Mumbai: India managed to be relatively insulated from the global financial crisis because of deft handling of the situation by the Reserve Bank of India (RBI) as well as the sheer luck that it was so far away from the epicentre of the crisis, Raghuram Rajan, professor of finance at the University of Chicago and an adviser to Prime Minister Manmohan Singh, said in a talk given at the central bank’s headquarters on Tuesday.
Rajan also seemed to have made a subtle change in his view on what RBI should be busy doing. The Committee on Financial Sector Reforms (CFSR) chaired by him had said in the draft report submitted to the Planning Commission in April 2008 that the Indian central bank should have a single target with a single policy instrument. The report had said that RBI should “formally have a single objective, to stay close to a low inflation number”, and move steadily to a single instrument, the short-term interest rate (repo and reverse repo) to achieve it.
Financial goals: Raghuram Rajan, professor of finance at the University of Chicago, speaking at the RBI headquarters in Mumbai on Tuesday. Abhijit Bhatlekar / Mint
This recommendation was in line with global conventional wisdom at the time that central banks should above all be inflation busters but it was at odds with RBI’s own eclectic mix of targets such as inflation, the exchange rate, credit aggregates and financial stability.
During the Tuesday speech, Rajan said the central bank should “have a clear focus on inflation”—a subtle difference from saying it should have inflation control as its sole objective—but also clarified that his report on financial sector reforms did not, contrary to popular perception, recommend strict inflation targeting as the sole goal of RBI.
His audience included RBI governor D. Subbarao, senior central bank decision makers, Securities and Exchange Board of India chairman C.B. Bhave and economists. Rajan was one of the first economists to raise questions about whether financial innovation had made the world a riskier place, an idea he spelt out in a famous presentation he co-authored for a 2005 seminar at Jackson Hole, Wyoming, in the US, which hosts an annual central banking shindig.
“There is some speculation that India may slow down on reforms. We will not slow down but recalibrate,” Subbarao said in his opening remarks.
Rajan also complimented former RBI governor Y.V. Reddy for his then unpopular decisions of restricting capital inflows into real estate and limiting the participation of foreign banks in the country, though he also said that the dominance of public sector banks should be reduced.
Rajan warned the audience that both over-regulation and under-regulation of the financial system are not desirable.
While acknowledging that the regulatory conservatism saved the Indian economy, Rajan questioned whether the regulators are being over-conservative, something that can halt economic progress.
“In a crisis, all conservative views happen to be right. But is conservatism the right way to go? Conservatism has served us the right way, but how many percentage points of growth have we given up? We have to consider that, too,” he said, adding that if more foreign banks are allowed to enter the country, it would lead to more competitiveness in the banking market and help the financial system reach optimum efficiency and balance.
Rajan also touched on a few other contentious policy issues in the course of his speech.
He suggested that the central bank should not continue managing the government’s borrowing needs. That job should be left to a separate debt management office while RBI should focus on monetary management.
He said that there is pressure on RBI to take some of the government’s debt on its balance sheet, leading to money creation and inflation risks.