Interview with Dr. Y.V. Reddy

Dr. Y.V. Reddy, the governor of India’s central bank for five years until September 2008, rarely makes public appearances or comments about contemporary macro-economics and policy-making. During his tenure, Mr. Reddy was criticized for introducing tough lending standards for banks and for putting curbs on derivative products. But, his supporters say, those were the things that stood India in good stead in the global financial meltdown and liquidity crisis.

WSJ: Is the fiscal dominance of the government through its large market borrowing worrisome?

Mr. Reddy: The issue of fiscal dominance has been a factor for most of the time in India. It is worrisome, it continues to be worrisome. Sometimes more worrisome, sometimes less worrisome but it’s not new.

WSJ: India still faces the fallout of adverse events in 2011, which are more or less an extension of the crisis of 2008. So, it has been a really elongated period of crisis, globally and in India. How do we see the economy through without stumbling?

Mr. Reddy: To say that when an economy is growing at 6% and 7% and to say that there is a crisis, when there is no financial instability, that is inappropriate. You can’t call an economy growing at 6% and even assuming that the inflation is high at 8% for an emerging market economy — 8% inflation, a current account deficit of 3% — in what way is it a crisis?

Yes, it is a disappointment relative to expectations. You can say expectations were high. To say that it is a crisis is wrong. It’s a crisis of inappropriate expectations. So what is the solution? The solution is to reset the expectations. In my view, you have to reset. And reset the expectations, both with regard to the Indian situation as well as the global situation; and there definitely the global situation is worrisome.

So, if you want to use the word “crisis” the rest of the global economy is having more crisis than India by any objective indicators.

WSJ: There is a worry over the trade-off between growth and inflation in India–we have entrenched inflationary expectations on one hand and sagging growth on the other. What is the way out?

Mr. Reddy: There is no trade-off between growth and inflation in the long run. There’s no trade-off in that sense. And secondly, inflation to the extent that there are supply side problems — the supply side problems are common for growth and inflation.

There is a trade-off. If the supply side factors are overcome, it will improve the inflationary situation, which will improve growth. The focus has to be on how to remove the supply in-elasticities, which will tackle both growth and inflation.

So, the answer to your question is that you can get over the problem of trade-off by concentrating on and improving the supply response. If you want to get over the trade-off, focus on the supply side. That is the root of the problem.

WSJ: Do you think the potential growth rate of the Indian economy has fallen to a worrisome level?

Mr. Reddy: The most important thing is to get a fix on productivity and the potential output. I think that is very critical for any economy. Ultimately, your potential output growth is a function of savings, investment and productivity – so you have to get a fix on productivity at the outset.

But, it is very difficult to get a fix on productivity except in terms of a range. About seven to eight years ago, when we recorded a growth rate of 9%, the range was actually 7% to 10% — a wide range. But definitely, when we clocked 9% at that point, we at the Reserve Bank were worried that there was a sort of overheating, which means that about eight to 10 years ago, the potential output was less than 9%.

Whether it was 8% or 7% is a different matter. So, if today it clocks at 8% or anywhere between 7% or 8%, then it does not indicate the deterioration of the potential output. You can say it is static.

So, first point I want to make is it’s not correct to say that the potential rate of output in India has come down. There’s no indication that it has come down. There’s no indication that it has gone up either.

In terms of broad range, if you want to get a fix on the potential output growth rate for India, it still continues to be the second highest in the world. As I said, whatever the range we’re talking about, it cannot be less than 7.5%, it’s not 9%.  But, there is a pressure. Let me be honest, that the potential rate of output has not been growing.

There’s no evidence that it has gone down, global factors have been adverse, domestic vulnerabilities have increased. So that I accept, but to jump to the conclusion that there’s a drop in potential output is not favorable. I think that is hasty conclusion.

(WSJ 16JUL12 Former RBI Chief YV Reddy)


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