RBI leads the world
There is an intense debate raging world
Vol 3 - Issue 8 | November 2009 | Rs.3.50
inside
margin compression threat
16 golden rules of investing
tightening starts
chasing value
by invitation
ethics in finance
global strategy & allocation stance
life support to be maintained
thoughts from the frontline
life in the time of great recession
global insight
mutual funds demystified
taking note of
voices
best & worst-india
best & worst-global
performance tracker-india
performance tracker-global
equity chart book
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investment quiz
Sundaram BNP Paribas Asset Management
regulatory capture and low interest rates
wide on whether central banks should just
focus on managing inflation or should they
also target financial stability. The India
experience clearly shows that there is a
robust case for the central bank to focus
on financial stability with equal zeal as they
do in handling inflation.
It is this prescient approach that helped
2,3 the Reserve Bank of India to adopt
policies that ring-fenced the banking
3 system from the financial crisis that has
engulfed the developed world.
4 October.
Just the state-owned nature of parts of
the banking sector was not the key factor
5 coverage to 70% of gross NPLs by
that helped India avert the problems.
We must remember India today has a
6 private-sector presence in financial
services that is significant and increasing by
7,8
the day. Parts of this space could have
embarked on ultra-risky products and
9 services but for the prudential regulation
by the RBI for the banking system.
10,11
Successive RBI Chairmen, especially DrY V
Reddy, have been ahead of the curve in
12,13 imposing prudential norm on real estate
lending, securitisation and provisioning for
14,15 doubtful assets, to name a few. It is the
focus on financial stability (in addition to
16,17 inflation) that helped fashion such a robust
response. In an article in The New York
Times (December 19, 2008) on how India
18
avoided the crisis, the Chairman of HDFC,
Deepak Parekh was quoted saying `He
19 saved us’ of Dr Y V Reddy.
In the context of the proven and informed
20
experience in India, the global debate
appears uninspiring. The forces of
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1 The Wise Investor November 2009
the crisis early. So his views are of
that brought this crisis have a vested
interest in ensuring that central banks
focus just on inflation. This coupled with
spins on Great Moderation led to ultra-
low rates for too long. It has led to one
bubble after another and the response to
this crisis is bringing one more.
Notably the RBI has already embarked on
moves to roll-back the flexibility that was
provided in the Q4 2008.This is reflected
in its moves to enhance provisioning in the
Monetary Policy Statement in end-
What the RBI has also shown is that a
focus on financial stability does dovetail
neatly into its overall policy framework. It
has also shown that as a central bank, you
need not be restricted in the pursuit of
financial stability by theory that holds such
an institution should focus on managing
one variable – almost always just inflation.
In our view, the central bank should
pursue management of inflation and
financial stability. Norway has taken a small
step in the past week towards this
objective. So the tide appears to be slowly
but surely shifting on the world stage.The
RBI has been there for years now.
The approach of the RBI has come for
high praise from independent thinkers.
Sample for instance the view expressed by
Christopher Wood, Managing Director &
Strategist, CLSA Asia-Pacific Markets, a
rare independent research outfit. Nobody
has been scripting the financial and
economic crisis as well as he has, though
there are a long list of persons who saw
significance.
This is the view Christopher Wood has
expressed in the latest edition of his
weekly, `Greed & Fear:
`If policy will remain easy in the West,
there will be growing talk of the need for
Asian policymakers to turn pre-emptive.
GREED & fear has long viewed the
Reserve Bank of India (RBI) as the world’s
most credible central bank and it has
made a pre-emptive move this week by
ordering the banking sector to increase
its Non-Performing Loans (NPL)
September 2010, up from the current
sector average of 60%.
The reality is that the pre-emptive nature
of the Indian central bank in recent years
has helped ensure so far a remarkably
smooth credit cycle given the scale of
credit growth seen this decade. Thus,
Indian total bank credit has risen by an
annualised 22% over the past ten years,
up from 22% of GDP to 55% of GDP’.
What is significant about the RBI
approach is that it has almost completely
steered clear of influence by Delhi though
it may not appear so going by what one
reads in print or hears in the electronic
media. It also shows that the RBI
Governor’s approach has had the backing
of the Prime Minister, thereby helping
curtail pressures from other parts of the
government.
If a central bank focuses on inflation and
financial stability by staying ahead of
curve, growth will take care of itself. We
think the RBI approach has been the
silent star of the India growth story. We
hope and have confidence that this
crucial element will stay an integral part
of the Indian economy in the years ahead.
This should be good for the economy
and investors.
T.P.Raman
Managing Director
Sundaram BNP Paribas Asset Management