India’s government has a blueprint for sweeping and effective reform of its finance sector, although it will only become clear in coming days whether it plans to do so.
The blueprint, a draft report by a committee headed by Raghuram Rajan, former chief economist of the International Monetary Fund, could increase economic growth by 1-2 percentage points and also provide an enabling framework for the economy to sustain double-digit growth.
The report will be submitted on Monday to the Planning Commission. The committee will submit a final report, incorporating relevant suggestions from the public, later in June.
Among the committee’s recommendations are a light-handed and clear-sighted approach to regulation, and a relaxation in the tight control the country maintains over banks and other financial intermediaries.
The 13-member high-level committee, which includes ICICI Bank Ltd managing director and chief executive K.V. Kamath, and is headed by Rajan, currently professor at Graduate School of Business, University of Chicago, was asked by the Planning Commission in August 2007 to come out with a blueprint for financial sector reforms.
Officials at the Reserve Bank of India (RBI) and the finance ministry could not immediately be reached for comment.
Rather than look at the finance sector as comprising discrete segments related to banking, capital markets, and other such, the Rajan committee has looked at it as a whole, studying linkages and influences, and suggested a radical revamp of how various finance businesses in India are conducted and regulated.
The Rajan committee has drawn from and developed suggestions of earlier reports dealing with the financial sector, particularly last year’s report by a committee on Making Mumbai an International Financial Centre.
The underlying themes of the Rajan committee’s report are inclusion, growth and a strengthening of the regulatory structure to weather turbulent markets.
Lessons drawn from the ongoing financial turbulence in Western financial markets and the decade-old Asian financial crisis prove that the financial sector needs more freedom and not less, the report says. The threat to India’s financial sector does not come from foreign capital, but from poor governance, murky bankruptcy laws and asset-liability mismatches, it adds. It further asks for reforms to be undertaken in an integrated manner as piecemeal reforms could increase the potential for instability.
Not all of the committee’s suggestions have found favour with experts. The report says that financial sector reforms needed to be accompanied by macroeconomic reforms to be effective and suggests that RBI should have a single formal objective: controlling inflation. Currently, though ensuring price stability and regulating credit are RBI’s overarching goals, there is no formal mandate to this effect.
“I personally wouldn’t recommend formal targeting,” said Bimal Jalan, a Rajya Sabha member who was earlier governor of RBI. Jalan said the situation in India is too complex to bind the central bank rigidly to a target. There is a trade-off between inflation and economic growth at the margin, and the central bank has to do a balancing act, which does not make a formal inflation target a good idea, Jalan added.
The Rajan committee also wades into the global debate on the need to have a single regulator for the financial sector and comes to the conclusion it is premature to move towards a single regulator. However, it suggests that India create a statutory body called Financial Sector Oversight Agency, comprising chiefs of existing regulatory bodies that would be answerable to a Financial Development Council headed by the finance minister.
A body such as an oversight agency would make regulatory process more difficult, Jalan said. Currently, a non-statutory body named High Level Co-ordination Committee on Capital Markets (HLCC) comprising representatives of first-line regulators such as RBI and the finance ministry meets to debate divergence in policy issues among different regulators.
Jalan, however, agreed with another of the committee’s suggestions that to liberalize interest rates banks can actually charge the poor, but only if there is transparency on the actual effective annualized interest cost. Currently, banks get a 2% interest subsidy to offer farm loans at 7%.
On the lines of earlier reports on financial sector reforms, the Rajan committee asks for greater operating freedom for banks and suggests that the government take a small step towards relaxing its grip on public sector banks.
The key suggestions in this area include: opening doors to new smaller banks with a strong local area focus; disinvestment in small underperforming public sector banks; treating locally incorporated foreign banks on a par with Indian banks; liberalizing takeovers by locally incorporated subsidiaries of foreign banks; and lifting restrictions on branch and automated teller machine (ATM) expansions.