"Whatever be the nature of the government at the Centre, RBI tries to ensure that its relationship with the government, its response to economic objectives and its policies remain in harmony," says Dr. Bimal Jalan, Governor, Reserve Bank of India, who is into his third year in office.
An economist by training, Dr. Jalan (59) has held several administrative and advisory positions in the Government of India. He was Chief Economic Adviser to the Union Government from November 1981 to July 1983; Special Secretary and Chief Economic Advise r between July 1983 and February 1985; Secretary, Banking, between February 1985 and June 1986; Secretary and Chief Economic Adviser in 1988; and Finance Secretary in 1990. As Finance Secretary, he was also on RBI's Central Board of Directors. Dr. Jalan was also the Chairman of the Economic Advisory Council to the Prime Minister between January 1991 and September 1992. He has also served as the Executive Director representing India on the Boards of the International Monetary Fund and the World Bank. He was also Member-Secretary, Planning Commission in 1997.
Educated in Presidency College, Calcutta, as well as in Oxford and Cambridge Universities, Dr. Jalan has written extensively on the critical policy choices for India and on international economic issues. Among the books he has authored on the Indian econ omy are India's Economic Crisis: The Way Ahead (Oxford University Press, 1991), and India's Economic Policy: Preparing for the Twenty-First Century (Viking, 1996) and edited The Indian Economy: Problems and Prospects (Penguin, 1993).
RBI is virtually in the eye of the storm created by the volatility in the rupee-dollar market. With the rupee at its all-time low against the dollar, RBI has reversed its policy of lowering interest rates (which it had done six times between January 1998 and April 2000), by raising the Bank Rate and the Cash Reserve Ratio (CRR) on July 21. This, according to Dr. Jalan, had to be done as "international market conditions had changed in respect of interest rates and we need to respond to changing condition s".
In his Mumbai office, Dr. Jalan spoke to T.B. Kapali and Asha Krishnakumar on a range of issues, including the current situation in the forex market, the role of RBI as the regulator of the financial system, its relationship with the Union government, and the central bank's strategy to monitor, and regulate, such new developments as e-commerce and software exports that are predicted to take off and zoom in the next few years.
Excerpts:The Finance Minister has more than once spoken about interest rate decisions being solely in RBI's domain. Can you outline the kind of autonomy and independence RBI has in formulating and implementing its interest rate views, especially, as it is the manager of the government's debt portfolio and acts as the public debt manager?
I do not particularly like to use the words "independence", "autonomy", "freedom" and so on while talking about RBI's relationship with the government. The reason is that in an emerging market economy, many public issues such as unemployment, regional ba lance, poverty alleviation, and monetary stability are involved. The economic situation in developing countries is complex and we cannot have a unitary objective or marked divergences in economic, fiscal and financial policies - with the central bank goi ng one way and government in another direction. What we need is harmony in order to deal with many conflicting objectives.
Thus, when RBI takes decisions on monetary issues, including interest rates, it gets a lot of inputs from the market participants, financial institutions, banks and the government. RBI takes into account the fiscal stance (of the government), before taki ng a decision and there is a fair amount of discussion with experts in the Ministry of Finance. And while the decision or the responsibility for taking a particular decision, such as on the Bank Rate, is that of RBI, the process of arriving at such a dec ision is a little more complicated.
Considering RBI's responsibilities, does this kind of situation where it has the responsibility of taking a decision but has to follow a consultative mechanism help the bank attain its objectives?
Reserve Bank does not have any independent objectives, apart from shared objectives with government and also Parliament. And those, to put it very generally, are growth with price stability in order to reduce poverty and increase in income levels. What e xactly should be the policy-mix depends on a lot of things. For example, beginning in 1998 and considering the phase of the cycle at that time and many other indicators of the economy, RBI reduced interest rates a number of times. Monetary policy was als o easy as inflation was coming down and external capital flows were high. More recently, RBI increased the interest rate; a decision which was based on a number of considerations, particularly the sharp change in international environment.
What is your view on the effectiveness of using interest rates to contain inflation - a weapon which may probably be more appropriate for an advanced market economy?
A lot of academic work has been done in this area. Generally, the consensus view is that in a situation where the inflation rate is high because of excess demand on account of demand pressures the monetary instrument is effective and has to be used. On t he other hand, if inflationary pressures are seasonal or due to external shocks (such as oil price rise), the monetary instrument is less effective in the short run.
If, as you say, RBI does not have any independent objective and its decisions on interest rates and such other economic targets are in consultation with the government, then, political control or direction from the government becomes an accepted fact. In such a situation, do you think RBI has more operating space or leeway in the present environment of a coalition government rather than a single-party rule at the Centre?
I do not want to make any comment on the political aspects except to say that whatever be the nature of the government at the Centre, RBI tries to ensure that its relationship with the government, its response to economic objectives and its policies rema in in harmony. If there is no harmony or if there is conflict, economic or monetary policies cannot be effective in emerging market economies.
For example, the write-off or waiver of loans made by banks was possible primarily under a single-party government at the Centre, but it may not be as easy under a coalition government...
Factually, this is not correct. However, as I said, it is not proper for me to make any comments on political aspects.
Does the legislation on fiscal responsibility or the fiscal deficit cap of the Union Government by RBI make any sense in the Indian context where the Centre and RBI have to work together on development issues which entail increased fiscal expenditure?
The content of a fiscal responsibility or tolerance levels in a country like India may be different, but the need for some rules and transparency with regard to accounting, how and where to spend public money, is necessary. The fiscal responsibility Act per se does not vitiate the objective of spending for development or infrastructure. It does not contend with "for what" but makes fiscal spending and rules more transparent. Thus, the content of the Act can be made suitable to our kind of environment.
In this context, what are the views of RBI on the system of ad hoc Treasury Bills which have been phased out? The agreement to phase it out was hailed as a landmark development in the Indian financial history. But what is the legal sanctity of the agr eement?
Parliament is sovereign. So obviously any agreement can be changed by Parliament or government. The agreement on ad hoc Treasury Bills was arrived at because it was in the country's interest, and I do not see why it would be changed.
Regarding the recent RBI guidelines on one-time settlement of the non-performing assets (NPAs) of the public sector banks, given that the government is a major shareholder in public sector banks, is it within RBI's domain to come out with such guideli nes? Don't you think the government should be dealing with it rather than RBI?
In this situation, I do not think this is really the core issue. Whatever the guidelines, settlements and procedures issued, it is always done in consultation with the government, the financial institutions and the banks. The idea is to look forward and try and make sure that this tremendous overhang of the NPAs and the inordinate delays in processes to realise them do not affect the financial health of banks.
The NPAs of the banks are estimated at Rs.52,000 crores. How do you propose to deal with the issue?
I do not know if you had the opportunity to read RBI's study on NPAs in public sector banks. A large proportion of the NPAs are very old ones, including those of factories, industries, and units which are now closed. These issues require resolution. Diff erent approaches have been tried. Settlement schemes have been worked out. Government has also set up tribunals to deal with pending cases speedily, and banks also propose to make increasing use of Lok Adalats to resolve disputes.
Is RBI's registration of institutions, other than banks, that take deposits complete?
The final phase of the registration process of NBFCs with net worth less than Rs.25 lakhs is on and is likely to be completed soon.
There are thousands of NBFCs meeting this criterion. Is RBI planning to work out a system of exception rather than focussing on all of them?
You are absolutely right. RBI is also discussing this issue. There are very small NBFCs, which are more localised. We would like to encourage their operations with a self-regulatory mechanism. As far as the smaller NBFCs are concerned, RBI is encouraging and laying emphasis on off-site surveillance. We hope to have some discussion on this and make the process simpler.
Is there a proposal to bring under one regulatory body the deposit-taking activity of all entities other than banks? For instance, the manufacturing companies taking deposits come under the DCA, the NBFCs under the Reserve Bank and so on. Does it not dilute the regulatory focus?
This has been discussed from time to time. The answer is not simple. To my mind, overburdening a single agency would create its own problems.
Considering the high interest rates promised by some NBFCs and the subsequent closure of many of them (particularly in the South) making lakhs of gullible investors face ruin, what is RBI's system of monitoring and regulating such companies?
The Reserve Bank has said more than once that it, in fact, encourages NBFCs. It encourages the development of NBFCs on sound lines. The future direction, as I see, involves much greater investor awareness. They ought to know whether the NBFCs are registe red/unregistered by the RBI and so on. Some of the initial regulations are also in place. And, we hope that the system works more by exception rather than detailed on-site inspection.
The RBI gives interest rate guidelines. If the NBFCs advertise very high interest rates for public deposits, this is wrong. We cannot prevent NBFCs from trying to cheat. They can only be penalised.
There seems to be some kind of an impression that the rupee can only depreciate vis-a-vis the dollar. Will this create a one-way street for speculators? Even when capital and other inflows are quite strong the rupee does not appreciate. There always s eems to be a bias towards depreciation. Does this give scope and potential for speculation in the Indian market? How does RBI deal with it?
Management of capital flows is always a difficult question. For example, if you have large capital flows, there could be very sharp appreciation in these markets followed by a turnaround and very sharp depreciation when there is a reduction in capital fl ows. The real issue is whether an emerging market economy can withstand that kind of sharp volatility. I am not sure whether there is a clear answer to this. The only clear answer I have is that this is a difficult problem during an era of volatile capit al flows.
Why did RBI see the need to intervene in the market and raise the Bank Rate and the CRR on July 21, reversing totally the nature of its intervention over the last two years. Also, particularly when the dollar is stronger even against other currencies such as euro and yen, would not Indian goods become competitive in the international market?
We have tried to explain this in our recent statement of August 3. The reality of the emerging market economy is that even relatively small changes in supply-demand position can have major impact on forex markets. Even euro has been very volatile. Second , we also have a very skewed market, in the sense that much of the demand is lumpy and cannot be postponed (for instance, crude oil imports). Supply on the other hand, is much more spread out and is much more sensitive to expectations of future exchange rate changes. Therefore it creates a market condition which is not really perfect or very deep. We have to do our best to tackle this problem.
However, using common standards of international competitiveness, we are not doing too badly.
In the latest (August 3) statement, RBI has stated that it will take whatever measures necessary to meet lumpy demands such as oil sector purchases. Some time ago, RBI set up the Venugopal Reddy Committee to go into the foreign exchange hedging activi ties of the public sector units, and a report was also submitted. What is the progress on the front?
Not much so far. But this is independent on the hedging problem. Even if the demand is spaced, the volumes are large.
Do we take advantage of some price developments in the international market?
Not yet.We hear that most of the purchases of foreign exchange by all the oil PSUs are mainly in the spot market and this causes a lot of volatility in the market. Is it true?
In certain periods it could be. That is why the Reserve Bank intervenes.
Does RBI encourage the PSUs to go in for hedging?
Yes, we would like them to hedge with appropriate accounting and financial rules.
On an overall reckoning, what would be the central bank's comfort level with the kind of risk management practices in PSUs now?
I am not an expert in this field, and cannot give a definite answer.
Various institutions have come out with varying perceptions of the economy. What is RBI's perception of the economy now?
Last year was a very good one. I do not see why it should change this year. Our reserves are high, exports are good, our policies for management of external markets are proactive, the monsoon is also good. The major uncertainty relates to the internation al situation, particularly extraordinarily high crude oil prices and high interest rates.
There is a system of taking inputs and feedback from outside the central bank also - from the broad market - in the central banking systems of advanced markets such as the Bank of England. Is there any such mechanism in RBI?
Yes. The Reserve Bank has opened up considerably. There are lots of groups and panels, meetings and discussions on all aspects of monetary policy at various levels. There is a weekly meeting of the Committee of the Central Board of RBI where that week's developments are discussed. And whether we should proceed to the next stage of involving in the central bank policy-making with outside experts who are not full-time officials is an open question. But we have enough outside experts advising us on various issues.
Experts say that e-commerce is expanding rapidly. Is RBI working out mechanisms to monitor the international e-trade?
The subject of e-trade is handled by the government. RBI has been taking a proactive stance as far as e-commerce is concerned. We are in the process of working out mechanisms to make it safe and secure.
Software exports are predicted to boom from $4-5 billions to $50 billions in the next few years. What is the kind of mechanism RBI is putting in place to monitor that kind of flows into the economy?
We are looking forward to it. The software industries will have our full support. We are in touch with the industry (software exporters) and are interacting with them on this.
As RBI's August 3 statement mentions, there is always a possibility of export earnings not being repatriated in time to take advantage of a falling rupee. Do you envisage this kind of a problem with software exports also?
If there are software exports of the magnitude that is envisaged, the problem of demand-supply mismatches would simply disappear.
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