Dr Y.V. Reddy, deputy Governor, RBI, speaks to BT's Roshni Jayakar on the challenges facing the banking sector. Excerpts:

Banks, whether private or public, will have to compete and be efficient

Q. It is ten years since the start of fiscal reforms and the liberalisation of the financial sector. Where does the sector stand today?

A. You have rightly combined fiscal reforms and the liberalisation of the financial sector because both are closely linked. While the end to automatic monetisation of the government deficit is the most crucial step in fiscal reforms, there is still a long way to go in terms of fiscal consolidation. There is a need for not only reduction in revenue deficit but also enhancement of quality of fiscal adjustment through fiscal empowerment.

As far as the financial sector is concerned, its progress has been significant alhough further acceleration is possible only once fiscal reforms pick up.

What would be our major achievements? The external sector, for instance, seems a winner...

Yes, it's a sure winner. The achievement is particularly impressive because the international experience as well as intellectual opinion on exchange rate management has recently moved dramatically in favour of our policy package.

Actually, we withstood domestic uncertainties and external shocks; in addition we have strengthened the capabilities to meet exigencies, with a build-up of forex reserves and the flexibility in the management of monetary policy and financial markets.

Overall, the tasks ahead in fiscal and financial sectors are essentially structural in nature and the milestones have been identified by the ten advisory groups set up in the context of international standards and transparency codes.

The Indian banking and financial sector survived the crisis of 1991, the securities scandal of 1992, the Mexican tequila effect, the Asian contagion, the non-banking companies scandal, the Pokhran effect, and the bubble of 2000. However it still seems vulnerable in terms of its long term survival-particularly the profitability challenge that it faces and the huge problem of non performing assets.

I do not agree that it is more vulnerable now. There is greater sensitivity and consciousness about what has to be done. The resilience in the banking sector is mainly because a number of recommendations of the two Narasimham committees have been implemented. What remain are essentially structural reforms.

The problem of NPAs exists but it is inappropriate to put the responsibility solely on the banking sector in as much as the overall credit recovery system and credit culture are still to be improved.

Given the precarious state of some public sector banks would you say the role apportioned to the banking sector through its nationalisation in 1969 is still relevant. Is the public vs private debate still relevant?

I agree with you about the precarious state but it is not of some but only of one or at the most two or three of the public sector banks and a few private sector banks too. Whether it is public or private sector, there will be some banks that are not strong and some that are strong. The critical issue is of really improving the overall efficiency of the banking system.

Banks are banks and they have to compete. They have to be efficient and regulated properly irrespective of their being public-or private-owned.

In terms of monetary policy, the RBI has moved towards a softer interest rate regime. This conflicts with the huge borrowing programme of the government. And the fact is that this hasn't quite triggered a rise in credit offtake. Could we then say that the monetary authority's role in triggering growth is now limited?

In a particular context, a softer interest rate regime may be alright but the general thrust of the monetary policy is towards appropriate interest rate. According to the monetary policy statement, there are rigidities in the interest rate regime in India. The financial markets are not well-developed. The financial institutions themselves are in a state of transition. The impact of the monetary policy should be viewed in this background, and in any case the credit offtake and the overall output are functions of several factors. Monetary policy in India, we believe, is playing an enabling role.