Duvvuri Subbarao, Governor of the Reserve Bank of India, struck an optimistic note on India’s growth path through the recent financial crisis and its prospects for the future.
Speaking at the Peterson Institute here on Monday following his attendance of the Spring Meetings of the International Monetary Fund-World Bank over the weekend, Mr. Subbarao said, “The growth drivers that powered India’s high growth in the years before the crisis are all intact.”
He added that the challenge for the government and the Reserve Bank of India was to move forward with reforms to steer the economy to a higher growth path that was sustainable and equitable.
Mr. Subbarao touched upon five key policy areas during his speech — capital flows, exchange rate management, inflation targeting, the harmonising of monetary and fiscal policies, and necessary improvements in India’s monetary policy transmission.
Arguing that India clocked an average growth rate of 9 per cent in the five years prior to 2007–08, he said that growth momentum had indeed been interrupted by the financial crisis, “more than we had originally thought but less than it did most other countries”.
He said that despite growth falling below 6 per cent for one quarter, the growth for the full year 2008–09 was “a resilient 6.7 per cent… [and] current estimates are that the economy had grown between 7.2 and 7.5 per cent for the just ended fiscal year 2009–10 and that growth for 2010–11 will be +8 percent”.
On capital flows, Mr. Subbarao said, “India’s approach to managing capital flows too has been pragmatic, transparent, and contestable. We prefer long-term flows to short-term flows and non-debt flows to debt flows.”
He corroborated this policy stance with evidence from the aftermath of the financial crisis: “The recent crisis saw, across emerging economies, a rough correlation between the extent of openness of the capital account and the extent of adverse impact of the crisis. Surely, this should not be read as a denouncement of open capital account, but a powerful demonstration of the tenet that premature opening hurts more than it helps.”
Mr. Subbarao added that it was notable that the IMF published a policy note in February 2010 that reversed its long-held orthodoxy and admitted there could be certain “circumstances in which capital controls can be a legitimate component of the policy response to surges in capital flows”.
Regarding exchange rate management, Mr. Subbarao clarified that the RBI intervened in the market only to smooth volatility that is harmful to trade and investment. He said the “abrupt” reversal of capital flows in the crisis year 2008–09 — in marked contrast to prior years — however showed that India did in fact have a flexible exchange rate, and “also evidences the increasing flexibility of the rate over time in relation to the magnitude of flows”.
On inflation targeting, Mr. Subbarao claimed that the RBI would never be a pure inflation targeter given the larger developmental context in India. He further said, “Price stability does not necessarily ensure financial stability.”
However, he noted that with regard to harmonising fiscal and monetary policies, both the government and the RBI had begun the process of exit from the expansionary stances of the crisis period. “The government has programmed a reduction in the gross fiscal deficit from 6.8 percent of GDP in fiscal year 2009–10 to 5.5 percent of GDP in 2010–11,” he explained.
On India’s monetary transmission mechanism, the process by which the central bank's policy signals influence the financial markets, Mr. Subbarao said in India it “has been improving but is yet to fully mature”. However. he said that improving monetary transmission was important if the RBI’s efforts at promoting growth with price stability were to be effective.
