He has been at the helm of policy making. Has served as the Chairman-Economic Advisory Council to the Prime Minister, headed the Twelfth Finance Commission, was Governor of Andhra Pradesh and now a member of the Rajya Sabha. But it is his stint as the Governor of the Reserve Bank of India, in 1992-1997 ? the landmark years for the Indian economy ? that have been most gratifying for C Rangarajan. He shares with Sarika Malhotra how it was ?An exciting but a difficult period. We were fighting with one problem or the other, whether it was balance of payments or reform in the banking industry. But we were in a position to introduce fundamental changes. The exchange rate system underwent the most fundamental change, from where the RBI was determining the exchange rate every morning to a market based one. We were able to dismantle the administered interest rate structure. Without that we would not have had open market operations today.? So did he enjoy being the RBI Governor? ?I am enjoying it in retrospect ? it was challenging, gratifying but difficult.? He believes that economic growth and social development are the two legs on which a nation must walk. And any strategy of development that ignores these will only make the nation limp along. Excerpts:
You write that the financial sector today is more volatile and vulnerable than before, how do you view it in the wake of the present crisis?
Financial sector has become more vulnerable today. There is an instability bias in the system because of the great interdependence among markets and participants. The contagious effects are much stronger now as a result of the closer integration that has been brought about. We have to ensure that there is no cause for any panic or flare up of even small things. That?s why financial stability has emerged as a major concern. It is important to distinguish between financial stability of markets and institutions. Institutions are stable ? if they are able to meet their contractual obligations without any external help. Markets are stable if the prices that emanate from the market are able to reflect the fundamentals and participants can safely trade on the basis of the prices of market. Prices do not fluctuate violently if there are no fundamental changes. That is the essence of financial stability. Setting standards, risk management, control and supervision therefore have become important for financial stability.
You point out that the 1991 crisis was converted into an opportunity to bring about fundamental changes in the content of economic policies; do you see the current crisis bringing about such changes?
There is a qualitative difference between the two crises. The 1991 crisis was essentially an Indian crisis and we utilised the opportunity to introduce fundamental changes in the content and approach to economic policy. The current crisis is different; we have had a slowdown in growth, therefore the decoupling theory does not hold true. We have suffered due to a slowdown in trade and capital flows owing to the international meltdown, but it is not as severe as what India had in 1991. The fundamentals remain strong and we will even in the worst of times grow between 6% and 6.5%. The most glaring fact about the current crisis is the regulatory failure, which has been of two types ? some segments of the market which have been losely regulated or not regulated at all. Secondly, there has been a lack of understanding of the implications of derivative financial products. There has been a mismatch between financial innovation and the ability of the regulators to monitor financial products. We need to put in place an appropriate regulatory framework which will cover all segments of the financial market and will also bring about a greater coordination between the various regulators of the financial system.
So, are we going to see over regulation and the state playing a bigger role now?
There has to be a balance between financial innovation and regulation. Overregulation can come in the way of financial innovation. There is need for new financial products to come into the system; they have to meet the varying needs of the community and the economy. The structure of the economy is undergoing change, therefore we need financial innovation. For example, even in the case of derivative products which are the natural outgrowth of financial innovation, when an importer has to pay for goods three months from now, he has to have a cover for his payments. But derivative products become problematic when we are unable to discern where the risk lies. Runway financial innovations which are dysfunctional in character do more than good. We need more regulation and proper coordination between the regulators. But the extent of coordination should be such that it does not impede financial innovation.
Is the Indian economy ripe enough to go in for total capital account convertibility?
It is a very distant goal. One is not very sure if that is needed at the moment. Capital account liberalisation is not a discreet event. It can expand from one level to another. Indian business entities should be able to borrow more freely from outside. We need to expand the scope, but all this will have to be done in sync with putting the financial systems on sound footing. Capital account liberalisation without establishing a sound financial system domestically can lead to serious problems. High level of fiscal deficit is not the right time to embark into total capital account liberalisation.
What is currently the scope and role of monetary policy?
Monetary policy is an arm of the economy and has multiple objectives, but multiple objectives without prioritisation can cause confusion. Traditionally, in India economic growth and price stability have been the two objectives of the monetary policy. It shifts from year to year. There is some trade off between the two in the short run but not in the long run. The threshold level of inflation in the country needs to be defined. When the economy is operating below the threshold level of inflation then other objectives become important. When the economy crosses the threshold level of inflation then price stability becomes important. In developing countries price stability is the dominant objective of monetary policy.
But recently, financial stability has emerged as an independent goal. On occasions it can become the lead objective also. Between financial stability and price stability, there is no conflict in the long term. It will be price stability that will lead to financial stability. In the current situation, financial stability concerns have been dealt by the financial bodies as the inflation situation was dormant especially in the western world, which gave them the space to inject more liquidity in the financial system. In India the prices though rising, have so far been under control, the consumer price index is showing a trend which is very different from the wholesale price index. While tightening of monetary policy may not be warranted now, a rise beyond 5-6% will call for tightening of monetary policy.
As the signs of recovery have started to surface, there have been suggestions about a V, U and W shape recovery ? what will be the shape of recovery?
In the last quarter of 2009 the world will start seeing a recovery. Negative trends in production will stop. The recovery will be slow, therefore it will be a U with a bottom. As far as India is concerned we have not had a negative growth but Indian growth will pick up in the second half of 2009 and we will grow between 6% and 6.5%. In 2010 -11 growth rate can be between 7% and 8%. However, to go back to the 9% we have to see the recovery in the world economy and the pickup in the world trade. As in the second half of last year, Indian economy grew at 5.8%, resulting in growth and recovery.
And the banks will play a crucial role in it. There is sufficient liquidity right now which is evident since the banks are placing deposits with the RBI rather than borrowing from RBI. It is for the banking system to make available additional credit to all industry and agricultural sector and embark forward.