Hyderabad: Reserve Bank of India (RBI) governor D. Subbarao made a strong pitch to allow the central bank to continue managing financial stability at a time when there is intense debate on whether an 18 June presidential ordinance puts its independence at risk. He was delivering a public lecture in honour of C.D. Deshmukh, his first since the controversial ordinance was promulgated.
Subbarao also reiterated that RBI could not be a pure inflation targeting central bank, but needs to balance between growth, price stability and financial stability.
Finance minister Pranab Mukherjee had in his Budget speech this year proposed a Financial Stability and Development Council “to strengthen and institutionalize the mechanism for maintaining financial stability”. Mukherjee has added: “Without prejudice to the autonomy of regulators, this council would monitor macroprudential supervision of the economy.”
Subbarao said that RBI has historically played a “central role” in maintaining financial stability in India. “What we did in India is a classic case of deployment of macroprudential tools to preserve financial stability, action made possible by the Reserve Bank’s broad mandate and the host of instruments at its command. It is interesting, although not surprising, therefore, that increasingly the reformed regulatory models around the world are moving towards resembling our model.”
A view in one section of Indian economists and policy makers is that RBI should focus on inflation control alone and financial stability should be handled by new regulator. The UK has recently withdrawn from this strategy, when its Financial Services Authority was abolished by the new government and the financial stability mandate was moved back to the Bank of England.
Subbarao said more often than not, the drivers of inflation in India emanate from the supply side and food items have a weight of 46-70% in various consumer price indices and were “notoriously subject to supply shocks which are normally beyond the pale of monetary policy”.
This, the governor said, “dilutes our potential effectiveness as inflation targeters”.
He also said that a necessary condition for inflation targeting to work is effective monetary transmission, but India’s monetary transmission mechanism, though improving, is yet to reach robust standards. “It remains impeded because of administered interest rates, the asymmetric contractual relationship between banks and their depositors, illiquid bond markets and large government borrowings. These impediments to monetary transmission diminish our effectiveness as inflation targetters.”
On fiscal dominance of monetary policy, Subbarao said: “The autonomy of monetary policy from fiscal compulsions is once again under threat and resolving that threat requires credible efforts by both governments and central banks.”
Referring to the global economic crisis and the way India shielded itself from worst impact of crisis through raising the provisioning norms and risk weights, Subbarao said several economies around the world were now moving towards the Indian model of deployment of macroprudential tools to preserve financial stability.
Saying that “strong” decoupling of emerging market economies from the advanced economies would not work in a globalized world, Subbarao said “soft” decoupling, however, works. “It is possible for economies to insulate themselves against an external crisis, but to be able to do so, they need to diversify their drivers of growth, institute automatic stabilizers and develop the fiscal space to accommodate those stabilizers, regulate their financial systems effectively, and be swift and nimble in economic management.”