Retrogressive as it may sound, the time might be right for the Reserve Bank of India to reconsider some regulatory measures, especially those launched in the wake of the 2008 global financial crisis. This should be viewed as a course correction in RBI’s regulatory growth.
After 2008, the developed world used the multilateral G20 platform which included emerging economies such as India and China to frame a new financial architecture that would not only get the global economy back on the rails but also install risk mitigation measures.
The platform required these economies to coordinate their financial regulatory and supervision actions with the rest of the developed world. In good faith, India implemented many policies that may have not been entirely necessary for its financial landscape. But that faith has now been shattered: Once the US economy stabilised somewhat, the Fed failed to coordinate its tapering programme — as it should have — with the rest of the G20 members, resulting in havoc for countries from Turkey to Brazil, and Indonesia to Argentina. So much for a global financial architecture.
One of the prominent decisions was to regulate bankers’ compensations. This made sense in the context of a rapacious Wall Street, but is inconsistent in the Indian financial system where over 70 per cent is controlled by public sector banks. It can be argued that compensation controls should be introduced for private sector and foreign banks as a measure of abundant caution. However, if non-performing loans are used as a yardstick for mismanagement, the RBI data for 2012-13 shows that a bulk of NPAs (compared to total assets) originated in PSU banks: 4.1 per cent as against 2 per cent for private sector banks and 2.9 per cent for foreign banks.
Another G20 decision was to tighten regulation for “shadow banks” or financial institutions such as Lehman Brothers which thrived in the cracks between regulatory jurisdictions. They were neither banks that could be regulated by Fed or pure securities brokerages directly under the SEC’s regulatory thumb. However, this inadvertently tightened the noose around Indian non-banking financial institutions (NBFCs) which were, in any case, subject to RBI’s gimlet regulatory gaze. NBFCs perform many important functions, including providing the last mile link between banks and borrowers, especially MSME clients. Eager to show off its multilateral credentials, the RBI squeezed the NBFC sector.
Anomalous decisions Many other policy decisions were similarly prompted, such as harmonising Indian accounting standards and reforming OTC derivatives trading. These were anomalous from an Indian standpoint: they were designed to rescue crisis-ridden western economies while India (and other emerging economies) needed forward-looking development and growth-oriented policies.
There were other aberrations as well. When a new IMF chief was selected in 2011, the developed world opted for the old formula of a European as president, while reserving the World Bank top-job for a US citizen. This, despite claiming to have “an open, transparent and merit-based selection process”.
The Fed’s unilateral action in the global financial markets has even led Governor Raghuram Rajan to lament in an interview: “International monetary cooperation has broken down.”
There is more than one reason for Rajan’s outburst; he was a co-author of a September 2011 report that not only advocated the setting up of an International Monetary Committee comprising representatives from major central banks, but also recommended that mechanisms should be adopted to allow central banks of large developed economies to internalise the spillover effects of their monetary policies.
This is exactly what did not happen when Fed started thinking aloud about tapering in May 2013.
The 2008 Washington communique promised, among other things: “Regulators should take all steps necessary to strengthen cross-border crisis management arrangements, including on cooperation and communication with each other and with appropriate authorities.”
Had Fed adhered to the G20 spirit, it would have coordinated its actions with the RBI and others.
This would have allowed the RBI to forestall the egregious impact of tapering. Withdrawal of monetary easing threatened to tighten liquidity in the global financial markets and.
This -- combined with the twin fiscal and current account deficits -- roiled the Indian currency markets with the rupee plummeting sharply, taking its dollar exchange rate to almost Rs 69. This could have been avoided if the RBI, forewarned and forearmed, had sold dollars in the forward market.
Caught unawares One reason for the panic in July-August 2013 was the perceived shortage of foreign exchange in the Indian market, prompting foreign investors to crowd the exit. If the RBI had had some fore-knowledge, it would have (apart from the other measures it initiated) bought dollars in the spot market and sold in the forward market. There would have been a steady supply of dollars over all time periods.
Caught unawares, the RBI could not exercise this option because if it started buying dollars in the spot market, along with other competing forces, it would have further damaged the rupee value. It is quite likely that global coordination would have also helped some of the other emerging markets to neutralise volatility.
Unfortunate situation It is unfortunate that some western commentators have not fully understood the impact of Fed’s unilateral action in a multilateral world. Economists Dani Rodrik and Arvind Subramanian claim that emerging markets are only reaping what they sowed. They are right — India has allowed its economy to slide into a morass of inaction, corruption, inflation and stagnation — but only partially. They have conveniently glossed over the relevant G20 communiques.
A communiqué from the latest G20 meeting in Australia says: “All our central banks maintain their commitment that monetary policy settings will continue to be carefully calibrated and clearly communicated, in the context of ongoing exchange of information and being mindful of impacts on the global economy.” Hopefully, this too won’t remain lip service.
(The writer is Senior Geo-economics fellow, Gateway House)