Economic strategies are dynamic & need reviewing: YV Reddy

In this edition of Indianomics, former Reserve Bank of India (RBI) Governor, Dr YV Reddy gives his insights on India's reform agenda and his new book, 'Economic Policies and India's Reform Agenda: New Thinking'.

In his book, Reddy has dedicated a chapter to India's reform agenda. Reddy gives the details on new strategies for economic development. He opines in the light of the global crisis, that the functioning of the global economy will be influenced, in terms of  growth or inflation or trade or protectionism. Hence, he says economic strategies need constant reviewing.
"When we are looking at economic strategies, we should review them and at the end of it, we may come to the conclusion that some of them are right and some of them need to be changed while some of them need not be changed. However, there should be a conscious understanding of this dynamic," he adds. Reddy says that much of the book is devoted to this new thinking at the global level.

Below is the edited transcript of Reddy's interview to CNBC-TV18.

Q: Give us your views on India's reform agenda. You have a full chapter in your book where you speak about new strategies for economic development. What exactly are the reforms you are referring to where we need to change strategies or revisit existing strategies?
A: I think globally when there was a great depression, there was a tremendous change in the thought economic policies. Now also, after this great recession, there is a lot of churning that is going on in regards to economic thinking.
In many countries, in particular systematically important countries like USA, UK and Europe, they are reviewing some of the practices. They are going through reform themselves. Therefore, globally economic thinking is changing and globally economic policies too are changing.
The policies that are being adopted by those countries are changing. Therefore, necessarily we have to look at that and consider what we thought was right. Also, what we thought was reform, may not exactly be the same now in the view of the new realities. That is another important element.
In the light of the experience of the global crisis, there will be a new type of normal. Even in terms of functioning of the global economy, both in terms of the growth or inflation or trade or protectionism, all these are going to be influenced. Therefore, when we are looking at economic strategies, we should review them and at the end of it, we may come to the conclusion that some of them are right and some of them need to be changed and some of them need not be changed. However, there should be a conscious understanding of this dynamic. Much of the book is devoted to this new thinking in the global level. Q: Another orthodoxy that you have questioned is the Washington consensus. The way forward is stabilise, privatise, liberalise, while in the West, that has certainly been questioned. Look at the situation in India. We privatised the public sector banks to some extent and that has not been a very big success, till 1995 or 2000. Every other day, every other year, one of the public sector banks would say ‘my net worth is eroded, please give me more capital’. Thereafter, after the listing of public sector banks, nobody has come and asked for a capital because they have eroded it. So, don’t you think in our case, we don’t have to question the Washington consensus to some extent because we have a long way to privatise. We need to privatise because public sector has been inefficient?
A: There are two aspects again. Interestingly, this is the experience in Latin America. I have given a speech with regards to the review of the role of public sector banking in Latin America where there was a lot of demand and they wanted to understand the Indian experience exactly. This is because we have entered a proper mix. The issue is a dynamic mix of public and private. In an important sector like banking, having a private sector is important to be able to generate certain efficiency parameters and benchmarks. However, having a public sector is also important because the regulator will get full information and the effectiveness of public policy will be more. So, when the externalities are more, then there is a legitimate role.
So, in a way what, we have a history and we have to learn from history that public sector can be inefficient and costly. Equally, the recent lesson is that the private sector can also be costly and inefficient. It can be greedy and can create a crisis. That is what India has to learn.
Even now, if we disaggregate the activities, there are certain areas where public sector can be efficient. More importantly, an average citizen, a lower middle class person or a poor person, when he enters a public sector bank, he is a little more confident. When he enters most of the new private sector banks, he certainly does not feel comfortable. In a matter like banking these things are important. It is an intangible in sectors like health and education where it should be a dynamic mix. Q: If you look at the recent numbers, the last three-four quarters public sector banks have come out looking a little worse in terms of asset quality compared to private sector banks. It is the same economy, the same slowdown but they seem to either have the intelligence to ask for better collateral or the courage to enforce and recover.
A: It ofcourse depends on the niche activity. Of most of the forex markets, 45 percent is by foreign banks. A majority is by private and foreign banks and that is not an area where you easily incur losses of the debt markets or financial market operations. So, you have to see the lending and particularly lending for working capital. That is pretty important and so is the direct lending for infrastructure. Therefore, then the risk is taken on your balance sheet. If one goes through the non-banking financial companies (NBFCs), the risk is not on the individual’s balance sheet, it is the public sector banks that are taking that risk.
Infact, my criticism of the banking sector as a whole in India, would be that they are not doing the real retail banking business. I am little uncomfortable with the financing or the working capital by the banks which is their core business, their main business. I am afraid it is coming down whereas everybody is concerned about investment, infrastructure, development of financial markets, However, a lot of collapse can take place because of the starving of working capital. So, I think the main business of the banks is not being done.
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Q: When you were deputy governor, Dr Jalan raised the issue that maybe we should start debating that government investment in public sector banks should be brought down to 33 percent so that the capital is more distributed and to some extent there are other interests that are represented in the board. Do you think the time has come to raise that debate?
A: That is one of the reforms that were proposed but not implemented. We have a lot to learn from reforms proposed and not implemented and find out why it has not been implemented.
This is a recommendation made by Narasimham Committee of restricting the government’s investment in public sector bank to 33 percent. Secondly, this was incorporated in the Budget speech of the finance minister and since then it has been pending. There is a more interesting point that Dr Jalan made in that discussion and though I disagreed with him then, I later realised the wisdom.
He said even if you bring down the shareholding, the public sector character of the bank should be maintained. That was the point he made. Now, I am more and more inclined. It is not the percentage of share in the public sector bank because the private shareholders cannot complain because they know there isn't a statute. The statutory bodies, the private sector shareholders have rights as defined in the statute. So, Dr Jalan and Narasimham between themselves, have already indicated what should have been considered for a long time. Q: Now, if corporates get banking licenses, does the government's responsibilities increase? The financial sector went trigger happy with derivatives and the muck finally fell on the government. Now, if we are going to venture forth to give licenses to private corporate sector and it misfires badly then won't the government end up looking very over burdened and even silly?
A: Trusting the financial sector, particularly trusting banking is important for the government and for the whole economic system. The government also depends heavily on financial sector when they recount on their resources. Therefore, they have to inevitably bailout the financial sector. So, in that sense, there is an underlying relationship. That should be kept in view whenever you are deregulating, re-regulating, regulating or not doing anything or doing too much with finance, it has fiscal implications, serious fiscal implications.
They may not be apparent for sometime, but they are underlying relationships, fundamental relationships and that is a general point. To the specific issue of the banking licence, it should be realised that banking licence is not like driver’s licence because there is a quasi fiscal or fiduciary responsibility involved in this. 
In every issue, we have to view it in two contexts- global and domestic. Globally, whether the corporate sector should be given banking licence or not is still a matter of considerable disagreement. Therefore, obviously on the basis of the experience there are risks. There maybe rewards but there are risks definitely. We found even in advance economies, supervisory, regulatory capacities were finding it difficult to supervise effectively powerful financial conglomerates. So, if financial conglomerate by itself is risky, then financial cum-industrial conglomerates would be even more risky.
This is an extremely difficult area, perhaps even a dangerous area and that should be trodden very carefully after assessing the considerable risks involved which appear to be pretty clear. The considerable benefits that may come are still not clear for many people. Q: The introduction has a lengthy analysis of the new thinking on CAD, were you quoted Lord Turner comprehensively. India's CAD, the latest number at 5.4 percent is a very ugly number, scary, but we console ourselves by saying that Taiwan and Korea in the height of their boom did use high CADs, but were able to get over it by generating high growth with it. You also pointed out that this is first time that there are huge deficits, which are not funded by official aid and foreign direct investment (FDI), they are funded by volatile portfolio flows or debt flows. So should the new thinking on CAD need to get highly sensitised to this new issue of capital flows?
A: First there was discussion about the global imbalances. How do I define global imbalance? Persistent current account surplus or CAD of more than 4 percent, that means first of all global economies and policymakers - this may not have been accepted in G20, but this was floated and discussed seriously, so there is some limit. Four percent was global. I am not saying it is for the USA, the UK or China.
That is where we start the lesson of the global crisis. If the composition of the flows is significantly portfolio flows or short-term borrowings, then that leaves less headroom. Therefore, I advocate that what should have desirable CAD for India over a medium-term -- the structural sustainable CAD. It can provide for cyclical variations and current year maybe cyclical, but it should be sustainable and the same point was also made by the Rangarajan Committte, on concept of sustainable CAD at that point he mentioned 2 percent.
We should recognise what is the reasonable CAD on the basis of the more recent experience of both global Asian economies and India. More important, what is the future? In the future, many advanced economies will increase their public debt enormously. If they increased their public debt and their domestic savings is less due to fiscal problem and demography in that case India's capital flows will have to compete with public debt financing required by advanced economies and it maybe at a period when the liquidity in the global system maybe slowly withdrawn. So, these aspects needs to be taken into account and therefore one must make a distinction between a ceiling up to which one can go during a cyclical situation and an average, which should be structural and this average should be between 0-1 percent in the case of India because we are vulnerable to shock. Q: How do we get there?
A: There are two ways of saying it, we can't get there, if we can't get there then we have problems, which indicates that we are not living within our means but how do we get there? I believe we can get there. There are two ways to get there. Encourage the domestic savings to fund your development. The issue is, we cannot afford to depend on foreign savings in an uncertain world given the geopolitical considerations we are a large economy. The global financial architecture shows that given the magnitudes of the problems in the case of a currency crisis or sovereign debt crisis, the global financial institutions cannot produce the type of resources that a large country like India was. They are not able to produce something for Greece, Ireland, and Portugal or whatever it is. So, we must consider these factors while undertaking the study.
_PAGEBREAK_ Q: Let me come to one issue that you raise, encourage domestic savings. Do you think tax incentives should be given for savings?
A: Both savings and investment, whether there is a bias in favour of attracting foreign savings. Is there a bias? Are we giving tax breaks for foreign savers rather than domestic savers? Investors are foreign investors getting better treatment in terms of tax or everything than the domestic investors - these questions need to be asked. I am not saying I know the answers. Q: The most fashionable topic now is should we tax the super rich. We have had the courage to bring it into the public space only after Obama raised it which is a shame because if you looked at now when we start doing the arithmetic, even we in the media, we realise how under taxed we are. Tax as a percentage of GDP, direct tax as a percentage of GDP - all these percentages make us look, or even the ceiling income tax - 30 percent - in the UK, USA all of them run between 45-50 percent. Do you think the time has come to correct this wrong?
A: Time was always there to right a wrong. I agree, when in USA, interestingly not only Obama raised but as you know, there are many millionaires and billionaires who pleaded for increases the tax. I think we have to learn lessons from both the governments and the private sector. From Indian's point of view, I believe and from good fiscal management, issue is fairness. This has nothing to do with my new role that I will assume after February 1 2013. After that, I cannot speak anything about fiscal because only the commission is authorized to talk, the chairman can't talk. I am exercising my freedom a little before the new assignment. The important point is, Indians feel that the tax system is fair? If any person feels that he works from morning to evening and earn around Rs 5-7 lakh or Rs 10 lakh and pay 20-30 percent tax and if you are able to get money from your parents, grandparents to invest in equity market and you don't pay any tax on this. The first question to be asked is, is there fairness? Is there at least proportional burden for the income that one gets? When we want to globalise in everything, then why not taxes? So if one want to be globally competitive, one should be globally appropriate in taxes. Very few countries don't have inheritance tax, dividends on capital gains are not taxed and the top bracket base is only 30 percent and in very few countries so much of exemptions are available. There maybe one or two, including USA but that is not exactly the standard measure. For any bad practice, we will always find a country in the world to adopt a bad practice. Q: On new normal on inflation. When Subbarao spoke to the former governors recently at Indira Gandhi Institute of Development Research (IGIDR), you said that we perhaps have to revisit our current inflation targets. At the moment, we believe that five percent is okay for India in the short term and eventually we have to work to three percent. These numbers you have put in when you were deputy governor and governor, did you really mean that you want to raise this? Is that the new normal you were referring to?
A: Infact, Raghuram G Rajan, chief economic advisor asked me - did you really mean that? I replied, no. Of course, now the interest rates are low in countries I was talking of the new normal which we are yet to reach, we are still in the crisis. But originally, when the inflation was indicated as indicative self imposed inflation number, the logic was to keep in alignment with the global inflation over the medium term. In fact even at that time we were higher than the global inflation but far higher than what we should have been. Now, in future I mean that the traditional number which India was thinking of is to be revisited. If the global inflation remains three-four percent and given our growth compulsion, we may have to revisit that but that issue that I have raised in the context of many things that I have to reviewed in the context of the lessons from global crisis, new thinking and the future of global economy, likely new normal in the global economy.