Picking up the book, Indian Financial Reforms: Priorities and Policies Post Global Financial Crisis, one does tend to be a bit sceptical. The 19 articles in the book have been written by three governors or former governors of the Reserve Bank of India (RBI), three deputy governors, two executive directors and three other authors, two of whom served with the RBI and the ministry of finance, and Joseph Stiglitz. Will these pieces deliver anything new, considering that most of what the RBI top officials say is already available on its website?
With this apprehension, the reading of the book was embarked upon, and it has been an amazing experience. The collection of articles is quite brilliant, which is the case for most RBI pieces, and one of the former RBI authors, NA Majumdar, brings in a breath of fresh air where he attacks the famous Raghuram Rajan Committee Report. Stiglitz is always a pleasure to read and this time, he talks of why quantitative easing (QE) does not make sense.
Governor D Subbarao takes on Basel III in an FAQ format and asks 10 questions that everyone wants answers to. He admits that there are short-term costs, which are worth the while as even nations like China, Singapore and South Africa have stiffer targets than the RBI. At another level, he talks of the importance of the G20 in the aftermath of the crisis. Here, his view is that governments should be accountable for their actions, as in this globalised world, all countries finally get affected by each others’ actions. There has to be a balance between short-term goals and stability in terms of monetary and fiscal policies. In another piece, he dwells on how the traditional trilemma of balancing fixed exchange rates, monetary policy independence and capital flows has now been replaced by price stability, financial stability and sovereign debt in light of the two crises that have taken place. He subtly hints at how with long-term refinancing operation (LTRO), there has been a tendency for fiscal dominance over monetary policy—something that is debated in India too over RBI independence. There are evidently limits to the use of non-conventional measures.
Talking about non-conventional measures, such as quantitative easing, Stiglitz is at his acerbic best, where he blasts these measures that have been introduced at a time when US companies are sitting on a pile of cash. What QE does is provide cash that can be invested outside the US, which makes no sense from the point of view of reviving the US economy. And these funds have created problems of overheating in some other geography. He refers to the Stiglitz Greenwald model, which shows that monetary policy ceases to work after a point of time, as it is no longer banks that dominate the landscape, but the financial system, which includes the shadow banks. This phenomenon is serious as it has come up essentially to dodge regulation.
Majumdar, a votary of the Indian banking system, is critical of the report, which spoke of a hundred small steps. He has enough to show that we should be proud of the RBI and the progress made by the banking system in the past 40 years or so, and it should not be viewed with condescension. He shows how the Indian banking system, led by public-sector banks, delivered a lot, thanks to nationalisation. The entire concept of inclusion that we talk of today was possible because of this effort. Therefore, he is against the use of the International Monetary Fund (IMF)/World Bank/Washington Consensus approach, which has proven to be a failure all over. Also, he is against the privatisation of public-sector banks (PSBs). When PSBs have delivered both stability and reach, why change them? He is caustic on the homework not done by the committee and gives an example of the talk on warehouse receipt finance, which was an old concept of 1956 and did not work. He feels that the committee should have worked out why it did not work rather than make such banal recommendations.
YV Reddy also writes on society and economic policies relating to the financial sector. An interesting point brought out, which makes one think, is on ‘regulatory capture’ in India. This happens when the regulator depends on the regulated for advice. Further, when academics are brought into such committees, they have links with market participants, voice their view and are hence not really independent. Also, based on experience, he articulates that often the financial sector offers jobs in the higher-ended treasury functions for those in the ministry. Clearly, this is not how the system should ideally function. His points are pertinent and while he does not take names, it is not hard for the reader to guess who the references are to in all these areas.
Deepak Mohanty is very clear about his vision for the money market. The movement has to be towards interest rate changes rather than quantitative measures. However, the transmission of interest rate changes has not been swift and has worked at the shorter end of the curve, helped a lot through the open market operations (OMOs) of the RBI. Alongside, he shows that the liquidity adjustment facility (LAF) is not the most efficient way out and we need to develop the term repo market. In another article, he stresses on the need for financial stability, which is as important as price stability and this holds across the world. His takeaway is that central banks across the world have to collaborate and as the responsibility is shared today, it cannot be left to only some of them.
On the same issue, Anand Sinha is quite eloquent as he points out that while financial stability is robust in India, there are still downside risks to the domestic economy on account of global inter-linkages. Internally, we have to be prepared for Basel III and banks and financial institutions (FIs) have to work with the RBI to ensure that we are on the right path. Here, he emphasises the need to pay more attention to risk management as non-performing assets (NPAs) are bound to rise along with the macro-economic cycles and we need to be prepared by having our systems in place. Stress testing and development of early warning signals will be the way forward for maintaining the sanctity of the financial system.
There are also two interesting articles on financial inclusion by Subbarao and RBI deputy governor HR Khan, which ask banks to look at priority sector lending as a business, which should set them thinking. Bank credit to Khan’s mind should be treated as a public good—very broadly speaking. The focus should continue to be on self-help groups (SHGs), micro-finance institutions (MFIs), BC (business correspondent) model, etc. Technology should be harnessed to deliver results here. Subbarao goes on to admit that critics of priority sector lending do have a point when they say banks should have the freedom to lend where they want to, but such laissez faire approach does not work in India given the necessity of addressing the requirements of the underprivileged. Therefore, we need to have a policy for extending financial inclusion.
Uma Kapila has brought out a very nice compilation of interesting articles and views that should keep us thinking. This is a superb update on everything one wants to know about the financial sector of India, coming as it is from some of the best minds in this segment.
With this apprehension, the reading of the book was embarked upon, and it has been an amazing experience. The collection of articles is quite brilliant, which is the case for most RBI pieces, and one of the former RBI authors, NA Majumdar, brings in a breath of fresh air where he attacks the famous Raghuram Rajan Committee Report. Stiglitz is always a pleasure to read and this time, he talks of why quantitative easing (QE) does not make sense.
Governor D Subbarao takes on Basel III in an FAQ format and asks 10 questions that everyone wants answers to. He admits that there are short-term costs, which are worth the while as even nations like China, Singapore and South Africa have stiffer targets than the RBI. At another level, he talks of the importance of the G20 in the aftermath of the crisis. Here, his view is that governments should be accountable for their actions, as in this globalised world, all countries finally get affected by each others’ actions. There has to be a balance between short-term goals and stability in terms of monetary and fiscal policies. In another piece, he dwells on how the traditional trilemma of balancing fixed exchange rates, monetary policy independence and capital flows has now been replaced by price stability, financial stability and sovereign debt in light of the two crises that have taken place. He subtly hints at how with long-term refinancing operation (LTRO), there has been a tendency for fiscal dominance over monetary policy—something that is debated in India too over RBI independence. There are evidently limits to the use of non-conventional measures.
Talking about non-conventional measures, such as quantitative easing, Stiglitz is at his acerbic best, where he blasts these measures that have been introduced at a time when US companies are sitting on a pile of cash. What QE does is provide cash that can be invested outside the US, which makes no sense from the point of view of reviving the US economy. And these funds have created problems of overheating in some other geography. He refers to the Stiglitz Greenwald model, which shows that monetary policy ceases to work after a point of time, as it is no longer banks that dominate the landscape, but the financial system, which includes the shadow banks. This phenomenon is serious as it has come up essentially to dodge regulation.
Majumdar, a votary of the Indian banking system, is critical of the report, which spoke of a hundred small steps. He has enough to show that we should be proud of the RBI and the progress made by the banking system in the past 40 years or so, and it should not be viewed with condescension. He shows how the Indian banking system, led by public-sector banks, delivered a lot, thanks to nationalisation. The entire concept of inclusion that we talk of today was possible because of this effort. Therefore, he is against the use of the International Monetary Fund (IMF)/World Bank/Washington Consensus approach, which has proven to be a failure all over. Also, he is against the privatisation of public-sector banks (PSBs). When PSBs have delivered both stability and reach, why change them? He is caustic on the homework not done by the committee and gives an example of the talk on warehouse receipt finance, which was an old concept of 1956 and did not work. He feels that the committee should have worked out why it did not work rather than make such banal recommendations.
YV Reddy also writes on society and economic policies relating to the financial sector. An interesting point brought out, which makes one think, is on ‘regulatory capture’ in India. This happens when the regulator depends on the regulated for advice. Further, when academics are brought into such committees, they have links with market participants, voice their view and are hence not really independent. Also, based on experience, he articulates that often the financial sector offers jobs in the higher-ended treasury functions for those in the ministry. Clearly, this is not how the system should ideally function. His points are pertinent and while he does not take names, it is not hard for the reader to guess who the references are to in all these areas.
Deepak Mohanty is very clear about his vision for the money market. The movement has to be towards interest rate changes rather than quantitative measures. However, the transmission of interest rate changes has not been swift and has worked at the shorter end of the curve, helped a lot through the open market operations (OMOs) of the RBI. Alongside, he shows that the liquidity adjustment facility (LAF) is not the most efficient way out and we need to develop the term repo market. In another article, he stresses on the need for financial stability, which is as important as price stability and this holds across the world. His takeaway is that central banks across the world have to collaborate and as the responsibility is shared today, it cannot be left to only some of them.
On the same issue, Anand Sinha is quite eloquent as he points out that while financial stability is robust in India, there are still downside risks to the domestic economy on account of global inter-linkages. Internally, we have to be prepared for Basel III and banks and financial institutions (FIs) have to work with the RBI to ensure that we are on the right path. Here, he emphasises the need to pay more attention to risk management as non-performing assets (NPAs) are bound to rise along with the macro-economic cycles and we need to be prepared by having our systems in place. Stress testing and development of early warning signals will be the way forward for maintaining the sanctity of the financial system.
There are also two interesting articles on financial inclusion by Subbarao and RBI deputy governor HR Khan, which ask banks to look at priority sector lending as a business, which should set them thinking. Bank credit to Khan’s mind should be treated as a public good—very broadly speaking. The focus should continue to be on self-help groups (SHGs), micro-finance institutions (MFIs), BC (business correspondent) model, etc. Technology should be harnessed to deliver results here. Subbarao goes on to admit that critics of priority sector lending do have a point when they say banks should have the freedom to lend where they want to, but such laissez faire approach does not work in India given the necessity of addressing the requirements of the underprivileged. Therefore, we need to have a policy for extending financial inclusion.
Uma Kapila has brought out a very nice compilation of interesting articles and views that should keep us thinking. This is a superb update on everything one wants to know about the financial sector of India, coming as it is from some of the best minds in this segment.
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