‘Fiscal policy had to do more than monetary’

Chief economic advisor in the finance ministry Arvind Virmani is looking forward to his next job as the executive director in the International Monetary Fund. The credit for changing the flavour of the Economic Survey by making it more current and newsy goes to Virmani. In this year's survey, he surprised many by taking a bold stance on reforms. In this exclusive conversation with P Vaidyanathan Iyer, he says India had to do more on the fiscal side because the RBI's monetary stance was quite conservative. Excerpts:

In terms of stimulus, are we past the hump both globally and in India? The US and the UK are saying that it is too early to withdraw the stimulus.

Globally what happened that required action? One was that Lehman was allowed to fail. Once it was allowed to fail, the major effect was the freezing of financial markets. Short-term money markets in the US and Europe froze. That affected the flow of credit to companies not only in those countries but elsewhere as well. The flow of export credit was affected. The problems spread outward and affected everybody. The problem had to be dealt on a monetary plane. Subsequently, the problems spread to the real economy. Overall demand, production, exports were affected requiring fiscal stimulus.

When the risk of financial transactions shoots up, you want to hoard money. The demand for money shot up. What the Federal Reserve Board had to do was to inject money to the extent of meeting this demand. They had to be innovative by their standards because of the unprecedented scale of the problem.

The second part of the problem was the real demand which had to be met through the fiscal. In this unusual situation where you are staring at an abyss, it was rightly concluded in the US that you need fiscal action also. In Europe, they were dependent on automatic stabilisers. People thought initially that they were not doing enough. But outsiders who are not experts on European economies do not know the exact extent of automatic stabilisers. Overall they did reasonably well. This worked and on the real side we are going to see a U-shaped recovery.

In India, initially, because the problem came from outside, our monetary base contracted. How did we address that? We reduced the cash reserve ratio. M0 had contracted. But by reducing the CRR, we ensured that the M3 also did not...