Changing phase of India's Financial System - Embarking on new growth paths
At present, most developed economies have open capital accounts coupled with liberalised domestic financial sectors. Gradually with progress, developing and transition economies also started opening up between the late 1980s and the mid-1990s. It is a widely & oft quoted remark that emerging economies are driving global growth and making a big impact on developed countries as these newcomers integrate with the global economy. In almost all Indian cities, one can find stores selling “Made in China” goods for price-conscious Indian consumers. This is the effect of globalisation, which opens up the Indian economy to a world of opportunities for ordinary people to reap benefits. Nobel laureate Joseph Stiglitz, in his book Making Globalization Work, pointed out that China and India are growing at historically unprecedented rates, largely because of globalisation, new technologies, and financial integration.
Against this backdrop, several issues have come into sharp focus: Where does India stand in the evolving global trade pattern? We have plans for garnering 2.5% share of world trade by 2014 but is our financial ecosystem capable of supporting it?
India has undertaken important growth-enhancing reforms over the past 15 years, placing considerable emphasis on achieving macroeconomic stability, liberalising trade, strengthening the financial sector and improving the business climate. Over the years, this has resulted in higher trade and investment growth but in order to leapfrog to the next growth trajectory we need to work harder and reform our financial industry to be able to take the challenge.
A robust financial system is not much good if most people don’t have access to it. The financial system is not providing adequate services to the majority of Indian retail customers, small and medium-sized enterprises, or large corporations. Thus financial inclusion is a key priority for India, especially in rural India. As a major chunk of India’s financial sector comprises of banking, it is the first place where reforms are needed. This means providing not just basic banking, but also relevant products like crop insurance, loans against produce/future. Nearly three-quarters of farm households have no access to formal sources of credit, leaving the rural poor especially vulnerable to moneylenders. Some of the action points which are needed to move India to next phase and achieve high growth levels are: Ø Shape a superior industry structure in a phased manner through “managed consolidation” and by enabling capital availability. This would create 3-4 global sized banks controlling 35-45 per cent of the market in India; 6-8 national banks controlling 20-25 per cent of the market; 4-6 foreign banks with 15-20 per cent share in the market, and the rest being specialist players (geographical or product/segment focused).
Ø Introduce credit guarantees and market subsidies to encourage leading public sector, private and foreign players to leverage technology to innovate and profitably provide banking services to lower income and rural markets.
Ø Create a unified regulator, distinct from the central bank in a phased manner to overcome supervisory difficulties and reduce compliance costs will help reduce decision time & complexities and take the financial sector to new heights.
Ø Work on creating effective structures & processes and move away from micromanagement. Another way is to improve corporate governance primarily by increasing board independence and accountability.
Ø Accelerate the creation of world class supporting infrastructure (e.g., payments, asset reconstruction companies (ARCs), credit bureaus, back-office utilities) to help the banking sector focus on core activities.
Ø Enable labour reforms, focusing on enriching human capital, to help public sector and old private banks become competitive.
At this point of time, Indian financial sector is at a point of inflection. Depending on the decisions we take, the sector will go in either one of the three directions:
Ø High Performance – Less regulation, proper structures, globally integrated & open sector.
Ø Evolution – Positive steps by regulators but with caution, slow movement towards integration & financial inclusion.
Ø Stagnation – Too much regulation, stifling environment; markets majorly controlled by public sector banks, unable to serve the financial needs of the fast growing economy.
While there is a will on the part of regulator for implementing key reforms, political challenges are much greater. Thus the need of the hour is to build an environment where we discuss the proposals on merit and implement them with utmost sincerity.
Contributed By:
Rohit Mittal
Indian Institute of Foreign Trade, Delhi
Batch 2010-12
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