An open letter to the finance minister

An open letter to the finance minister
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First Published: Mon, May 25 2009. 01 15 AM IST

Updated: Mon, May 25 2009. 10 18 AM IST
Dear Mr Mukherjee,
Congratulations!
Even though you presented the interim budget as a stand-in finance minster, your new assignment marks your return to North Block on Raisina Hill after 25 years.
Chief executives of public sector banks, in their first meeting with you in February, were pleasantly surprised when you did not ask them to cut loan rates. There was not even gentle persuasion. Instead, you spent time understanding the bankers’ predicament in a slowing economy and told them you would play the role of a “facilitator” and not an “intruder”. That’s quintessential Pranab babu, the master strategist who has an open mind and knows how to carry people along.
The purpose of writing this letter is not to tell you what you should do, but to flag certain issues. I’m sure you’re familiar with all of them. Last Monday, the stock market was euphoric in welcoming the United Progressive Alliance’s election victory. India’s most tracked equity index, the Sensex, rose 17.34% in two brief trading sessions that lasted less than a minute and investors’ wealth swelled by Rs5.6 trillion, something unprecendented in the 133-year history of the Bombay Stock Exchange.
For the week, the Sensex rose 14.08%, its highest weekly gain in 17 years. This exemplifies the markets’ expectations from the government in general and you in particular. Many feel that you will aggressively push financial sector reforms by lowering the government’s stake in public sector banks and allowing foreign banks larger play in India.
Under current norms, the government’s stake in public sector banks cannot fall below 51% and no single foreign entity can hold more than a 5% stake in any Indian bank.
Will you change the rules of the game overnight to show the colour of reforms? I have my doubts.
In 2000, Yashwant Sinha, then finance minister of the Bharatiya Janta Party-led National Democratic Alliance government, first announced the intention to lower the government’s holding in public sector banks to 33%, but in the past nine years there has been no movement on this front.
You may take your time to decide on this. Government ownership is now globally perceived to be a great strength for the banking sector. At the same time, banks need capital to expand assets. With the economy slowing, banking assets in India have not been growing as fast as they were between 2005 and 2008, but once credit demand picks up, you will have to find ways to infuse capital in these banks.
Another long-pending issue is the removal of the cap on voting rights for banks. In private banks, voting rights are capped at 10% and in public sector banks at 1%. Your government had planned to remove these caps so that voting rights reflect the actual ownership of banks, but could not move ahead because of resistance from the Left parties, your former allies, and the banking regulator. If you plan to stick to the 20% cap on foreign ownership in public sector banks for the time being, the lifting of the cap on voting rights will not make any material difference because, under the corporate law, an investor needs at least a 26% stake to play a meaningful role in running a company.
Nothing can, however, come in the way of taking the first steps towards consolidation. The government has been talking about this, but you should walk the talk. Mergers among public sector banks will add scale and reinforce the industry’s risk-taking ability.
Similarly, you should not lose any time in raising the limit on foreign direct investment in insurance firms. They are capital-starved and lifting the limit from 26% to 49% will help them get fresh capital from overseas partners without any significant change in the ownership structure.
Similarly, no time should be wasted in pushing the Pension Fund Regulatory and Development Authority Bill that has been pending since 2005. Even though the government has opened the new pension scheme to the general public, in the absence of legislation, the scheme cannot succeed.
Indeed, the Bill may lead to a turf war between the proposed pension regulator and the existing insurance regulator as all private pension schemes will be overseen by the pension regulator, but I am sure you will find an amicable solution to this problem.
Similarly, the turf war between the banking and capital market regulators should not come in the way of developing a corporate bond market, critical for meeting the funding needs of Indian companies after the economy weathers the slowdown.
Yet another long pending proposal is separating debt management from the banking regulator.
With the fiscal deficit rising, the government’s need to borrow from the market also increases, and a government-run public debt office may end up arm-twisting the public sector banks to subscribe to government bonds that will be used to bridge the deficit. So this may not resolve the issue of so-called conflict of interest that had prompted the government to plan taking away the Reserve Bank of India’s role in debt management. You’d need to take a close look at this.
Before I end, Pranab babu, a few words on what you should not do as finance minister. Please do not talk publicly about interest rates. There can always be discussions between you and the banking regulator on the direction of interest rates, but if you or your bureaucrats openly offer guidance on interest-rate movements, the market will get confused and the central bank will lose credibility. This is one job that should be left to the central bank.
Wishing you a memorable stint.
Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as a deputy managing editor of Mint. Please email your comments to bankerstrust@livemint.com
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First Published: Mon, May 25 2009. 01 15 AM IST