Dr Reddy’s life-saving medicines

Independent institutions under independent individuals

Joe Nocera’s piece in the New York Times crediting Y V Reddy, former governor of the Reserve Bank of India, for pursuing policies that (relatively) insulated the Indian banking system from the global financial crisis, has some of India’s top bankers sounding like people looking back at their adolescence and thanking their strict parents or school principals for, well, being strict parents or school principals.

Now that those risks have been made painfully clear, every banker in India realizes that Mr Reddy did the right thing by limiting securitizations. “At times like this, you tend to appreciate what he did more than we did at the time,” said (Yes Bank founder Rana) Kapoor. “He saved us,” added (HDFC chief Deepak) Parekh. [NYT]

Now, a few experts, like V Anantha Nageswaran, have been arguing that Dr Reddy’s exemplary stewardship of the RBI was among the few bright spots in India’s economic management in the last five years. And as events proved, they were right.

Beyond individuals though, the underlying point is that independent institutions can deliver competent governance in their mandated areas even under bad governments. Of course, even independent institutions can be undermined over time, by packing them with less than independent-minded individuals. And that, unfortunately, might well be on the cards. The tenacious Dr Reddy is no more at the crease. The Election Commission could fall into the hands of Naveen Chawla, who the Shah Commission declared “unfit to hold any public office which demands an attitude of fair play and consideration for others.”

15 thoughts on “Dr Reddy’s life-saving medicines”

  1. I agree.

    The undermining of independent institutions in India is a massive danger that weak governments run by insecure parties exacerbate considerably.

    And I might also add that the undermining danger looms not just over independent institutions but also over (civilian govt order) ‘dependent’ ones such as the military.

    And then there are some dependent ones that should really be independent – such as state prosecution and law enforcement.

    After Shri YV Reddy, his replacement Subba Rao seemed to be doing a good job, I thought. Any indications to the contrary, Nitin?

  2. I have mixed opinions.

    RBI has been cautious, but too cautious. The way it restricts banks from opening branches including, is nauseating.

    Shouldn’t the number of branches be decided by market around a place, demand for credit etc, instead of RBI’s watchdog policy?

    I am still informed by many bankers that Indian banks fudge a lot of documents, bribe auditors to “ignore” certain anomalies and include lot of fraud documents for issuing or processing loans.

    I am sure experts like Ananth would know more about banking & RBI, but I felt RBI was over-regulating banking in India. It has grown to be an argus eyed granny with 60’s mindset, instead of being a young attractive 17 year old teen [post 1991!!!] 🙂

  3. Ultimately in a mature democracy, it is in the interest of the parties concerned to have an independent regulator. Then, when the party is out of power it can be assured of fair treatment. I guess that we have not reached that stage as yet.

  4. @Venkat

    I agree that there was some degree of avoidable micro management. But Reddy was absolutely spot on when it came to his major policies, brilliantly so. Many of his decisions (like raising interest rates last year, for example) were pretty much against the popular mood of that time, but he had the inteectual conviction to proceed with those.

    Thanks for the all those links.

  5. The NY times article essentially compares the the Fed with the RBI. I think a more valid comparison would be between the RBI and central banks of other emerging economies. Any perspective on that? Atleast I have not read about any financial crisis in Brazil, SE Asia or China – so they too appear to have taken a conservative stance during this period. of course, in the case SE Asia, it was probably helped by the scars of the crisis in the previosu decade.

    Apart from the issue of independent institutions, the other worry is whether we would continue to get administrators of the calibre of a Reddy or a Damodaran (ex-SEBI CM). We have already seen the serious depletion of quality in the political class over the last 4 decades or so. The current crop of senior beuraucrats are from the 1970s batch when private sector careers were very limited. As the batch of the 90s and the current decade come to the top, I fear things will get really bad.

  6. I suppose serendipity can be applauded too. BTW, if one looks closely, the applause for RBI would be for putting sever limits on capital migration – ie on Bharatiya banks and investment firms buying subprime, falsely floated as AAA, securities. Unless Dr. Reddy was looking at the way mortgage markets were being manipulated in US, by every intermediary, a highly unlikely scenario, it’s a hard case to make that RBI purposefully avoided the risk of securitization (especially the extremely leverage that entities took backed by these securities pricing boom).

    RBI was being typical command and control org of quasi-socialist country. It did nothing special to avoid the current global financial crisis other than being a socialist entity.

  7. serendipity?!! how easy it is to roll off criticisms or brush aside achievements. then, why should we be surprised when we get the governments and the bureaucrats we deserve.

    it will be useful to know if the sceptics here read and understood the steps that RBI took before they hit the keyboards with gusto.

    asking banks to bolster the investment fluctuation reserves when interest rates were too low was an act of foresight.

    suggesting that the profits of securitization be distributed only when the securitization SPV was wound up was a display of understanding of how investment banks and bankers worked.

    Dr. Reddy and the RBI may or may not have understood what was happening in the US mortgage market or mortgage finance market. But, to recognise that excessive credit growth would bring forth asset price booms and busts did not require one to know the failures in the US mortgage market.

    Also, to recognise that financial liberalisation was not akin to economic liberalisation and that the theories of perfect competition did not work in finance does not suggest a command and control mindset but clarity of mind a superior intellect.

  8. Sai
    “As the batch of the 90s and the current decade come to the top, I fear things will get really bad”

    I had the same fear. But think of this. In 15 – 20 years time, when we fear this would happen, the voting pattern would have changed completely, since many of the present school going kids would enter voting phase. Their brought up is completely different from ours and hence would their voting pattern be [hopefully!!] and this would force a new set of lawmakers to take centre stage who would reform the administrative system. Isn’t this like an utopian thought? 🙂

  9. I think the fear of not having good people in the future is overstated. Far more people are getting a good education and exposure today than say even a decade ago. The absolute number of good people will continue to increase.

    They can perform if they operate in an institutional context of independence and political non-interference.

  10. Dr. Nageswaran,

    What you say is true but it won’t have mattered if Indian banks loaded up on subprime MBS which were stamped AAA – this is what I call serendipity. They would have still met RBI’s conditions to take away liquidity from the economy when inflation started taking off in late 2006.

    Also, no one else were behaving the way the corrupt American rating institutions were. If Indian financial institutions were using SPVs based on false rating (in fact shop around for false rating), I am not sure RBIs rules on profit distribution regarding SPV would have mattered either.

    Finally, my point is not that RBI is not a cautious institute. On the contrary, it is too cautious. If it avoided a financial crisis, which it has in 1997 and early years of 00s (and of course since independence), it did so because it won’t open up – not because it prevented fraud that didn’t happen (and thankfully it didn’t have Chinese help to let the excess liquidity policies to continue without spikes in inflation).

  11. @Chandra

    [BTW, if one looks closely, the applause for RBI would be for putting sever limits on capital migration – ie on Bharatiya banks and investment firms buying subprime, falsely floated as AAA, securities.]

    This is definitely not true. there was no such risk at all of Indian banks investing in all this at all – why would they do it when there was such huge domestic demand for capital and the banks could get very attractive returns too for such loans. One just needs to have a look at the kind of low spread that even high yield bonds had upto 2007 (250 bps over treasury bond rate, for example). The yields on such bonds would be lower than what an Indian bank would get by loaning out to a good Indian company. Please note that one of the main reasons for growth in India was the huge NET INFLOW of capital during the last few years.

    The credit for Reddy is due mainly because he prevented a credit bubble from taking place in the domestic economy. For example, he intervened decisively when he notes signs of overheating in the real estate sector. Or when he stood firm in his stance of higher interest rates, despite severe pressure from chidambaram and the industry, that he would sacrifice some growth in order to control inflation.

    By disallowing distribution of profits until the SPV is wound up, he actually showed a keen understanding of the perils of securitization. What it did was transfer the risk back to the banks which originated the loans. hence, the banks still felt sufficiently responsible to not make reckless loans. Note that one of the primary reasons for the current credit turmoil in the US is becasue banks were actually inecenctivized to give loans to undesreving customers since they could securitize and shift the risk away to other investors.

  12. @Sai,

    Indian banks would have invested in US mortgage products, if allowed by RBI, for the same reason any other bank or investment company did – they were stamped AAA, which means risk of default is extremely low, and their value was growing along with boom in home prices. Apparent risk return profile appeared very good.

    Most non-Indian, primarily US, banks got into trouble precisely because they were holding their mortgage products on their balance sheet – ie they started believing their nonsense (although earlier on they were packing them and selling them). Again, the thing that saved Indian banks was that Indian banks didn’t become as corrupt and fraudulent as their counterparts in US with regards to home loans. But if they were allowed in invest in US mortgage products, ie if India didn’t have capital controls (which is why I say Indian banks got lucky), they would have gotten into trouble too irrespective of whether the banks are government owned or private.

  13. (Indian banks would have invested in US mortgage products, if allowed by RBI, for the same reason any other bank or investment company did – they were stamped AAA, which means risk of default is extremely low, and their value was growing along with boom in home prices. Apparent risk return profile appeared very good.)

    This, I repeat, is simply incorrect. I work in credit research and it is really amazing how invetsors were willing to take amazing degree of risk for marginally higher spreads – it was a crazy time. Please explain why an Indian bank would invest in a AAA bond in the US (4-5% at that time) when it can easily get a higher yield not just by loaning out to a good quality Indian company, but simply by invetsing in govt bonds! Forget all that, the returns on such a security would be even lesser than the cost of borrowing for the bank.

  14. @Sai, I am sure you are right. I don’t know what I was thinking.

    btw, which firm do you work for? Just curious – you may know a common acquaintance.

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