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Financial reforms and development

S. D. Naik

THE FINANCIAL sector reforms were initiated in India in 1992-93 as part of the process of liberalisation and globalisation. These were aimed at promoting an efficient, well-diversified and competitive financial system with the ultimate objective of improving the allocative efficiency of resources so as to accelerate economic development. However, looking at the sorry state of the crises-ridden financial sector today, it is apparent that something has gone terribly wrong.

Over the last decade, the financial sector has moved from one crisis to another because of securities scams and the gross misuse of bank funds. The UTI fiasco for the second time in the less than three years, the CRB capital episode in which thousands of small investors were duped of their savings in its mutual funds and fixed deposits, liquidation of Madhavpura and other co-operative banks, the huge bailout packages the Government had to offer to UTI, IFCI, IDBI and the weak public sector banks (Indian Bank, United Commercial Bank and United Bank of India) are some instances of the financial sector mess.

The picture is worse in the case of the NBFCs that had witnessed uncontrolled and unregulated growth till 1994-95 as also the large number of mutual funds in which thousands of small investors had invested their hard-earned money and lost it.

Experts blame the wrong sequencing and piecemeal approach to financial sector reforms, and inadequate attention paid to the strengthening of the regulatory framework, including monitoring and supervision. In this context, the two volumes containing 95 selected articles by Dr N. A. Mujumdar (former principal advisor to the RBI) brought out recently by the Academic Foundation (Financial Sector Reforms and India's Economic Development) provide a central banker's perspective on what has gone wrong with the financial sector reforms in India.

The central theme which emerges from the articles brought together in these two volumes is that the financial liberalisation introduced in the 1990s broadly followed the models prescribed by the IMF and the World Bank, totally ignoring the India-specific socio-economic milieu. In effect, they succeeded in alienating the country's financial system from the business of development. What is more disappointing, the public sector banks have become practically dysfunctional, with their credit deposit ratio hovering around 50 per cent for the last few years, even as priority sectors, such as agriculture and small-scale industries are starved of credit, indicating a sort of lending fatigue.

Shortage of bank credit co-exists with a mountain of liquidity. The PSBs have developed an unhealthy appetite for government securities with the result that actual investment in these securities is far in excess of the prescribed limit. According to latest figures, the banks' excess investment in government securities (over and above the prescribed SLR of 25 per cent) stands at a staggering Rs 1,60,000 crore or 15 per cent of their total deposits. The lowering of SLR and CRR requirements under the reform agenda was expected to release more banking funds for the real sectors of the economy. But this has not happened, as the PSBs prefer to play safe by investing in government paper.

Dr Mujumdar believes that the two Narasimham Committee Reports (1991 and 1998), which largely set the reform agenda for the financial sector in India, did not pay adequate attention to the role of banks and financial institutions in the future growth of the economy. The objectives of employment generation and poverty alleviation were put on the back burner. The casualties of the new revolution are the small borrowers, small-scale industries, tiny sector, micro businesses and the whole range of institutions involved in rural credit. He says: "If the reforms in the economy in the post-1991 phase have come to acquire an anti-poor image, the financial sector reforms are also to be blamed for it".Dr Mujumdar is particularly critical of the Committee's recommendations that the share of priority sectors in aggregate credit be brought down from 40 per cent to 10 per cent, concessional rates of interest applicable to priority sectors be phased out and rural branches of national banks be segregated.

)Thankfully, the Government did not accept the recommendation to bring down the share of priority sectors. In practice, however, the PSBs defaulted merrily on the priority sector target of 40 per cent of net bank credit and the RBI chose to wink at the default. Also, the new interest rate structure, which has been evolved as a result of various measures designed to move towards a market-related system has become highly regressive and unfriendly to the priority sectors. Of course, Dr Mujumdar welcomes some reforms in the banking sector, such as capital adequacy, provisioning, simplification of interest rate structure and so on.

He also supports the recommendation that the dual control over co-operative credit institutions by the State governments and the RBI/Nabard may be eliminated and co-operative institutions be brought under the Banking Regulation Act. However, he goes on to emphasise that banking reforms do not only mean ATMs, computerisation of treasury operations, credit cards, NRI branches, and dealing in derivatives. They also involve lending to the productive sectors, priority sectors and small borrowers.

It is pointed out that the new banking culture focusses on three Cs: Corporate elite, consumer credit and capital market-related activities. Lending to priority sectors and small borrowers has taken a back seat. The small-scale industries sector, which contributes more than 40 per cent of the value added in manufacturing and about 35 per cent of the total exports, has received a raw deal in the new industrial finance regime.

In this context, Dr Mujumdar draws attention to the change in the thinking of even the World Bank and the IMF in recent years. The World Bank has now recognised the need for subsidising credit to specific target groups. Inspired by the success of Grameen Bank in Bangladesh, it has been trying to evolve micro-credit programmes to increase self-employment among the poorest through provision of small loans at concessional rates of interest. The IMF has also articulated a new philosophy for poverty alleviation and social justice.

Dr Mujumdar is also not in favour of moving towards universal banking as suggested by the Committee. Citing the example of East Asian `Tigers', he wants the development and commercial banks to continue to confine their operations to their specialised areas. He says that while universal banking may be alright for developed economies, for developing economies, a well-differentiated financial system is more appropriate to ensure optimal use of financial sector resources. He is in favour of restoring the flow of the RBI's concessional finance under its Long Term Operations (LTO) funds to the IDBI and Nabard, which was discontinued since 1992-93, to enable them provide medium- and long-term finance to industry and agriculture at concessional rates of interest. Ironically, the funds so saved by the RBI were utilised to bridge the Budget deficit, another instance of the reforms diverting funds away from productive sectors to support government consumption.

It is also pointed out that, perhaps, the worst casualty of the reforms is the rural credit delivery system. The co-operative credit institutions are in disarray; in some States, the co-operatives have been superseded. A majority of the Regional Rural Banks (RRBs) are loss-making institutions and a sizeable number of rural branches of PSBs also fall in the same category.

In the area of medium- and long-term credit to the rural sector, the operations of the Nabard were crippled because of the withdrawal of (LTO) funds from the RBI.

Dr Mujumdar welcomes the number of initiatives taken by the United Front Government in rural credit in its first Budget in July 1996, making a departure from what he calls the Washington model. He is also happy that the RBI's Monetary and Credit Policy for 2000-01 gave for the first time in 10 years or so, equal importance to streamlining the credit delivery system for agriculture, micro credit institutions, small-scale industries and self-help groups (SHGs), thus setting the tone for resurrection of rural development. Evidently, the persistent stand taken by him over the past decade and more seems to have been vindicated.

True, at times, Dr Mujumdar's criticism of the reform process appears too harsh. Mr S. S. Tarapore, the RBI's former Deputy Governor, who has written a foreward to the volumes, has expressed his disagreement with many of the views expressed by Dr Mujumdar on India's financial sector reforms. Nonetheless, he welcomes the healthy debate the volumes would generates. As he rightly puts it, economists, bankers, academics, bureaucrats, industrialists and students would greatly benefit from Dr Mujumdar's penetrating analysis on a subject of great concern.

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