Former civil servant and RBI governor YV Reddy revisits his mistakes and interventions in a new book

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5 days ago

When a political party sweeps to power, they sometimes abandon the unfinished projects started by the previous regime in order to start their own new projects, which are in alignment with their particular agendas. But abandoning projects close to completion, especially those that were 80 per cent or more complete, had been proving to be highly wasteful.
As Secretary, Planning, Government of Andhra Pradesh, I went to Chief Minister NT Rama Rao with a proposal to earmark Rs 1 crore per district (it was a substantial amount in those days), purely on grounds of efficiency, for projects that were 80 per cent completed (last mile projects). This Rs 1 crore would be spent only to complete these last mile projects. These projects were to be identified by a technical committee headed by the district collector and would be outside the normal budgetary allocations to the department concerned. The district collector's office was not subject to short-term political changes and would, I reasoned, ensure a longer-term perspective. I argued that the funds should be sanctioned straightaway as 'crucial balancing investment'. It would, I argued, greatly improve efficiencies.
The then Secretary to the Chief Minister and my dear friend, UB Raghavendra Rao, was not convinced. He warned me that it would undermine both the process of expenditure authorisation by the government and the parliamentary system. I disagreed and persisted. NTR approved the crucial balancing investment scheme for each district. For a while, it was a success.
After about five years, a weak Collector gave in to pressure from local politicians. The Rs 1 crore was distributed equally among Members of the Legislative Assembly (MLAs) without the need to follow the 80 per cent completion guideline. Over time, this malpractice spread to other districts. Later, even the guideline of 80 per cent completion was officially diluted. Exactly the opposite of what was intended had taken place, and the original problem had worsened. Raghavendra Rao was proved right. Later, a similar scheme called the Members of Parliament (MP) Local Area Development Scheme was adopted by the Government of India with an even greater dilution of guidelines.
What seemed at first an obvious solution using a pragmatic, dynamic plan to improve efficiency had had unintended consequences. This happened because I did not pay attention to possible second-order and third-order effects. A costly mistake, indeed.
Although it is impossible to accurately envision all possible second and third-order effects, I have found that it is important to at least contemplate them. Over time, one's skill and judgement pertaining to next-order effects get honed, providing a very useful framework.
As a government officer, my father would visit the villages in his jurisdiction. Despite his stature, he would sit with farmers and talk about their problems in local gathering places. He showed his deep empathy for the poor. During my vacations, I would accompany him. My father's concern for the common man influenced me greatly. As a student in Anantapur, I shared a hostel with young men from poor families, and this close experience also had a deep influence on me.
The Telugu phrase 'samayam, sandarbham' translates to time and context. Samayam, sandarbham are always predominant in my decision-making. Nearly all actions and situations are meaningless when stripped of their time and context.
What are considered pillars of virtue in one society (for example, the quality of harmony and collectivism in certain Asian cultures) might be less important in another, or might even be considered inferior (for example, in certain Western cultures, disruption and individualism are valued over harmony and the collective good). Also, developed markets with robust legal systems can support certain policies. These same measures will not work in less developed markets that lack strong and swift legal systems to which citizens can turn in the case of fraud or failure.
Formulaic prescriptions should be viewed in context. There is a standard formula for measuring the optimum level of foreign exchange reserves of a country. In India (and elsewhere), forex reserves are the reserves of foreign convertible currencies (mainly US dollars) and gold held by the monetary authority for various reasons, including to provide stability to the system. (The International Monetary Fund's [IMF] Special Drawing Rights form much smaller components of the forex reserves.) The optimal level of forex reserves is calculated in economic terms and exposures.
But what of geo-political factors? I maintained that we needed to also take geopolitical risks and security into account. President Bill Clinton was once quoted as saying that the US should help bail out Mexico in a time of need, but not some other country, such as India. (He specifically mentioned India as a country that the US would not help bail out.) In such a situation, Mexico can afford to have fewer reserves than India, which must have more because it does not belong to any bloc and cannot expect a bailout from anyone. India has to take care of at least three potential shocks from the external sector – food, fuel, and finance (external finance).
I have also learnt from the sound counsel of Bimal Jalan. The RBI manages the public debt of the Government of India through the Public Debt Office. In 1997, as Deputy Governor, I argued for creating an independent debt office, separate from the RBI. This separation of powers seemed logical, efficient, and consistent with international practice. I made a presentation to Governor Jalan. He listened attentively and complimented me. Then, to my surprise, he asked me to write a note opposing my own recommendation (I later realised this was to help me think through the opposing view).
On reflection, I understood his viewpoint. Our context was unique. When the RBI is the public debt manager for the government, it keeps in mind the government's interests. Once that function is taken out of the RBI's purview, the government is exposed to market risk and possible vested interests. Jalan felt we should hold off till our markets were sufficiently well-developed and the government was able to raise money without the RBI's help as a public debt manager. My initial view, while attractive at first, did not give sufficient weight to these realities. The experience of Greece (and several other countries) during the financial crisis of 2008 supported Jalan's wisdom.
In summary, it is wise to look at formulae, theory, standard practice, and the experience of others while crafting policy or making decisions. To then evaluate their relevance in the particular samayam and sandarbham of the practitioner's system is even wiser.
The RBI viewed certain financial innovations as healthy, but only in small quantities. A proliferation of these innovations often presented systemic risks that could be difficult to undo. Also, unlike Food and Drug Regulation authorities, which can first carry out controlled experiments with a drug before releasing it into the larger population, financial systems do not first test the safety of financial innovations before injecting them into markets.
Timing can be crucial. In the 2004 elections, the Bharatiya Janata Party (BJP)-led coalition government, the National Democratic Alliance (NDA), was defeated and the United Progressive Alliance (UPA) coalition government, under the Congress's Sonia Gandhi, was elected. Although eventually Manmohan Singh was declared the prime minister, there was, for one day, great uncertainty about who would lead the country.
During this time, there was an attack on the stock exchange. This resulted in a huge dollar outflow due to demand for the currency. The rupee began falling dramatically. The market sentiment was totally against us and acting in such an environment posed risks and costs. In addition, as RBI Governor, I had to keep the political leadership informed of my actions in a situation where we were politically rudderless.
I called the outgoing finance minister, Jaswant Singh. I explained that I was not intervening immediately but would act at the appropriate time. Jaswant Singh was puzzled. He pointed out that he was not the finance minister anymore. I told him that, legally, until the next Cabinet was formed, he still was. Therefore, I reported to him. I assured him that he could convey this information to anyone he wanted if he felt it was appropriate.
The rupee continued to fall, but we at the RBI did not act. By late morning, several people were asking the RBI to intervene. The clamour grew louder, as did the support for intervention. A little after lunchtime, we acted. The RBI intervened in a massive way – spending huge amounts to buy dollars, showing our strong determination, and stemming the slide. The markets stabilised.
If the timing was wrong, the costs of intervention would have proved prohibitive in an environment of adverse market sentiment. We waited till such time as there was a critical minimum level at which at least some people in the markets started thinking that enough was enough and demanded that the RBI intervene. That was when we considered it appropriate to hit hard and decisively— we turned the anti-rupee sentiment into a pro-rupee sentiment.
In all this, timing was key.
At the RBI, one of the highlights was the chance to meet and interact with distinguished people. I served under Manmohan Singh and worked with P Chidambaram, Yashwant Sinha, and Jaswant Singh. The RBI board meetings were a delight. The Board of Directors included many eminent people – scientists such as APJ Abdul Kalam and UR Rao; industrialists such as Ashok Ganguly, Ratan Tata, and Narayana Murthy; economists such as A Vaidyanathan and Mihir Rakshit; and social workers such as Amrita Patel and Sashi Rajagopalan. The insights and perspectives gained during our regular meetings, as well as relationships formed during those sessions, still stay with me. I hosted many central bankers from other countries and a G20 summit (which at that time came and went without much fanfare). I also greatly enjoyed my interactions with journalists and looked forward to the friendly banter and repartee I shared with them. My job as RBI Governor was the ultimate in satisfaction, and in many respects, the highlight of my entire working life.
Professionally, I had had a dream run and my working life had been intense, eventful, and consequential. In addition, I was immensely fortunate to be recognised for my work internationally and nationally, including with a Padma Vibhushan.
YV Reddy was born on August 17, 1941. He is an Indian economist and a former IAS officer of the 1964 batch belonging to the Andhra Pradesh cadre. Reddy served as Governor of the Reserve Bank of India from September 2003 to September 2008.