‘Avoid mantras,orthodoxy; no one answer for the world’

There is always a merit in debate on what is the most effective way forward. The most important thing to bear in mind is to avoid these mantras or orthodoxy that there is one answer for the entire world — copying the West or the East. Today,the same solutions — of having one single regulator,financial innovation,separation of government from central bank,independence of central bank have all come to naught. Inflation targeting has come to naught. If you have inflation targeting and then there is negative inflation in Japan,then how does it help? The most crucial point therefore is to continue debating,but not take a rigid position — it has to evolve according to Indian circumstances.

If you had followed the orthodoxy of the day and separated monetary authority from the regulator,allowed banks to have holding companies,permitted financial innovation.… you could have landed up in the same mess as the US finds itself in today. So,what I am saying is the situation must evolve.

Orthodoxy,either current or old,must be avoided. We must change policy as required rather than getting bogged down that it is going to be unpopular. You remember October 2007. We were celebrating that India hasn’t suffered as much on the real economy side. But what was happening in the stock market? We reached 20,000,but then we collapsed to below 10,000. Now,we are celebrating again. In September 2009,you are lower than what you were in October 2007. Everybody felt it was a bubble even then. In the real economy,the rate of growth then was 8-9%,inflation 4-5%,so in aggregate terms,the economy was increasing by 13-14%. But the stock markets had more than doubled. There was complete de-linking of the real and the financial economy. We did not take any steps. FIIs were pouring in,leading to appreciation of the rupee at times or forcing the RBI to intervene. We should have taken strong action at that point of time to check the bubble.

You should be willing to take unpleasant decisions. We should celebrate our strengths,but not get bogged down in our strengths. If you look at the issue of access to banking,how many Indians have access to banking products? We have to do it.

So,should we have taken stronger action in October 2007 to ensure that India did not have a hard landing?

Absolutely,what measures could have been taken,that is a matter of detail. Lots of things could have been done. Foreign institutional investors receive tax-free return in India; their dividends are not taxed. However,interest paid on bank deposits is taxed. How do you defend this? Why is this happening? We should take some measures; create a level-playing field so that one form of short-term financial flow does not dominate or discriminate against long-term bank deposits.

Is there a tendency to forget these issues once the problems are fixed in the short-term?

I am all for maximum freedom to the investor,minimum micro management,minimum returns required of savers,investors. What regulation means is we have to keep a watch. Are there segments of our economy — financial or real — which have no relation with the situation on the ground? For example,in the real estate sector,the bubble was for all to see. We allowed special economic zones without any exports. If these are required for the benefit of the poor,for backward regions,then certainly. But if you are creating an SEZ in Maharashtra for the domestic market then it is tax free,but if you are outside the SEZ,then it becomes taxable. How? Why?

Is there a case for tightening the monetary policy now?

We have to worry about the growing gap between the wholesale price index and the consumer price index. The economists’ minds and brains should be focused on this. The wholesale price index is -0.1 per cent and the consumer price index is in double digits.

What I am trying to say is,on the issue of government-RBI relations,I think we should talk,but wait a while. Take step-by-step measures when the pre-conditions are satisfied. Learn from the experience of other countries of separation of treasury,regulation and inflation-targeting by central banks,rather than jumping into the water. Why did this happen? UK was the prime mover,the trend setter,and is the worst economy today. I am not saying what we are doing is right,but orthodoxy must be avoided. We are not as badly affected as many of the other countries. You take 1987-88. The mantra then was either we have the fixed exchange rate or fully floating exchange rate. For the first time,we introduced the concept of managed float. We were criticised by the IMF. We said it’s a self-feeding process,because we are short of reserves. Now all countries in East Asia are following the managed float concept.

What about separating the debt management functions of the RBI?

We had mooted this concept,subject to the fiscal deficit being reasonable. If my fiscal deficit is very high,and most banks are public-owned,it creates problems. It becomes a very complex issue when you have fixed interest rates on deposits,interest rates on securities that are market-determined,government’s increasing liquidity needs combined with banks’ statutory liquidity ratio requirement. So,essentially,you are compromising with the godly principle of free market. This is because the government has subsidised schemes for the poor and expenditure patterns that are not market-determined. So,you have to do some compromise and move first in the direction to cut deficits without hurting the poor.