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What Saved Indian Banks
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The book gathers steam in the second part where Mohan discusses growth in the financial sector. The changes in the banking system with focus on how the RBI followed a gradualist approach, albeit consciously, forms the theme of financial sector reforms in India. He shows how this was the prudent way to go about regulation. It helped us stave off the financial crisis that engulfed the West a few years ago. We have, hence, moved over to a virtually market-oriented system for both interest rates and exchange rates under the umbrella of prudential regulation.
Mohan is well guarded as he talks about financial inclusion — the buzz in India today. While it is a necessity, and the RBI is working towards making it more all-encompassing against the background of the financial crisis, Mohan rightly says we must not get swayed and create a situation similar to the sub-prime crisis. Given the controversy surrounding microfinance institutions, this argument is quite relevant. The system may get reckless often when addressing this issue — which runs more at the emotional rather than practical levels.
There is a whole section on the financial crisis, which Mohan aptly describes an "interpretation". He is all praise for the RBI, which manages a stable forex situation along with domestic markets with appropriate monetary policy action. The RBI has fine tuned interest rates and made available adequate liquidity to banks.
We did better for four reasons, says Mohan, and these can be lessons for central banks in developing nations. First, our macro management has been flexible as we have avoided "doctrinaire positions"; we have not given in to the prevailing fashion. Second, regulation was gradually modernised, which has now been accepted as being the right course. Third, we created new institutions at the right time, and never went beyond the curve. Finally, gradualism in opening up the external account was the right choice after all.
Mohan also debates the challenge of the famous trinity for any country — managing independent monetary policy with capital account convertibility and fixed exchange rate. He argues in favour of what India has followed — a certain modicum of convertibility, regulated floating exchange and a virtually independent monetary policy as being the best trade-off that we have chosen. In this context, he discusses in detail the aspect of communication of the RBI, which hitherto had been non-existent. The central bank's voice rather than its action, at times, could be more effective in driving the market, and he shows how this has helped move rates down. He also has his own anecdotes to share when his personal view as deputy governor of the RBI was different from the President (A.P.J. Abdul Kalam).
The main challenges for the economy would be three fold, says Mohan. The first is financing of infrastructure, given that the corporate debt market is virtually non-existent. Second, the development of financial markets in an orderly manner is critical as we always walk on the razor's edge given that they are susceptible to volatile global conditions. The third is monetary policy, which will have a more important role to play in the growth of the economy due to its influence on both the real and monetary sectors. In a refreshing take at the end, Mohan says the new focus of economic reforms must be on empowering the public sector to do what it is supposed to do: provide public services.
How should one look at Mohan's book? It is a very good exposition of the RBI's stance and way of thinking. Coming as it does from a person who has run the show twice in his career, it tends to be sympathetic or apologetic at times for actions taken. The reader, however, is at liberty to think otherwise.
Rakesh Mohan is professor in the practice of international economics and finance at School of Management and senior fellow, Jackson Institute of Global Affairs, at Yale University. He was deputy governor of the RBI and secretary at the department of economic affairs under the finance ministry. His books include, Monetary Policy In A Globalised Economy(2009).
Sabnavis is chief economist at CARE Ratings
(This story was published in Businessworld Issue Dated 26-12-2011)