As governor of the Reserve Bank of India (RBI) till September last year, YV Reddy was in-charge of monetary policy at a time when the economy grew at its fastest pace ever. Ahead of his book launch in New Delhi, he tells John Samuel Raja and Sapna Dogra that the government should convince financial markets that the high fiscal deficit is temporary.
In the past, when external crises took place, we were relatively insulated. But in the five years till March 2008, India has got integrated with the global economy. What is the way forward to tackle the crisis?
We should have an understanding of integration, which is on different counts. First, all economies are not integrated equally. Second, the nature of integration is different for different countries. Third, the size of the domestic economy is important. Fourth, the current crisis is centering around finances. So, financial integration is more critical. Within this, you have the markets integration. Then you have the government's responses.These have to be co-ordinated.
We can consider three sectors: fiscal, monetary and financial. If there is a country where the markets have collapsed, its first priority is to get the financial market into shape at a reasonable cost. The same case exists for institutions. But in India, institutions are not in need of capital infusion.
Within this, we have to see fiscal and monetary policies. Both should address those elements of the aggregate demand which were affected by the crisis. If you're looking at aggregate fiscal stimulus and a country is already running a fiscal deficit, one has to see how to implement and withdraw the fiscal stimulus. Withdrawal becomes more important because of the level of public debt. Why? Because the financial markets perception is important. The quantity and quality of fiscal stimulus implemented by the developing economies depends on the capacity to convince the financial markets.
In monetary policy, we have to look at various instruments. Here, too, exit is important. Yes, the rules of the games have changed. But the dominance of the domestic factor still exists with the external factor now more important than before.
Are you saying that there should be a clear roadmap for exit in stimulus measures?
I won't say roadmap. But markets have to be clear that these are temporary measures that are being constantly reviewed. It should be clear to everyone that this is a special measure and won't continue.
Do you see any further need for stimulus?
I don't want to give any opinion. I only want to give an analysis. Broadly, the measures are in the right direction.
Some argue that the difference between the trend growth rate and the current level gives room for additional government spending and not the absolute amount of debt adds. What is your view?
Analytically, it is right. But then you should look at realities. I would like to use the word potential output instead of trend growth rate. You will have to consider the lagged effects. Then, the efficiency in the system. In the Indian context, we can look at the fiscal deficit from two angles.
First, how vulnerable the economy becomes because of the deficit. Second, how much of the system's efficiency is affected. You have created a lot of defences, like non-resident people not being allowed to invest much in government securities and FDI (foreign direct investment).
We have been able to maintain high fiscal deficit because these defences were there. Virtually, the priority for RBI was to manage the government borrowing programme. You cant have a situation where I will have a modern banking situation and 25 per cent SLR (Statutory Liquidity Ratio) requirement.
What is your reason for saying this?
If you say that, for the next five years, my fiscal deficit based on trend growth rate still has a headroom, then the assumption is that SLR will remain as it is. The moment you say SLR has to be reduced, we have a real issue on how to deal with trend instruments.
If you're going to use trend instruments, how are you going to open up the banking system and the financial system? Banks in other countries have low SLR and our banks have higher SLR requirements. How are we going to compete? If we dont want to have SLR, then we cant maintain trend growth rate and trend defences.
Are you saying reforms cant go hand in hand with this high fiscal deficit?
If you want external sector reforms or financial sector reforms, you need to have a fiscal deficit which is under control. And, for opening up real sector, we need to first open up controls within our country.