When Y.V. Reddy called on P. Chidambaram

Friction between the Union finance ministry and the Reserve Bank of India continues to be a matter of much speculation. And when a former Reserve Bank governor publishes his memoir, this aspect of the relationship is likely to draw attention.

Yaga Venugopal Reddy, governor from 2003-08, dealt with not one but two finance ministers: Jaswant Singh and Palaniappan Chidambaram. In a soon-to-release autobiography, ‘Advice & Dissent: My Life In Public Service’, however, Reddy, 75, goes beyond the usual skirmishes between the government and RBI. “It is hard to find the government’s version of dealing with the central banks. Since I worked in the government also, and dealt with the RBI, a part of the story relates to this," he writes in his introduction. In recounting his years in public service, Reddy also touches upon his time as a bureaucrat during the Plan era, being in the thick of action during the 1991 balance of payments crisis, and his years as governor during the boom preceding the global financial crisis.

Lounge presents an excerpt that touches upon farm-loan waivers, a topic of crucial significance today, and details the nuances of Reddy’s equation with Chidambaram, including the time he barged into the latter’s home. Uninvited, of course.

I opposed the proposal made in February 2008 to write off loans to farmers amounting to Rs60,000 crore. I argued my case before the finance minister, and at one stage before the prime minister accompanied by the finance minister. Economic logic including preservation of credit culture was in favour of RBI’s position. During the discussions, references were made to precedents of periodic write-offs in the past, urban-rural divide in growth, social unrest and farmers’ suicides. The arguments advanced were on the following lines. Fifty per cent of the population dependent on agriculture have to be content with 15 per cent of GDP. Worse, their per capita incomes were growing at about two per cent, while for the rest it was a multiple of that. This was a threat to social order unless immediate concern was demonstrated. Loan waiver was the best fit for this.

I could see the government was acting out of broader concern for the welfare of farmers. I suggested that the government should pay the money to the banks on behalf of the farmers. We suggested that the banks could be compensated by providing budgetary support over two financial years, but within a period of six months. I added that we could take this into account and provide for an enhanced transfer of surpluses from the RBI to the government. The scheme was implemented accordingly. I believe that as governor, I could advance arguments from the point of view of money and credit, but I had no legitimacy to question the judgement of the government on social order.

Monetary policy and management of the external sector are considered within the parameters of economic reforms. P. Chidambaram and I were in agreement on the broad directions of the reforms in the financial sector, that is, broadly rebalancing in favour of markets and designing a monetary regime and a financial sector that would serve the country in terms of higher growth with stability. However, we had differences of opinion and in judgement on the sequencing of reforms across the sectors, that is, finance vis-à-vis other sectors of the economy. There were also genuine differences in regard to the priorities for reform within the financial sector, especially between banking and capital markets.

Consistent with the prevailing beliefs, Chidambaram was keen that the financial sector should lead the process of reform. I had, however, taken the view that there should be reasonable amount of market elements in the real sector (the part of the economy that deals with the actual production of goods and services). For example, severe restrictions on access to trade in goods, infrastructure and non-financial services undermine genuine competition. Premature liberalisation of financial markets might result in misallocation of resources and induce distortions in the markets. The financial sector can facilitate and enable growth of the real sector but cannot lead or induce economic growth. He was of the opinion that the reforms in the real sector were not a pre-condition and, in any case, such reforms would take a long time. Hence, he felt that the financial sector reform could not wait and it might even induce reforms in the real sector.

The state of finances of the government were in urgent need of improvement, and fiscal consolidation was considered important by both of us. It meant that ideally current revenues should meet current expenditures (elimination of revenue deficit) and borrowings by the government (fiscal deficit) may be restricted to a reasonable level. I was particular that the fiscal consolidation should take place before, and the financial sector reform should follow rather than precede consolidation in the fiscal sector. Chidambaram demonstrated considerable consolidation in the fiscal arena and felt that reforms and liberalisation in the financial sector are slower than the progress in fiscal consolidation. While I deeply appreciated the progress that was being made in fiscal consolidation, I felt that the pace of the financial sector reform had to take into account the possible fiscal slippages in view of the political economy (namely, persons and groups with common interests using politics to effect changes beneficial to their sectional interests) considerations in our country. It is extremely difficult to roll back progress in financial sector reform unless there is a crisis, while the fiscal position can easily slip, and hence I wanted a firm and convincing evidence of fiscal consolidation to accelerate the pace of the financial sector reforms significantly.

I pointed out that the level of financial repression in India with continued existence of cash reserve ratio and statutory liquidity ratio at elevated levels put the financial institutions in India at a disadvantage compared to the financial institutions outside the country if our financial markets were opened up excessively. Above all, I was clear that the public sector banks were vulnerable in view of their limited capacities to participate in sophisticated financial market operations. While Chidambaram could appreciate many of these arguments, his major concern was maintaining the reform credentials and the pressure from various quarters to expedite the financial sector reform. Yet, after detailed discussions, we could arrive at a path that moved forward in reform on several fronts, without taking unacceptable risks. All measures in this regard were announced by Chidambaram after deliberations between the two of us, with a few exceptions.

Within the financial sector, I felt that the reform of public sector banks was most critical since banking dominates the Indian economy and public sector banks dominate the whole banking system. However, the skill levels in the organisations and the governance arrangements were not in a position to respond appropriately to the reforms of the financial sector without serious damage to their balance sheets. He was inclined towards consolidation in the public sector banks as a route to efficiency. I was not equally enthusiastic with consolidation because I felt that the issues in regard to public sector banking had more to do with the structure of governance and political economy, and not the size. In regard to all the improvements of the public sector banks that were possible under these circumstances, we were on the same page.

Chidambaram was also totally supportive of merger of weaker private sector banks with other banks, preferably other private sector banks. Thus, the banking system could virtually get rid of almost all banks with which there was a regulatory discomfort. This process is usually resisted by the political leadership till a crisis occurs, but Chidambaram provided unstinted support in this regard. Formal approvals of the government were needed for several actions which had to be obtained in utmost secrecy and great urgency. He obliged us even outside office hours. Improvement in standards of governance in banks was given priority by my predecessor (Bimal Jalan). I continued with the policy and this was also supported.

A major area of disagreement between us related to the development of financial markets. Chidambaram was keen about development of bond currency derivatives in an integrated manner. I explained that there were other priorities for the financial sector reform. I was particular that the integrity of the financial markets was important. In regard to debt markets, my position was that most parts of the debt markets relate to the government securities and the government securities market provides the basis for many benchmark rates. Hence, the development of the government debt markets had to be given a priority, and on this there was an agreement between us. We also agreed that the report of a committee headed by R.H. Patil should be the basis of reform in corporate debt markets. There were differences only in respect of sequencing of elements of reforms relating to corporate debt. Most of the corporate debt was privately placed or listed, but seldom traded actively, which were areas of concern.

After the budget of 2007, in the latter half of the year, C. Rangarajan wanted my suggestions for the position of chairman, Thirteenth Finance Commission. I offered myself as a candidate and I told Rangarajan that I would be happy to leave the present position since my relations with the minister were not as smooth as I would have liked them to be. After a few days, Rangarajan told me: ‘I mentioned to the finance minister that you are keen to go to the Finance Commission. The minister said that he was not willing to release you. Chidambaram said: ‘Even if Venu wants to go, I would like him to stay.’"

Despite the unwillingness of finance minister to relieve me, I felt that there was a growing distance between us as months passed by. His image as a reformer pushing for double-digit growth was, in his view, being dented by my caution to the extent of resisting implementation of some of his policies. At one stage, he said that he was cancelling his foreign tour because he could not face them with nothing to report on reform. His frustration was confirmed later, I think in early 2008.

Y.V. Reddy with then president V.V. Giri at the Ongole railway station, in 1969.

I got a call from the Prime Minister’s Office to say that I should travel to Delhi and meet the prime minister urgently, that too on a Sunday. Normally, the prime minister would not entertain visitors on a Sunday. I flew to Delhi not knowing what it was about, and after arrival, I rang up the finance minister, as I usually did, and informed him that I had been asked by the prime minister to meet him, and that I did not know the subject. I wanted to know whether he would like me to keep anything in mind, but he said: ‘There is nothing from my side.’

I met the prime minister (Manmohan Singh) in his house. He told me that he was having a fever. He was looking tired, and somewhat tense. He said: ‘Venu, the finance minister is very upset with you. I do not know what to do. I cannot be taking sides between Chidambaram and you. I am very worried about this.’ I responded: ‘Sir, you have many worries. You have many important issues. You please take care of your health. You need not bother about this problem. I will take care of my relations with the minister.’ He thanked me profusely. From the PM’s residence, I called Chidambaram over the phone and said that I would like to straightaway drop by at his home. He said, ‘There is no need for you to come.’ I replied: ‘Sir, I am coming, and I will not take more than a minute.’ I put down the phone without waiting for the answer and reached his home on Safdarjung Road, right around the corner from the PM’s house, within a few minutes.

I had called him on impulse but I did not think of what I would say. I could discuss with him and sort out the differences, so that we could work together, but I did not think that it was possible for both professional and personal reasons. I could resign and quit on health grounds, but that would be letting down the prime minister, who was always positive with me. It would not be fair.

I recalled the book release event in Mumbai in mid-June 2007. Chidambaram was releasing his book titled A View From The Outside: Why Good Economics Works For Everyone. I bought a copy of the book and took it to him for his signature. He wrote on the flyleaf, ‘For Governor Y.V. Reddy, one of my Economic Gurus.’ I felt that I should be warm and pleasant to a person who expressed such regard, despite our differences at official level.

I decided that I would render an unconditional apology for offending him in the past, and do nothing more. I could keep the option of retiring any time.

When I met Chidambaram he was unusually formal. He felt that while he was very supportive, the RBI was not adequately reciprocating by progressing with reforms. I expressed my unconditional apology to him and conveyed that I would keep in mind the issue of being supportive.

Y.V. Reddy at the Institute of Social Studies, The Hague, Netherlands, in 1968.

A couple of months before the end of my tenure, Rangarajan told me that Prime Minister Manmohan Singh was considering reappointing me as governor. I told him that I was already sixty-seven years old and, in any case, my relations with the minister were not great. He said that prime minister was thinking of a two-year and not one-year reappointment. Apparently, the PM was not sure about the political developments in the near future and wanted to secure the financial sector. Rangarajan asked me for my reaction to convey to the PM. I thought for a while and said: ‘Sir, I want to be relieved. But you can say that I will accept a three-year extension.’ I said this with the intention of politely conveying my rejection of the offer. Nothing happened after that. As my tenure was coming to an end, there was a rumour that I might accept an extension if it were offered. I had written in my new-year message to all officers and staff that I would be retiring that year. I wanted everyone, including me, to be assured that I would not continue beyond my current tenure. I conveyed to those interested that I had already sought and sought farewell while at BIS (Bank for International Settlements), Switzerland, in July.

The board met on 14 August 2008, and by that time no orders were issued about my successor. Rumours continued that I might have to postpone my departure. To convey that I would not continue as governor beyond the current tenure, I gifted the members a book titled The Last Lecture by Randy Pausch and Jeffrey Zaslow. The book, based on Pausch’s lecture on 17 September 2007, literally his last one, is described as one-of-a-kind last lecture that made the world stop and pay attention. I wanted to convey to the board that it was indeed the last board meeting I would attend. Farewell speeches were made by the members thereafter.

Chidambaram and I worked closely for over four years. Most of our tensions could be described as constructive or as discord that ultimately gave rise to better ideas or outcomes.

I moved out of the RBI on 5 September 2008. Chidambaram left finance and became home minister soon on 30 November.

Edited excerpts, with permission from HarperCollins India, from Advice And Dissent by Y.V. Reddy. The book will be released on 27 June.