Mr Rangarajan, congratulations on your appointment as the governor of Andhra Pradesh. You have had five trail-blazing years as the governor of the RBI. What do you regard as the real achievements of the RBI since December, 1992? And what is the unfinished agenda for your successor, Bimal Jalan?

In the first phase of the financial sector reforms, we were primarily concerned with the policy framework. We tried to strengthen the financial system as much as possible. With a reduction in the Cash Reserve Ratio and the Statutory Liquidity Ratio, the lendable resources of the banks have increased. They are now free to determine the rate of interest. The introduction of prudential norms has imparted transparency to the balance-sheets of the banks, and has made them more conscious about the quality of lending. We have also introduced greater competition in the system: 10 new banks in the private sector have been set up; quite a few public sector banks have been able to raise funds in the market; and the accountability of these banks has shifted partly in favour of their shareholders.

The second phase of the reforms should concentrate on the organisational effectiveness of the banks and the financial institutions (FIs). Customers have become more demanding, technological upgradation has become important, and organisational restructuring has become imperative. To fulfil these requirements, initiatives will have to come from the banks and the FIs. At the same time, greater autonomy needs to be extended to the banks to restructure themselves. In the previous credit policies, we have taken steps to improve the functioning of various markets: the money market, the government securities market, and the foreign exchange market. These markets will have to be made more efficient.

Recently, the RBI took steps to accelerate credit flows. We have given greater autonomy to the banks to assess the credit requirements of the borrowers. We have also asked them to provide credit to sectors where the multiplier effects of investments will be greater. However, the issue of accelerating credit flows to industry will need constant attention. Another task of the new governor should be to build a consensus on the issue of price stability.

Monetary policy acquired a distinct tenor during your tenure. Are you satisfied with its objectives as well as its achievements?

In fact, our financial sector reforms have two components: the conduct of monetary policy, and the strengthening of the financial system in terms of its basic functions. Monetary policy has emerged as an independent tool of economic policy. It has become more effective in achieving its objectives, the most dominant of which has been price stability.

Let me clarify that price stability is not an end in itself, but a means to ensure sustained economic growth. It achieves a number of things: it promotes savings, prevents the diversion of investment into speculative channels, and sharpens our export competitiveness. In addition, there is a social dimension to price stability. It protects people who have no hedge against inflation. For these reasons, we regard price stability as the most important objective of monetary policy. Stable prices facilitate--not inhibit--growth. The lowering of interest rates has been possible only because of relatively-stable prices.

As far as the weaknesses of the financial system are concerned, we have sharpened our instruments. The bank rate is emerging as a signal, and a reference rate. But for the bank rate to affect the system in the desired way, we need to create a functional correlation between the bank rate and the other interest rates in the system. Open Market Operations (OMO) have also become more effective, and will emerge as an important tool of monetary policy in the future.

Another hallmark of your tenure has been greater autonomy for the RBI. How soon do you think the RBI will become as autonomous as the central banks of the developed economies?

Autonomy has many dimensions. One dimension relates to the conduct of monetary policy. In this regard, the institutional arrangement that has evolved gives the RBI adequate freedom to pursue the policy it thinks fit. In a parliamentary democracy, there has to be a continuous process of consultation between the government and the central bank since the finance minister is answerable to Parliament for his economic policy. But monetary policy should, ultimately, be the responsibility of the central bank.

I must admit that there has been a greater congruence of ideas between the government and the central bank in recent times. The government has wanted to reduce the fiscal deficit, and there is a greater appreciation for the need to maintain price stability. If we can evolve a consensus on these issues, the RBI can, more or less, become as autonomous as its counterparts in the developed economies.

Sir, you talked about increased freedom to the banks to lend. Unfortunately, that has only increased the banks' hesitancy to lend. Why is it so?

Let me first restate that the traditional definition of non-food credit does not give a clear picture of bank credit to industry. However, even non-food bank credit has risen to Rs 3,400 crore in the first half of 1997-98 from Rs 2,382 crore in the corresponding period of 1996-97. And if we take into account investments in bonds, debentures, commercial paper, and preferential shares, the total funds flow from the scheduled commercial banks to the commercial sector this year has been Rs 11,980 crore--up from Rs 3,946 crore last year. It is, therefore, wrong to say that credit offtake has not taken place. If you look at last year's figures, you will see that an increase in non-food bank credit of Rs 27,000 crore took place in the second half of the year. If that happens in the current year too, there will be a considerable pick-up in the overall credit.

What is, however, true is that the banks' investments in commercial paper, bonds, and shares will, mostly, help highly-rated corporate borrowers. Therefore, I still stress the need for credit flows through the normal channels of loans and cash credit to expand. In future, the banks' flow of credit through investments will also expand. People are talking about the securitisation of loans, which is, basically, the conversion of a loan into security.

So, you also foresee an economic upturn soon Economic sluggishness could be due to a variety of factors. First of all, sluggishness is a relative term. Having grown very fast in 1994-95 and 1995-96, the growth rate of industrial production decelerated in 1996-97. The same rate of growth about a decade ago would have been regarded as satisfactory.

There are some sectors in the economy where capacity is out of alignment with demand. There is a likelihood of a pick-up in the demand for consumer durables following the recent increase in the salaries of government employees, the favourable impact of improved agricultural production last year, and the expected rise in international trade. I am hopeful of an upturn in the second half of fiscal 1998.

The supervisory arm of the RBI has drawn flak in the past two years, especially in relation to the Indian Bank Scam and the collapse of CRB Capital Markets...

One should not judge the system by a few instances, however unfortunate they may be. What should be evaluated is the quality of the supervisory system. We have made a number of changes in addition to setting up the Board for Financial Supervision (BFS). The focus of our supervision has shifted to liquidity, and management of the banks. And the frequency of supervision has increased. More importantly, we have introduced a time-schedule according to which, within a year of the closing of accounts, a supervisory report will be prepared and discussed with the banks.

As far as the Non-Banking Finance Companies (NBFCs) are concerned, the RBI Act, 1939, has been amended recently, granting more teeth to the RBI. We have just finalised a system to supervise the NBFCs. The prudential norms have been settled. We are trying to make a distinction between NBFCs based on the type of activities they perform, their size, and whether or not they take deposits from the public.

Do you think India should also go in for a single supervisory system along the lines that has been proposed in the UK and South Korea?

There is no single model which is good. In the UK and South Korea, supervisory functions are separated from the central bank. But there are countries, including the US, where the central bank has a supervisory role. There are some central bankers who believe that supervision is an indispensable function of the central bank.

We recently created a BFS within the RBI, as a committee of the central board of the RBI. Certain powers that the RBI earlier exercised through its Department of Banking Operations & Development are being given to this institution. Certain amendments to the RBI Act can be made to make the BFS an independent board within the RBI itself. We could then assess how the new system functions.

Your stint with the RBI ended at a time when the Asian economies, and their banking systems, are trapped in turmoil. How well is India insulated from the occurrence of a similar crisis?

There are a few lessons to be drawn from the Asian currency turmoil. First, when the current account deficit exceeds a certain level, countries become vulnerable to an external shock. In this context, India is in a better situation than most of the other Asian economies. India's current account deficit was only 1 per cent of Gross Domestic Product (GDP) in 1996-97, and is expected to be just 1.40 per cent in 1997-98. Whereas, most of the Asian economies had current account deficits ranging between 5 and 7 per cent of GDP.

The second lesson relates to the financing of the current account deficit. When the proportion of short-term debt to total debt becomes very high, countries become vulnerable as the former needs to be rolled over at frequent intervals. In the case of Thailand, for instance, the ratio of short-term debt to total debt exceeded 32 per cent. In the case of India, the ratio is between 6 and 7 per cent. In fact, this is a lesson that we learnt in 1991 as well.

The third lesson relates to the soundness of the financial system. Soundness has many aspects. One aspect is the extent to which the residents of a country have unhedged exposure to foreign borrowings. That not only puts the borrower in a difficult situation, but also harms the banks, which would have lent for other purposes instead.

Should our stance on Capital Account Convertibility change?

The Committee On Capital Account Convertibility has suggested a time-frame of three years. We may exceed it a little bit. But three years is enough to bring about the necessary changes. The progress we make will depend on what happens in the international foreign exchange markets and trade. If international trade expands quickly, it will facilitate the movement towards convertibility. And if the world is free of currency disturbances, that too will have a positive impact.

The depreciation of most Asian currencies has made the Indian rupee relatively stronger. What, according to you, will be the consequences for the economy?

Every crisis produces a new term. The new term that the Asian turmoil has produced is the contagion effect. We are living in a highly-integrated world, with increasing trade and investment flows across countries. In such a situation, what affects one country will also affect another. But what is important is the magnitude of the contagion effect. The value of the rupee will continue to be determined by factors that are related to us. To some extent, our competitiveness in exports to some areas may be affected.

Capital inflows may also be slightly affected because of the generalised view taken by the institutional investors. But, I believe, investors are sophisticated enough to distinguish between countries. India's situation is different from that of the Asian economies since our current account deficit is quite low. I do not foresee any major disequilibrium in the demand for, and the supply of, foreign exchange which could make exchange rates unreasonably volatile.

Manmohan Singh was a personal friend. What kind of rapport did you enjoy with his successor, Union Finance Minister P. Chidambaram?

Mr Chidambaram is a very distinguished person. He has been a very distinguished lawyer, trained in economics, and business. It has been a pleasure to talk with him, and argue about various things with him. He is committed to the reforms and is articulate. I enjoyed working with him.

You have been an academician and a technocrat for most of your life. What do you look forward to doing as the governor of Andhra Pradesh?

The governor of a state is above politics, which is a fact that should be understood. There are well-defined, Constitutional functions for him. In addition, the governor can also play an advisory role whenever it is sought. An economic administrator with a background in finance should be of some use to the state government. That is the way I look at it.

Thank you, Dr Rangarajan and best wishes for your next governorship.