2008 financial crisis affected emerging markets more than expected: D Subbarao

When were you informed? If I remember right, you told me that you were woken up at midnight by the then deputy governor Shyamala Gopinath. Just recount to us those moments and how you were informed of Lehman bankruptcy?
Just as you said, Lehman Brothers filed for bankruptcy sometime during the day on September 16th during day in New York, which was night time for us in Mumbai. So I recall Shyamala, who was deputy governor at that time, waking me up around 2 o’clock and telling me that Lehman Brothers has collapsed and that there might be some instability in the advanced economy markets and we must be prepared.

It’s not as if we were completely unaware of some pressure building up in the financial system. If you throw your mind back to that period, you would find that in the week to ten days before the crisis, there were a number of institutions falling one by one starting with Fannie Mae, Freddie Mac, Countrywide, AIG came to the brink of a collapse and Merrill Lynch vanished. Several big banks in the US were closed down. They were isolated instances in the week to ten days leading to Lehman collapse, but Lehman event was a big bang event. And the RBI, the experienced staff including Shyamala and other deputy governors read the situation very well, very correctly that this will have an impact much more than the earlier isolated incidence and that we must be prepared.

Before September 5, 2008, you were the finance secretary and therefore, all sides were kind of somewhat prepared. How was the RBI prepared? Did you get a sense that they were preparing for it for months or something?No, I didn’t get that sense. If there was one central bank in the world that was actually prepared for the crisis, it was the Reserve Bank of India, because the RBI under governor YV Reddy had instituted macro prudential measures. In fact, macro prudential became a fashionable term after the crisis, but much before it became fashionable. The RBI had tightened the regulation of the financial sector, both banks and non-banks. So if one central bank that was prepared was RBI, but even then I would not say that the RBI saw crisis of this magnitude and this proportion unleashing on us all of a sudden and that night was quite a bit of hectic activity for all of us in the RBI or the night after Lehman Brothers collapsed.

If you recall, that very night we had done two things. The first thing was to ring-fence the two subsidiaries of Lehman Brothers in India. I think Lehman Brothers had non-bank finance company and a primary dealership. The first thing we did was to issue a statement ring-fencing them, so that no money would go out from them. The second thing we did was to issue a statement that the RBI is keeping a close tab on the developments and is prepared to take whatever action is necessary. It was a very blunt statement, in fact, I was new to central banking, I was wondering about the necessity of issuing a very blunt statement like that. But in the event, the cumulative experience in the RBI guided us into doing right thing, which was to release a statement and that went a long way in assuring financial markets the first thing in the morning.

What happened in the days following the Lehman Crash? Sid you have something like a war room, did you have daily video conferencing with the finance ministry, because they also had to participate in what should have been joint ring-fencing of the economy? There is always a war room in the RBI. The financial markets committee meets every day, but certainly during the days and weeks after the Lehman collapse, war room was much more active. If you throw your mind back to the situation, immediately after Lehman Brothers collapsed, we had quite a bit of turmoil in our financial sector, because bond yields had gone up, call money rate had gone up, capital had fled and there was clear uncertainty in the banking system. So our effort in the RBI was to ensure that our financial markets function properly, unlike the western markets, which were close to seizure and also to ensure that credit continued to flow. So, our actions at the RBI were guided by these two objective.

You also asked whether there was dialogue or video conferencing with the government, it's true to say that we were working very closely with the government, as indeed every country in the world was. You must understand that both for the government and the RBI, there were shared anxieties, shared tensions, shared uncertainties and the objectives were also shared that we must ensure that confidence in our financial sector remains unshaken.

Coming to the global scene, India was suddenly in the big league table. The G20 was created and suddenly it was realised that India and China are all important in synchronised rate cutting or bringing peace to financial markets. Can you describe how India was included in the global decision making lead table? The G20 came into being even much before the financial crisis and the Lehman Brother collapse. But it became much more important forum after the crisis erupted. I recall the first G20 meeting after the Lehman Brother Collapse in mid-October. It was convened at a very short notice on the sidelines of the IMF and the World Bank annual meetings in October.

And in one such meeting, when you were speaking, George Bush gatecrashed into that meeting? Yes, in that very special G20 meeting, I was asked to speak on behalf of emerging economies. I accepted the commitment. The meeting was around 7 PM in the evening in the IMF headquarterd building and there were about 125 people – governors, finance ministers, World Bank staff and the mood was quite gloomy. So, the meeting started with the speech of Hank Paulson, who was treasury secretary followed by Ben Bernanke, followed by Jean-Claude Trichet, the ECB President at that time and my turn came later after that. While I was speaking and was making a point that the crisis had impacted emerging market economies much more than is acknowledged around the world. Also, even as advanced economies were synchronising their actions, they must also take us on board and tell us what they were doing, because what they were doing had an impact on us – what was happening in the global financial system had an impact of us.

As I was speaking, I saw somebody entering followed by two grey suited burly men with stern demeanour and the one who had entered looked like US President Bush and I was wondering how could he come into a meeting like this. There was no announcement of it, because I thought if President Bush was actually coming for the meeting, there would have been quarantining the building etc. Instinctively, I stood up and slowly everybody caught on and stood up and Bush walked around and sat at the head of the table. Now, everybody was surprised and taken aback about how to conduct the meeting from there on. He said start from wherever you left off. So, I had the opportunity, privilege or the occasion to continue and I thought the message went quite well.

We were talking about the coordinated actions that the RBI and the government were taking. I know that there were significant increase in fiscal deficit that year. We had started off with something like 2.5 or 2.6 percent fiscal deficit, when you were finance secretary and the budget was announced, and by the end of the year for 2008-2009, the fiscal deficit was 3.5 percent. There were also significant cuts in monetary policy. I think the repo rate came down all the way from 8-9 percent to 3.25 percent over a two-year period. Now, when you look back at those actions, do all of them look justified to you, do you think you would have done anything differently now? That is a very big question, but let me confine myself to the monetary policy part of it as I was in the RBI after the Lehman brother collapsed.

We did a number of things in the weeks and months following the crisis. Like you said, we had cut the CRR and SLR to historically low levels. We cut the repo rate like you said, 8.5-9 percent. When I took over from Dr Reddy, we were still fighting inflation. Then, I think over four-six months, we brought it down all the way from 9 percent to as low as 3.5 percent. We did take a number of steps to increase liquidity, rupee liquidity as well as foreign exchange liquidity lacks the norm for external commercial borrowing (ECB) for NRI deposits. We did some unconventional things as well. Although the general impression is that all that we did was the textbook, orthodox banking but we did unconventional things by relative terms like for example, the RBI instituted a line of credit for specially helping non-bank finance companies and mutual funds. We instituted a line of credit for SIDBI and NHB, which was quite unorthodox in relative terms. So we did a number of things in those years, in those weeks and months.

To answer your question, looking back I don’t believe that I would have done anything differently in terms of actions because if you look back, like we talked earlier, the markets were hit by a lack of confidence, exchange rate had nose-dived, inflation had come down, growth was decelerating, stock market had collapsed, capital was free. So, all these things we had to do in order to restore confidence and the best or the most effective way of restoring confidence is to infuse the system with both rupee and foreign exchange liquidity.

So I don’t think I would have done anything differently in terms of the content of policy, but one place where I would have done differently was communication. Everywhere around the world, central banks were communicating more deliberately during the crisis and so were we in the RBI. But I think since you ask me a certain question, what would you have done differently, perhaps I would have communicated more frequently and more deliberately.

Now, when we look back at the moment we are still fighting a large increase in NPA that has bedevilled us from 2012 onwards maybe it got recognised forcibly perhaps by the asset quality review in 2015 and thereafter recent history is well known. Some of it is stressed back to the regulatory forbearance given at that time if a loan was going bad, banks had to keep 5 percent provision and restructure it. Do you think that perhaps was kept for too long or was too much of leeway given? In some sense I have to agree with you. Today NPA is a big problem, one of the biggest problems coming in the way of India’s growth and development. Certainly, over the last five years authorities in India are fighting the NPA problem and there are number of causes for it. It is not that problem as complex as this does not have a simple or a single cause but certainly one of the contributing factors to the growth in NPAs was the regulatory forbearance liked you called it during the crisis.

We had asked banks to restructure accounts in order to keep the flow of credit going. But the express indication, express mandate of the Reserve Bank to banks was to restructure only those accounts, which are illiquid because of the crisis not to restructure accounts, which are insolvent.

However, it is quite possible that in all anxiety, uncertainty at that time, some insolvent accounts too might have been restructured and certainly the regulatory forbearance at that time was a contributing factor to the NPA although I would want to emphasise once again that there are number of factors that have resulted in NPA problem.

Of course, global slowdown and decision from courts and everything contributed. Finally, let me ask you about quantitative easing. The emerging markets like India is synchronised and cut rates at that time maybe for our own good. But when quantitative easing got withdrawn or the first bugle was sounded by Ben Bernanke what is now famous as taper tantrum, do you think that could have been done better? Everything could have been done better with the benefit of hindsight, but you must remember that people who make public policy act in real time, act within the universe of knowledge available to them at that time. That was the case with every central bank every government around the world – that was the case with the government of India and with the Reserve Bank of India in our country.

But coming back to quantitative easing, the specific question, the goal of quantitative easing was, in my view, there were two goals. First to repair broken financial markets and the second to stimulate domestic demand in their own countries.

I think quantitative easing fulfilled the first objective of repairing financial markets, but it did not fulfil the second objective of stimulating demand and all that money, which was expected that it will be borrowed and used in their own jurisdictions, flat to emerging economies such as India, over 2010-2011-2012 and put pressure on our financial system and on our exchange rate. Normally, when you run a current account deficit (CAD) on year-on-year like we did from 2010 to 2013, there should have been some signals coming like the exchange rate would have depreciated or the cost, the European Central Bank (ECB) would have gone up. But that did not happen, because we were lulled that this quantitative easing money was coming and we did not get the signals so the pressure built up in our external sector.

Yes, the rupee tantrums we had in 2013 and in the last months of tenure was a consequence of this quantitative easing, our inability to catch the signals and make the adjustments in the right time. But whether it was because of Ben Bernanke’s statement, I cannot agree with you because we knew – right, even when QE started, we knew it's going to be tapered at some point of time. So, merely because he said it, to accuse him or to criticise him or to charge him with being thoughtless, I think would be inappropriate.

Our problem, I think, was because of our structural pressures within our own system.

(Source: CNBC TV18.com)