During his five year stint as RBI governor, Yaga Venugopal Reddy initiated several measures that helped the country escape virtually unscathed from the financial meltdown. In his latest book Global Crises Recession and Uneven Recovery Reddy talks about the financial crisis and the lessons to be learnt. He tells FE?s Mahalakshmi Hariharan and Sitanshu Swain that given the uneven recovery globally, India should not take things lightly. Excerpts:
How is QE II likely to impact India?
The US has had to initiate QE II because the real sector wasn?t growing and unemployment has been high. It is a mix of fiscal and monetary measures though monetary policy instruments are slightly more effective for controlling inflation and less effective in kick-starting the economy. There will be some pressure on other economies because the US dollar has an impact on the rest of the world. For growth to happen in the rest of the world, they need to depend on the growth in the US. In India, excess capital inflows may come into the equity and commodity markets, which may lead to the prices shooting up, leading to inflationary pressures. Moreover, currency volatility is a policy challenge.
How do you think the RBI should manage these challenges?
I don?t know what the central bank or policymakers will do but it will depend on where the inflows are headed. Analytically, there is global liquidity, uncertainty and volatility. There is also a current account deficit which needs to be worked upon.
Should RBI intervene in the forex markets?
RBI is not intervening too much as it needs capital inflows to the extent the current account deficit persists. No doubt excess capital inflows will put pressure on the exchange rate. So for policymakers it will be a challenge to decide how much is adequate and how much is excess.
How do you see the economy in the medium term?
In the medium term, the outlook for the Indian economy looks bright but one has to be careful given the global situation. There are no macro imbalances, the financial sector is strong and the economy could grow by 8.5-9% in the medium term, depending on the cycle it can be little less or more. Physical infrastructure needs to be attended to. Fiscal deficit is one problem, which needs to be well managed by the the government but it is aware that fiscal consolidation is necessary.
Do you see any problem in the banking sector ?
Well, there are no weaknesses as such, because banks are very well capitalised. However, not much traditional banking?working capital, SME funding, priority sector lending?is happening. Instead, activities such as investment banking, funding overseas M&As are on focus, which over the medium to long term, is not conducive to growth. In fact even in the US, banks have been asked to adhere to traditional banking. Funding SMEs should be a priority rather than lending to a promoter to acquire a telecom licence. They are supposed to engage in core banking operations, essentially giving working capital. The strength of the bank is retail deposits and working capital.
How can this be changed?
There are many policy instruments that can be used by RBI and the government to rectify the loopholes. If you give money for infrastructure financing, M&As, there is no money left for the others. In the last couple of years advances to the sectors which need money has been limited and that?s not good for the economy.
Should corporates be allowed to open banks?
It all depends on the circumstances. In some countries, they allow it, in some they don?t. So, we have to analyse our own circumstances. Even the US does not give a corporate licence to open a bank.
You have talked about ?uneven recovery? in your book titled Global Crises Recession and Uneven Recovery?
Some countries have recovered, some haven?t. For instance, India, China or other Asian countries have recovered but countries in the euro zone and US are still struggling while Japan is in a state of stagnation. So, it is multi-dimensional and the recovery is not uniform. Some are also afraid of a double-dip recession.There is a ?V-Shaped? recovery in India and China, and when the recovery is uneven, the policy responses are different and thus global policy co-ordination becomes very complex. However, the collapse has been avoided.
Do you think world is heading towards a currency war?
There is a lot of volatility in currencies and it has been difficult to establish greater coordination. Unless countries establish coordination, it will be a difficult situation.