Former Reserve Bank of India governor YV Reddy said India's reaction to 2008 economic crisis was not coordinated and nobody picked up his warning bells in 2005.
YV Reddy said he was sure of 2008 economic crisis and it was a battle of ideologies back then.
"I became sensitive to the impact of global factors on the domestic economy when I was ED at International Monetary Fund (IMF)," said Reddy.
“After I joined as governor, in a couple of years I realised that there are global imbalances and they should be warned,” he added.
Its ten years since the powerful investment bank, Lehman Brothers filed for bankruptcy. The global financial markets lost 60 percent of their value, global economy contracted by 5 percent, an estimated 8.8 million jobs were lost and $19 trillion of household wealth was wiped out.
Reddy finished his term as the RBI governor just ten days before the Lehman bankruptcy.
Q: Before I let you speak, I want to tell you an anecdote which you may or may not remember. Sometime in March or April 2008, you suddenly called a few of us business journalists. The Reserve Bank of India (RBI) called us with about one hour's notice, that was the first time when it did not give us a cup of tea or biscuits at the press conference. We were just made to sit in a room, you rushed in and you spoke to us for exactly five minutes. You said bad things are going to happen, very bad things, warn people that the crisis is just beginning. That was the first time we got a sense of something bad is going to happen but we still didn’t realise that the market, the Sensex would crash from 21,000 all the way to 7,000. What made you call us and warn us? When did you smell that 2008 is a bad year?
I will give you a bit of history. I became sensitive to the impact of global factors on a domestic economy when I was executive director (ED) in the International Monetary Fund (IMF), 2002-2003. I saw the suffering of Turkey, Argentina, Brazil and Mexico. From then on I felt one of the most important things for the emerging market (EM) economies is to be very conscious of the risk from the global economy.
After I joined as the RBI governor, in a couple of years I realised that EMs as a whole, there are global imbalances and they should be warned. So I gave a talk on ‘Global Imbalances and Impact on Emerging Market Economies’ in Paris in 2005.
That is when I introduced the concept of national balance sheets and how a corporate financial sector can be overleveraged and India and some of the emerging market economies are no exception to that. So one is the sensitivity, second is the feeling of discomfort about what all is happening. Even in 2005, there was slight discomfort.
I think, again in September 2006, I said that there is excess liquidity and I think the word I used is ‘Dark Future’ or something like that.
In one of the monetary policies maybe late 2007 or early 2008, you made a remark that India overheating.
That was essentially Indian phenomenon but partly because the global economy, global capital flows are pushing us.
Because we had a flood of flow. But when did you guess – you must be meeting a lot of the central bankers, at what point were global central bankers uncomfortable about the imbalance?
I would say in 2007 when the housing bubble came and Fannie Mae and Freddie Mac – when they started getting into trouble and when I was discussing with the governors of the central banks, I sensed that they were worried that there is a problem and they are worried whether they will make a policy mistake by doing something about it.
Both from an ideology point of view. But I could see that. But my problem was not so much whatever their problem but how its result will affect me.
But I got a definite feeling that something is going to seriously happen soon after this housing problem came in 2007. I felt that we have to be prepared. I gave a speech and this is the background perhaps for what my warning you on January 3, 2008, I spent three to four hours on two sentences, how to say that something very bad is going to happen, capital flows may go back and we should be prepared for that. So internally we got prepared for it but that communication, nobody picked up.
In January 2008, I think it was a speech in Hyderabad. None of us understood.
Nobody picked up and I was struggling with how to tell but not inject fear or something like that.
How did you prepare in 2008, how did you prepare the Indian economy? I remember that there was a lot of pressure because the Fed had cut rates couple of times. In January of 2008, there was pressure on you to cut rates but you refused. So, from January to June, how were you preparing for the crisis?
I haven’t said January to June as such but the other problem, which we seldom notice is that very high oil prices, that is one problem, one issue and to face it, we required more capital flows and people were keen to get that so it is a complex factor.
Also in the country, politically and ideologically they never imagined like having anything like excess capital flows, excess growth.
So it was a battle of thinking, the battle of ideology, not just like the government of India or RBI but fortunately, I think we had Prime Minister, Finance Minister – they didn’t agree – but they allowed us to talk.
But let me tell you when I was almost sure that it would happen by June-July 2008. That is where in Manchester, I simply said that financial turbulence will become a crisis.
Our inflation hit double digits in July and the then finance secretary Subbarao said monetary policy is the first line of defence and the next time you raised rates to 9 percent?
That time we took two-steps. One step – few months before I didn’t want to raise saying that we have risen enough but the next round – and I had to raise though I didn’t want but next time I said you have to continue. Once you start the process, there is no point in doing it once and getting it back.
Let me come to the way India reacted. Does it look like India overreacted, everybody cut rates so even we have to bring our rates down to one percent and 2 percent, did we overreact? We went down in repo rates all the way to three quarters?
I think at that point in time, we wanted to be more careful and not – in some senses. I would say that in such a crisis, overreacting is better than underreacting. That is the beginning. But very quickly it would have been possible to assess that we are not that much affected.
Whatever it is but even when the reality of the extent of damage was evident, I think we weren’t convenient to continue. So on all three fronts that monetary fiscal policy, monetary policy and regulatory forbearance, all three of them in retrospect were excessive and certainly they were prolonged and they were uncoordinated.
Let me remind you of another advice you gave me. This time you were not the governor, this was I think early 2009 or late 2008. We met at some press conference where you were also present and you said, can you stop calling it a crisis? We are not in a crisis. The more you use the word crisis, the more the government will blow up the fiscal deficit and they will be happy to do it because they are going into elections in three months. So you clearly said that the government will blow the fiscal deficit, you could see it at that time that the fiscal will overreact more to its advantage because they were going into elections?
All research has shown apart from my own practical experience that just before the election sitting government’s expenditure shoots up. Now if you give an intellectual excuse to do that and that too a global factor, they will just lap it up and by then I think indirectly what I was trying to hint was that we are too keen to fall in line with the global trend rather than accept that we were not that badly affected. So that was an illustration but overall also, we did pay a price a little later, of course.
Would you say that first the balance of payments crisis of 2013 and then the non-performing assets (NPAs) crisis which is currently underway is to some extent our sequel to the global crisis?
Let me put it this way there was a problem of everything delayed. First, there was excessive regulatory forbearance, it was excessive to start with. Second, it was prolonged. Third, when it had to be recognised, there was a delay in recognition. There was a delay in recognition of the NPAs.
So when the recognition came, it had already been accumulated. So, whenever in these case of NPAs, each year it gets accumulated, imagine for 4-5 years NPAs accumulated has shown in one year. So actually the NPA numbers which you see, is an exaggerated picture because that is really accumulated NPAs.
It should have been divided by five years.
A: Yes, in fact, even more.
But looks like India was not the only one which went into excess monetary, fiscal and regulatory excesses. It looks like even China, other emerging markets also seem to have done that?
If I am not mistaken, the other economies they got into trouble subsequently more due to the commodity prices, not so much on the monetary and fiscal excesses.
The cures, lot of Acts were passed and banks were asked to reduce their prop book in fact not trade on their prop book at all, many of the derivatives were cancelled. Do you think the global financial system took enough steps?
I think there are three dimensions, I would put it this way. One is the money, the other is the regulation of financial entities and third is the global financial architecture. Let us look at all these three. Apart from political and economic factors, these are the three.
So, as far as the global monetary system is a non-system. It is US dollar, the US could print and US dollar supply is determined by US interest but it affects the whole world. Has it changed? China is trying to question but it is nowhere near replacing it as such at the moment. So, therefore, substantively as far as the monetary system is concerned, it is more or less what it was before.
Second is the financial sector regulation. As far as the financial sector regulation is concerned, regulation continues to be national, finance continues to be global that dichotomy is continuing.
But that will never be resolved?
If that is not resolved it will always undermine the policy space available for the countries. Secondly, the balance sheets of these large financial houses cut across nations and to that extent, they can undermine the policy itself.
Third, of course, is the capital is globalised, labour is not.
So that gives the emerging economies like us a disadvantage.
That is the second part so there not much has happened and the effect of this in terms of inequalities we have found expression and nationalism in the national politics.
Third, the global financial architecture and global financial. Has the IMF changed much? Has the World Bank changed much? Nothing. So, what has changed? There are two-three things that have changed.
The first thing that has changed is the euro is no longer as important for the global economy. In fact, Asia has become more important, developing countries have become more important and the differentiation between developing and developed has disappeared.
Second, the dichotomy between finance and real has increased. Real economy is not improving as much whereas the financial is doing very well. The liquidity conditions have continued to be as huge as ever. Except that there is even more fear of allowing the markets and in some case, the central bank balance sheet will also be affected.
So regulatory capture is complete?
In fact, I call it comprehensive regulatory capture in one of my speeches. So, in terms of the big problems, which caused the crisis, they have not become less, they have becomes bigger problems.
Now we are entering a new bipolar world very clearly. We have got China and the US and they represent two conflicting ideologies in some senses. China believes in the state driven economy, America believes in the market driven economy. China is strong in the real sector, America is strong in the financial sector.
So you have this contrasting but more important they are rivals but there is a difference between their rivalry and the rivalry between Russia and America before. Because Russia and America were two different worlds. Whereas here what China's actions affect America and what America does affects China.
Deeply interrelated, interconnected.
Yes, it is a bipolar world where the leaders of each world are interdependent that makes it very difficult for the rest of the people.
Therefore they will also not nuke each other with their policies?
Yes, but the point is that those tensions will be transferred to the rest of the place. So let me give you one simple example. The debt sustainability of different countries, especially smaller countries and African countries requires information about the external liabilities.
Now many of the Chinese large projects, cross country projects are bilateral and there is not enough information about how much is the debt. So there are two things that are happening debt sustainability itself is uncertain for some of the developing countries. The IMF and the World Bank itself doesn’t know how much it is.
Second and more importantly China wealth which used to be in financial instrument dollar denominated now it is in countries where the return is less, they are illiquid but there is a political advantage of being there and insurance against the dollar dominance.
The point is if China is having its external wealth entirely in dollar their capacity to quarrel with America will be less. In fact, many of these things are happening. India is very important in this situation. Because it is a large economy.
China is our immediate neighbour.
Yes, and in some senses, we depend on the financial market definitely, but on the real sector, we can import quite a lot from China. We have to look at our positioning in this new bipolar world. How do we position ourselves in trade and in finance?
I want to come back to Lehman, since this is trying to understand the Lehman crisis and its consequences? There was an article in Bloomberg where the author very effectively argues that one of the big reasons why Barack Obama lost and Donald Trump won was because no Wall Street banker served prison term in spite of the fact that crisis was entirely created by the bankers, by those fancy derivatives, by completely under capitalising their institutions? What should we learn from that? I mean we need to punish, is that a lesson that we should learn?
Punishment is warranted on two-three grounds. One is the way the rest of the economy has been affected. But more important even when irregularities and virtual criminality has been proven that was settled with the money of the banks.
No individual paid and even the truth is not known because it is compounding without establishing the real. Not only that no punishment was given but that is reflective of the power.
If some group of people who have made money became number one and there was no punishment for them. They are thriving and continuing to benefit. So in a way question, today is gross domestic product (GDP) growth revival for whom, a revival for whom.
Do you think when we are looking at our NPA problem, the punishment should be a part of it? Personally I am glad that the insolvency code at least for the top marquee cases has ensured that the defaulters don’t get their companies back. Do you think that was the right way to go?
I think definitely one thing is clear, the Indian system required a shock treatment. In very broad terms, it required a shock treatment, it required a structural change.
The insolvency code is a good structural change but it is not complete. Public sector banking system is still not done. So in that sense but there is one part of it, it is necessary essential urgent. The other thing is the punishing part of it. There it is good that it has been done but I think that should not be overdone.
We see a lot of investigations and witch-hunt against bankers as well and probably some uninvolved bankers who were just present there are also getting in caught?
In some senses, I think it is a systemic problem. Even honest people, the system was such that you could not survive unless you followed a norm and the norm was the board. How was the board constituted? It is the board that leads you.
But people who were sympathetic to the big business houses.
In a way what I am saying is if there are many bankers who had given loans not for their own benefits but as a board wanted it. So you will find a signature of an honest banker on a bad loan. That is a totality of this framework and the culture of the board.
Therefore, when you are judging the individual actions of the bankers, in general, it is a reflection of the board. Only those who have really made money, you can call them guilty in substance.
At least the prevention of corruption act has been amended to that effect?
It is not amended retrospectively, it is amended prospectively. There still can be some innocence. Finally, do you smell a crisis around the corner because all global markets are doing well? Do you think they can continue like this or do you think imbalance can hit?
If the problems have not been solved of the last crisis and we are still not clear what is the new normal then how can we say what is happening is sustainable. So, whether there is a crisis or not I think the “recovery” that we are seeing is a blip and we should keep our fingers crossed.
As it has been said nothing is settled unless it has settled right so probably we have to be very cautious as you said?
The problem is we still don’t know what is right.
First Published: IST