Mumbai: The Indian economy has suffered more acutely from global troubles because it was already in a vulnerable position, said former Reserve Bank of India (RBI) governor Y.V. Reddy.
“The domestic economy was already vulnerable, and global problems intensified the situation,” Reddy said.
He identified three problems: the large fiscal deficit that has left policymakers with less headroom to stimulate domestic demand, the fact that fiscal expansion was led by consumption spending and the structural deterioration in public finances because the stimulus is difficult to withdraw.
The Indian economy has been rapidly losing momentum and the growth rate has fallen for four quarters in a row. Economic growth in the fourth quarter of fiscal 2012 was at its lowest level in almost a decade. Slowing growth has been accompanied by persistently high inflation and a wide current account deficit, a sign of deep structural imbalances in the economy.
Earlier this year, RBI governor D. Subbarao said in an interview that the potential rate at which the Indian economy can grow without high inflation is 7%, or 1.5 percentage points lower than before the crisis. Reddy said that he agreed with his successor’s assessment. “When we were clocking 9% growth, it was clear to me we were growing above potential. I had even described it as overheating,” he said.
The former central banker was in Mumbai to launch Of Economics, Policy and Development: An Intellectual Journey, a book of essays by I.G. Patel, described by Prime Minister Manmohan Singh as “the dominant economist in the finance ministry” during his tenure. Patel was also RBI governor, executive director of the International Monetary Fund and director of the London School of Economics. The book has been edited by economist Deena Khatkhate and Reddy.
In a discussion with Mint, Reddy said that the global crisis has created an intellectual vacuum that is encouraging economists and policymakers to take lessons from the past. “The tools used earlier may not all be irrelevant,” he said.
The former RBI governor pointed out that there is now need for a more eclectic rather than ideological style of policymaking, with due recognition given to the ground realities in various countries, a style that would have appealed to Patel. Among the tools that could be resurrected, suggested Reddy, are selective credit controls and moral suasion. He also pointed out that some countries in Latin America are reconsidering the advantages of public sector banking.
The central bank under Reddy had been criticized by purists during the boom years for trying to cool down the Indian economy, often through policies such as sector-specific controls that were frowned upon by the conventional wisdom of the day. However, Reddy’s reputation has risen after the crisis exposed the instability that can result from an uncontrolled financial sector. “What was then considered unconventional may become mainstream in the future,” he said.
“We need to learn from the problem-oriented and pragmatic approach that Patel followed, despite the fact that he was also an accomplished technical economist,” said Reddy. “Technical skills are used these days only as an endorsement of scholarship rather than for solving practical problems.”