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, Dr Reddy, Deputy Governor, RBI, spoke about the mid-term monetary policy. He also shared his views on issues like universal banking and the scope of retail participation in the government securities market.
EQM: What were the main economic issues that you had to bear in mind while drafting the monetary and credit policy for the second half of the current fiscal year?
Mr. Reddy: Basically one is that we have had in the last couple of years a perceptible slow down in the Indian economy. But the slowdown by itself was not such a serious concern but for the fact that it coincided with the global slowdown. So you have a situation of global slowdown. And on top of it because of the September 11th incidence, the possibility of a global recovery perhaps seems to have been delayed. So therefore, in that sense, we reviewed the situation and we felt that whatever we indicated in April required support and perhaps needed to intensify. That is how further movement mainly on the liquidity and on the interest rate side was taken.
At the same time, reflecting the global uncertainty and reflecting the possible way in which the financial markets tend to behave, globally and to some extent occasionally in our country, the monetary policy is clearly warning the market participants. In a way, we are also alerting ourselves that we have to look not only at the credit availability and price stability but also the volatility in the financial markets. This is what was in our mind, contextually speaking. But it is also consistent with the medium-term objective. The medium-term objectives being (a) reduce the CRR limit (b) improve the interest rate flexibility and (c) emphasis the implementation of the prudential measures as well as the development of the financial markets. I think this captures the philosophy behind the mid-term monetary policy.
EQM: You mentioned about the reducing CRR and increasing interest rate flexibility. But do you think in an environment where we continue to exceed the fiscal deficit target year after year such a task is achievable?
Mr. Reddy: As you know, the original expectations of the reduction in the CRR or rather the timetable for the CRR could not be adhered to for two reasons. One of course is the fiscal situation. And the other is the state of the financial markets. So, you see, fiscal situation comes under a reasonable control then the reduction becomes easier and quicker. But you are right. One of the key factors that will determine the pace of reduction in the CRR is certainly the fiscal deficit.
EQM: What would you rate as the single most important development in the policy? Any other highlights that you would like to bring out.
Mr. Reddy: In a situation like monetary policy, every measure is given equal importance. But I am sure for different market participants, different measures would be important. So it is not appropriate to have an abstract judgment.
EQM: The RBI has infused an additional Rs 80 bn into the markets with a 200 basis points cut in CRR. Probably with low inflation environment and crude oil prices staying low, this gels well. But what if crude prices move up?
Mr. Reddy: That is a factor we have to reckon. But one thing is that the forex reserves are comfortable. To the extent forex reserves are comfortable, it is unlikely that we should have any problems, particularly when we have adequate food stocks. If there is an oil shock, it will definitely have an impact on the economy in some ways. But there is no big threat to the external sector.
Let me put it this way. The current account deficit, we indicated that it would be definitely below 2% of GDP. If there is no oil shock, it will be far less than 2% of GDP. In case of an oil shock, it will be closer to 2% and therefore I would say that this is a manageable situation and the excess liquidity problem, given the inflation rate of 3.2%, is manageable. Both of them would still be consistent with the liquidity because of the variety of the instruments that we have to manage things.
EQM: You mentioned about the oil shock. What about the food stock shock?
Mr. Reddy: Actually you find a reference to that in the monetary policy that the food credit, both with regard to the volume of credit and the way credit is administered, has significant implications, atleast in three different levels. One, at the level of fiscal policy because of the cost. Two, at the level of monetary policy because it has monetary implications of money held in the form of stock. And three it has credit implications. These are the matters that require attention and continuous attention.
EQM: The Global economy has been slowing down rapidly. However there is a view that since approximately 90% of the Indian economy is domestically driven, we will buck this general trend? What is your view and how do you see the economy performing in the coming years?
Mr. Reddy: Again, as indicated in the annual report, though it was before the attacks, the extent to which our economy will be affected is relatively less than other countries. It is inappropriate to think that we will be totally insulated. No, we will not be insulated completely. But we will not be affected as much as other countries. The two economies, which they expect will be able to by and large hold on and have a respectable growth, are China and India. Particularly vulnerable perhaps amongst emerging economies are Asia or Latin America.
EQM: Against an export growth of around 20% last year, the current year prospects for exports are modest. How do you see India faring on the external front this year? How will this impact the domestic economy?
Mr. Reddy: The policy has clearly indicated that the export growth has been sluggish. The sluggishness in export growth, which is of a contextual nature, is basically related to the global environment. But in the medium-term perspective, issues like country’s competitiveness also play a vital role. But at the moment, it is the global environment that is affecting us at a higher rate.
EQM: Retail holding of government securities is becoming a reality with companies like PNB Gilts and IDBI Capital Markets taking the initiative. However, a lot still needs to be done before retail investors take active interest. How do you plan to take it forward for wider retail investor participation?
Mr. Reddy: Once we are able to put in position our Clearing Corporation, then it will be possible to have a national network, which would be offered through stock exchanges. Basically there are two things that are required to increase retail holding. One, a position to able to reach the retailers quickly and second, a secondary market where the retail person would be able to quickly sell and get the money. This will require institutional arrangements, trading platform, trading practices and intermediaries, if need be. We are progressing on all fronts. If you ask me a time frame, my personal view is, it should start taking shape in one year from now. In two to three years time, you should be able to see a definitive impact.
EQM: Universal Banking is another issue that has been grabbing a lot of headlines. Indeed with IDBI and IFCI facing financial difficulties, Universal Banking has been made to sound almost as a cure for these difficulties. What is your view on Universal Banking and how do you see the banking sector shaping up in the future?
Mr. Reddy: From the RBI’s point of view, there have been three steps as far as approaching universal banking is concerned. The first is where on the basis on various committees and discussions have been put in. The second stage was that a formal circular was issued indicating the policy statement and subsequently some institutions have shown interest. Now, in the current policy framework, very clearly the RBI has come out the parameters of whole objective of the concept of universal banking. As you would have noticed, the idea is certainly that if a certain institution wants to expand its activities, you should certainly encourage them. But certainly it is not meant to solve the inherent problems of individual institutions. That has been clearly elaborated in the report.
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