For India, the shock may come from commodities: YV Reddy, former RBI Governor

Financial wizards dubbed him 'conservative', 'anti-market', and the man who is 'stifling development' of the Indian financial sector. Few beyond the money market and currency dealers bothered about what he said. That was before the 2008 credit crisis. Now, the world turns to listen to him on what he has to say about the way central banks are run and governments manage finances. In an interview with ET before the Standard & Poor's downgrade of the US rating, former Reserve Bank of India governor Y Venugopal Reddy discussed the fragile global economy and vulnerable India. Excerpts:

Where are we headed now in terms of the debt crisis?

Let me put it this way. Before the crisis, the whole world was going in one direction of asset bubble, of easy monetary policy. So, at that point in time, India took a particular approach . It was active in the financial market and careful in its integration with the global markets. It was one strategy that worked. We had the highest growth rate, price stability and financial stability. I think, because we started with a balance and others had financial sector reforms, India could manage the crisis with less volatility. Even countries like Singapore came in a 'V' shape. It was not so deep for India. Now, the challenge is different. We don't know where the world is headed. At that point in time, we knew where the world is. But now, things are different. Countries are doing different things to correct the imbalance. There are divergent national policies to handle divergent problems linked to the unwinding of the imbalances. Therefore, you must have highly nimble strategies, which is a lot more complex.

What should be this nimble strategy?

First challenge for India is to start thinking in terms of a nimble strategy, not just cautious policy, to handle a divergent world. There is a divergence between the real sector and the financial sector; there is a divergence between policy and the markets. There is a peculiar divergence in the problem of the debt problem of the advanced markets, which we did not have earlier, and at the same time, we may have to chase global capital. It is an entirely different ballgame. I will not be surprised if there will be some protectionist measures because of the kind of domestic pressures in these economies.  First is to have a strategy, second is to be nimble. The next question is how are the other emerging markets going to do is an issue. Most other EMEs, particularly in Asia, are stronger than India. Then our fisc is weak. In the past 2-3 years, the quality of the fisc deteriorated. Other countries did a stimulus that could be withdrawn, we did a stimulus which is not easy to withdraw. They did the stimulus on the investment side, we had a stimulus on the consumption side. Compared to other EMEs, we are weaker on the fisc. We have to be watchful even in the external sector for two reasons. In this type of situation of commodity prices, especially food and energy, we are vulnerable on both sides (fiscal and external) more than other countries. Many other EMEs have an advantage in the commodities sector. We don't have that advantage. Therefore, the hit comes from the external sector. I am not talking about the normal external sector. I am talking about sources of shock and these would be essentially commodity prices - oil or food. In the current account, it will be commodity prices. We already have a current account deficit, unlike others. Whenever you have a current account surplus we have a headroom, when we have a current account deficit, we don't have that headroom. Then, you get into a situation of capital account shocks. When we take stock of external liabilities, and we are certain that portfolio flows are fairly high. Vis-a-vis emerging markets, India will have less maneuverability in managing its macro-economy because of the vulnerabilities. We did well in the past twenty years in spite of the vulnerabilities. You do well because you understand vulnerabilities. That' a challenge.

What are the policy options that India should weigh?

We can't pre-decide. We need unconventional measures. For example, financial instability was unconventional, when we started it and we can't go with a pre-disposition. The point is, first we need to establish the problems and see the various elements of the problem.

ET