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There has been considerable delay in the adjustment of administered prices... - Views on News from Equitymaster
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  • May 9, 2000

    There has been considerable delay in the adjustment of administered prices...

    An officer of the Indian Administrative Services, Dr Yaga Venugopal Reddy, has spent most of his career working in the areas of finance and planning both at the State and Central level. Dr Reddy, who has keenly pursued his interest in economic research, has been a Deputy Governor at the Reserve Bank of India since 1996.

    In an interview with Equitymaster.com, Dr Reddy, Deputy Governor, RBI, spoke of the current economic scenario and offered his views on subjects ranging from inflation to the recapitalisation of public sector banks.

    EQM: Your view on the current economic climate.

    Dr. Reddy: On current assessment, the prospects look reasonably promising. Notwithstanding the sharp increase in oil prices, the international inflationary environment continues to be reasonably benign. A freer trade regime, combined with a high level of food stocks and a high level of foreign exchange reserves, should provide sufficient scope for effective supply management during the year. On the demand side, the budget stance of reining in the overall fiscal deficit is welcome. Some allowance, however, has to be made for the fact that there has been considerable delay in the adjustment of important administered prices, including prices of petroleum products. However, such adjustments cannot be avoided if fiscal deficit has to be kept under reasonable control in order to keep potential inflationary pressures under check and future expectations favourable.

    As we have recently indicated in the Monetary and Credit Policy for 2000-2001, for purposes of monetary policy formulation, on the basis of current trends, we have placed growth in real GDP at 6.5 to 7.0 per cent for 2000-2001. This assumes a normal agricultural crop and continued improvement in industrial performance. Assuming the rate of inflation to be around 4.5 per cent (i.e., close to the average of last two years), the projected expansion in M3 for 2000-2001 is about 15.0 per cent. This order of growth in M3 should lead to an increase in aggregate deposits of scheduled commercial banks by about 15.5 per cent (or Rs 1,250 bn). Non-food bank credit adjusted for investments in commercial paper, shares/debentures/bonds to PSUs and private corporate sector is projected to increase by around 16.0 per cent.

    However, it cannot be over-emphasised that this outlook can change dramatically within a relatively short period of time in the event of unanticipated domestic or international events. Several unfavourable events that affected the outlook for the economy during the years 1997 through 1999 point to the need to respond quickly and to change course, if and when required. In the past three weeks, even after eliminating the effect of the change in the base year of the Wholesale Price Index, the inflation rate has been somewhat rising. Some states have also been affected by severe drought. On the inflation front, therefore, there is need for continuous vigilance and caution.

    EQM: The RBI, on April 1, signalled a lower interest rate regime by slashing the CRR and the bank rate. Where do you see the interest rate headed in the long term? In view of the large fiscal deficit are lower rates sustainable?

    Dr. Reddy: The overall monetary management has become much more complex now than was the case a few years ago. The last year witnessed relatively high growth of output, fuelled by sustained industrial recovery, combined with low inflation and high reserves. These developments provided a positive environment for monetary management. This was partly due to the fact that the economy was in a phase of business cycle when there was no problem of excess demand or emerging inflationary pressures. Apart from this, there was negative growth in monetised deficit of the Government (i.e., net Reserve Bank credit to Government), and low growth of reserve money, despite large borrowing requirements. As a result, we were able to manage a large government borrowing programme without undue strain on interest rates or the overall liquidity environment.

    Clearly, such high levels of fiscal deficits are not sustainable over the medium term. If the economy were characterised by excess demand and liquidity pressures, it would have been difficult to meet the large borrowing requirements of the government without a sharp increase in interest rates and some crowding out of private investments. Under those circumstances, the economy could have slipped into a vicious circle of tight liquidity and high interest rates. It is of utmost importance that such an eventuality is avoided by taking credible fiscal action urgently. A national consensus on an effective and time bound programme of fiscal correction is, therefore, essential so that efforts made in this direction in the Union Budget for 2000-01 can be further intensified.

    EQM: Inflation is once again raising its head. The RBI will probably have to choose between higher inflation or tighter credit availability (which will hurt industrial growth). Or is there a median path?

    Dr. Reddy: It is true that the rate of inflation on a point-to-point basis moved up from 3.7 per cent at end-March, 2000 to 5.5 per cent during the week ended April 15. This was primarily driven by rise in prices of few primary food articles and some administered prices of POL sector. The underlying core inflation remains under check. In any case, while framing monetary policy under the uncertainty of several relevant parameters, we do build in necessary flexibility and try to smoothen out monetary policy changes in the short run. As pointed out in the Monetary and Credit Policy for 2000-2001, on the inflation front, there is need for continuous vigilance and caution. The Reserve Bank will continue to monitor domestic monetary and external developments, and tighten monetary policy through the use of instruments at its disposal, when necessary and unavoidable.

    EQM: The Reserve Bank of India is becoming increasingly autonomous. However, we still lack a structure as in the UK where there is an independent monetary policymaking body and a regulatory body (the FSA). Is such a structure desirable in India?

    Dr. Reddy: The concept of separate monetary authority and a separate regulatory body is under experimentation in some advanced countries, most notably the United Kingdom. We have already set-up a separate Board of Financial Supervision and the RBI is closely collaborating with other regulatory bodies. We constantly review the arrangements as we move along on the path of financial innovations and sophistication. We are also keenly observing the experience of other countries.

    EQM: The RBI has taken several measures to develop the government securities market - appointing primary dealers among others. However, domestic investors are as yet unable to participate in the risk free securities market. What are the measures being initiated by the RBI to tackle this situation?

    Dr. Reddy: Yes, much has been done to develop the retail market for government securities over the past couple of years. The measures taken so far include efforts to deepen and widen the market. As a result of these efforts, today, there is an active secondary market for government paper, which augurs well for retail investors as it makes the market very liquid for them. To make the market easily accessible for the retail investor, however, some legal and technological changes are necessary. The Securities Contract Regulation Act has recently been amended and the RBI is pursuing with the government to replace the Public Debt Act, 1944 with the Government Securities Act. The RBI is simultaneously also working on a risk-free clearing and settlement mechanisms through a clearing corporation. All this is expected to take approximately two years. Once, this is done, the retail investor's entry into the gilt edged market would be facilitated.

    EQM: With India increasingly becoming integrated with the global economy, what measures is the RBI taking to ensure a smooth transition. What are your views on Capital Account Convertibility (CAC) and its implementation in India?

    Dr. Reddy: Our convertibility on the capital account has been gradual and there is a hierarchy to it. We differentiate between inflows and outflows and within this between corporates, individuals and banks. Currently, the priority is to liberalise inflows and in particular on corporate account. The recent freedom given to corporates to raise funds through ADRs/GDRs is a signal to this effect. With regard to liberalisation of outflows the hierarchy is corporates, financial intermediaries and individuals, although Tarapore Committee preferred liberalisation of flows on individual account earlier in the hierarchy. It would, therefore, be reasonable to expect some liberalisation on outflows with regard to corporates in the near term and in regard to banks and other financial intermediaries after some progress in financial sector reforms.

    EQM: Recapitalisation of weak banks is a widely debated issue. In view of the economic liberalisation and increasing competition in the domestic markets, should not the government consider exiting the banking sector? Is there any alternative?

    Dr. Reddy: In India, recapitalisation of weak banks is just one part of the overall strategy for banking sector reforms. The Narasimham Committee on this issue had examined all aspects at length and given a broad direction to this effort. In line with the recommendations of the Working Group on Weak Public Sector Banks set up under the Chairmanship of Shri M.S. Verma, the Union Budget 2000-2001 has announced the intention of setting up bank-specific Financial Restructuring Authority (FRA) to deal with weak banks. The proposed FRA would be given powers to supersede the Board of Directors of weak (or potentially weak) banks. However, instead of being a permanent body, the authority would be constituted as and when the Reserve Bank requisitions the intervention of such a body of professionals. At the same time, recapitalisation of weak banks has also not been ruled out, subject to the proviso that the Government and the Reserve Bank are satisfied that an appropriate restructuring mechanism has been put in place.

    Asset reconstruction would be another essential element in our strategy. We are seeking an enabling legal framework to facilitate the process. This would help banks bring down the levels of non-performing assets (NPAs), which remain high in case of several banks. We are strengthening the arrangements for the Debt Recovery Tribunals (DRTs) attend to their cases on a priority basis. We are also in the process of establishing a Credit Information Bureau.

    EQM: Who are the 3 people that you admire the most?

    Dr. Reddy: I admire at least three good qualities in every human being that I meet; and I have no inclination to look for any bad quality in any person.

    EQM: Which are your favourite books?

    Dr. Reddy: Collections of short stories, preferably in Telugu, my mother tongue.



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