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Financial economy out of sync with real world: Governors

business Updated: Dec 08, 2009 22:54 IST
HT Correspondent
HT Correspondent
Hindustan Times
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The best financial brains in India believe that the surge in foreign capital flow, drawn by the India growth story, could vitiate the relations between the financial and real economy.

Joining three former governors of Reserve Bank of India (RBI) in a CNBC-TV18 panel discussion, the incumbent governor, D Subbarao, said the surge would be managed as and when it becomes necessary.

Former RBI governor C Rangarajan felt that FII inflow could take stock prices irrationally high and this has to be controlled. Bimal Jalan, who concurred, pointed out the need to harmonise the relationship between the real economy and financial economy.

“When the Sensex increases by 75 per cent at a time when the GDP has grown by 9 per cent, it is an issue of financial sector de-linking from real economy,” he said. “Our financial economy is out of sync with real economy.”

The panel rejected Tobin Tax — a suggested tax on all trade of currency across borders — as an answer to the problem. “Given the uncertainty in the world, the question is what instrument to use to control inflow of excess liquidity. We use both price and tax based instruments,” said Subbarao.

The former governors were unanimous that capital flow is generally welcome, but should be controlled in certain aspects. “Capital is flowing in because India gives them confidence. We have to learn to manage capital flows when it comes, and as it comes,” Subbarao said.

The banking regulator termed asset price inflation a greater threat compared to consumer side inflation.

“The asset bubble is a potential, but the threat is not there yet. RBI should guard against asset price inflation, consumer side inflation is not as dangerous,” Subbarao said.

He said the 17 per cent inflation in food prices is a supply side phenomenon - resulting from a bad kharif crop and fall in food supply. He advocated monetary policy as an effective instrument to check supply-side inflation and galloping food prices.Former governor YV Reddy predicted that it would take more than a year to ease out excess liquidity from the system. "There will be pressure during exit from excess liquidity; global compulsions might conflict with national compulsions," he said.

Speaking on the challenges faced by the RBI, Reddy said, "Generically, the nature of central bank's interventions and measures taken are changing. Policy action need not be quick or jerky."

"The biggest challenge is to support growth without compromising on price stability and financial stability," said Subbarao.