A Breath Of Fresh Air

Till the day he retired from the finance ministry, Duvvuri Subbarao betrayed no signs of unsoundness. Day after day he read files, made sensible comments on his junior colleagues’ ideas, allowed his ministers to flow forth, and proved himself a well oiled cog in the wheels of power.

It was no wonder that P. Chidambaram made him governor of  Reserve Bank. He had had enough of Yaga Venugopal Reddy’s forthright and willful ways; sending Subbarao to Bombay would restore harmony between the finance ministry and Reserve Bank. Subbarao had also worked with the Prime Minister in his Economic Advisory Council. So, his appointment was expected to bring Reserve Bank in line with New Delhi.

These expectations were fulfilled. Subbarao had none of Reddy’s penchant for high interest rates; nor did he deliver endless homilies to the government. As governor he had forums where he could have strutted — the release of biannual monetary policies, and the jamborees abroad of central bank governors. But he did not succumb to the temptation to play to the gallery.

A year of this low-key performance led everyone to believe that we could settle down to a period of dull, boring monetary government. So when Subbarao asked his audience in Indian Merchants’ Chamber whether banking should be made boring, his observers did not know how to take him. Was he pulling their leg, or had he lost his marbles? The reactions within Reserve Bank are not known, but it can be imagined that its officials, who have devoted a lifetime to being dull and respectable, are in a state of deep shock.

If, however, they recover and read the speech, they will find it instructive. Subbarao took up a question Paul Krugman asked: do recent financial convulsions prove that banking should go back to its old style of giving loans to sound borrowers from industries producing real goods and services? Should banks abandon the casino style they recently took to and go back to being utilities? His answer was no; old-style banks have been no less vulnerable to crisis than new-style ones. And, he might have added, banking crises are centuries older than the new-style banking; in fact, the nineteenth-century engendered an entire branch of economics, trade cycle theory, centred on a debate about whether economic fluctuations were a monetary phenomenon or a real one.

After skating swiftly over the proposals floating about international financial regulation, Subbarao turned to India’s major financial problems and the solutions thereof. He selected four “challenges” — another favourite word of government types — financial inclusion, financing infrastructure, risk management and efficiency improvement. In all four areas, he outlined the official measures being taken.

Whilst he stressed the need for innovative solutions in all these areas, he did not venture forth with suggestions. Perhaps this is understandable; in our contentious country, if one wants to kill an idea, one should put it up for public debate. But the Reserve Bank’s preferred solutions are ineffectual; realizing that fact is the first step Subbarao needs to take before he can find something better.

Let me give a few examples. The Reserve Bank’s way of spreading banking is to have banks appoint business correspondents — agents to give primitive banking services. Banks have no incentive to appoint them; they will kill the idea. Subbarao should think of competition and of new models. Thousands of self-help groups are functioning, but will not spread over the country unless they are given the freedom to expand, coalesce and spread. Mobile payment systems were spreading until the Reserve Bank stepped on them. If moneylenders were allowed to start banks, they would come under regulation, and provide services where banks do not care to spread.

The Reserve Bank can think only of bank loans; it never thinks of markets. It should promote local debt exchanges where banks can trade their loans. They would thereby increase liquidity and make risk transparent. And the exchanges would give savers an alternative to bank deposits.

Subbarao complains of maturity mismatch in banks’ loans to infrastructure. It can be easily corrected; all that banks have to do is to take deposits of tenure matching the loans, to reward them in proportion to what banks earn on long-term debt, and to sell off the loans to the public. These are only some of the solutions that are strewn all over if only the Reserve Bank were prepared to give them a chance.

The author is Consultant Editor of Businessworld.

ashok dot desai at gmail dot com (This story was published in Businessworld Issue Dated 14-12-2009)