The Reserve Bank of India (RBI) governor, Duvvuri Subbarao, expressed fear that the next financial debacle could stem from a currency crisis or from the way the government handles its ‘stimulus exit’. Speaking at the first International Research Conference organised by RBI here on Saturday, Subbarao said,
“I worry that in resolving this financial crisis, perhaps we are sowing the seeds of the next crisis. Next crisis could be a currency or a fiscal crisis.” The central banker, however, denied that RBI would back out from its commitment to full convertibility of rupee but would impart flexibility to its pre-determined course in the light of the recent global economic developments.
Participating in a panel discussion, the RBI governor said the developed economies may fail to wind down their borrowings, leading to cyclical deficits morphing into ‘structural fiscal deficits’, affecting the system as a whole. In the wake of global credit crisis, following the US sub-prime crisis in 2008, many governments and central banks pumped in huge funds and resorted to low-interest-rate monetary policies, for boosting their sagging economies. These have resulted in bloating of fiscal deficits.
Calling for adequate attention to address current global imbalances, Subbarao said that the saving grace of the recent crisis was that these imbalances were confined to the financial sector, and did not explode into a currency crisis.
This is not the first time that Subbarao has expressed his concern about the fiscal deficit.
In the third-term review of the monetary policy, he identified rising fiscal deficit as the biggest risk to both short- term economic management and medium-term economic prospects. In this context, he emphasised the need for the government returning to the path of fiscal consolidation with a clear roadmap.
“It is important that there is co-ordination in the fiscal and monetary (from easy money policy) exits. The reversal of monetary accommodation cannot be effective unless there is also a roll- back of government borrowing,” he argued.
The consolidation can begin with a phased roll- back of the transitory components in the stimulus, Subbarao added. Though spiralling inflation has been the serious emerging concern, the governor was of the view that pure inflation-targeting would not work in India, with both growth and financial stability commanding equal priority.
Inflation is threatening to cross the RBI- set limit of 8.5 per cent by end-March, 2010, according to economists. Such a prospect could force the apex banks to resort to policy rate hikes, which in turn could affect growth pace that is just recovering from the recent slowdown.
“Inflation-targeting is important, but not sufficient. Price stability does not guarantee financial stability. You need to look beyond inflation-targeting,” Subbarao said.
RBI also wears different hats besides being the monetary authority. They include as lender to banks and non- bank financial companies, regulator of financial markets and debt manager for the Centre and state governments.
On full convertibility of rupee, he said, “Are you backing down from the capital account convertibility roadmap? The answer, I believe we are not. We are still traversing the roadmap, but we will re-work the roadmap depending on global developments,” the RBI governor said.
The next worry could stem from a currency crisis or from the way govt handles ‘stimulus exit’.
In resolving this financial crisis, perhaps we are sowing the seeds of the next crisis.
RBI would back out from its commitment to full convertibility of Re but would impart flexibility.
The developed economies may fail to curb borrowings… affecting the system as a whole.
The government should return to the path of fiscal consolidation with a clear roadmap.
Consolidation can begin with a phased roll-back of transitory components in stimulus.
Inflation-targeting is important, but not sufficient. Price stability does not guarantee financial stability.