V. Sridhar

BANGALORE: Policy makers the world over are facing “dilemmas” in trying to evolve an “exit” from the policy of monetary expansion, which is in response to the global financial crisis, former Reserve Bank of India Governor Y. V. Reddy said here.

He said: “An exit cannot be done too early, nor can it be too late. Too early an exit will lead to instability and too late an exit will cause inflation. Any exit has to be timed right.”

Dr. Reddy was delivering the inaugural address at an international conference on public policy and management at the Indian Institute of Management (Bangalore).

Dr. Reddy said authorities — political as well as heads of central banks — would need to take a “judgment call” based on “signals”.

“Any exit has to be gradual,” he said. Although countries have to take into account their specific characteristics, they would also have to take “concerted action,” he added.

Providing an outline of the financial crisis, which escalated into a “global economic problem,” Dr. Reddy asked: “What do we mean when we say we want to go back (in terms of tightening liquidity again)? Do we exit so that we go back to status quo ante?” “There is a big debate about how to exit,” he observed.

The former RBI Governor said, “Public policy did not do very well in preventing the global economic crisis, especially because of excessive deregulation.”

There has been a failure of governance and there has been a failure of regulation, he added.

Referring to the role of the private sector, he said, “company boards, audits, committees, rating agencies and managements have failed,” “This is about the failure of the government, the market and regulators. The role of intellectuals and the media was also not very different,” he added.

“There has been a moral failure,” he remarked. “Serious issues with respect to the governance of financial markets remain (unresolved).”

Referring to the Basle norms governing supervisory norms in the global banking industry, Dr. Reddy said they were essentially “pro-cyclical” in character.

The emphasis on “self-regulation” rather than “external” regulation posed systemic risks. Moreover, the risks in the system were “exaggerated because all institutions depended on the same models.”

The growth of “off-balance sheet items such as derivatives’ also compounded risks, he added.

The fact that there are only 15-20 rating agencies and that only two financial information companies control information flows in the industry suggest that it is not as competitive as is made out to be, Dr. Reddy said.