COLUMN: JAYATI GHOSH
Y.V. Reddy’s book, a reasoned critique of policies of unnecessary deregulation, is important in the context of the ongoing debate on financial sector reform in India.
THERE is no doubt that the financial sector in India was generally much less affected by the global financial crisis of the past year when compared with the situation in many other developed and developing countries. This is not to say that Indian finance was unaffected: there were wild swings in external capital flows (particularly portfolio flows) as well as in the stock market. And the credit crunch that was so evident in September 2008 may have abated for large corporates, but it continues to plague small producers in all major sectors. If anything, the lack of financial inclusion, which has been a major failing of institutional finance in India, was further intensified during the crisis.
Even so, the overall resilience of Indian banking is now the object of international interest. This outcome is seen to reflect the combination of a relatively cautious and calibrated approach to financial liberalisation (reflecting also the political equations that affect government policy in this regard); the continued presence and strengthening of public sector banks, which account for the majority of banking transactions in the country; and the recognition that in a developing country such as India banking and monetary policies need to serve a variety of social objectives.
Obviously, the central bank is crucial in all of this. Therefore, much attention has also been focussed on how exactly the Reserve Bank of India dealt with issues of monetary and capital account management and financial sector reform in the past five years, which was a relatively unusual period both globally and within the country.
Particularly, the role played by the then RBI Governor Yaga Venugopal Reddy has been widely noted because of his judicious approach to various financial liberalisation measures that were eagerly pushed by some sections of the Indian establishment. During his five-year tenure, the RBI displayed, as it now turns out, extremely effective responses, in terms of strengthening public sector banks by recapitalisation; preventing some of the financial “innovation” that allowed risk to be disguised rather than actually reduced; taming the overexposure of domestic banks to what are now seen as toxic assets globally; restraining the excessive bullishness of financial investors in real estate; regulating the activities of systemically important non-bank financial institutions; and speaking out against hasty and potentially risky attempts to liberalise the capital account of the balance of payments.
The RBI also argued (albeit unsuccessfully) against some practices that continue to be dubious, such as the Participatory Notes route for portfolio capital inflows. All these measures stood India in good stead not only by preventing overenthusiastic responses during the global boom, but also by reducing the negative impact of the global slump.