It is most unfortunate that the idea of setting up a Financial Stability and Development Council (FSDC), announced by Pranab Mukherjee as part of the 2010-11 Budget, is fast degenerating into a narrow turf war between babus in North Block and RBI. No wonder the only issue being debated so far is who should head the FSDC— someone in finance ministry or the central bank. No one is really talking about the real issue of what the financial stability council will do in terms of contributing to our knowledge of potential risks that may emanate from either the domestic or global financial system in the future.
Indeed, the Council is being set up against the backdrop of the global financial crises of 2008-09, which did not affect the Indian banking system partly because our banks did no business with their western counterparts in terms of sharing the risks contained in the trillions of dollars of dud derivative assets. Indian banks largely steered clear of toxic assets, although many private sector bankers repeatedly pleaded with the then finance minister P Chidambaram to be allowed to buy into the global derivative market, simply because easy money was being made.
As is now widely recognised, India did a decent job of regulating the banks with strict micro prudential norms. RBI discouraged too much easy money coming into the Indian real estate sector, thereby preventing the kind of bubble that got built in the western housing markets. RBI may have gone overboard in other aspects of monetary policy making which impacted growth. For instance, it was criticised for keeping interest rates too high for too long in 2008 which could possibly have retarded GDP growth by a few percentage points.
Many central bankers around the world were baffled by the sheer volatility in commodity prices—driven by easy money on Wall Street—which made anticipating inflation behaviour an impossible task. So central bankers ended up making the mistake of raising interest rates too rapidly, not realising that a deflationary bust cycle was around the corner!
These are entirely new behavioural issues caused by the high risk taking global market participants that need to be urgently studied. Mind you, these issues have not gone away yet. Cheap money being thrown around in the western financial system is building another commodity bubble. Commodity prices, especially of oil and some metals, are today at the same level as they were at the peak of the 2007 boom.
India today is again on the threshold of importing massive inflation from the rising global commodity prices. Human memory is short and we seem to have forgotten about the G-20 promise to study asset bubbles under the aegis of the Basel Committee. India is trying to come back to an 8%-plus GDP growth path and this will become possible only if it can import commodities at reasonable prices to fuel sustainable growth. Assessing and mitigating the risks arising from unusual volatility in asset prices is therefore a very critical task for emerging economies like India.
Indeed, these are the real issues which a body like the Financial Stability Development Council must address in a spirit of healthy cooperation with the central bank. One is not sure whether the turf-conscious babus of North Block are at all aware of the big picture that is staring at us. As far as the venerated Indian Administrative Service (IAS) is concerned, the FSDC is another platform which they must capture.
So far, the informal word out of North Block is that finance minister Pranab Mukherjee will head the FSDC, which is to be a purely advisory body. The finance minister did well to clarify that the FSDC will not act in any manner prejudicial to the autonomy of the current set of regulators.
Some bright babu had also suggested that the FSDC must get a statutory status through an Act of Parliament. An internal note to this effect was moved. But the seasoned finance minister was smart enough to realise that in a fractious coalition system this would be fraught with other risks. An unpredictable coalition system also cannot guarantee that you get balanced and statesman-like finance ministers all the time. Conceptually, the political class cannot be expected to be detached enough to research and regulate professionally. A body of knowledge, in this regard, is built over the decades.
The larger issue is what the government’s direct involvement in FSDC will do to the progressive maturing of India’s regulatory regime. Over the years, the finance ministry and RBI have evolved a relationship in which the latter has been accorded more and more autonomy to oversee monetary stability and to operate the currency and credit system of the country.
This process had gathered momentum after the launch of economic reforms in 1991-92. It is true that RBI is a peculiar multi-service central bank that performs many roles. Central banks in other countries don’t get involved in such multiple functions.
Managing government debt, micro-regulating banks through a regular reporting process, overseeing development of new financial products which have an impact on interest rates or exchange rates are all functions RBI undertakes at present apart from its core objective of maintaining price stability.
It can be argued that RBI has too much on its plate and must gradually divest itself of some of the current roles it performs. If so, this must be done in a manner that does not affect the integrity of the institution which has painstakingly evolved over decades and served the needs of the country.