Wise Investor

RBI leads the world Vol 3 - Issue 8 | November 2009 | Rs.3.50

inside margin compression threat

2,3

16 golden rules of investing

3

tightening starts

4

chasing value

5

by invitation

6

ethics in finance global strategy & allocation stance

7,8 9

life support to be maintained

10,11

thoughts from the frontline

12,13

life in the time of great recession

14,15

global insight

16,17

mutual funds demystified

18

taking note of

19

voices

20

best & worst-india

21

best & worst-global

22

performance tracker-india

23

performance tracker-global

24

equity chart book

25

fixed-income chart book

26

commodity chart book

27

investment quiz

There is an intense debate raging world wide on whether central banks should just focus on managing inflation or should they also target financial stability. The India experience clearly shows that there is a robust case for the central bank to focus on financial stability with equal zeal as they do in handling inflation.

regulatory capture and low interest rates that brought this crisis have a vested interest in ensuring that central banks focus just on inflation. This coupled with spins on Great Moderation led to ultralow rates for too long. It has led to one bubble after another and the response to this crisis is bringing one more.

It is this prescient approach that helped the Reserve Bank of India to adopt policies that ring-fenced the banking system from the financial crisis that has engulfed the developed world.

Notably the RBI has already embarked on moves to roll-back the flexibility that was provided in the Q4 2008.This is reflected in its moves to enhance provisioning in the Monetary Policy Statement in endOctober.

Just the state-owned nature of parts of the banking sector was not the key factor that helped India avert the problems. We must remember India today has a private-sector presence in financial services that is significant and increasing by the day. Parts of this space could have embarked on ultra-risky products and services but for the prudential regulation by the RBI for the banking system. Successive RBI Chairmen, especially DrY V Reddy, have been ahead of the curve in imposing prudential norm on real estate lending, securitisation and provisioning for doubtful assets, to name a few. It is the focus on financial stability (in addition to inflation) that helped fashion such a robust response. In an article in The New York Times (December 19, 2008) on how India avoided the crisis, the Chairman of HDFC, Deepak Parekh was quoted saying `He saved us’ of Dr Y V Reddy. In the context of the proven and informed experience in India, the global debate appears uninspiring. The forces of

What the RBI has also shown is that a focus on financial stability does dovetail neatly into its overall policy framework. It has also shown that as a central bank, you need not be restricted in the pursuit of financial stability by theory that holds such an institution should focus on managing one variable – almost always just inflation. In our view, the central bank should pursue management of inflation and financial stability. Norway has taken a small step in the past week towards this objective. So the tide appears to be slowly but surely shifting on the world stage.The RBI has been there for years now. The approach of the RBI has come for high praise from independent thinkers. Sample for instance the view expressed by Christopher Wood, Managing Director & Strategist, CLSA Asia-Pacific Markets, a rare independent research outfit. Nobody has been scripting the financial and economic crisis as well as he has, though there are a long list of persons who saw

the crisis early. So his views are of significance. This is the view Christopher Wood has expressed in the latest edition of his weekly, `Greed & Fear: `If policy will remain easy in the West, there will be growing talk of the need for Asian policymakers to turn pre-emptive. GREED & fear has long viewed the Reserve Bank of India (RBI) as the world’s most credible central bank and it has made a pre-emptive move this week by ordering the banking sector to increase its Non-Performing Loans (NPL) coverage to 70% of gross NPLs by September 2010, up from the current sector average of 60%. The reality is that the pre-emptive nature of the Indian central bank in recent years has helped ensure so far a remarkably smooth credit cycle given the scale of credit growth seen this decade. Thus, Indian total bank credit has risen by an annualised 22% over the past ten years, up from 22% of GDP to 55% of GDP’. What is significant about the RBI approach is that it has almost completely steered clear of influence by Delhi though it may not appear so going by what one reads in print or hears in the electronic media. It also shows that the RBI Governor’s approach has had the backing of the Prime Minister, thereby helping curtail pressures from other parts of the government. If a central bank focuses on inflation and financial stability by staying ahead of curve, growth will take care of itself. We think the RBI approach has been the silent star of the India growth story. We hope and have confidence that this crucial element will stay an integral part of the Indian economy in the years ahead. This should be good for the economy and investors.

T.P.Raman

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Managing Director Sundaram BNP Paribas Asset Management

Sundaram BNP Paribas Asset Management

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The Wise Investor November 2009