Viral Acharya On India’s Incomplete Bank Cleanup, Liquidity Policy And His Exit
Urjit Patel with Michael Patra, NS Vishwanathan, BP Kanungo and Viral V Acharya, at the RBI headquarters in Mumbai. (Photograph: Shashank Parade/PTI)

Viral Acharya On India’s Incomplete Bank Cleanup, Liquidity Policy And His Exit

During his tenure as Reserve Bank of India deputy governor, Viral Acharya saw the country's wide fiscal gap impact most aspect of the economy, which led to a difference of opinion between the government and the central bank on a number of issues. These issues ranged from banking regulation to liquidity policy.

“A central bank’s horizon, given its mandates of protecting depositor interest, of external stability, of inflation stability, is very long term,” he laments in his book Quest For Restoring Financial Stability in India. “The government’s objectives, unfortunately, can be very short term.”

Speaking to BloombergQuint about his term, decisions and perspective on what went on in the two-and-a-half years, Acharya said India’s fiscal dominance affected the country’s financial regulations system the most. “I think what I experienced in my time was that the fiscal management went completely for a whack,” he said. “I think the FRBM targets were being violated left, right and centre, the accounting was I think quite pitiful.”

“There was no real, significant fiscal consolidation and prioritization or reorientation of expenditure for the long run growth of the economy.” This, in turn, meant that the government had no fiscal room left to support the economy and leaned on credit-fueled growth.

Also read: Push For Credit-Fuelled Growth Led To U-Turn On Banking Clean-Up: Viral Acharya

Next in line was liquidity, according to Acharya. The government’s lack of ability to boost economic growth via expenditure made it resort to what previous governments had done before—open the liquidity taps and encourage banks to lend money “left, right and centre”.

Monetary policy, which is now managed by a committee under a flexible inflation targeting regime, was relatively less influenced by fiscal dominance, Acharya said.

Watch the full conversation here:

Edited excerpts from the interview:

You say that India has a problem of fiscal dominance and you add that that’s the theory of pretty much everything in India. Where did you see the impact of fiscal dominance play out most starkly? In monetary policy or liquidity policy or financial sector regulations?

I would put the financial sector regulation as the number one area where I think the fiscal dominance has its overbearing influence. The reason is simple. There is still a large presence of public sector banks in our financial sector. We have a legacy problem. I don’t even want to call it a legacy problem anymore, it’s an ongoing problem of their lack of adequate capitalization for the risks that they take on.

Invariably, that’s something that the exchequer has to plan for. Because we are always catching up rather than capitalizing these banks in a manner that they make healthy decisions and have the buffers to bear losses; it’s easy for the owner of these banks to turn to the regulator and simply say relax the rules, give this kind of concession, that sort of concession so that the fiscal doesn’t have to do the hard adjustments that are really long overdue.

I think what I experienced in my time was that the fiscal management went completely for a whack. I think the FRBM targets were being violated left, right and centre, the accounting was, I think, quite pitiful. All that fiscal management did was juggle above the line, below the line, on the balance sheet, outside the balance sheet, before Jan. 31,. after Jan. 31. There was no real, significant fiscal consolidation and prioritization or reorientation of expenditure for the long-run growth of the economy.

The reason why this matters and the reason why I’m highlighting this as the core issue is because this then leads to relaxation of bank regulation, which applies not just to the public sector banks but also to the other players in the financial system.

On the monetary policy side, we are very fortunate that we actually have an institutional framework that prevents the central bank from actually giving in that easily. It is charged with an explicit inflation targeting mandate. It is flexible in the sense that there is some attention that has to be paid to growth and while different committees, members and governors may interpret the mandate slightly differently in terms of their relative fates, it is a legal mandate. At the end of the day, they are answerable on whether the mandate was achieved or not.

The third point that you made was liquidity policy. I would say that’s a little bit somewhere in between, it remains entirely within the scope of the central bank. There is no institutional framework that’s driving it. In fact, if you recall during my two and a half years, people were even questioning us on whether targeting the repo rate as the objective of the framework was right, even though ultimately that is the policy tool that the central bank has and if you can’t achieve that target in the money markets, what’s the point of calling it your target policy rate?

So I do think there is slippage on the liquidity front because there is no institutional framework attached to it. As I lament in the book, I do think that the liquidity management in the end, directly or indirectly, is geared towards fixing the government bond yield curve. It’s often done also to achieve transmission of monetary policy rates, but the first and foremost transmission is only to the government bond market.

So I would say, fiscal dominance is impacting bank regulation first and foremost. I would put liquidity next and I would say we are very fortunate that in the last five-six years, the inflation targeting framework has been put in place. It has delivered, I think inflation was achieved, I don’t know where things are since I left in the sense that there is clearly more emphasis on growth. The last two quarters inflation prints are close to 6%, so it remains to be seen how the MPC respects the mandate going forward. But I would say, this is certainly the hierarchy.

Let me talk about the financial sector now. You came in at a time when the AQR had already started and for a while both under Dr. Rajan’s leadership at the RBI and then Dr. Patel and yours. It seemed like there was the government buy-in into this clean-up. But both reading your book and Dr. Patel’s book, it looks like that turned somewhere. Where did it turn and why did it turn?

Firstly, I want to acknowledge here Deputy Governor NS Vishwananthan. He was the rock as far as some of the efforts were concerned. I was more on the side as you know, it wasn’t really my area.

I reflected on why is it that in the end, even when we want to do the right thing, we take two steps back in the end? The root cause for it is fiscal dominance in my view; the root cause is the fact that our fisc has not left any buffers for counter cyclical expenditures when growth numbers are not right. Let me explain what I mean by this. It’s natural there can be growth swings up and down, whether through your own mistakes or just external shocks or shocks such as the one we are experiencing right now. Nevertheless, if there is capacity in the fiscal balance sheet to undertake meaningful long-term expenditure, spend on infrastructure; spend on health, spend on education, you can create a movement towards long run growth out of these kinds of cyclical shocks. But when the capacity is not there; ultimately you turn to the banking sector. You want the banks to do the growth push rather than the fisc actually managing a growth push either through structural reforms and infrastructure investments on its own.

I think ultimately they realized that what they wanted was exactly what the previous governments wanted. They wanted banks to be lending left, right and centre. They wanted credit and liquidity taps to be opened up. I think the pressures got more as their horizons became very short for the reasons that we can all understand around 2019. So, I think there was backtracking,

I’m sure there was tremendous lobbying pressure from corporates. Unfortunately, our incumbent industrialists have simply not accepted that when they don’t run their firms well and they can’t make the payments on the bank loans, they have to hand over their firm to someone else. I’m sorry, you didn’t run the firm well and you had your opportunity, you borrowed the money, it’s time to clean you up—get your assets into the hands of someone else. The interactions that we had with industrialists at the RBI when I was there, not a single time did they actually want to impose the self-discipline on themselves.

Now what’s the cost of all this? The cost of all this is that we just don’t have much entry of new players in our traditional firms. Look at where our IT sector is. Look at where our pharma sector is, look at where some of our traditional sectors are because we have simply not had any turnover. We have been rolling over bad loans, retaining excess capacity, leaving these valuable assets in the hands of those who have demonstrated over and over that they can’t actually run them well; either because they have incentives to siphon off funds and assets or because they are just genuinely incompetent managers. We were really trying to do what the system needs.

I think interestingly, there was a buy-in as you say from the system for a short period-- I think it was just 10 months, it was as short as that, and then we reversed track. Many of us hope that the Insolvency and Bankruptcy Code, which I consider this government’s most important structural reform after the inflation targeting framework, I hope that it is allowed to run its course for time-bound resolution of defaulted corporations which creates some churn in our over-indebted segments.

You partly answered my next question but I’m going to ask it with a slightly different nuance. When the RBI started to refer large corporations to insolvency, everyone expected a pushback. That pushback came in the form of some cases going up to the highest courts, getting stretched out etc. But what one did not, at least obviously, see was the government standing in to try and prevent these large corporations from losing their businesses. It looked like what triggered the turnaround in the financial sector reform process, if I can call it that, is more country-level growth concerns and running out of growth ideas rather than corporate lobbyists fighting back. Am I right in that or was it a complex a mix of the two?

Absolutely, I agree with you. That is why if you see my chapter doesn’t dwell too much on the lobbying. I do refer to it here and there.

I think the first and foremost problem is that when growth slows down, there have to be automatic stabilizers in the system of various types. I think the mistake that we now all acknowledge, is that you should not use an undercapitalized banking system to do lending left, right and centre. You’re not able to clean it up for years after that.

What is the option? The option is that the fisc has to leave some buffers of its own to provide the counter cyclical automatic stabilizers. But if the fisc doesn’t have that buffer; then it starts turning towards the central bank, it starts turning towards the banks; it starts turning towards other parts of the financial sector wanting to get some quick credit-based push to boost consumption, to boost investments. But this doesn’t work out in the end.

I have this sort of one para in the book where I say that what we are doing is before we have cleaned up the leveraging of the past sector; we simply start levering up another asset class. This is not the way to create long run growth.

I think long run growth has to be on the basis of structural reforms, it has to be on the basis of productivity. It has to be on the basis of a highly robust financial and fiscal macro-economic management of the entire system. I think we are taking shortcuts. That’s an easy thing to do but there are long-run consequences as we know from the last decade of doing this.

Along the way, there were other turnarounds. One was certainly on the hard stop the RBI had appeared to put on restructuring, we went back on that. The other was the PCA idea which I know you articulated more than once during your speeches. Was all of this driven by in some ways frustration at the resolution process not moving along at the pace that it did? As an extension, should we have considered a bad bank like solution?

I’m not so sure in the end. I think what you asked earlier is the most important question we have to ask. So the question a lot of people are focused on is, why is it that our banks are regularly getting into this situation? I think the question that I’m trying to pose in the book, especially in the new chapter, is why is it that even after having recognized this, even after having started this process, we are not able to go ahead with the clean-up because clean-up takes time.

It requires incurring some short-term pain; it requires fixing the banking system to a point of stability where you have to accept somewhat slower credit growth so that when the impulses are right, the financial sector goes about lending in a robust way.

I think we got a bit too short term focused on whatever immediate pressures were there for the authorities and that led to a complete reversal on a large body of what I thought were really foundational reforms for restoring financial stability in India. I think whether you do it through a bad bank or whether you do it through Insolvency and Bankruptcy Code; I think the important point is that the distressed assets need to get resolved. Excess capacity in indebted sectors needs to be cleaned up so that the healthy firms have the pricing power to make profits, to make investments to employ people and capitalize on the next round of investment opportunities that are coming up.

We were also trying to improve the disclosure rules. We focused so much on lending as being supply-push, but we don’t realize that big parts of India are simply not included in the credit engine. Why not actually create a financial infrastructure such as a public credit registry to improve financial access of these individuals who are not in the credit safety net so we can democratize credit and, at the same time, improve the credit accountability for the large defaulters who have frankly been allowed to run rogue in the system. I think these were truly foundational steps.

I’m still hopeful that they will be taken to the natural conclusion and therefore, here I am, trying once again through this book to send the message that it’s never too late to restore financial stability. It doesn’t matter that we made mistakes over the last decade, doesn’t matter we made mistakes over the last two years. I think we still have a very vibrant demography, we have hard working people in the country, we are ambitious and I think if we plant the right seeds of financial stability for our system right now, I think the benefits will be there in 10, 20-30 years’ time. That’s the horizon we need to look at to be a great country that grows on a sustainable basis for a period of time.

Given your views, you probably don’t like what’s going on right now or do you make some concessions for the kind of environment we are in. We will probably have a six-month long moratorium and there’s a clamour for a one-time restructuring. Do you make concessions because of the environment and allow for some of this or do you think that for India that’s a no-no?

Since you touched upon Covid, of course, I want to take this opportunity to thank all the medical staff and the people who are working very hard to get the country to come to grips with what is clearly a very difficult situation.

I think I have never been averse to actually some concessions on the debt restructuring side and let me be very precise as to what I mean by this. I think, in India debt restructuring means that you give a freebie to the corporate so you write the loan down. Why is it a freebie is because the bank actually doesn’t take any write down on its balance sheet when it happens. So usually when we talk about restructuring in India, it’s not actually always to favour the end borrower. It’s also to simultaneously ensure that the banks are not writing off their capital when the restructuring happens. Now, all corporates need to restructure at some point of time. They may do it willingly, they might pay down their debts or it happens through a bankruptcy or it may happen out of bankruptcy if the mechanisms exist.

Essentially debt restructuring is writing off some debt and freeing up the equity so that the solvency of the underlying balance sheet is brought to reasonable levels so that it can function in a normal way. What I have a problem with is that we do all of this without accounting for the losses on the bank balance sheets in an honest manner. Our provisioning of losses is entirely back-loaded. Almost the entire provisioning of losses in India starts after a loan has actually defaulted. In a system where banks recover on average barely 25 to 40% on their defaulted loans, clearly this is too late.

You are always kicking the can down the road as far as recognizing losses are concerned.

So, I think we absolutely need to factor in that our enterprises, which are hit by this unexpected shock, will need some debt restructuring. The question is, can the banks bear the losses? If they can’t bear the losses, they need to be given capital. If they are public sector banks, the capital may have to come through disinvestments of government stakes or through the government balance sheet as recap. If it is private banks, perhaps the central bank can do a quick stress test as the financial stability report of the RBI already does and tell banks how much capital they need to shore up over the next two months -- so that when the debt moratoria expires and the losses come to the front, then you know the banks can actually accept these losses. If we don’t do this, and I think this is my crucial point where I’m completely uncompromising, is that we go around doing these debt restructurings without marking the bank’s books properly. That’s the worst thing you can do because this is a legacy problem that you will be dealing with for a long time and it’s always tempting to say this time is different. But the new shocks are not going to wait for you. They’re going to come unexpectedly just the way that the Covid shock has come unexpectedly.

We just don’t have this kind of time to be fighting fires all the time; we have to restore the resilience of the financial sector balance sheets once and for all as a principle that we need to run a banking system that can absorb the losses it takes on and simultaneously make healthy loans to the healthy parts of the rest of the economy.

Just to make sure I get what you’re saying. So you’re saying that you are not averse to restructuring as long as there is provisioning which goes with it. But are you okay with it not being marked into an NPA category?

What I’m trying to say is that if a loan is non-performing, it is non-performing. That is what it is and that is what it should be classified as. Then whatever provisioning needs to be applied to that loan needs to be applied right away. I think to borrow an excellent phrase that Dr. Patel has mentioned in his book -- that a restructured standard asset is an oxymoron. He’s absolutely right. If there is restructuring, it is not a standard asset. The bank has actually converted some of its debt into some other claim or made a loss and that needs to be recognized on the balance sheet of the bank.

You say in the book that “attempts to alter the governance structure of the RBI to institutionalize such outcomes in future would have meant crossing the Rubicon and have to be foiled. As a result, the RBI lost its governor on the altar of financial stability”.

Public perception was that the exit of Dr. Patel was more about the central bank’s balance sheet. Was it was more the tussles on the financial stability side that led to the exit?

I don’t want to get into specifics of what events led to any particular thing because those are details at the end of the day. I think as I tried to explain in the fiscal dominance chapter, all of these things-- regulatory forbearance by the central bank, pressures to cut rates, pressures to provide liquidity to monetize the government deficits, lack of recognition of timely defaults on bank loans, the push for short-term external debt being issued by the government and the desire for RBI’s balance sheet in the form of surplus. All of these issues are ultimately tied to the government trying to solve its fiscal problems not through its own decisions to reorient expenditures, to consolidate, to undertake the right structural measures but basically turning to the central bank as a quick way of getting some sort of concessions along the way.

As I mentioned, the central bank’s horizon, given the mandate of protecting depositor interests, protecting the external sector, protecting the banks, is very long term by nature. The government’s objectives, unfortunately, can be extremely short term. I think when they come to a head, the central bank has to have the ability to say no when that is not in the public interest. I think we did say no, I think we put up exactly the right defence and resistance that needed to be put up in face of such pressures otherwise we would have seen a repeat of the previous mistakes of this decade without actually having fixed them in the first place.

So, my sense is whatever defence we put up was entirely in public interest. I think the country is far better off because our banks are not in worse shape than what they could have been given the pressures that were on us at that time. I think it came at a huge professional cost to some of us but I think given the mandate of the RBI and given what we interpreted that mandate to be, we thought we had to pay that price.

Did you also exit because you felt that you weren’t being able to achieve the agenda you had in mind even when you came into the RBI. Was it part disappointment that led to your exit as well?

No,I have no disappointment about anyone’s exit. I think exit is a form of voice, exit is a part of what one has to use I think in various situations in life when you have to stand up for what you believe in. I have no disappointment, I think it was an extremely fulfilling job experience, I learned a lot on the job. I worked very closely with so many wonderful people, very talented people and very committed people at RBI and there is nothing that I would do differently if I had to start all over again. I have no disappointment whatsoever.

I think at some point, as you said, I had to take a call on what I think I was capable of doing. I had to take a call given my personal constraints as to whether this was the best opportunity for me to contribute to the country, going forward. But I think I would not do anything differently than I did over those two and a half years and yet I entirely think these were extremely fulfilling years of my professional career.

Let me ask you about the liquidity side. The new liquidity framework acknowledged that the call money rate is what needs to be targeted, they acknowledged that the system would typically need to be in a small deficit but then they threw in a statement saying that “if financial conditions warrant a situation of liquidity surplus, the framework should be adaptable.”

Do you think the liquidity framework is also a little bit diluted?

You know my take on this is that I think with the system that the RBI presently has, which is basically that the policy repo rate is what RBI controls, the only way RBI can control the money market rates and the yield curve with the policy rate being the linchpin is if, net-net, it is actually providing liquidity to the system at that rate. So, the system net-net has to be in a small deficit.

If RBI wants to maintain the system in surplus, because for whatever reasons it thinks that is the right liquidity stance given the macroeconomic conditions, then to restore monetary control, the monetary policy committee has to set the reverse repo rate because that is the floor rate at which it is now actually absorbing liquidity from the system. I think what is happening is that we are now in this, I would say a little bit here-a little bit there situation, where the effective money market rates are being controlled by a rate that is actually set potentially outside of the monetary policy committee. I think institutionally, this violates the spirit of the inflation targeting framework; it violates the spirit of the monetary policy committee.

Therefore in my view, either the RBI should resort back to the deficit system. That seems a long way out given the surplus liquidity we have and we know that the preference for OMOs in the entire system is asymmetric; something that I fought against unsuccessfully at the central bank. But if it’s not prepared to do that, I think it should be prepared to switch to a floor system in which it basically absorbs the liquidity at the repo rate and that is the only way that repo rate can then have the economic meaning that is supposed to be.

I think right now what’s happening is that RBI can potentially control the entire yield curve through its liquidity management policy. If it starts doing that it’s losing important information and impulses from the yield curve about monetary policy and taking that away from the monetary policy committee. It’s not clear to me that this was the original intent and spirit of the inflation targeting framework.

Is it partly a design flaw as well? Perhaps the MPC should have been designed either with some input from the liquidity side or the reverse repo rate should have been part of the MPC’s mandate. Or is it an intent issue because you do mention in your book that there is still a fair amount of pressure to control government yields.

In my opinion, it wasn’t a design flaw to start with. I think we were in a deficit system; the repo rate was actually the effective rate. If you recall during demonetisation when the surplus liquidity was very large we had to actually narrow the band because otherwise the money market rates were going far below the repo rate. So I think the system was exactly the right system for a deficit system.

What has been done is that the liquidity framework has changed over the last 15 to 18 months without fully acknowledging that this actually is transferring a part of the control of monetary policy out of the control of the monetary policy committee. I think it is certainly a flaw. This is a flaw that’s been openly mentioned in many accounts of what is presently going on. I think these are things that shouldn’t be taken very lightly in my opinion.

I do want to stress this. I think inflation credibility is one of the many important pillars of financial stability for India. As we know, India’s vulnerability has always materialized on the external front, as it also did during my tenure during the sudden oil price spike from April to October 2018. Why was inflation targeting put in place? It’s to give credibility to the external investors that when fiscal deficits are large, when growth pressures are high, the central bank will not lose sight of reigning in inflation and allowing for a depreciation of the currency that can erode the value of the money that the external investors have put into the country. I think this has helped tremendously with external sector credibility. I think it needs to be preserved and I think it needs to be preserved especially right now, when, for the right reasons, the demand for additional fiscal expenditures is high.

This needs to be combined with fiscal reforms to build credibility with investors for any extra expenditures that are required. To send the message that down the line we will actually consolidate, we will respect the FRBM targets. Of course simultaneously, we need to ensure that the financial stability remains in a good shape.

Would it help if there was an independent debt office? This is a discussion that used to happen many years ago, it went completely underground. I don’t know if you heard of it during your term. Would that help to take some of the fiscal dominance on liquidity policy away?

I have mixed feelings on it. I don’t have a very clear take either way. What I would ideally prefer is that it stayed with the central bank but there be some kind of a Chinese wall.

See it’s supposed to be debt management. Debt management is managing the auctions; it’s managing the placement of the debt. Debt management is not about managing the prices and the yields of government debt. So, if you actually have the right framework, where you are simply an institutional mechanism to manage the placement of the debt and not think that you are the mechanism for managing the prices of the government debt, I think it is possible for the RBI to have this Chinese wall inside it. Whether it’s there or not I think you can all assess yourself; it varies at different points of time.

I think the reason why some people push for the separate debt management is because they think that is the only way to ensure the separation of objectives is to actually sever the link in the first place. I think the question that they have not adequately answered, and this is why I have mixed feelings, is whether setting up a separate office will provide infrastructure support, human capital support, take away moral suasion over public sector banks and other public sector institutions such as our large insurance companies and so on. Whether that problem could get even worse if actually the debt management office moves entirely to the government side?

So I would say either of the solutions is fine if it stays with RBI, you need a separation of objectives that RBI’s job is not to manage the yields; it is to actually manage the auctions. If it goes to the government side, clearly they have to beef up the human capital support and so on but I think they have to simultaneously figure out ways to commit to not using the banks and the other public sector institutions to basically rig the auctions, to ensure you don’t get them to buy entire auctions where auctions are failing and things like that. So I think there are downsides to either.

I think it continues to stay with the RBI because, maybe incrementally, it’s status quo that prevails when neither of the options is clearly dominant.

Reality though is that the RBI does step in to manage prices. Operation twists, LTRO etc, it’s all about managing yields. What did you think of those two steps?

I think these are steps that are partly inspired by central banks of other countries who have gone down this path. Of course there is a great amount of experimentation that’s happening on monetary policy right now. I would like to stress that there is no evidence that this is working. I think Europe and Japan who are the pioneers of these sorts of policies, they are hardly the role models India should be looking forward to for generating high growth.

I think the only country where quantitative easing seems to have worked out, at least in the sense of having been coincident with a good growth recovery, is United States. But this is a country which also adopted very tough recapitalization of its banking sector, very tough stress tests and so on, and which have come to stand the test of time given the Covid shock that has been witnessed now.

Whether the central bank in India should be experimenting with this or not; let me just pose a few thoughts for them here.

Many countries embarked on quantitative easing because they had hit the zero lower bound. Why had they hit the zero lower bound? It is because they had actually entered recessionary phases and in many cases even deflationary phases. That is not the situation in India, where inflation over the last two quarters has averaged I think above 6%. Therefore, the interest rates in India are not at zero lower bound. So if the objective is to push growth, the first lever has to be that you have to convince the MPC or that framework to accept that we are happy to accept higher inflation and lower the interest rates.

Now, presumably they are not doing that right now because I think inflation is not actually allowing them the space to undertake these decisions. Then to bypass that altogether and simply start managing the yield curve directly, at a minimum, I think it reflects inconsistency. Now you might say this is a way of creating transmission of the monetary policy to the real sector. As I’ve argued, the transmission happens first and foremost to the government bond yields and you only encourage fiscal dominance of a greater amount when you do that. Ultimately, you have to ask the question why my financial sector is not transmitting my monetary policy impulses.

I think the number one factor in India is because their balance sheets are not as healthy or as well capitalized as they should be. So I can understand if you want to use these as temporary tools but you have to diagnose why the transmission is not working. Ultimately the central bank can’t do all the functions of the financial sector of the economy. Some functions have to be left to the decentralized markets and the way to get decentralized markets for transmission to work well is to get the banking sector, banks, NBFCs and others to be recapitalized well. How can we do that? I think it’s a great time right now to recapitalize given the buoyancy of equity flows-- both externally as well as internally.

RBI has a financial stability unit which produces excellent financial stability reports every six months. They have been prescient about many of the upcoming problems. I think one should put some weight on the forecasts that they have provided for where the NPAs might end up if we don’t get a healthy recovery out of the Covid shock that we have witnessed. I think, rather than being too unconventional, why not first try what is conventional and traditional which is to have a healthy banking system to grow well in the long run. I think it is as simple as that. Why are we not able to achieve this? I think it comes back to fiscal dominance.

Therefore I want there to be a public debate about whether India’s fiscal, whether its fiscal institutions are in the right place. Do we need an independent fiscal council that ensures transparency of accounts, adherence to the FRBM targets, ensuring that the disinvestments take place when they have been budgeted at the beginning of the year and not just cosmetic disinvestment where you sell one public owned enterprise to another? That’s what we’ve been doing. We’re just doing musical chairs with our public sector enterprises.

I think we need a genuine open debate with constructive dialogue as to how to give confidence on debt sustainability to external investors so that the government can undertake the fiscal expenditures that are going to be necessary to deal with a slowdown that Covid has inflicted upon us.

A lot of people have said that this is the time to put that independent fiscal council or some sort of structure in place because many believe it’s inevitable that the government will have to ask the RBI to even directly monetize debt.

Your view on whether this is inevitable and if one does need to go in that direction, does it need to come with that institutional change this might be the moment to push it through?

Absolutely. I again go back to the external sector issue. India gets into trouble when the fiscal deficit is not right or the current account deficit is not right or both. So, whether RBI monetizes it or not, ultimately on a consolidated government balance sheet, this is actually government debt. RBI has to ultimately suck out the excess liquidity. We are already in a system of surplus liquidity; we have already monetized portions of government debt over the last two years.

RBI is actually paying a cost every night to actually mop up that liquidity back onto its balance sheet from the system. It may not be paying the market rate because it has kept the reverse repo rate very low. Nevertheless, it is in the end a cost, because this reduces the surplus that RBI is going to pay the government at the end of the day. So, once you take a consolidated view we are just moving debt from one balance sheet to the other even though on the consolidated government balance sheet what should matter is the total debt that you have out there.

So, ultimately the question we have to ask is what the debt numbers will look like if growth doesn’t recover. Suppose the lack of financial strength; overall in the intermediation sector prevents us from achieving what we think or what many think is the potential output rate; will the debt to GDP numbers rise? Will they reach 85%? Will they reach 90% over the next three to five years? What are some institutional mechanisms that you can build right now, just the way we built inflation credibility after the taper tantrum, to give credibility to external investors?

Now is the time to give external investors the confidence that we will keep our fiscal numbers in check, we will get onto a path of consolidation, reorient of expenditures and do whatever divestments are required on a fast pace if required. I think it’s better to do it before a certain shock occurs. It’s better to do it in anticipation, it’s better to visualize what the stress scenario might look like and, if it’s not pleasant, I think it’s better to manage that risk.

I’m not in the camp which says that we have to ignore inflation; we have to ignore the fiscal deficit numbers right now; all that we have to do right now is spend because otherwise the growth will collapse. Well, spend because you need to support growth but anticipate the risks and put in place the structures that will give confidence to investors that when and if those bad scenarios arise, you are actually adequately and structurally in the right position to guard against it.

I always give this analogy that as a central banker, I always wanted to play like Rahul Dravid, which is to be stable, be the anchor of the entire economy, don’t go for hara-kiri because that’s not the way you play a test match. I think that’s really the message I would like to send to all my dear friends at RBI.
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