Speaking exclusively to CNBC-TV18 Former RBI Governor YV Reddy said that the institutional identity of the banking regulator has been damaged. It is a full-service central bank, he said, adding that the emphasis is only on the monetary policy.
“Monetary policy is being put on a pedestal. Who is then accountable for regulation or currency coins?” The RBI can't be treated merely as a regulator, he said.
The role of central bank is under threat, he said, maintaining that it is a national problem.
Referring to the cash ban, he said the pain has happened. The question remains how do we maximise the gain. “This is the beginning of handling of the problem,” he said.
Black money should be targeted in all formats, he said. India has one of the lowest taxes in the world. Black money handling can’t be solved simply by destroying cash. It is a much bigger problem, he contended.
Below is the transcript of YV Reddy’s interview to Latha Venkatesh on CNBC-TV18.
Q: Why is your book in Telugu? We are all students of public finance and we are so eager to read, why did you write it in Telugu?
A: First of all, let me correct. It is autobiography more than memoirs, and it is in Telugu. My memoirs, in the sense of dealing with policy, policy issues, that will be in English to satisfy people. And it will come in the next 3-4 months. I must also tell you the title. It is being published by HarperCollins. The title is, ‘Advice and Dissent’. I believe, in my life in policy making, because all my life, and that is what comes out that I think for a civil servant or an economist, it is his right to advise and its obligation to dissent, if you feel strongly, not just end with advice. So, that is how I would sum up.
Q: Also you role as a governor. Someone has helped me translate most of the chapter headings, but I am straightaway going to Chapter 23 which is on the Balance of Payments (BOP) crisis. What was your role? Do you see yourself has having mitigated that crisis in any fashion?
A: Actually, there are three parts to the whole issue when I was there from 1990 to 1993. First it was the stress, then it became crisis and crisis has to be managed. And then you have the reform. When both politics and economics interact, then that is what happens. So, in a way, BOP crisis was really a crisis of political leadership which could not handle the economic problems because they did not have stability.
Q: There was a political vacuum at that time.
A: In essence, yes, at that time. Therefore, in those three years, we had three Prime Ministers, three Finance Ministers, three Finance Secretaries.
Q: But one Banking Secretary.
A: No, Joint Secretary. I was Joint Secretary in charge of BOP. So, therefore, I was sort of a continuing factor and in a way, while the decision making was at a far higher level, I was merely Joint Secretary, I was two advantages. One is I was the only continuing factor and secondly, I knew almost all the players. And so they trusted whoever came in. So, in that sense, I was privy to information and to some extent, assistance and perhaps even advice and dissent.
Q: But, in that case, whom would you give credit? To the economists, would you give credit to the bureaucrats or would you give credit to the political leadership?
A: As far as economists are concerned, they have warned about this situation, both in the government and from outside the government. And as far as the bureaucrats are concerned, I am sure they were also aware. In a way therefore, the problem was essentially, political management. And in that sense, it could be resolved only by political leadership. So, if I have to give credit, I will give it entirely to political management by the Prime Minister of the day, P V Narasimha Rao because the problem was essentially political. The problem and the solution were known to the economists, to the bureaucrats and both had briefed the political leadership. They did not have authority or the skill or the capacity. So, therefore, I would say the credit for resolving. Now the circumstances were favourable, all that is a different matter. When bureaucrats and economists were equipped in some senses, they made it happen. But clinching factor, the same economists, the same bureaucrats were available even before.
Q: Chapter 27 is the chapter where you are speaking about stepping into RBI. It was translated and I was told that you were Defence Secretary and you rejected that you became Deputy Governor. Now that looks like a lower position. Why did you agree?
A: Frankly, yes. I was told that I was being positioned as Defence Secretary and some alternatives were also indicated and mentioned to me, but somehow, I felt that I had interest in economics and I was wanted in the RBI. So, I moved over as Deputy Governor. I mean Mr Rangarajan was asking me, so I agreed.
Q: But would you do it even now? Are you happy with that decision you took even now? If you have Secretary and Deputy Governor, would you be Deputy Governor of RBI?
A: At this time, no way.
Q: Why do you say that?
A: In those days, it was a feeling that Deputy Governor is almost equal to Secretary.
Q: The Deputy Governor was as powerful as the Secretary?
A: Basically, the Governor was very much almost on par with the Minister. That is general. There was no formal protocol.
Q: So, you would say that from your time to now, the Governor’s position has been devalued and therefore, the Deputy Governor’s also?
A: Whatever it is, definitely, I think there is a problem, especially after the legal amendments, the way the Governor is selected, the way they are interviewed basically, let me tell you, if the Deputy Governor has to be selected by an interview by a Secretary, I was myself a Secretary, I cannot be interviewed by colleagues and juniors for a job. There is no way I would go.
Q: So, you think it should be restored to the Governor because up until this current change where the Cabinet Secretary is in charge of several appointments, the Governor used to appoint the Deputy Governor.
A: At the moment, I think there is a committee where the Cabinet Secretary is the Chair and the Governor is a member. Let me be very frank. I have a feeling that the RBI is treated as a regulator to the confusion at a philosophical level. There are two types of confusion. To be very frank, my own suspicion is that the institutional identity of the RBI has been damaged, let me be frank. Earlier, the RBI is the monetary authority, yes. But it is a full service central bank. It was in charge of many other things.
The recent emphasis appeared as though monetary policy is the main function. Governor is accountable to monetary policy. Then he is not accountable to regulation, he is not accountable to currency coins? There is a confusion about relative importance. That relative importance is being decided more outside than within.
Q: So, there are two problems. One upgrading or taking out monetary policy.
A: Yes. As putting on a pedestal.
Q: Yes, in your time, even the Governor in charge of banking supervision would be involved in the monetary policy.
A: Currency coins, everything.
Q: Now, they are taken out of monetary policy.
A: In a way, instead of being a full service central bank, it is primarily monetary than the rest. That is number one. There is a problem that is coming up. The second issue, in many of these procedures, they say all the regulators, and then the RBI comes in, is the procedure applicable. The procedure applicable for a regulator has to be different from the procedure applicable to the monetary authority. In a central bank, regulation is one function. Just merely one and to say that head of an institution who performs eight functions and one function is regulation is equal to, and that is performed essentially with Deputy Governor is equal to other regulators, there is some lack of clarity.
Q: So, this devaluation has been happened for some time then.
A: Yes. It is not very recent.
Q: Yes, it is an evolving devaluation.
A: Yes, it cuts across political affiliations. And the third disturbing factor. If the regulator is being thought of as an umpire, maintaining integrity, the RBI is creating money, is destroying money and that is a different character, particularly in our system where banking is most important. And the final analysis and particularly, for our country, the financial stability function should have been with a non-political set-up like Governor of RBI. Now, that initiative is gone to the government. In most emerging market economies, the financial instability and political instability happen at the same time as it happened when I was there in 2004. So therefore, it is quite possible that the central bank with stature will not be able to handle instability when there is a political vacuum.
Q: It is dangerous to take away financial stability from RBI.
A: I would even go to the extent of saying that particularly recent events, I have seen the comments from the economists, from Standard and Poor and they are disturbing. For the RBI, for a central bank, reputational risk is the worst risk. Credibility is the worst risk. And if this is happening in the international opinion, I would say that it is a national problem now and it is not just a political issue. I think it is time, it is like army which is the security of the country, the financial and monetary security of the country. So, there should be a debate at this juncture given the type of comments internationally cutting across political parties that what should be the nature of central bank and what it should be and how it should be run.
Q: So, a national effort to restore the status and the reputation of the RBI.
A: I am not going into the status. The question is that there is a problem of reputation and the reputation cannot be ascribed entirely to individuals. There has been institutional changes and procedural changes which have created confusion about the identity itself and effectiveness and therefore, the reputation. Now, what should be the new structure? There should be better clarity about the new structure. The old framework, whatever the background, which committee, which commission, which judge produced it, we need not go into it. The limited point is, the role of central bank in our economy is under threat and it is a national problem which has to be addressed as a national problem.
Q: I wanted to ask you about your role as governor. One of the first steps you took was outlawing overseas corporate bodies (OCBs). We are now in the process of fighting blackmoney, the first step of attacking blackmoney came from you by outlawing overseas corporate bodies.
A: I did not invent anything, I did not discover anything, I just acted upon what was on record, namely the joint parliamentary committee report in the context of Ketan Parekh scam. There was sufficient indication that two possible sources of round tripping were OCBs and participatory notes (P-Notes), faceless, nameless, unknown investors could come and play and much of it maybe blackmoney which has gone out of the country.
Now given the evidence as soon as I came in I simply took the decision in the evening. However I had consulted with chairman of Sebi because there are two routes and both had to be simultaneously stopped if we had to handle the possible incentive to take blackmoney from inside to go outside and come back. So, we did it on OCB. Next morning Finance Minister called, I explained and we continued with it.
P-Notes somehow were not banned, that was kept open. Then my battle against P-Notes because that was the source of - because for me it affects the external sector, it affects the integrity of the financial markets. I took care of the banking system but capital markets they are still subject to P-Notes.
It is very important because of two things, first the blackmoney fight inside is one thing, blackmoney which goes outside and comes back is another type of blackmoney- round tripping and it is not cash, it is going through the financial system. You don't take millions of dollar cash in suitcase and put it in bank in Switzerland, it has to be through financial system. So, it is not as though it is cash.
Q: So, the whole system becomes corrupt then? Internal external trade gets corrupt, the coming back and the financial markets also become corrupt.
A: Yes. More importantly the regulation of our own financial markets become lose. So, if you want to go and open a bank account they want a pan but you want to bring USD 10 million into India you are prepared to take it without knowing the name. So, that is a little odd. So, in a way therefore the fight against blackmoney will not be complete unless these type of things are also tackled.
Secondly the assumption that cash is equal to blackmoney is not correct. Unfortunately this is something which is still fully attended to.
Q: Do you think unless P-Notes are actually banned, you are still leaving a window open?
A: That is what I said long back, I have no reason to change my mind.
Q: The country is now in the throes of fighting blackmoney in a separate way - demonetisation, your comment on that? Why didn’t you write a book on demonetisation first? Can we expect a book?
A: Any demonetisation that occurred generally by itself takes care of the currency. It becomes a fight against blackmoney incident because of the incidental benefit of getting information or making it non-valid. So, demonetisation and blackmoney link is not direct, it is indirect and incidental analytically. There are lot of other implications as we go along.
At that point of time we had not thought about it. I will take your suggestion seriously but if I have to do it, I will have to do it very quickly, so don't be surprised if you get a book.
Q: Do you think demonetisation was the right way to attack blackmoney? Do you think the pain equals the gain?
A: If I have to be analytical, conceptual, academic and not ex governor, the way I look at it is from a practical point of view, the pain has happened, going forward to the extent possible we would quickly relieve the pain. More important is gain, how do you maximise the gain? In that sense therefore I would say this is the beginning of handling the problem of blackmoney. In a way you have done a lot, gone through the pain and to handle the problem which is a complex problem where both the administration, the incentive mechanism, the judicial mechanism, the legal mechanism are outdated for a modern economy. Then the inappropriate policies. I will give you an example - gold smuggling - huge blackmoney was produced because you had an unrealistic policy of gold. So, you have to look at unrealistic policies, unrealistic law. You have increased punishment but ineffective because it is never implemented.
Q: If you were governor, would you advise demonetisation?
A: At this point I would say why are you asking me now? I would rather say you ask me what we should do now. The way I would look at it is what will be done from now on, there is lot more to be done.
Blackmoney is a result of several factors. The most important being there are two actors, one is the administration, other is the people who are indulging in blackmoney. Unless both are in some ways colluding it won't happen.
Now if you say that I am fighting blackmoney and I empower the people, administration then in a way you are weakening one party and strengthening the other party. So, if there are two factors then the attack should be simultaneous, symmetrical and synchronised. Therefore what I am saying is the next step should be how do you look at the whole issue of governance, effective deterrence, appropriate incentives?
Q: So attack the corruption on the role of blackmoney in the polity and bureaucracy as well?
A: Yes and judiciary.
Q: Accept political donations only by cheque, is that your point?
A: That is one part, whether it is Rs 1 or Rs 20000 it doesn't matter but that is one part. For instance the idea that you should reduce the taxes is ridiculous because our is lowest tax in the world from similar countries. We don't have inheritance tax, tax rates are lower than USA, Britain. There is no major economy in the world which has as low tax rates as India. So, it is a problem of compliance, it is a problem of fairness. People in India think that the way the tax is administered is not fair. So, it is not a question of lower or higher taxes or the functioning of the government - the money that is being spent by the government is being misspent. So, there are bigger problems.
Similarly judiciary, there is no judicial redressal, there is no contract enforcement. My point is that the blackmoney handling cannot be solved simply by destroying cash, it is a bigger problem.
If this is the beginning of all that problem then it is worthwhile otherwise the pain will remain and the gain becomes illusive.
Q: You have said that one of your contributions is contribution to the RBI annual report. In fact now that becomes very critical. At the moment the question is academic because out of the Rs 15.4 lakh crore we understand almost Rs 15 lakh crore has come back. However if it had been say Rs 14 lakh crore, it was expected that the Reserve Bank of India would give Rs 1.50 lakh crore dividend to the government. If such a dividend had come to pass, what would your comment be on this plan itself?
A: The RBI balance sheet is different from other balance sheets. Let me give an example, RBI when there is excess liquidity they issue bonds, take the money in and pay interest rate. They don't require money, they create money but they are paying interest to destroy money. That means they are incurring expenditure. So you find a situation where RBI is incurring expenditure to destroy money. It can create money and destroy money. So, therefore the balance sheet does not drive, balance sheet is a result of operations which are undertaken with macroeconomic objectives.
Whatever the reserves happen that is between the public sector. So, government and RBI in a consolidated balance sheet it makes no difference to the rest of the world as long as it is confined to in between. The transfer to reserves simply means for that moment we are suppressing the money. Transfer to government means you are giving the money to the government, if it is additional then you are going to spend more. Now by spending more if there is addition to money supply then RBI has to come and destroy the money supply. So, even if they give excess money to the government they will have to end up taking out the money because of stability.