There
is no doubt that the financial sector in India was generally much
less affected by the global financial crisis of the past year than
in many other developed and developing countries. This is not to say
that Indian finance was unaffected: there were wild swings in external
capital flows (particularly portfolio flows) as well as in the stock
market. And the credit crunch that was so evident in September 2008
may have abated for large corporates, but it continues to plague small
producers in all major sectors. If anything, the lack of financial
inclusion that has been such a major failing of institutional finance
in India has been further intensified during the crisis.
Even so, the overall resilience of Indian banking is now the object
of international interest. This outcome is seen to reflect the combination
of a relatively cautious and calibrated approach to financial liberalisation
(reflecting also the political equations that affected government
policy in this regard); the continued presence and strengthening of
public sector banks, which account for the majority of banking transactions
in the country; and the recognition that in a developing country such
as India banking and monetary policies need to serve a variety of
social objectives.
Obviously, the central bank is absolutely crucial in all of this.
Therefore, much attention has also been focussed on how exactly the
Reserve Bank of India (RBI) dealt with issues of monetary and capital
account management and financial sector reform in the past five years,
which was a relatively unusual period both globally and within the
country.
Particularly, the role played by the then Governor of the RBI Dr.
Y. V. Reddy, has been widely noted, because of his judicious approach
to various financial liberalisation measures that were eagerly pushed
by some sections of the Indian establishment. During his five-year
tenure, the RBI displayed what now turns out to have been extremely
effective responses, in terms of strengthening public sector banks
by recapitalisation; preventing some of the financial ''innovation''
that allowed risk to be disguised rather than actually reduced; taming
the overexposure of domestic banks to what are now seen as toxic assets
globally; restraining the excessive bullishness of financial investors
in real estate; regulating the activities of systemically important
non-bank financial institutions; and speaking out against hasty and
potentially risky attempts to liberalise the capital account of the
balance of payments. It also argued (albeit unsuccessfully) against
some practices that continue to be dubious, such as the Participatory
Notes route for portfolio capital inflows. All these measures stood
India in good stead not only by preventing over-enthusiastic responses
during the global boom, but also reducing the negative impact of the
global slump.
That may be why the Nobel Prize-winning economist Joseph Stiglitz,
who was most recently head of the Commission set up by the UN General
Assembly to examine the international financial architecture (of which
Dr Reddy was also a member), famously said in an interview to an Indian
television channel: ''If America had had a central bank chief like
Y.V. Reddy, the US economy would not have been in such a mess.''
Naturally, in such a context, a book written by Dr Reddy that outlines
the important elements of his approach and describes the challenges
of central banking in these complicated times is of very great interest.
In general, books by central bankers are not known for their readability
or their wider appeal. But this particular book (''India and the Global
Financial Crisis: Managing Money and Finance'', New Delhi: Orient
Blackswan 2009) stands out as an exception. It is very clearly written,
in as accessible a style as possible given the inevitable complexity
of much of his subject matter. While describing the experience of
the recent past, Reddy makes a number of points that remain even more
relevant today.
The approach outlined in the book is essentially a pragmatic one,
eschewing orthodoxies of either Right or Left and not falling easily
into any definable camp in terms of policy orientation. The Introduction
as well as the various speeches and articles collected in the book
make it clear that Reddy sees that central banker's task in an economy
like India is fundamentally about growth, stability and financial
inclusion. The latter is the most important addition, and it is significant
that all three goals are seen to be equally important. This makes
the approach very different from mainstream ways of looking at central
banking, especially the recently popular paradigm in which inflation
targeting was typically seen as the only goal, with the interest rate
as the sole instrument, while financial markets were largely left
to fend for and regulate themselves.
This approach is elaborated in several chapters that provide a fascinating
account of the dilemmas and policy choices that faced the RBI in particular
episodes, in what must be seen as a turbulent and constantly changing
domestic and international environment. The difficulty of trying to
ensure that prudential regulations operate in a counter-cyclical way,
given that they have been designed to be pro-cyclical in effect, is
neatly described - and it remains one of the central issues facing
the Basel Committee today. The problems of identifying which are the
systemically important financial institutions (both banking and non-banking),
and how exactly their activities need to be controlled, are also clarified
through descriptions of actual decisions made at different times.
The need to curb excessive enthusiasm in introducing futures markets
on an extensive scale within India is highlighted. The risks inherent
in opening up of financial markets, especially debt markets, to foreign
investment, are identified in what now seems like a very prescient
analysis.
During Dr. Reddy's tenure at the RBI –when the articles collected
in this volume were written – many if not most of these positions
were seen as not just cautious but also heterodox and possibly even
heretical. But the validity of these arguments has been effectively
underlined by subsequent experience, not only in India where many
of these views prevailed in terms of actual policy, but in the counter
examples of economies where excessive deregulation and lack of a coherent
central bank strategy for controlling finance were closely associated
with financial crisis.
Reddy does not subscribe to the view that foreign banks or foreign
capital are critical to enabling improvements in the domestic banking
sector, which continues to be dominated by public sector banks. Rather,
in the Indian case, domestic banks were effectively dealt with and
strengthened through a variety of measures, by easing some constraints
on the functioning of public sector banks and addressing the problems
of vulnerable private sector banks through capitalisation, mergers
and regulatory rigour. This remains a critical issue since the advocates
of further privatisation and foreign ownership of banks continue to
press for such changes, despite recent international experience.
The book also provides a valuable insight into how the approach of
the central bank has to change not only according to various goals
that are seen as important, but also in response to the changing economic
situation. Reddy describes how the period after 2000 witnessed a move
from what had been characterised by ''lazy banking'', in which banks
simply invested in safe securities such as government bonds even in
excess of the statutory requirement, to what he designates as ''crazy
banking'' with an explosion of credit after 2005. This was dealt with
by insisting on additional capital requirements, because of the uncertainties
and risks that seemed to be emerging. At the time there were those
who cried foul, but there can be no denying that such protection eventually
proved to be of great consequence.
The need for a more financially inclusive policy is clearly one of
Reddy's central concerns, as is only to be expected given the very
poor degree of access to institutional finance to the bulk of the
Indian population and large parts of the productive sectors in the
economy. Despite some efforts, this clearly remains a major area of
underperfomance, at least partly because microfinance has been treated
as an alternative. Reddy provides a very interesting discussion on
the qualities and possibilities of microfinance, and correctly notes
that the long term objective should be the financial inclusion of
all persons through the banking system, rather than to have two separate
institutions, micro for the poor and banks for the rest.
This is an extremely useful book not only for those involved in finance,
but even for laypersons who wish to understand how the Indian financial
system works. But it is also significant because of the importance
of several of Reddy's arguments for the ongoing debate on financial
sector reform in India. Now that the Indian government, in an apparently
incomprehensible move, has chosen to take a World Bank loan to recapitalise
public sector banks (even though the banks are generally perceived
to be in good shape financially and in any case no foreign exchange
is required for such a project) it is likely that many policies such
as unnecessary opening up to foreign capital and allowing greater
risk exposure and financial innovation will be pushed. It is therefore
essential to have cogent and sensible positions on the need for and
the likely impact of such policies, as identifying alternative strategies
for Indian banking and finance.
So Reddy's book does much more than provide an illuminating account
of central bank policy from the point of view of a recent practitioner.
It provides a reasoned critique of policies of unnecessary deregulation
and highlights the need for balance and for recognising the requirements
of the development project. While it may not provide full details,
it also sets out the possibility of an alternative framework that
can be applied even in these more open and externally integrated times,
to work towards the goal of social banking for all.