should be there, movement of capital?

Well you know I am not aware anyone in the rest of the world regards the crisis as a reason for saying we must move back from a belief in what are well functioning markets. At the same time it has been known for lo0ng that the financial markets are prone to market failure and so more than any other market financial markets need regulation. I think what has happened is that there has been a failure in global financial markets in many levels. One is a straight management failure. Innovation created a number of new instruments that enabled a lot of people to participate in the lending and borrowing business and created what is called leverage. The total volume of borrowing shot up. It was the job of the management of these corporations.

8226;Did you hear Greenspan testimony on this?

I read it.

8226;He said well people designed these derivatives and got the Nobel prize and later we realized that data fed into computers was data from 20 euphoric years. They didn8217;t get data from a distress year.

I think that8217;s a very valid point. And I think Greenspan in his testimony admitted that he was maybe a little too complacent about the risk built into the system. He was the principle regulator. Well regulators failed. Credit rating agencies failed. I think people learnt something.

8226;He was described as somebody one big shot fund manger in the US as 12 year olds running around with shotguns and lining them up and shooting anybody. The least I want done to them is to be bound and gagged.

I think this is the important lesson. No oine that I know is talking about moving away from either an open global economy, or a global economy in which well functioning markets would play a role. But I think that people also recognise that the probablitiy of market failure in the financial sector is much greater than was earlier.

8226;At any point of time?

At any point of time.

8226;Montek if the crisis continues, would be open to more radical methods like govt buying shares, orthodox or innovative howsoever you8230;

Well you know unorthodox measures become orthodox when enough people start adopting them. so I think govt buying shares is one extreme. To my knowledge, nobody at the moment anywhere in the world is talking about that. But there are innovative ways of addressing the issue.

8226;Banning of shortsales for example. 25 countries have done it.

But that8217;s not unorthodox. Banning of shortsales has very often happened. We have done it in the past, in the US they did it for a period only for financial stocks.

8226;We haven8217;t done it here in India.

Its very restricted in India. Its not as unrestricted as it is elsewhere.

8226;Because you know a lot of Indian fund managers say where is the level playing field? A foreigner can borrow and short sell, I cant.

In India, people can shortsell. The difference is that it is felt that people abroad operating through the pea note window avoid the regulations on short sell and that people think is something that the regulation needs to adapt.

8226;Do you think that8217;s a valid point?

I think it might be a valid point. It is certainly true that either you give the same flexibility8230;.

8226;It might be a valid point or it is a valid point?

Well I haven8217;t studied it enough. But let me put it this way. From what I have seen the flexibility to take positions and engage in all kinds of actions, which maynt be allowed domestically does exist in certain cases for investors from abroad. I think this can be taken care of in one or two ways, either you give more flexibility at home or you ensure transparency in the behaviour of FIIs. I think as a general rule it would be a very good idea to have more transparency. Non transparent actions are not reliable.

8226;Is it something you are discussing internally?

Well I am not but I am sure chairman SEBI is looking at it.

8226;And the other question, the economy is slowing down, Montek, but you know we are also blessed to be calling 7 , 7 and a half slowing down, actually 7.7 if RBI says a slowdown. Five years back we would have been celebrating.

No absolutely. This is one of the key positives. Anyone looking at the present situation should really look at. It is a slowdown but we are talking about a slowdown from much higher growth rates. Our target was to achieve 9 sustainable growth during the 11th plan. Hardly anyone doubts that 8.5 was gonna happen anyway. So the slowing down is from a range of 8.5 to 9 to what now8230;

8226;So some of the gloom is uncalled for?

I think most of the gloom is the unhappiness that people have experienced quite legitimately at the sudden fall in the stock market and that is something painful and anybody who experienced a large loss is not going to be distracted by economic growth issues. That8217;s something that8217;s causing much of the concern. on growth I think if we do 7 which the PM said you know 7 and a half, but he said you know the lowest the most pessimistic is 7. quite frankly in the previous 4 years, we have done close to 9, in the 4 years before that it was about 6.2 or something like that. So 7 is really a very robust performance. The key issue is not just this year it is going to be 7 , we must work hard to make sure it is 8, 8 and a half next year, year ahead.

8226;Your concern would be the corporates would now be scaling down their expansion plans because the money wont be available, there would be anxieties.

Yes interest rates if they are up, if profit margins are down. And more than that it8217;s the international environment about investment which does affect their sense of well being and what they think about their future. So these factors are quite likely to cause a weakening of a lot of normal investment. Now I think we should offset that by some kind of contrasicklcal potion to infrastructure investment.

8226;That8217;s what I was coming to because that8217;s directly under your domain.

Well not under my domain, we are very much involved in that.

8226;How do you bring in that contrasiclical push?

One good thing that has happened in the last 2 or 3 years is that the thrust in getting infrastructure going has created a lot of projects that are in the pipeline at different stages. Some have already achieved financial closure, and are starting to being implemented, some are in the middle, they have got the approvals and are now getting to financial closure. Still others have not yet got the financial approvals but we could process them faster. Now these are what I would call the PPP projects on infrastructure. In addition, you have pure public sector projects on infrastructure which are also in different stages. Now if you wanna have an impact in the next 2 years, you wanna make an impact on projects that are somewhere down the pipeline. We pick some of these projects and essentially try to find out how can we8230;

8226;Because there has an impression lately that they are contracting a slowdown on highway projects.

On highway projects but I think that is about to pick up again in the sense that they have sorted out the problems they had with their documentation. My information was that the NHAI they have a number of projects in the pipeline and if they stick to their schedule by the end of this year, they would have contracted out about 5000 kms 8230;

8226;That is within about 2 months now?

Ya but that is about last two months of a very long time.

8226;Some of the other projects could be fast forwarded at least the contracting.

Certainly the contracting could be put on absolute priority.

8226;What happens if they find financial closure more challenging than before?

That8217;s one of the key issues. To what extent can we be innovative in making sure that existing channels to provide finance are unclogged. So that good projects get finance. But at the same time we have to keep in mind due diligence and so on. You cant sort of fill every hole. I think there is scope for doing that. It involves talking to banks. In some cases it might involve relooking at some of our prudential norms, norms of exposure to single projects, norms of group exposure. That kind of thing. You know we have this new window which govt had opened 8211; the India infrastructure finance company. Logic of that window is that reserve bank, we would be able to use this inorder to park some of our reserves here and they could then lend to infrastructure. Now in a period where external finance gets limited we can use this window very effectively. All the procedural requirements are done, its operating, the legal structure is there.

8226;You just have to transfer the money which you could do now because you are going to save nearly a 150 thousand crore this year because of the fall in crude prices. That8217;s in the future because of oil bonds but that saving is there.

There are a multiple other factors. The inflows may come down.

8226;Inflows coming down is given but crude prices remaining down is also given

The net effect for this year of all these changes is that the current account deficit may be a little wider. But the net capital inflow will be significantly lower. Now the reserve bank in its most recent statement has said the capital in flows are just about equal to the requirements in terms of the current account. Its possible the situation might become more difficult. We might have more of a reserve loss, but the reserves are so large, that if we are talking about next year to 18 months, I mean nobody has any doubt that India could maintain the foreign exchange needs of an expanding economy for a 2 year period.

8226;More than that all of you very wise people in this govt8217;s economic team will find a way for these infrastructure projects to get financed.

We certainly should. There are many ways of doing it. I don8217;t care which particular way we choose. But we certainly should be able to do that.

8226;Montek, looking back till September, we were choking of liquidity. The outgoing governor on the day, he demitted office said that more tightening was required. Within a week we were than loosening and loosening like hell, as I said throwing the kitchen sink. Do you think we have been confused or do you think we have been taken by surprise because its almost like a doctor who doesn8217;t know what the disease is and first gives the patient the anti biotics then steroids, then anti biotics then steroids. For a conservative establishment that8217;s very funny or not funny.

Actually its not contradictory. Because Towards the last week of even governor reddy8217;s time the concern with inflation was very high. On the day he left its not true that the oil prices had crashed. This very big change in the status of commodity price situation came very suddenly and very quickly. I think its true that the earlier situation first was there was not the same sense of crisis internationally. Remember all this sort of AIG takeover its all in September that it happenend. Internationally except for the northern rock fiasco in Britain and the Bestons earlier in the year in the US, this big sort of tsunami on the financial side hadn8217;t occurred. Therefore the choking up of the credit from rest of the world to Indian corporates hadn8217;t occurred. My guess is that through August, even when we talked to our corporate guys I don8217;t think the perception was that there is a huge choke.

8226;But they were all complaining bitterly about the choking of liquidity in India. Very high rates suddenly, availability of credit8230;

There8217;s a difference between liquidity and high rates, yes they were all choking, they were all complaining that rates in India were high.

8226;Automobile manufacturers were saying I cant sell because I cant find financing. Housing sales were down. There was this squeezing.

Some of this is normal kind of squeeze you expect when slowing down. Certainly automobile, real estate they were facing some slowing down after a very rapid growth.

8226;But they were blaming it on credit as well.

Absolutely. But the problem really was at that time the inflation was a major concern and there was no major financial collapse. And no collapse of external borrowing. It was legitimate for reserve bank to worry about inflation. The thing that really changed was in September8212;the lehman brothers, the AIG, the fact that American banks were not lending to each other. When a US treasury secretary has to say that American banks don8217;t have confidence in other American banks the ripple effect of that on our economy just in terms of financial attitudes is very serious. So every thing went into high gear that look we are not insulated from the world. We have to think.

8226;The psychology is then to shove your money under your bed.

Absolutely, bankers ultimately rely on confidence and trust. Liquidity is only one part of banking. A good banker just because he is liquid wont lend, unless he thinks that he would get his money back. So we are taking care of liquidity, now we do the rest.

8226;Now would you say that we are on top of the curve. Things will go up and down but we are in control? We can sleep well.

When we say top of the curve, I am not saying that problems are over. I think the problems will have to unwind and unfold. A lot depends on what happens to the global economy. The day you tell me that the global economy has got the global financial system under control, I think we can feel pretty relaxed. We are definitely not going to be behind the curve. Situation is being watched carefully, not being viewed as a routine matter. At the highest levels in govt people are looking at it. Reserve bank has said we are ready to take more action as and when necessary.

8226;Let me sum up. One, banking system is absolutely solid, safe and functional. And will lend more as days pass. Two, ways would be found if necessary innovatively to support NBFCs and dead mutual funds and also top bring them into better supervision etc.

Yes people are looking at that and I hope they will find that.

8226;Third, 7 growth is nothing to laugh at and you don8217;t see that slipping. This August IIP numbers have spooked everybody.

You know IIP numbers do go up and down and its true that growth rate of industry was slipping but I don8217;t think August numbers would reflect numbers for the year as a whole. We have to recognise that to the extent to which it may have been an early warning sign. There has been a lot of change in policy and the assumption is that will have an effect also.

8226;Four, you are not just quite open to the idea but you are engaged in the idea of fast forwarding and increasing infrastructure investments and infrastructure building in these times.

Yeah I personally think that is one of the most important things we can do to maintain the growth momentum not just because the expenditure would do it but because it will precisely provide the supply improvement for the future. Infact the PM in Beijing said we need to use infrastructure as a contra cyclical tool. I take that as a policy direction.

8226;That8217;s a new one. Many new expressions have been added to our vocabulary. Now this is a contra cyclical tool.

You know that8217;s very important. Some of the things we talk about8212;the banks, that8217;s also contra cyclical because prudential regulation, one of the major things people have learnt about the present crisis is that a lot prudential regulation is pro sector. When things go down, value of stocks go down, banks shrink credit, that8217;s pro sector. Maybe people are thinking that while maintaining the importance of prudential norms bank regulation should be a little more ant cyclical or contra cyclical

8226;I think once this is over there will be many papers written, many Phds, nobel prizes, but right now they fire trucks at the door. Isn8217;t it??

I think you can call it fire trucks but with a little bit more of realization that this is not as big of a crisis that people might have thought.

8226;Montek those are very brave words, very reasurring ones as always. It was wonderful to have you on Walk the Talk.

Thanks Shekhar