At a time when India's increasing current account deficit(CAD) has become a point of concern for all economists, former Governor of Reserve Bank of India, Dr Bimal Jalan says making the exchange rate flexible could be a solution to easing the CAD.
At a time when India's increasing current account deficit (CAD) has become a point of concern for all economists, former Governor of Reserve Bank of India, Dr Bimal Jalan says making the exchange rate flexible could be a solution to easing the deficit. In a move to lower the deficit, Finance Minister P Chidambaram also increased the import duty on gold from 4 percent to 6 percent in order to decrease demand for the yellow metal.
"Your imports are much higher than your exports and part of that can be a monetary issue. So, the exchange rate certainly has to be flexible and we should manage it in that way," he adds.
Also commenting on the current state of governance in the country, Jalan says the country is troubled by systemic political problems. According to Jalan, every country and its economy faces ups and downs. What is of prime significance is whether the problem is structural or not. "In economic terminology, it means if there are some fundamental bottlenecks which are generating the kind of downside that one is seeing, or is it cyclical," explains Jalan.
Jalan opines India is a great democracy, however, it is marred by corruption committed by ministers cutting across all party lines. "The issues that we are facing today are systemic and political in nature because ultimately, in a vibrant democracy like ours, the policy making must be with the political system," he adds.
In an interview to CNBC-TV18, Jalan shares his views on the Indian economy, and the complex entwined nature of politics, business and economy.
Given below is the edited transcript of Jalan's interview to CNBC-TV18.
Q: We are perhaps not in a crisis today, but the environment is froth with risk. The twin deficit; the current account and the fiscal deficit and with the growth slowing down and inflation being very stubborn, how long do you think it will take to get out of the situation?
A: One thing that we must remember is that there are ups and downs in an economy always. It is all the time, in all economies. The issue is, whether it is structural or not. In economic terminology, it means if there are some fundamental bottlenecks which are generating the kind of downside that one is seeing or is it cyclical.
In any system, one would see growth rate go up. It can come down and so on and so forth. So, at the moment, we are in transition and the real issue is that the political shape of India has changed quite dramatically. I cannot talk too much about it but we have fractious politics and it is not a coalition per se. Lots of countries have coalitions but they share an ideology, they have a programme. In our coalition, we have to worry, but there is not very much that one can do.
Q: So you are saying that the fact that inflation is stubborn high and growth rate is falling are symptoms of a possible structural problem?
A: One can just look around. If one just sees the political shape of our country as it has emerged, we are a great democracy, we are very fortunate to have free and fair elections, yet if you see, the same country has corruption in any allocation decisions being made by ministers. These are ministers belonging to different parties without any accountability, without responsibility. I am not pointing a finger at one person. The issues that we are facing today are systemic and political in nature because ultimately, in a vibrant democracy like ours, the policy making must be with the political system.
The RBI can execute, different agencies can execute, one can allocate coal through auctions or one can allocate coal to backward areas. While policy can be decided and debated, administration is the best way to implement the policy.
Q: That perhaps explains why although after the present finance minister, Chidambaram came back in September, sentiment picked up, the market is possibly near all time highs but the mood is still cautious because everybody realises the political reality in which he operates. What would he need to do to transform the mood or nurture the green shoots of the optimism that is coming back again?
A: I am not in a position to comment on that part. I have great regards for P Chidambaram. So far, he has done extremely well and he has infused a sense of confidence in our economy both on investment side as well as on the fiscal side. We have lot more confidence now, than would have been the case earlier. We earlier had a jam, retrospective taxation and all. There was a complete confusion and so, I must compliment how the present finance minister has taken some measures.
However, the primary issue is not about that. The problems we are facing are systemic. For example, we have different parties allocating public resources. There is expectation that elections will be held six months hence, nine months hence. There is a whole situation of who will win the election and who won't win the elections. So, we are going through that kind of a period and whatever you do, you find different voices.
Q: The fact that states are getting more powerful and more competitive and states that are apparently being governed well are seeing those governments come back to power, does that give you hope that there could be a rush for competitive governance and we could see the structure changing?
A; Absolutely, that is a superb development. If we had the political will to maximise the benefits of that development, one has regional parties across our country which through a democratic process are in power.
If one looks at the distribution of powers between centre and the states they remain the same. Why should a central minister decide all allocation of land, coal and 2G spectrum. Does the Election Commission, the political authority would decide that there would be an election, the timing of elections. Election Commission then executes that decision, it doesn’t have to report to Prime Ministers Office (PMO) or to home ministry or to some other ministry.
Q: In theory all our regulators are meant to be as independent as Election Commission?
A: Not really. This is the most important point. If one looks at the Reserve Bank of India (RBI) fortunately there is a whole convention. There is a whole tradition of what one might say, not independence but autonomy in decision making, monetary decision making and then it is done with consultation with the ministry of finance.
There is a good coordination and harmony or supposed to be a good harmony between RBI and the government. About the Asian Crisis, we could not have handled the kind of problems that arose at that time unless we had compete harmony in policy making in a very difficult situation. Also taking extremely non-conservative measures, to handle the crisis with full concurrence of the government.
One will be surprised to know when the Asian crisis came we had the same finance minister as the present one. There was a very good dialogue politically. Then, I was succeeded by the next National Democratic Alliance (NDA) government, they also cooperated fully. So, there was a whole culture whereby difficult issues could be handled.
Q: What is the level of current account deficit (CAD) that you would be comfortable with? Is 5.6 percent too high in your opinion or is it something that is inevitable in these times?
A: No it is high, of that there can be no doubt. However, the issue is slightly more complicated than numbers. There is absolutely no doubt and everybody would agree that real effective exchange rate must be competitive.
However, the second issue which we also should examine is, why is the current account deficit increasing. For example, one has an issue which is good from our point of view of rising consumption levels in our country. Is it that we are importing more foreign goods to consume at home?
Q: You are talking about the quality of the CAD?
A: There are some monetary factors like exchange rate and one must keep the exchange rate effective. If some measures have to be taken one must do that. However, there maybe some real factors also like technology, investment shortage or if you drive and you go to your office from here you will see how many are Indian cars and how many are foreign cars.
Q: So, in that sense would you say if the CAD, large component of it is say because of gold imports, you would not be too worried because then you are actually importing an asset?
A: No, but I would be worried about why gold. Indians are Indians there is no change in the attractiveness of jewellery or gold in our households or in marriages. India in that sense you can’t say that people have started wanting more gold but gold as an asset. That requires a looking into the reasons for why. Is it because people are afraid that gold prices rise very high?
Q: When your CAD is rising despite rupee falling how much leeway does any policy maker have because one option will be to bring your currency down, push up exports but exports aren't going up, the rupee has come down so are we in a real fix there?
A: No, not in a real fix because one has got time. I want to emphasise that we have sufficient resources and reserves to be able to handle the problem in say three, four or six months.
Q: So are we, maybe approaching a crisis but not rushing towards one?
A: No, one has to find reasons. CAD is high no doubt. Imports are much higher than exports and part of that can be a monetary issue. So, the exchange rate certainly has to be flexible and we should manage it in a way. However, there maybe some more real reasons of why most of the cars on the roads are foreign rather than domestically manufactured Honda’s.
Q: Why are we loosing our competitiveness?
A: Exactly and where is our competitive advantage. For example, there is no doubt that we have all the technological resources today unlike 15-20 years ago. We have the competence and the entrepreneurial energy then why is it that Indian companies are going abroad to buy companies and not investing here.
Q: So, we are ahead and Budget is approaching.
A: If one looks at our fundamentals and at India’s rank as being 137 out of something in doing business, why does one need an administrative structure of this kind? We are all talking about the Budget, rates will be higher or something but have one seen the direct tax code (DTC), it probably runs into 100 of pages.
Why, don't we simplify our administrative system and make it easier to do business? One can’t do business which intrudes into public property or which is not in the public interest. However, why is it that you’re doing business should be so difficult because of the administrative system and again go back to the politics of it.
Q: Another point you made way back in 1991 and Dr. Reddy reminded us of it recently is that you said India was just hitting the 5 percent growth rate and if we needed to continue at this level and if capital was to be made available at this scale you needed to drop public holding in banks to 33 percent, government holdings back to 33 percent, that didn't happen but we managed. Has that now led to a structural problem in the banking sector where it could now really impede our growth?
A: Not really. In terms of the banking system there has been a fantastic amount of progress in that area. So, that is not that kind of an issue, that era was different when we just had public sector banks and no other private sector banks. Then there was lot of restrictions. That one needed money to expand and didn’t have it and lastly the budgetary resources, the same thing that we are seeing in some segments or economy today.
Q: Now new bank license will be given out very soon. What are your hopes and fears here?
A: It is an excellent idea. The only thing that we have to remember is that banks deal with peoples’ money. We are depositors, we take money, we deposit there and the security of those deposits is utmost important. Therefore one has all the providential guidelines and everything else across the world. However, at the same time for the banks to function, the regulatory system has to be hands-off rather hands-on.
Giving this background because we have done extremely well in our banking system as of today, but if we want to expand, as there is a need to expand the banking system, the outreach of the banking system, the competitive system and we have to make sure that this does not lead to regulatory overreach. Now I am being very cautious in terms of regulatory overreach. It is of utmost importance. There is a whole argument, let me give you the instance of European Central Bank and there should be one banking system across different areas.
Every region has its own fiscal policy, its own debt gross domestic product (GDP) ratio and the banks have the same. Now somebody has to supervise and make sure that they are safe. One can get into this regulatory overreach in Europe. If one increases the dimension of banking, there is a whole talk about industry, whether it is industrial houses and non-industrial houses.
Q: Where do you stand on that?
A: In principle there is no problem but one has to make sure that there is no conflict of interest. Then to avoid the conflict of interest, it is not as if one has to do a regulatory inspection every time to ensure that there is no conflict of interest so how do you do it.
Q: How do you do that without having regulatory overreach?
A: Yes, that is right. One has banks owned by companies, which are borrowing. It is not that they are doing anything wrong but how does one make sure that there is no conflict of interest when the problems become bad and it has happened. One has seen it in so many areas, in our country also, in the stock market and other pieces and so on. How does one prevent the system from fostering any conflict of interest between different agencies.
I am not saying for or against. I am sure the RBI will take a view but the view has to be consistent. In my view, which I can say as a policy that is consistent with avoiding regulatory overreach.