Home / Opinion / When you have Rs.20 trillion of cheap money, why reform?

As the country prepares to love or hate the next government, some of us finance nerds are keeping our fingers tightly crossed that the next finance minister understands finance. At stake is the implementation of the Indian Financial Code—a set of laws that puts the Indian consumer of financial products and services at the heart of the financial system. India is possibly the first country in the world to attempt to codify consumer protection in finance into law. Loaded against this changeover are two giant forces. The first are the powerful lobbies of banks, insurance companies and other finance firms who benefit if fuzzy regulation, regulatory arbitrage and cosmetic attention to consumer issues continue. The second is the government itself. There is a conflict of interest for the government to change from a system that ensures cheap money to one that will make the government less dependent on money from financial repression.

Financial repression are measures that governments take to ensure a flow of cheap money to themselves. This money may have gone elsewhere, had the rules been different. Why rock the boat when you have at least 20 trillion of cheap money coming from 600 million people? Notice how one of the first things that every FM declares is his (why have we not had a woman FM?) intention to encourage retail money to flow out of gold and real estate and into ‘productive’ assets. The increasing share of gold and real estate in the past few years (over 67% of household savings went into physical assets in 2012-13, up from just over 52% in 2009-10, while the share of financial savings declined to just over 32%, down from over 47%) has worried the policy makers. Not because you and I are getting less returns, but because the steady and increasing supply of cheap money is important to them.

The government speak comes from a forked tongue because it is conflicted. Ever thought why it has taken a major scam in life insurance that cost retail investors upwards of 1.5 trillion for the government to mandate reforms? Or, why has it allowed commission levels of an exorbitant 40% on the first year premium on traditional plans to continue? Follow the money.

In 2011-12, all the life insurance companies put together invested 4.68 trillion in central government securities, or money that could fund 91% of the fiscal deficit. The numbers for 2012-13 are 5.12 trillion, equivalent to almost the entire gross fiscal deficit. Add together the investments of life insurers in state government paper and other approved securities and the total is 10.2 trillion in 2011-12 and 11.03 trillion in 2012-13. This is an annual tap whose pipeline gets thicker each year. Why do you think alarm bells ring in North Block when life insurance premium rate of growth drops (it dropped because investors realized they had been cheated and stopped buying more toxic products)? Not because they worry that you and I are underinsured. On the contrary, it is because cheap money flowing to fund the government starts to dry up and hence the cry for a move to ‘productive assets’. No wonder reform of insurance has been, and is, so tough.

Let’s come to banks. Wondered why retail facing bank reforms are so tough to push through? Because 23% of total deposits must be invested in government bonds. That means that banks have at least 14 trillion invested in government securities at any point in time and as bank deposits grow, so does the market for government paper. No wonder it took more than a decade of work to change a formula to calculate interest on savings deposits from a grossly unfair one (read my piece on this here http://bit.ly/12d95F2) to the one we use now, which looks at the average balance in the account and not the minimum balance.

So there lies the dilemma for the FM: how do you change the rules of the game so that retail money can actually move from ‘unproductive’ assets to more efficient ones, while not disturbing the supply of cheap money to finance your deficit? The blame can be pushed onto the silly and primitive Indian investors with a preference for gold and real estate, but the real blame must come home to roost with policymaking. If the government is serious about moving money to ‘productive’ assets, it needs to facilitate the transition. The transition must not be to negative returns on bank deposits nor should the government be an accomplice in the cheating that goes by way of insurance sales in India, but to better products like inflation-indexed bonds and equity. We need two things for that. One, a single regulator across all financial sector products. Two, a move from buyer-beware to seller-beware in retail financial products market. Please understand that a financial literacy plus disclosure model is the ultimate policy cop-out—a fig leaf of an argument for allowing financial firms to cheat investors with regulatory backing.

Monika Halan works in the area of financial literacy and financial intermediation policy and is a certified financial planner. She is editor, Mint Money, Yale World Fellow 2011 and on the board of FPSB India. She can be reached at expenseaccount@livemint.com

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