He was stressing on financial stability while addressing on the topic RBI’s Role in India’s Growth and Navigating Global Challenges – at Princeton University, USA on 18 April.
“Financial stability is the bedrock on which an economy prospers and grows sustainably,” Malhotra said.
“Our pursuit of financial stability is duly reflected in our broader regulatory framework. We have been willing to sacrifice some short term upside for long term growth. While some regard this as conservatism, we believe it is prudence. This is evident from our resilience over various crises,” he said.
Malhotra also cited some examples.
When the Asian financial crisis swept through the region in 1997–98, it brought down currencies and economies that had been held, only months earlier, as models of export-led development. India watched from a position of comparative stability, and the reasons were not accidental, he noted.
RBI had maintained controls on the capital account, particularly for residents. Short-term external debt was maintained at levels well below what foreign exchange reserves could comfortably cover. It refused to permit the kind of short-term foreign currency borrowing that had left our regional neighbours exposed to sudden reversals in sentiment, Malhotra said.
When intervention in the foreign exchange market was warranted, the RBI acted — but it did not commit to an indefensible peg. India’s current account deficit was manageable and foreign currency exposure reasonable. The lesson embedded is that for a country at India’s stage of development, the sequencing of capital account liberalisation is not a technicality — it is a first-order question of macroeconomic sovereignty, he added.
“If the Asian crisis demonstrated the importance of external discipline, the subprime crisis of 2007-08 showed the importance of maintaining internal discipline,” Malhotra pointed out.
“As the global financial system was developing ever more elaborate and complex financial architecture through the mid-2000s, the RBI was doing something that appeared unpopular by prevailing standards. When in 2002, interest rates were falling and banks had no reason to anticipate a reversal, the RBI required them to build a counter-cyclical buffer called the Investment Fluctuation Reserve, against precisely that eventuality. Subsequently, during 2005-07, risk weights and provisioning requirements were raised, inter alia, for commercial real estate. On securitisation, recognition of profits was required to be spread over the life of securities. Moreover, accounting standards at the time did not permit the recognition of unrealised gains,” he noted.
None of these was particularly popular at the time. But when the global financial system came under stress, these measures gained significance. Indian banks came out of the crisis with relatively stronger balance sheets, Malhotra said.
“We continue to value financial stability. A number of measures have been taken in the last decade. Asset Quality Review launched in 2015, Insolvency and Bankruptcy Code (IBC), 2016; alignment of prudential norms to global standards, and governance reforms in public sector banks are some of them. On account of these, our financial system is very healthy and resilient today, thereby supporting economic development,” he said.
