The message is reforms can succeed if you take everybody along with you and if you have broadened the axis

•Zeenat Nazir: One of the arguments you made in your report on the financial sector is that the economy should be opened up. In that sense, do you think that Indian FDI norms are enough at the moment and have you seen a slowing down of the degree of openness over the last years due to political considerations?

We are already fairly open but of course, there are various areas where we are still very much protected, like Press, for example. In general, we all benefit from competition, and from being in an open economy.

•Sanjay Singh: What is your take on the oil situation, with Goldman Sachs predicting oil prices will go up to $150-200 per barrel. And are the present high prices because of the demand-supply constraints and what role does speculation play?

Part of the reason for the rise in prices is clearly fundamental — there is a growing gap between demand and supply. There is not enough spare capacity. In that context, there is one recent development — the fact that we are finally seeing a demand effect. This was not seen before. In the US, prices are high enough to be pinching consumers — secondary market prices of SUVs have fallen through the floor. India and China are growing, but the largest source of the demand is from the US. So, if the US curtails consumption growth, the gap between demand and supply could be shortened. On the whole, I would expect a stabilisation of prices and perhaps some fall as well. It will turn into a deep fall only if the oil producers break the cartels, and I do not think that such a thing is going to happen in the near future. But as I said the demand reaction is already starting to set in and you would presume that it is going to be difficult for prices to go up much above where it is today in the near future.

•Sanjay Singh: How difficult is it going to be to lessen the oil subsidy bill by the government, and how viable are alternative energy sources?

I am not sure that it is role of the Indian government to look for alternate resources. The private sector is already motivated enough to do research itself ,given the higher oil prices. The viability is more of a political issue. If only the political parties could get together and say that we are not going to make capital on this, and we are going to pass on some cost of the oil. But this goes back to the broader issue of how do we make the system of direct monetary transfer more effective in this country. The excuse for intervention is always that we are helping the poor, but we have subsidies across the board and thereby, end up helping who do not always deserve it.

•Subhomoy Bhattacharjee: Your colleague Prof Banerjee at MIT says that PDS is a bad idea and it would be better to have simple cash transfers for the poor and let the people decide what they want to do. What is your opinion?

I agree with him. The notion behind the cash transfers is that you are putting purchasing power in the hands of the poor. Once you empower them with purchasing power, they can actually exercise it. The real problem exists when you do not have a choice. So, I think cash transfers is an important idea, but more important is the fungibility and how to identify the poor.

•Dhiraj Nayyar: On the international financial crisis, you have written that the basic problem is that banks and other financial institutions reward excess risks while there is not enough sharing of losses. How much is this problem of distorted incentives valid for emerging economies and what is the solution?

I think incentives are a major part of the issue. For example, if I write earthquake insurance and earthquakes do not happen frequently, I will collect a premium without seemingly taking any risk. Think of places like UBS. The idea is if I borrow some and invest in AAA securities that pays me 40 bps more, and if I think that chances of securities defaulting are much less, then it is just free money. Unfortunately, this is exactly what has happened, and they (UBS) have a $40 bn hole in their balance sheet. The problem, therefore, is the kind of incentive structure where the risk probability is very small. It is one of the major problems in the system. Can you regulate these? These are the kind of things that are hard to regulate. One of the things you understand in such a crisis is that the top often did not know what was happening at the bottom, and when they knew what was happening then they did not have the power to shut down their positions.

•Ravish Tiwari: Last year, prices of food grains shot up by 200 per cent and there was a drought in Australia, yet production was 9 million tonnes more than the year before. So, is it more of speculation in the commodity market or the demand supply mismatch that is driving prices?

One of the things economists would say is to look for the inventories. If the futures market is driving the prices then you should see the inventories of the commodities also expanding. But the inventories don’t seem to be expanding that much across the board. Also, the futures prices in the oil sector are pointing downwards. Usually, changes in the futures prices drive the spot prices. It could be that there is a genuine fear of shortage, which could be remedied. If the benefits of the raised prices flow through to the farmers, then they would have greater incentive to expand production. I think the food prices situation will rectify itself, but the political intervention will not. I would say that the banning exports by various countries is the exact wrong reaction we can have and this is going to have severe effects on food markets in years to come.

•Saubhik Chakrabarti: How do you think RBI is behaving on the inflation front?

RBI, as all central banks in the emerging markets, is in a difficult position, because of the serious supply shocks in oil, grain, etc. The important question is what to do about this supply shock? It would help if, for instance, politicians acknowledge that these high prices will stay. Some of them are saying that these are beyond their control. So, what does the RBI do? What matters for RBI is inflation. RBI is more worried about the fact that there is a second round impact where the local street shops says prices are increasing, or the input prices are increasing like cooking gas. But then again, an increase in prices is not just by the amount by which the inputs have increased, but by an additional amount. So, for RBI the problem is not just that inflation is there but when it begins going up in general, that’s when the spiral starts. To the extent that if central banks are not vigilant against that, there could be more of a problem in emerging markets, because once inflation takes hold it’s much harder to kill it, and that’s when interest rates have to go up even further. Now there is a school of thought where some people are saying it’s the supply shock, so don’t just raise the interest rate. But I am not really part of that. RBI has to be vigilant because if inflation becomes stronger and gets out control, it is going to be much more problematic for the economy.

•Saubhik Chakrabarti: What do you think should have been the role of the rupee as the RBI sees it? There has been the criticism that last October there was a rupee appreciation and that is when the mishandling of the inflation issue started. Do you think RBI has some policy goal in terms of rupee depreciating?

I don’t think that the RBI can control rupee that effectively. In fact, one of the arguments this committee (Raghuram Rajan Committee) is making is that do not presume that both inflation targeting and exchange targeting can be done at the same time. I think in the long-term, the RBI should be focused on inflation and should not be given an implicit mandate on exchange rate. When the rupee was appreciating, there were plenty of cries of outrage from the export sector saying that we are losing jobs. Now of course, we are not hearing those cries because the rupee has depreciated.

•Soumya: You talked about the financial inclusion, but how do you think that in a country like India with large imperfect markets the right incentive can be given to the private sector institutions to expand their services in the backward areas — particularly given the inefficiency of the public sector which is mainly the body that is catering to the rural areas?

There are two ways. One is to create the infrastructure. One thing that we need to do is to capture the information that is already available for poor people. Think of the micro financing and self help groups lending that is already capturing information about individual’s saving behaviour. Now, if we could feed that into the database, it could allow us to know what people actually do. We need to start capturing information; we need national ID; we need better credit information sharing. To deal with the issue we might need some element of subsidy, but that subsidy has to be thought of more carefully. I think savings, payments and insurance are the things which we need to get to the poor first, and then comes the credit.

•Sanjeeb Mukherjee: You just said that the benefits of the growth can go to the poor in the emerging economy if they have the access to growth. Who provides that access? If the government intervenes to provide that access, then the open economy does not flourish. So what should be the ideal combination?

The government does not have to provide the services to the poor, but they need to make sure that what is provided works effectively, and sometimes they have to pay for that provision. For example in the tribal areas, the real problem is how to ensure that they are functioning effectively. I think you can’t get them functioning effectively unless you give purchasing power in the hands of the poor.

•Ravish Tiwari: One of the general arguments is that capitalism per se is good. But the process is mediated through politics and in that context does the fragmentation in Indian politics allow for more flexibility or does it allow for more rupturing in the system? So does the fragmentation of the politics help the economics?

Frankly I don’t know the answer. Yes, there are issues there. You can see the downside of the capture, because people don’t have a long-term view and politicians only have a short-term view.

•Zeenat Nazir: As you said development happens by giving purchasing power in the hands of the poor and not in the form of charity, so what’s your opinion on the recent farm loan waiver?

We need to know whether it was properly targeted or not, and if it was the poorest who benefitted? We have to ask them is this the right way to do this or is there some better way? There has been a lot of work to develop the credit culture and one would believe that it is necessary to keep the credit culture alive, but an intervention like this tends to create a break.

Transcript prepared by Sanjeeb Mukherjee.