Tuesday, March 30, 2010

The Federal Reserve Bank of India?

The crisis of 2008 had revealed beyond doubt that regulators and policy makers contributed to it in no small measure. It is also a fact that regulatory and policy failures were not of the same nature everywhere.

In the US, the belief that failures were mostly regulatory in nature is now gaining ground. There is, of course, some criticism of monetary policy as well, but it is clear that de-regulation of financial entities bears a significant share of the responsibility. Also, proof of monetary policy successes in the US is available in plenty, especially after 1980. The belief that excessively loose monetary policy led to successive asset bubbles is rational as well, but an asset bubble needs regulatory support. Monetary policy, by itself, can create the required environment, but a bubble cannot be inflated if regulators remain vigilant.

India, on the other hand, experienced the crisis differently. An exceedingly pragmatic regulatory environment ensured that the Indian Financial system was completely insulated from contagion. But monetary policy ensured that India suffered around the same time and almost the same fate. For a detailed discussion, please read my earlier note - Inflation and the RBI. In summary, we can conclude that the RBI has been an excellent regulator, but has performed disastrously in the conduct of monetary policy.

Now, imagine an environment where the RBI's regulatory expertise and the Federal Reserve's monetary policy skills could co-exist. Monetary policies designed for a low inflation, high growth environment could be coupled with a regulator vigilant enough to prevent undue risks to the financial system.

The Indian Economy would grow at the pace needed to create enough jobs for our rapidly growing workforce. The Indian Rupee would be a strong and stable currency, one the world would trust. Inflation would remain low because of currency strength, and interest rates would remain low as well. Growth would be driven primarily by domestic consumption and prosperity of the local populace driven by job creation. The regulatory environment would include enhanced deposit insurance which would result in even more trust in the financial system. Strict regulation of banks and other financial entities would ensure that they did not take undue risks with depositor money, either as deposit taking institutions or as second level intermediaries, which would in turn protect entities insuring the deposits. In short, the present regulatory environment with skilled monetary policy conduct.

That's what dreams are made of.... And all it takes is for the RBI to open it's mind.

1 comment:

  1. who,my friend,is this mythical vigilant regulator?
    are we to depend on the existence of selfless omniscient regulators?who will regulate this regulator?
    there is no regulator worth his salt outside of the free market.
    babus,saints,nerds,intellectuals -all have tried and failed before.some may succeed,to prove the exception.lets not be utopian and pray for vigilant regulators.its a pipe dream