India's reaction to 2008 economic crisis was not coordinated, says former RBI governor YV 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.

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.

That was essentially Indian phenomenon but partly because the global economy, global capital flows are pushing us.

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.

Nobody picked up and I was struggling with how to tell but not inject fear or something like that.

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.

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.

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.

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.

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.

A: Yes, in fact, even more.

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.

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.

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.

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.

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.

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.

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.

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?

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.

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.

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.

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.

Retrospectively.

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.

The problem is we still don’t know what is right.