Yaga Venugopal Reddy is the man credited with injecting a dose of realism in policy-making during the boom years of 2005-2008. The former RBI Governor and Chairman of the 14th finance commission spoke to Shweta Punj about India's reform agenda at the release of his latest book: Economic Policies and India's Reform Agenda - New Thinking.
Q: You talk about the need to rethink the reform agenda. What are the challenges there? Why do we need a rethink?
A: The most important event that has happened in the last 40-50 years is the global crisis - because of the crisis there is a considerable rethink on some economic policies that were considered appropriate before the crisis. There is change in the thinking on economics. In the future, the global economy is likely to be a different ballgame with the change in economic balances.
Whatever we thought we should be doing as part of reform (before the global economic crisis), we should be looking at now in the light of the experience of other countries and India. Should we review and change? The financial sector models of Washington, New York, London were the models, but after the crisis they have changed. Now, there is a lot of emphasis on coordination than on separation of responsibilities. There are references on counter-cyclical policies. There is recognition of coordination between fiscal and monetary and other policies. We are going to be more and more part of the global economy, therefore we should understand what's happening in the global economy. We have to contextualise and evolve a new global thinking. It is to provoke debate on Indian reform.
Q: What are the new principles that India needs to consider as it takes a fresh look at its reform agenda?
A: There are no new principles; there are three aspects for review. Markets: give freedom to markets and government should intervene only when necessary and markets will adjust themselves. Now there is a recognition that markets may adjust themselves, but in the process some people may benefit and another set of people may pay a price. So, for instance, if the financial sector corrects itself in the U.S., who is paying the price - the people who built the house. The financial sector gets bailed out, bonuses may be less, but they are still huge. Even if the markets correct themselves, they may not remain corrected for a long time, it may happen at a huge cost for the government or for the people who initially didn't benefit.
Second is the way government regulators function. Originally it was thought that regulators would correct the failures of the market or the regulators have failures. Now, the regulators and regulated, their interaction has become a matter of debate. Regulators are drawn from the market, they go back to the market and they all have a relationship with political masters. This is a new development.
Thirdly, inequality as a source of instability. Earlier, it was morally bad to have inequality. But now, inequality may lead to erosion of social cohesion, may lead to instability. It's a new reality that we have to recognise.
Reform agenda: it is better to consider the reform agenda in the light of new developments convincingly. In the end you might say that it doesn't make a difference. No problem. But you must think about it. Unless considerable research and analysis is done, we cannot come to the conclusion. My submission is that you should look at it.
Q: So, are we looking in to a new direction?
A: I am not sure ..
Q: You also talk about the mandate of the central bank extending beyond inflation targets and output or employment - the mandate would certainly include, explicitly or implicitly, financial stability and development of financial markets.
A: In terms of central bank functioning, by and large it has been quite good. The issue is of the broader picture of the relationship between the financial sector and the real sector. Earlier it was generally thought that the financial sector can lead, allocate resources efficiently. But it is now recognised that if there are distortions in the real sector, the financial sector can bring about more distortions. Earlier, we thought market development is good. Now, there is a feeling that some sort of market development can be toxic or bad. We may not be at that stage yet of sophistication of financial markets, but we should learn before we move too forward.
In external sector management, the previous thinking was capital controls should be avoided unless absolutely essential. Now, globally, more countries are adopting capital controls. Even advanced economies are intervening in the forex markets after the crisis, even IMF has changed its position. In forex reserves, earlier, they were looking at what are the costs; now, they are also looking at what are the benefits. Even IMF is. Therefore we have to keep re-evaluating.
Q: Coordination issues between fiscal and monetary issues - how big a problem is it? What can India learn from the global experience?
A: In some way, some countries had gone far ahead in silo thinking. Monetary policy will only handle inflation. Fiscal policy will only deal with fiscal policy. Financial markets should be left alone - the regulator will only protect consumer interests. But now they have found that the fiscal and financial sector are related. In Ireland, fiscal was not a problem, but banking was a problem. In Iceland, fiscal was not a problem. So, you have a situation where what was not a fiscal problem, becomes a problem - a fiscal problem becomes a financial sector problem. These linkages are coming out. There should be recognition of that. Globally there is a recognition of that, and that knowledge we should incorporate. We must make sure that policymakers and academics are closely following global developments. I am raising a debate, so that people discuss it.
Q: There does seem to be a lack of coordination between the key agencies in India, which is hurting us.
A: We must recognise that there should be checks and balances also. Thinking and working in silos is wrong, but it doesn't mean everybody should have exactly the same view. Central banks take a longer term view, governments take a shorter term view. It is not the same view of reality. Coordination means that each should know what the others' problems are. You still have operational autonomy, but there should be full understanding of each other's goals.
Everywhere, there is no perfect coordination. If we have two institutions that think exactly alike, then why two institutions? I remember when I would have discussions with the Ministry of Finance, they would ask me why do you keep defying. I would say, look, if I have to say the same thing, I would be a part of you. If you keep agreeing, you are superfluous, and if you keep disagreeing, you are obnoxious. So, you should have a creative dialogue. But it should not be at cross purposes. Policymaking is complex; there is always a trade-off between short-term and long-term.
Q: You also speak of accountability in the new scenario. What kind of accountability mechanisms do we need?
A: Globally, there is a feeling that any central bank where a crisis has happened, they are not able to say who is at fault, because in some countries central banks are too technocratic. Now, we are following the British banking legislation. We can argue that we haven't gone that far. They went that far and now they have to come back. We need not. But we have to make sure that we need not go as forward as they did. We should avoid excess. In the U.S. there was excessive deregulation, now they are coming back. If I am deregulating I should know where to stop.
We need not have a crisis of crisis proportions. But in the context of reform, we have to see if we are going back to what was considered a model in the US before the crisis. Now, they are going back on those models. So, we should say that we cannot go in the same direction.
Q: And India needs to evolve its own model of accountability...
A: Yes, absolutely. But in doing so, you should remember that you are not immune to fundamental economic laws. Whatever model we have, we cannot imitate the global model. We should understand the global model, because we are constantly interacting with the global model. But we should have your own model, which recognises the implications of dealing with the global model.
Q: What non-conventional policy measures should emerging economies consider?
A: Advanced economies are considering non-conventional policies after the crisis. Since they are considering non-conventional policies, you should not be bound by conventional policies - if necessary you should be willing. By definition, unconventional is unconventional. It is something not done before. Switzerland intervening in the forex markets is unconventional policy. Brazil has gone in for huge capital controls - also unconventional. In the context of global uncertainties, we should be prepared. Don't be afraid of unconventional. Don't be apologetic - be prepared to take the decision, that's all.
Q: In the chapter 'New Thinking on Economic Policies and Thoughts on the Indian Economy', you mention there is perhaps a structural deterioration in the fiscal situation following the financial crisis. What is the structural deterioration you see and what's the way out of it?
A: You have a structural deficit. After that, you have to take stimulus measures. Stimulus is something you will withdraw. If you pay commission, you can't withdraw.
You have to make a distinction between stimulus - something you can do now and remove - and normal circumstances. NREGS was conceived as a regular programme, a permanent programme, not as something that was temporary because of the crisis. Once it is a permanent programme, it is a permanent expenditure and if regular revenue is the same then there is a structural deterioration.
Q: Is it possible for us to have a zero current account deficit? If so, how?
A: Between 2003-2008, growth was close to nine per cent. The CAD (current account deficit) was 0.3 per cent. It is not necessary that high growth means high CAD. Empirical evidence and India's own records show it is not necessary to have a high CAD. If you are competitive, you have high exports. If you are competitive, you grow.