Interview with Dr. Viral Acharya

The Vinod Chowdhury Memorial Event is one of the most prestigious events organized by The Economics Society, St. Stephen's College. On 25th September 2020, Dr. Viral Acharya (VA), Former Deputy Governor of the RBI, delivered the Vinod Chowdhury Memorial Lecture. The topic for the lecture was ‘Some Reflections on Microcredit’, based on his book ‘Quest for Restoring Financial Stability in India’. Post the lecture, Shagun Tyagi (ST) and Prerana Bhadra (PB) interviewed him. Following is the transcript of the interview:

ST: You graduated from IIT Bombay in 1995 with a Bachelor’s Degree in CS and then you went on to pursue your Ph.D. in finance from NYU. What exactly motivated you to make this switch from Engineering to Finance and Economics?

VA: So, you know, in my last year of Computer Science, I wasn't sure whether I wanted to continue doing Computer Science. I felt I had adopted the degree choice because everyone who sort of went to IIT with a decent rank opted to do computer science, so I also took Computer Science. But I felt I didn't have a passion and an aptitude for the subject. So I wanted to figure out what it is that's my calling, what it is that I want to do. And in my last year at IIT Bombay, I took an elective course in the Humanities department with Prof. Pushpak Trivedi of Economics. It was on International Finance, I liked the course, I felt I could relate to the subject a lot more than the theoretical Computer Science that I was doing. I had a family friend who had just finished a Ph.D. in finance at New York University, I spoke to him and he said, “You know, this is an interesting subject, it can be very analytical and mathematical, if you want, it can be very applied. You can be an academician if you want, you can join industry if you want.” And so because I was constantly in search of what it is that's really my calling, I said, “Let me take the plunge and figure it out.” So it was really just the process of exploration. And I always stress this when I speak to students that it's good not to straightjacket yourself in the standard choices that are out there, you're ultimately asked the question, “Is this really what I want to do and will be excited to do for 30-50 years down the line?” So one has to keep soul searching, you have to explore, you have to be willing to fail. But then, you know, gradually the answer becomes clearer over a period of time.

PB: Since you elaborated on fiscal dominance in today’s lecture, what steps would you suggest to reduce fiscal dominance in India because it does lead to suboptimal policy outcomes and also reduces the financial stability?

VA: Now, so, in the previous chapter, I give a more extensive overview, but in my view, the fiscal stability and the financial stability in India have now become very intertwined or closely hinged to each other. And therefore, we need to address both issues. First, I would say on the fiscal front, the government needs to undertake some institutional fiscal reforms, so that while it has to undertake necessary expenditures in the short run to meet the COVID related relief and repair efforts, it simultaneously gives commitment in the medium term to the markets, investors and rating agencies that it's on a better fiscal consolidation part. So how can you do that? It needs to set up an independent fiscal council. It needs to be bipartisan or nonpartisan. It can't just be something that reports to the finance ministry because it needs to hold up a mirror to the government on its progress on the targets that are being set. It needs to provide transparency on the government accounts. And it needs to vet every single budget program that's being announced as to whether reasonable assumptions are made on what it's going to cost the taxpayer in the end.

Second, I would say we need to calculate what is called a public sector borrowing requirement. This is an idea that we should measure not just what is on balance sheet government borrowing but we should consolidate government borrowing between the center, the states, the public sector enterprises held by the center and the states, so that we get a 360-degree view. And if the government is simply meeting the targets by doing off-balance sheet accounting, they are not fooled by it because you know, the public sector borrowing requirement would pick up that the government has to borrow some debt.

But third, and maybe most importantly, the government needs to reduce the reliance on borrowing in the first place. It needs to undertake substantial divestments, in my view, of its stakes, it has majority stakes in a large number of public sector enterprises. I'm told there are more than 300 of these in the country right now. And they keep growing rather than shrinking. So the government needs to shed its takes below majority, including in public sector banks and other public sector financial institutions, in the insurance sector in the power finance sector, etc. And eventually, it needs to reprioritize some of them. And as we were discussing in the lecture today, reprioritize some of them to more profitable business models, such as in microcredit, or microfinance. So I would say independent fiscal council, public sector borrowing requirement calculation, and divestments are on the fiscal front. On the financial side, I give a more elaborate review in the previous chapter. But let me say that one big problem there is public sector banking. So the central bank needs to be given powers to regulate and supervise public sector banks with disciplinary actions that are as stringent as the central bank can undertake for private banks. In particular, it should be possible to replace management. And you know, the government should figure out a way to dilute its stakes automatically, then it can't actually inject the regulatory capital requirement. Right now, the tendency is to push the regulator to adopt compromised standards, rather than actually shedding its stakes and raising money through the market and allowing private capital to come in.

Second, I would say that the central bank should adopt more rules-based decision making just the way we have a flexible inflation targeting framework. Maybe it is useful, in my view, to have set this kind of a rules-based framework, even in supervision and regulation of banks, so that any exceptions are with reports, which are democratically accountable and you know they're following the due process. Because I think if the discretion is reduced, the ability of the fiscal dominance to take over the supervisory and regulatory functions will also be circumscribed.

The last thing I would add here is that the central bank does have to lean against the wind, it has to recognize that pressures will arise when these specific points of electoral cycles come about and therefore it has to leave some policy space in its buffers in good times. So that when these pressures get absorbed, it doesn't act, it means that you had left some buffer and you're just running down that buffer rather than actually ending up in a bad place.

Now, this may require sometimes saying no to the government in the first place, it may also require speaking truth to power because you have to be honest about what the fiscal situation is, what the banking reality is on the ground. But sometimes, as I said, it may also involve saying no. I give the example in the previous chapter of the late governor, Paul Walker of the Federal Reserve Bank of New York, who after having arrested double digit inflation in the United States basically said, “No, President Reagan, we will not be able to fund your expansionary manifesto by lowering rates because you know, we have just arrested double digit inflation and we can't sacrifice the gains that we have made.” So in the end, President Reagan adopted a much less expansionary manifesto, the US fiscal deficits didn't rise much and borrowing aid came down. And I see this as the kind of role model that central banks, especially in emerging markets where fiscal dominance pressures are very high, need to hold at times.

But you know, I think the bottom line is that we need to put a lot of primacy on financial stability, we need to consider it as a prerequisite, or the linchpin for sustainable growth of the economy. We can't keep jettisoning it for short term gains every now and then when the pressures arise.

ST: The viewers would be really keen to explore the concepts and the ideas that you introduced today in the lecture on financial instability, microcredit, and the banking system. What resources and books would you like to recommend to the readers and the viewers, so that they develop a more holistic understanding of the banking system in India and in general?

VA: Reading has to be very, very comprehensive to understand the subject. And it doesn't mean just reading academic papers and books, I think it has to include reading the newspapers, it has to include reading the articles by macroeconomists, it has to include textbooks, and it has to include the slightly more narrative style of writing. Because as a student of economics, what is when trying to do? There are a lot of complex dots all over in the canvas, you're trying to connect them in an interesting way so that you can have a framework to explain why the dots move in a certain way when one of the dots is actually shaken up or some external shock comes in, it's that you want to understand how the system as a whole responds. Because very often, especially when you are interested in banking and central banking, you are not working in a partial setting, you are working in a manner that is going to affect the entire economy. So you want to understand the intended consequences as well as the unintended consequences. So I would say, first, keep your reading very broad and use it as a way of being able to understand and explain what is going on, see where the gaps are, try to understand those gaps yourself from first principles. And then you can start thinking about other opportunities to make it better.

In terms of specific books, I would say you can look at if you want to get a great idea of the global economy. I think both of Dr. Raghuram Rajan’s books in the last decade will be excellent. The first one was called ‘Fault Lines’ the second one is called ‘The Third Pillar’. I think they are very broad and give a very sweeping understanding of what's happening in the world as a whole. In case of near, I would say, if you want a good book on the Indian economy, there is a book by Dr. Vijay Joshi, which is trying to explain the macroeconomy of India and the long road ahead. I think that could be an interesting book to look at. Recently, as you know, Governor Patel and I both have come out with our respective books. So if you want something more current on banking and central banking, that could be a good reading, possibly. And I shared in the chat room actually a paper that Dr. Raghuram Rajan and I have just put out on a possible comprehensive path of reform for Indian banks. So those are some of the current things. Going back, some of the committee reports may also be interesting to look at. There was the Narasimham Committee report, the first report in ‘91. And then there were successive Narasimham Committee reports, there was the P.J. Nayak Committee report in 2014. That could also be interesting to look at.

And finally, I would say it is indeed useful to look at some of the Reserve Bank of India's documents such as its financial stability report, audit reports on trends and progress in banking. These are excellent reports, which give you a good sense with data and very interesting graphs on how the banking sector as a whole is headed. It’s a lot, you are to start from something simple. But, in the ideal to try and cover a fair bit of ground. And the last point I would make is that it may be a good idea to still focus on the foundations, I think, you really want to take your coursework very, very seriously. Because if you don't have the foundations of microeconomics, macroeconomics, financial economics, statistics, and econometrics in perfect grounding, it becomes hard sometimes to take the next step. You know, it's like doing net practice, you have to do enough net practice before you get on to the cricket ground. You can't just go and represent the national team, right?