Mumbai: Reserve Bank of India governor Y.V. Reddy on 19 March said an imbalance in the growth of financial sector and real sectors such as agriculture and industries could increase the risk in the economy.
“Without the real sector development in terms of physical infrastructure and improvement in supply elasticities, the financial sector can even misallocate resources, potentially generate bubbles and possibly amplify the risks,” Reddy said at a conference here.
While the financial sector is the money-issuing part of the economy, the real sector is the money-holding segment that produces goods and services. “Public policy may have a crucial role to play in ensuring balanced reforms in both the sectors,” he said.
Reddy said policy-makers should ensure that reforms in financial sector complement, and not constraint, the pace and process of reforms in the real sectors.
On emerging challenges to monetary policy in the preference for open economies, Reddy said every country should take a holistic approach to the trinity—free flow of capital, fixed or managed exchange rates and independent monetary policy. He favoured a close coordination between monetary and public policies to ensure management of the trinity.
The RBI Governor also observed that inflation process has become highly unclear in view of uncertainties of price levels.
“Central banks are faced with the need to recognise the importance of inflation perceptions and inflation expectations also, as distinct from inflation indicators,” he said.
Reddy said existence of administered prices in commodities critical to inflation expectations, perceptions or indicators complicate the relationship between prices and monetary policy, though the outcome may be socially desirable.
On interest rates, he said what is considered as “neutral rate” of interest in the present period appears to be much lower compared to several years before.
“The issue is whether the neutral rate in respect of the emerging market economies, which has been coming down in tandem with global rates will tend to be distinctly higher than in developed economies,” he said.
He favoured the use of monetary policy in conjunction with other prudential measures for financial stability.
“There could be even a trade-off between raising the short term interest rate and tightening of prudential norms, if the risks are perceived to originate from certain segments of the market,” he said.
The highly leveraged lending operations in the backdrop of asset-price bubbles might require adjustments in the lending margins and risk-based capital requirements.
On “opaque” hedge funds, Reddy said while transparency to investors is largely an issue of investor protection, the need for counterparties to have adequate information is a risk-management issue.