The Hindu Business Line : Finding funds for ambitious Plans

For the Eleventh Plan's Approach of faster and inclusive growth to happen, the country would need to make enormous investments. A. VASUDEVAN wonders if the reforms environment is conducive to realising such a high private investment rate, and if the prudential guidelines and other institutional mechanisms are in place.

The India growth story is a stimulating mixed bag. On the one hand, it brings cheer to all those who hope to improve their real incomes. On the other, it requires policy-makers to intensify and rationalise financial sector reforms. The context of this story is the Planning Commission draft document `The Approach to the 11th Five Year Plan' (2007-2012) with its enticing sub-title, `Towards Faster and Inclusive Growth'. The spirit of the draft remains intact even as the Plan is being finalised.

The document postulates growth of 8.5 per cent a year on the average that `must be' accompanied by inclusiveness, namely, provision of access to basic facilities such as drinking water, education, and health-care to not only large numbers of those who do not have such access but also those groups (for instance, tribals, adolescent girls and children below three) whose voice for rights is not heard.

Huge resources needed

The resources needed for achieving such inclusive growth are enormous. Investment as a proportion of GDP has to increase by 6.1 percentage points from 27.5 per cent during the on-going Tenth Plan to 33.6 per cent during the Eleventh Plan period. About 70 per cent of total investment (23 per cent) has to be provided as at present by the private sector (farming and small enterprise sectors as well as the organised corporate sector). The domestic savings rate is estimated at 31 per cent (of GDP), with external capital flows accounting for 2.6 per cent of GDP (counterpart of the estimated external current account deficit).

Private sector investment would have to be financed mainly from domestic savings. Financing from outside the country would be very limited, since the credibility about the sustainability of India's external debt profile requires to be maintained. The organised corporate sector's savings that would be ploughed back as investment may not exceed 6 per cent. In other words, 17 per cent of the requisite private investment would have to come from other domestic sources in case external financing is zero.

Disturbing questions

Such a private investment leap raises many questions. Is the reforms environment conducive to realising such a high private investment rate from the household sector? To put it differently, do the current prudential guidelines and other institutional mechanisms foster high investment rate? In case the public sector dissavings are high — higher than estimated — will the private sector savings provide the compensating variation?

These questions are formidable. Policymakers often believe that interest rates strongly influence investment inclinations. Though this hypothesis is not unequivocally proven, it is necessary to ensure that real interest rates are positive and a tad lower than the growth rate to foster bullish sentiments about the economy's prospects. Savings would grow and bank deposit expansion would be pronounced, as the Indian experience shows.

Banks are the chief intermediaries and, therefore, given `special' treatment here.

Deposit growth would help expand credit as well as investment. The Reserve Bank of India's comprehensive regulations/guidelines on banks' portfolio distribution between credit and investments are often viewed as promoting financial stability. This is a legitimate view but it is now time to ask if they also induce growth and, at the same time, promote inclusiveness.

Banks have to comply with regulations on priority sector lending, export financing, margins on certain types of credit such as housing/real-estate loans, minimum statutory liquidity ratio (SLR) of 25 per cent of total liabilities, and investments in non-SLR securities (commercial paper, equity shares, bonds/debentures and bills, rediscounted with other financial institutions).

Debilitating regulations

Some of these regulations tend to also affect financial sector development and the flexibility that needs to accompany it. The limited number of mergers in banking so far is a reflection of this phenomenon. When scale economies operate, vulnerability tends to be reduced. And widening of portfolio choices would improve scope economies. Given the scale, diversification of operations would help banks to improve their efficiency and to offer products that serve customers' increasingly divergent interests.

For this reason, SLR reduction over a time path of, say, three years to not more than 15 per cent could be tried in the first instance, with a recap of the experience with this experiment at the end of three years. Simultaneously, the current restrictions on investments in non-SLR securities may need to be progressively relaxed, especially since Basel II, with its emphasis on risk management, is likely to be set in place by the end of the current fiscal.

One of the areas where relaxations could apply is in respect of investments in the corporate bond market, the development of which is essential for developing infrastructure that is vital for sustaining the growth story. In this connection, the report on corporate debt and securitisation under the chairmanship of R. H. Patil, released in December 2005, makes several recommendations that are worthy of implementation.

Fortunately, the Securities and Exchange Board of India (SEBI) has taken due recognition of the need to groom the corporate debt market. Its first moves in this area are, rightly, cautious.

However, issues relating to trading and settlement, reporting as also the need for a separate exchange must be resolved quickly — within a time-frame, say, of three months from now — so that SEBI would be enabled to create a favourable regulatory environment.

Three problems

Three problems would nonetheless arise here. First would be the fiscal problem of having enough resources. Second, the issue of `inclusion' would have to be addressed; without this the growth envelope would appear starkly elitist in orientation. Finally, there is the problem of getting around the hugely admired caution on relaxations on capital account.

The resources crunch of the government needs to be addressed by a combination of initiatives. Consider here two illustrative cases. Since all laws should promote national interest, the take on the targets under the Fiscal Responsibility and Budget Management Act has to be deferred, notwithstanding the opposition working under the influence of, to quote Keynes, some `defunct' economists.

The Government could also consider issuing long-dated paper that has both the principal and interest inflation-indexed with a reasonable lock-in-period provision.

The `inclusion' in the growth envelope from the banking perspective may have to be seen mainly through the prism of micro-financing — a very promising channel provided there are in place supportive institutional mechanisms including accountable `civil society' organisations or groups.

Convertibility issues

Capital account liberalisation is an emotive issue, tinged, at times, with ideological hues. The policy in this regard would go along with the articulate majority that favours caution. Hopefully, this will be partially taken care of when it becomes clear that market practices are conducive to the orderly development of markets.

There could still be a resources gap despite the above-mentioned financial sector reforms. It would be interesting to see whether growth can still be sustained with productivity gains or, in the alternative, by either relaxing the FRBM Act or letting external financing, in particular foreign investment, take a northward leap. What would happen to the rate of interest in the event of fiscal relaxations could well be an exhilarating drama to watch.

(The author, a former Executive Director, Reserve Bank of India, can be contacted at asurivasudevan@hotmail.com)