REFORMS IN THE FINANCIAL SECTOR AND CAPITAL MARKETS The Indian economy has shown considerable underlying strengths. At the same time, it suffers from serious deficiencies in its financial and real sectors. The East Asian crisis underscores the point that financial infirmities in an economy sooner or later result in a serious economic crisis with consequent social unrest. The fact that India has remained insulated from the global contagion effect should be viewed as an opportunity to initiate major reforms.If India sets course on a 7% GDP growth rate, she will have to wait 68 years to be on par with the GDP of the developed world. India’s growing population, with over 350 million Indians coming into the work force from now up to the year 2025, will not wait this long. India has the potential and must set its sights on achieving and maintaining double-digit growth rates in GDP. India is an investment driven economy with a large social imperative of creating employment opportunities for its teeming millions. Therefore, India must focus on higher investments, higher productivity of capital and higher employment elasticity. This can come about only if there is a scope for a large quantum of investment, flows of investment are smooth, investment is channelled to productive uses and there are no inefficiencies in the financial system. These imperatives, when addressed adequately, would be the foundation of financial sector and capital market reforms in India. Reforms in the financial services sector and capital markets, apart from ensuring that transaction costs are minimised through competition and better productivity, lead to a lower and more stable interest rate structure in the system. They have the added benefit of bringing about better flow and efficiency of capital. They channel funds efficiently from savers to users. It is not that funds are a constraint. What matters is the efficiency with which the financial intermediation takes place and the smoothness with which funds flow to productive uses at competitive costs.India enjoys a high savings rate and the potential for higher savings does exist. The global capital pie is enormous. India’s share of this pie is insignificant. However, the competition for global capital is intense. Even smaller economies have attracted larger investments than India. India can easily attract five to ten times its current capital inflow if it brings about an environment of openness, transparency and freedom for entrepreneurs in their economic decisions. At the same time, one must face realities of the current economic situation in India and address them boldly. India is in a debt trap. High fiscal deficits of the centre and state governments are throttling growth in an investment driven economy. Assets with financial intermediaries are of poor quality and are placing pressures on the financial system.Major areas of concern on the supply side in the financial sector are in terms of high degree of government control of financial intermediaries, pre-emption of funds by the government, high cost of funds and poor quality of funds. On the demand side, the areas of concern are high government fiscal deficit, borrowing by government to meet unproductive outgo on interest payments, poor state of government finances and poor quality of assets due to high non-performing assets. One must recognise that poor quality of assets is partly a consequence of the government’s past policy which led to sub-optimal size industries with fragmented units of less than minimum economic size. The financial system suffers from illiquid markets, inadequate disclosure, disparities in regulation and lack of adequate legal system reforms. One must also recognise the impact of excessive vigilance and investigation in the lending environment on credit flow. Greater freedom of action, as well as recognition that some commercial judgements may go wrong even if bona fide, are needed. Capital markets in India are shallow. They need to be strengthened to unleash their immense potential to intermediate between savers and users. Areas of concern revolve around their morbidity, poor liquidity, poor disclosure standards, rigidity of legislative environment and, above all, poor investor confidence. Reforms in the real sector are equally important. They are complementary to reforms in the financial sector and capital markets. Reforms in the real sector have to focus on agriculture, labour policies and infrastructure. Structural deficiencies in Indian industry in terms of technology, scale and competitiveness have to be urgently tackled. Given the social imperative of finding millions of job opportunities for a growing work force, labour policies are critical. India can no longer afford to protect 20 million jobs in the government, public sector and organised private sector at the cost of creating 350 million new jobs. India needs a flexible labour policy that can enable government and entrepreneurs mark labour productivity and costs to market, redeploy or retrench unproductive labour and have freedom of choice of new labour. Only such a policy can impart flexibility to labour as a factor of production, thereby encouraging new investments, especially those that are employment elastic.Thus, financial sector and capital market reforms are critical to strengthening the financial system and, in turn, Indian economy and society. A double-digit economic growth rate on the back of freedom for investment, trade, capital flow coupled with competition and productivity are the cornerstones for a new India.
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