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Dr Y.V. Reddy

Vinson Kurian

Thiruvananthapuram, Sept. 4 Dr Yaga Venugopal Reddy inspires emotions ranging from the extreme to the sublime as he prepares to sign off as RBI Governor. “Not a hawk by any stretch of inflation!”, raved a leading economist.

“May not have stretched himself fully as one; but a dove of a human being all the same,” said another.

“Was hawkish at times, but so what, didn’t he prove a point or two,” asked a third.

According to Dr Ajay Shah, commentator on banking, public finance and macroeconomics, Dr Reddy was not a hawk by any policy-making logic.

A hawkish Governor does not leave behind raging inflationary fires unattended. But India is in the midst of the worst inflation in over a decade even as Dr Reddy bids adieu.

With capital account becoming more open, exchange rate pegging has increasingly hijacked monetary policy, evidenced money supply growth rates running in excess of 20 per cent in recent years.

In contrast, Dr C. Rangarajan as Governor had fought valiantly to wrestle inflation back to low numbers in the 1990s. This presented a classic dilemma of the impossible trinity – capital account being eased for pegging the exchange rate, which, in turn, forced unpleasant monetary policy decisions.

Successor Governor Mr Bimal Jalan was caught in the vortex of the Asian crisis. The exchange rate pegging required raising interest rates in order to prevent rupee depreciation, despite prevailing weak business cycle conditions.

After the Asian crisis subsided, capital flows resumed. Exchange rate pegging now demanded buying dollars in order to prevent an appreciation. Dr Jalan’s RBI enjoyed a long run of ‘sterilised intervention’.

Taking over from Dr Jalan, Dr Reddy did not bother to question the exchange rate peg as the monetary policy framework. He ended up buying dollars for achieving exchange rate pegging, and actually poured fuel on the inflationary fire. The resulting monetary expansion has ignited the worst inflation of post-reforms India.

A strong rupee is best achieved by shedding excessive reserves. India has built up $300 billion in recent times, well beyond what is required to assure stability, and with its explicit and implicit fiscal costs, says Dr Shah.

Mr Abheek Barua, Chief Economist, HDFC Bank, countered this argument by saying that the link between inflation and exchange rate is tenuous at best, as Dr Reddy himself would iterate from time to time.

Simply relying on exchange rate mechanics to control inflation is a bit optimistic. Taking the inflation bull by its horns would require taming inflationary expectations first. And Dr Reddy was an astute reader of these, if ever there was one.

This explains his ‘tightening’ initiatives but largely at the expense of stimulating growth. He has been roundly criticised for this resolute policy stance. But he has acquitted himself well by seeking to shield the economy from crude oil spikes and commodity price spirals, when it really mattered.

His fixation with a competitive exchange rate entailed active intervention in the market with implications for money supply. Mr Barua hailed the manner in which the rupee was allowed, during a crucial phase, to appreciate from a low of Rs 46 to 39.50 a dollar in the face of strong capital flows.

In doing so, the regulator had kept in mind the travails of small exporters with large employment potential – for instance, textile exporters based in Tirupur who had faced a problem that threatened to throw them out of existence. The lifeline extended here revealed a mind that was flexible and free of dogmas of any kind.

Dr Reddy was a hawkish Governor, but justifiably so, since he has been proved right on more than one count as later events would bear out, Mr Barua said.

On a personal note, he said Dr Reddy was easily accessible. He also recalled how the latter had bothered himself to reply to e-mails sent to him, although with some delay. This was perfectly understandable given his hectic schedule.

Trade, industry and other stakeholders may be forgiven for crediting Dr Reddy with the appellation of a ‘hawk’. But he is far from one, says Dr M. Govinda Rao, Director of the Delhi-based National Institute for Public Finance and Policy (NIPFP) and an expert in public finance and taxation.

On the contrary, he was only hawkish by half and stopped short of pandering to designs of powerful lobbies at work. He went the distance to do a fine balancing act in the face of surging inflows to keep exchange rate volatility well under control.

This could not have come at a better time for an economy that landed huge import bills sparked by the incendiary mix of a ‘crude oil super spike’ and run-away food and commodity price spiral.

Asked if the frenzied mop-up of dollars had not added to liquidity concerns fuelling inflation further, Dr Rao said sterilisation always meant incremental rupees sloshing around the system. The high inflation and climbing rates, marking the end of his tenure, were not his making but had been triggered by supply-side concerns, and therefore largely imported.

Dr Reddy has excelled in his tough job by guiding the economy efficiently through thick and thin, and has had an illustrious term at the helm of the Reserve Bank.

“Venu is a very good human being more than anything else, and very polite and easy to get along with. I have great respect for him both as a professional and a career bureaucrat,” Dr Rao said.

“This is saying much considering that I’m not given to holding the bureaucracy in high regard,” said Dr Rao who is Member of the Prime Minister’s Economic Advisory Council and holds the rank of a Minister of State.

“I would say Dr Reddy has done an excellent job on the external front and managed to keep the exchange rate at an acceptable level,” said Dr Pinaki Chakraborty, Senior Fellow, NIPFP, specialising in macroeconomics and public finance.

Since the 1991 economic liberalisation, RBI has undergone a series of changes in relation to framing of interest policy, monetary policy and credit policy. Its relationship with the Government has, in the process, become more autonomous.

But the huge forex inflows have posed a major problem. The result is that the RBI has been increasingly required to deal with extreme exchange rate volatility. This has been the case during the last 10 to 15 years and has marked Dr Reddy’s term as well.

At the same time we have also passed variously through a regime of low interest rates and subsequent hardening. There may be a case that the rupee has gotten stronger in the process. This is all part of macro-economic adjustments, somebody will gain from them, but others will lose.

The management of the macro economy also has been excellent during Dr Reddy’s tenure. But people with short memory would always gripe that they have had to live with high inflation. The fact is one cannot judge Dr Reddy’s era just on the basis of high inflation during the latter period.

Asked if he thought Dr Reddy was hawkish, Dr Chakraborty said a bit of conservative monetarism is alright. The Governor had tried out this as an instrument of controlling money supply. When you have high inflation, interest rates are bound to go up.

As for implications for liquidity from Dr Reddy’s exchange rate stance, he said that “we again have a short memory. We have had a much higher CRR and equally high SLR rates before. We are not in that situation now. So this marginal hike is short-term only.”

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