Operating within their own slivers, there has always been a disconnect between major economic policymaking institutions. More than inter-institutional antagonism, this is a lack of coordination in the design of macroeconomic policy.
The classic example involves the Reserve Bank of India (RBI) and the finance ministry. Over the years, there have been many instances when fiscal policy has been at variance with monetary policy. While the former has been expansionary, the latter has been deliberately contractionary, causing major policy distortions.
There have also been differences over public expenditure policy between the ministry and the Planning Commission. These differences at the macro level percolate to the micro levels. For example, the balance from current revenue used for Plan financing by the commission, and the revenue deficit in the Union budget, are analytically the same. Yet their estimates can never be reconciled.
The latest policy disconnect is between the Planning Commission and RBI. The commission, the archangel of equity, is focusing on “inclusive growth”; while RBI, the guardian of growth and inflation, is engaged in “financial inclusion”. The two seem to be the same, but there are vast differences in the manner in which they are designed and implemented. Ideally, one should have complemented and catalysed the other, resulting in a virtuous cycle of total economic inclusion.
The central bank’s agenda of financial inclusion is almost exclusively in the realm of personal finance. The focus is to expand access to financial services, including credit, to the poor. Hence, the efforts to put distribution channels in place are only appropriate: be these rural bank branches or the just announced liberal business correspondent norms.
In a sense, shorn of the social angle, the model is one of pure play retailing: increase the number of outlets and touch points to distribute financial products. However—to carry the retailing analogy further—even as distribution channels are being put in place, conspicuous by its absence is the lack of attention to manufacturing the financial products that are to be distributed.
The rub is that most banks and financial service providers don’t have the right kind of financial products, let alone the business processes to deliver them. In fact, most don’t even have a formal product development process. It should come as no surprise that the product research and development spending is the lowest in the financial services sector.
Even with products such as variable rate mortgages, open-ended and closed-end mutual funds, as well as hedge, venture and derivative funds, we have yet to see a bouquet of products relevant not just for the poor but also for the vast small and medium enterprises (SMEs) sector and rural businesses. New product development includes not only the introduction of new financial services, but also features such as loan terms, amortization schedules and interest rates, as well as technologies such as smart cards—being used to some extent now.
How does one link this with the 11th Plan and achieve inclusive growth along with financial inclusion? The key lies in extending the financial inclusion initiative to include the micro and small businesses, on the one hand, and dovetailing inclusive growth strategies with the financial inclusion programme, on the other. In other words, inclusive growth needs to be financed through financial inclusion initiatives.
As such, financial inclusion has to go beyond personal finance. There is need for the launch of an SME finance inclusion programme. The aim should be to catalyse finance for SMEs and to give the generators of incomes and jobs a chance to solicit and attract financing. This sector currently accounts for 95% of industrial units and contributes around 40% of the value addition in the manufacturing sector. More than 3.2 million units spread over the country produce around 7,500 items and provide employment to more than 40 million persons.
Most SMEs are too small to attract commercial bank or investor interest, and too large to benefit from microfinance. To date, few scalable solutions to support this “missing middle” tier of businesses have been found. Bringing them under the financial inclusion plan will generate the momentum for financial empowerment.
While this will create the demand for finances, better product development in financial inclusion will supply the right kind of financial products to be delivered to the populations outside the formal banking system. Otherwise, financial inclusion will essentially be reduced to an elaborate system of distributing government doles such as the Mahatma Gandhi National Rural Employment Guarantee Act. The sustainability of income generation has to ensured by bringing SMEs within the ambit of financial inclusion.
An inclusive growth strategy must devise a new approach to public expenditure policy, taking it beyond the confines of sectoral allocations. The sectors must be crossmapped, with institutions and specific financial inclusion strategies relevant to each.
This leads us to the next big issue: Is the financial architecture designed to promote inclusive growth and generate financial inclusion? This will be discussed in the next column.
Haseeb A. Drabu is former chairman and chief executive of Jammu and Kashmir Bank. He writes on monetary and macroeconomic matters from the perspective of policy and practice. Comment at firstname.lastname@example.org
To read Haseeb A. Drabu’s previous articles, go to www.livemint.com/methodandmanner