Dr Y.V. Reddy’s tenure at the Reserve Bank of India (RBI) is officially over. Speculation has been laid to rest and we have a successor. We wish him well. He inherits a challenging situation, as RBI has to work under an ill-defined framework for monetary policy. The central bank also has to work with an unhelpful polity that has a congenital proclivity to flirt with fiscal disaster.
For the most part, fiscal policy in India has been expansionary. Therefore, the central bank perforce had to engage in demand restraint. That is anathema to many who believe there is no ceiling to growth in a developing country. It is true in theory. In reality, long-term growth is a function of macroeconomic policy, not monetary policy. Reddy understood that and did not overreach. Demand management is what we focused on within the constraints imposed by the conduct of broader economic policy.
It was also evident from the monetary policy decisions of RBI that Reddy was conscious of the fact that the still-evolving legacy of Alan Greenspan was entirely due to monetary policy overreach and regulatory forbearance. Despite making a judgement that was becoming of a central banker, Greenspan refrained from acting on it and speculated on the possibility of once-in-a-lifetime productivity gains. America is still reaping the whirlwind. The core principle of central banking is not to take risks but to ensure stability. Hence, the job requires an intrinsic inclination to be risk-averse. Reddy possessed that. Thus, India has distinguished itself from other Asian countries that decided to tolerate higher inflation only to discover that households are more enfeebled by inflation than by higher interest rates.
His strongest achievement also happens to be the focal point of criticism. It has to do with financial sector liberalization and the high-sounding words such as innovation and transparency that go with it. Bare Talk wagers history would actually remember him kindly for his signal achievement in recognizing the vacuous and bogus claims of windfall from financial liberalization. Neither theory nor empirical evidence supports the argument of gains from financial liberalization as much as they do for liberalization of free flow of goods across borders. In fact, empirical evidence points to the contrary. History is littered with corpses of victims of premature, ill-prepared and ill-founded financial liberalization followed by bail-outs that made nations permanently bonded to external capital and its whims. It is almost impossible to calibrate it and capital flows do harm, both when it comes in — it comes in abundance — and when it leaves — it leaves in a hurry. Previously strong votaries are now cautious champions if not downright sceptics.
Another reason for the failure of financial innovation is that more number of players in the industry, instead of enhancing competition, consumer welfare and systemic stability, actually ended up endangering all three. They didn’t operate as a cartel but as an unthinking herd. Bare Talk’s personal experience in the industry for more than 15 years suggests the industry would score high marks for the safety it seeks in being part of the crowd. “Me-too” is the norm. That is why paeans to innovation and liberalization in the financial sector were more amusing than convincing. Reddy’s gradual approach towards opening up the sector to new players showed he was in tune with the actual and not the theoretically projected behaviour of the industry.
Further, it would have been unsurprising for him to find that products conjured up by such an industry dominated by groupthink were, for the most part, not innovative but opaque and non-transparent mechanisms to hide risk rather than to diversify them away. Innovation was not a virtue in finance, just a profiteering mechanism for investment bankers and the institutions are poorer for that. That insight informed the decisions the central bank took under his stewardship on securitization and on the provision of higher risk capital against mortgage loans, to name just two. Global developments have vindicated him.
As he lays down office in the next few days, Bare Talk suspects Reddy would have reasons to be both satisfied and to feel that his mission has not been fully accomplished. He would be satisfied that his cautious attitude towards the financial sector has been the right one. His mission as a monetary policymaker to deliver growth with price stability is still a work in progress. There is also the unfinished agenda of teaching market participants to learn to manage risk on their own instead of accusing the central bank of non-transparency, and simplifying the communication of monetary policy decisions, ex-post.
In the end, the most fitting tribute to his stewardship of RBI comes from the fact that he attracts strong praise and criticism. Only those who stand up for their beliefs achieve that feat. That alone is testimony to a successful tenure at the helm of the nation’s monetary affairs in a country where policy leadership is an endangered skill.
V. Anantha Nageswaran is head, investment research, Bank Julius Baer & Co. Ltd in Singapore. These are his personal views and do not represent those of his employer. Your comments are welcome at firstname.lastname@example.org