Public Relations
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India's Financial Sector in Current Times
Friends, - Yaga Venugopal Reddy: What next for India's financial sector?">Yaga Venugopal Reddy: What next for India's financial sector? - Food supply complicates monetary policy review: CEA - Inflation may touch 10 per cent by end March 2010 - Arvind Singhal: The zero tolerance imperative">Arvind Singhal: The zero tolerance imperative - Inflation may cross 6%, food prices biggest challenge: PMEAC">Inflation may cross 6%, food prices biggest challenge: PMEAC - Asia set for dramatic changes; India "real sleeper": Roach I am greatly honoured by the invitation to deliver S. Guhan Memorial Lecture. I am grateful to the organisers namely, Citizen Consumer and Civic Action Group, for extending the invitation. Mr. Guhan’s reputation as a distinguished scholar, as a thorough gentleman, as an outstanding civil servant, as a respected authority in applied economics and above all as one committed to highest values in life, are well known. Personally I had the privilege of meeting him on several academic and policy fora and, interacting closely with him. In fact, I was deeply touched when he invited me, about twenty years ago, to consider heading the Madras Institute of Development Studies. So, there are many good reasons for my being here and paying a personal tribute to Mr. Guhan and his lasting contributions to a better informed and more civilised society. I have chosen the subject for today’s lecture, keeping in view both the contemporary relevance and fundamental importance of issues relating to the financial sector. The global financial crisis which is still underway, has replaced assertions of what is the right model of financial sector and has imparted great uncertainty to what it should ideally be. Most countries, especially those who were leading the way for others like U.S.A, U.K, and Europe have embarked on a mission to reform their financial sector, while a group of 20 of leading countries of the world is attempting coordination of policies at global level. In this scenario of heightened uncertainty and simultaneous search for optimal models of financial sector, in global community and at national levels, it is useful to look at where we in India stand and what we should be doing or not doing. Currently, there are several responses to this question of what next for India’s financial sector? I will state a few of them and briefly comment on each of them. First, some say that India has been saved from the financial crisis only because the policy was conservative and did not act to improve the efficiency of the system. Hence, the prescription is to act now. This view is not right simply because India was active in policy interventions in both monetary and financial sector. RBI adopted active countercyclical policy; while many others failed to intervene. There is another problem with acting rapidly or comprehensively now for reform; because there is no agreement on right model for financial sector. It is therefore desirable to look carefully and pragmatically at specific and urgent issues that need attention and not to proceed with what I would call yesterday’s beliefs on what is good for tomorrow. Second, some say that we have had good growth, stability and have withstood crisis. Hence, let us proceed with what we already have in place. In my view, inaction across the board is wrong since there are several inadequacies in our financial system, ranging from credit-culture to financial exclusion and poor service. Serious infirmities that could cause a crisis may not exist in our system but financial sector is yet to fully serve the needs of real sector. The needs of the real sector can be met only when there are synchronised reforms in both real and financial sector. A thoughtful and pragmatic approach to segment or sector specific inter connected issues of real and financial sectors in India is needed; and not inaction. This point may be illustrated with housing finance. Housing should be a priority for India, in view of demographics, growth trend and urbanisation. Hence housing finance ought to be encouraged. But for housing finance to be viable and efficient, there should be reasonably good housing markets, preferably liquid markets. The nature of formal and informal construction activity as well as financing models; high transaction costs in terms of registration fee etc; difficult tenancy laws; non-standardised layouts etc; inadequate processes of price discovery; unrealistic loan to rental value ratios etc., make the housing markets in general, very complex and illiquid at this juncture. Thus, developments and reform in housing products and housing finance products should be reviewed together while focusing on increasing of housing finance and innovating related products. Third, some feel that our financial system needs improvements and there are reform proposals already announced such as in the budget, economic survey etc. They argue that these should be implemented but with changes in view of the lessons from the global financial crisis. We should recognise that the lessons that we are in the process of learning are of a fundamental nature and not merely incremental. The intellectual basis of some of the reforms under consideration in India prior to the crisis are being questioned now. Let me illustrate with attitude to Tobin Tax. This was considered by many to be retrograde and unpractical till recently both in India and globally. Now, eminent persons in finance such as former U.S. Fed Chief Paul Volcker and current chief of U.K. F.S.A, Lord Turner suggest consideration of such a tax even for domestic financial transactions. Brazil has actually announced a few measures. G-20 has recognised the need for capital controls, if temporary. What does this mean for India? This idea could be examined for forex market and also suitably modifying securities transaction tax system and extending them to transactions in participatory notes, though they are traded abroad. Similarly, issues of tax arbitrage and residents are being revisited globally, and need to be revisited by India also. Finally, as a result of the crisis, there are some fundamental factors that have been identified as being critical to the efficiency and stability of the financial sectors. I subscribe to the view that it is essential to assess our financial system with reference to these critical factors or questions that have been flagged in the global debates. I will now pose some of these possible questions and comment on the status. First Question: Is macro economic management reasonably balanced? The answer is obviously yes – by and large. We have no excessive current account surplus or deficit; no excessive dependence on exports or external demand; no excessive reliance on investment or consumption expenditure; and, no excessive leverage in most households or corporates or financial intermediaries. We are, however, vulnerable to shocks on four fronts: Fuel; Food; Fiscal; and Finance – external. In regard to fiscal, the quality of management and subordination of monetary policy continue to be issues. On external sector, the quality of capital flows will continue to be an area of concern. In particular, quality of FDI (Foreign Direct Investment) also deserves a close look, in terms of extent to which FDIs are financing green field projects. Second Question: Is monetary policy sound and well equipped? The answer is yes, by and large. The objectives of growth, price-stability and financial stability have been delivered and our regime of multiplicity in indicators, objectives and instruments has gained respectability globally. The successful management of impossible trilemma has also been noticed. There are, however, some challenges which will continue to confront monetary policy: fiscal dominance; public policies especially on administered interest rates that inhibit transmission of monetary measures; management of capital account; and reliance on whole sale price index as headline inflation in contrast to the practice in the rest of the world. Third Question: Are there suitable mechanisms for regulatory coordination in financial sector? The answer is broadly yes, but with some scope for improvement. A high level committee (assisted by inter regulatory technical committees) on financial markets presided over by Governor, RBI with membership of other regulators and Ministry of Finance is in place. The interesting feature, however, is that the secretariat to this committee is provided by the Ministry of Finance while RBI is expected to assume responsibilities for financial stability. Fourth Question: Are there incentive systems that are inappropriate for stability of the financial system and the interests of depositors or investors? Perhaps a systematic study may be needed on this before we make any conclusions. Let me illustrate this with mutual fund industry which could be a potential area for a serious study. Mutual funds are institutions meant to serve the interest of several small investors who may not have time, experience, expertise or means of managing their investment portfolio directly. So, savings of individual investors are pooled into a fund with a genuine mutuality. Contrary to this objective of any mutual fund, corporates, non-bank financial companies and banks are permitted to invest in these funds and they enjoy tax benefits also. If the mutual funds which are meant to service individuals are permitted to raise funds from other institutions, the incentives in the whole management could serve the interests of these large institutions only. Infact, if such funds are sponsored by such institutions, the incentives may be to dilute the focus on individuals’ interests, to the point of their subordination to interests of other institutions and markets with systemic consequences. Fifth Question: Is there evidence of conflicts of interests in financial sector? ThisPages: [1] 2