Financial Daily from THE HINDU group of publications
Monday, Dec 29, 2003
Money & Banking - Insight
Reflections on scoring a century
It is a striking coincidence that Dr Y. V. Reddy, who was then Joint Secretary in the Ministry of Finance helping to monitor the BoP, is now in charge of the Reserve Bank of India. He was an important player in many of the decisions taken at the time, including the controversial one of shipping of part of RBI's stock of gold.
The trauma of that transaction gave an impetus to the reform process, bringing home as nothing else could, the gravity of the crisis.
It is a pity that apart from anecdotal recollections of the events of the 1990-91 crisis, an authoritative report has not been published as to the origins of the crisis and the various steps taken to surmount it. While the various reports of RBI are rich sources of information, RBI should definitely bring out a detailed story of how the crisis arose and how it was overcome.
True, the High-level Committee on BoP, headed by Dr C. Rangarajan, has included a brief, but too brief, summary of the events. RBI should attempt a more comprehensive report to fill in the gap about a critical period of India's economic history.
My own recollections were of a pervasive sense of doom when I took charge of the RBI in December 1990. The foreign exchange situation was causing anxiety. I recall meeting Dr Manmohan Singh, as Adviser to the then Prime Minister, Mr Chandrashekhar.
As I came up with the idea of using gold, he took me to Mr Chandrashekhar. I gave expression to my thoughts on the subject, although I had not worked out the details. Mr Chandrashekhar's reaction was one of guarded acceptance. He wondered how the political parties would view it. He cautioned secrecy.
At the same time, he expressed the view that Rajiv Gandhi might be opposed to it. At least, Government's political opponents would derive mileage from the spectacle of gold going out. He proved prophetic!
I must explain that at one stage in the process, I did call on the Rajiv Gandhi, who was supporting Chandrashekhar's Government at that stage. He was his gracious self when he discussed the various economic problems. He felt that of the alternatives being canvassed, he would not be averse to pledging gold. After all, he asked, what is the country's gold for if not for use in an emergency.
The decision to move gold was not an easy one. The consent of the then Finance Minister, Mr Yashwant Sinha, was obtained and the transaction undertaken in two stages. In the first stage, gold smuggled and kept with Government of India was transferred to SBI, which then took a loan from a Swiss Bank on a sale and repurchase transaction. It was, in effect, a gold "repo" transaction.
The more dramatic transaction was that involving RBI's own stock of gold. International Monetary Fund was already considering assistance to India in response to a request made to it. It expected India to use its gold reserves as collateral to raise money from international sources.
Before we asked other countries for aid, it was only reasonable, so ran the argument, for India to use its own gold reserves. We argued in vain that we should be allowed to pledge the gold while keeping it in our own territory, since the RBI was already an international depository for IMF's gold. But, this argument did not prevail.
The international lenders insisted on our moving the gold physically out of India's borders. This insistence itself was an indication of how low India's credibility had come. We had to swallow our pride and send the gold out to London. The details of that transaction have been told elsewhere.
The transaction was carried out under the able leadership of the then Deputy Governor in charge, the late R. Janakiraman, under the watchful guidance of our guru Dr C. Rangarajan. The Bank of England received the gold stock both on its own behalf and on behalf of the Bank of Japan, both central banks, crediting India's reserves with the proceeds.
The root-cause of the 1991 crisis was a sudden lack of liquidity. The Middle East crisis, which burst on the world with the first Iraq war, had depressed the prospects of fresh NRI deposits. The price of crude was rising. India's own political situation was messy. International rating agencies had also lowered India's credit rating.
On top of all this was the phenomenon of flight of capital. The fall of reserves during the crisis also reflected in part an exodus of money both by residents and non-residents.
The main villain of the piece was, however, the short-term debt contracted by India through SBI taking on "Bankers' Acceptances" credit limits to the extent of a few billion dollars. Credit raised against Bankers' Acceptances had been used during the previous years for financing imports, principally crude and petro-products by Indian Oil Corporation (IOC).
When the time came to pay up, the RBI's reserves were too low to help out SBI. SBI had no other recourse. It had to seek a rollover of credits, which became difficult.
The saga of our search for a solution to the immediate problem has also been told elsewhere. There were doubts, however, expressed at the time about the wisdom of not defaulting. Influential advisers to the then PM felt that not defaulting on one's debt was a bourgeois virtue and no great harm would come to India if it defaulted.
Fortunately, these siren songs in favour of default went unheard. We decided to go the extra mile to see that the credit reputation of India be preserved. The consequences of default are too serious to be ignored. The recent experience of Argentina and Russia shows the extreme consequence of default, which we avoided.
This brief recital would serve to remind us of the distance travelled and the benefits of economic reform initiated by Dr Manmohan Singh under the leadership of Mr Narasimha Rao. True, the current level of reserves is an embarrassment of riches. But, this should not blind us to the dangers that we have avoided. Another time when we had such a feeling of abundance, but not the same order, was when we had large sterling balances. During World War II, we went on accumulating external balances through our exports of goods and services to Great Britain.
The sterling balances, however, became a shadow of their original worth, when Great Britain devalued. The current situation is not, of course, on all fours with that India faced in respect of sterling balances. But, there is a lesson in this. Our reserves are today being invested in a potentially falling currency, the greenback. Their value is in danger of being eroded.
It should be possible to use our reserves for faster development of India instead of the US. However, to use reserves for rupee expenditure will end in their return to fill the RBI's coffers. It should not be beyond the central bank's ingenuity to place part of the reserves with the selected lending institutions, like ICICI, SBI and SIDBI, so as to lend the funds in forex at close to international lending rates to Indian entities seeking fresh equipment.
The utilisation of these funds should be primarily directed to finance imports of technology and equipment as also acquisition of foreign companies for enhancing India's export competitiveness. Our reserves are held in the form of IOUs from richer countries. Part of them should be cashed to import equipment and acquire real assets in those countries.
The problem of management of abundance is at least as tricky, if not more that of scarcity. But, we cannot wish away our good fortune. We have to use the conjuncture of high reserves and low inflation to make possible a bolder public investment policy.
Agreed, the time is definitely not ripe for other ways of utilising the reserves, such as capital account convertibility. But the time is surely opportune for using the strength of the forex pool to support a bolder investment stimulus as we have the wherewithal to offset inflationary pressures. That will surely help us realise our dream of a higher rate of both GDP and jobs.
One hopes the forthcoming Budget will outline a strategy for using our abundance of forex to create a platform for meaningful growth, which will keep "India shining" for the millions of the youth seeking jobs jobs for which they are qualified and which will help them to escape the depths of poverty.
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