The Hindu Business Line : `To develop, we have to explore a lot of innovative ideas'

Access to credit for the very poor is one area where we have not done well. Innovative approaches could be tried for taking deposits and delivering loans through various points of purchase.

In the same way as we allow adolescent children a little more freedom, we should allow private and public sector financial firms to do more and trust them.

DR RAGHURAM G. RAJAN, CHAIRMAN, COMMITTEE ON FINANCIAL SECTOR REFORM.

With the Planning Commission appointing the former Economic Counsellor and Director of Research at the International Monetary Fund (IMF) Dr Raghuram G. Rajan to head the high-power Committee on Financial Sector Reform (CFSR) in India , the UPA Government has sent an unequivocal message that it means business for initiating the much-needed action on this crucial plank of the market economy. At a time when the country is cruising on a high-growth trajectory, the need for bridging the huge deficit in infrastructure, both physical and social, is crucial to make growth inclusive to a majority of people whom the reforms have bypassed. What better way to do this than to find innovative ways to marshal funds for development.

Currently, a Professor of Finance at University of Chicago's Graduate School of Business and an academic fellow at the Indian School of Business in Hyderabad, Dr Rajan has a new role to don, that of sprucing up the financial system, with a remit to submit the report by March, 2008. Dividing his time among multiple tasks, Dr Rajan spoke to Business Line in New Delhi on a range of issues with lucidity and clarity.

In a lighter vein, Dr Rajan said that "we tend to look for an easy `magic solution'. We have always wanted to find the silver bullet which will solve our problems in a flash. But now there is change in mindset, which is talking of individual choice and competition, a mindset that wants to create a more enabling environment which will allow more experimentation with solutions without the government forcing outcomes. Our private sector and public sector financial firms have become more mature. In the same way as we allow adolescent children a little more freedom, we should allow them to do more and trust them. There will be some mishaps and sometimes some major ones but if you don't let them grow and constantly say no, for fear that there will be accidents, they will always remain children. Certainly, the Government is giving them more freedom, but the question is should we increase the pace, and my sense is yes.

"In order to develop, we have to explore a lot of innovative ideas. What is encouraging is a number of States are experimenting. If we have a national passion to innovate, things can happen. One of the smartest ideas by Tamil Nadu was the Mid-day Meal Scheme which not only brought the child into school but also improved his/her nutritional level and capacity to learn. You created human capital. People derided `MGR' at that point saying it was populist. In retrospect, it was a brilliant idea. Let us look at more such ideas and see what can work. Let us not theorise too much but do practical, clear and careful evaluation of whether it is actually working and roll out on a small scale, larger scale and eventually at the State and national levels," contends Dr Rajan.

He was awarded the inaugural Fischer Black Prize in 2003 by the American Finance Association for contributions to finance by an economist under 40.

Excerpts from the interview:

On financial inclusion

We should re-examine the ways we have been trying to include people in growth and see whether old ways have worked and if they have not, we should be prepared to accept new ways of reaching them. It makes sense to give the poor choices.

Take, for instance, rural finance schemes to give loans to the poor. A World Bank study reveals that the average bribe on these loans is 40 per cent of the size of the loan. If I pay 40 per cent to get the loan, do I have any incentive to repay? None. Essentially, there is 100 per cent leakage in this process, which also destroys the incentive for the borrower to repay and, therefore, vitiates the credit atmosphere. Even if you recognise these loans are effectively grants, you have not reached the right borrower because, after all, who has the confidence to go and bribe a loan officer. So how can we get the loan to the very poorest - assuming, of course, they can use it well?

Access to credit for the very poor is one area where we have not done well. Innovative approaches could be tried for taking deposits and delivering loans through points of purchase - for instance, the e-choupals, the retail shops that have started coming up. South Africa is allowing cell-phone companies to offer credit and take deposits.

Also, if the Government is giving subsidies, can we think of more effective targeting? For example, could we identify the truly poor, and offer to transfer to the bank making the loan some fraction of the loan amount, perhaps after the recipient makes the initial repayments?

If carefully structured, it is not just the public sector banks which could provide the loans, even the private sector may be willing to make loans for them. Some of these "solutions" may not work. But we need to experiment.

On the Indian economy

Nine per cent GDP growth is not a mirage. Some of it has come as a result of past reforms and some of it is coming as a result of continuing changes in the private and public sectors in ways we don't quite see but cumulatively add up to quite a bit. Private sector certainly has improved its efficiency considerably. The Government has been reforming in different ways - not just the Centre but the State governments too. The question is whether the pace of reform is enough.

For example, the transport network is not strong and it gets quickly used up by this tremendous growth in traffic. Not just roads, but in cargo transport and ports we are barely keeping pace, in some cases, falling behind. Resources are available, if you provide the right framework. In infrastructure financing, if you could provide sufficient assurance of returns to investors and not make them keep thinking about unexpected changes in the rules of engagement in the future, I think they would be very happy to invest in infrastructure. We need to work on this.

Rule changes can limit bidder interest. They can also ensure we don't get the right winner. One example is when you have a bidding process where once the winning bid is accepted, you change the terms of contract in favour of particular winners, which the other bidders did not know of beforehand and could not bid appropriately. This is a very unfair system of working. Sometimes, the terms are changed immediately afterwards, sometimes a couple of years down the line when operators claim they are not making money. We do need to experiment with appropriate contracts and bidding processes, but at some point we should freeze the process and let it work, without interference.

Also, you can't expect private parties to do what you as a government don't have the political will to do. For instance, you can't give an un-cleared piece of land, with people still living on it, and say we have given the necessary land for your construction. This does not mean the Government should clear the land by brute force. Instead, it should create a framework for land acquisition, where private parties try and buy out farmers, with some provision for squeezing out the holdouts -people who quote an exorbitant sum for selling and refuse to move. In a country where most farmers are small and don't have the power to hire their own lawyers, the Government should not add its coercive might to that of the private developer, except in the rarest of cases.

I think enough value is created when you transform agricultural land into industrial that is, if you give the farmers some of the profits by paying a fair price for that land and that fair price is set up in a transaction between the private buyer and the farmers. Many farmers will jump at the offer. Unfortunately, land acquisition is an area where there is still no transparent framework.

On poverty and growth

Inclusion is now becoming a big issue because we want poor people to participate in the growth process. I think it is not just a moral imperative but it is also a political imperative since if the differences get too large, you have the kind of conflicts that you see happen in Latin America and Africa. For a long time we held the view that this needs a separate set of instruments - that because the poor people can never participate in the market economy, let us devise a set of programmes for them, subsidies, a set of anti-poverty measures. My sense is that many such anti-poverty programmes have not taken into account the interests of the participants carefully, both for the recipients and for those who are delivering the services. Invariably we find that it does not quite work and there is tremendous leakage. People who have studied this over time tend to argue that a better way is instead of treating the ultimate receivers as somebody deserving of charity, treat them as consumers and give them choices and allow them to exercise those choices. Let us not confront them with a government created monopoly (even a monopoly charity) where they have no possible choice. Let them create their way out and they will find very innovative and very entrepreneurial ways to sustain growth.

The National Rural Employment Guarantee Programme is best treated as an experiment. Let us do a proper evaluation and see if it is working. We need to experiment on a small scale in many different ways. In Mexico, a programme like Progresa is working quite well.

What they did was to identify the poor through a community-based approach, then give them IDs and accounts, and eventually send them direct income transfers so that they have the capacity to buy what they need conditional on them satisfying some important things such as sending the children to school, doing appropriate amount of prenatal care and nutrition.

The important thing here is to treat the poor with respect, and to give them the purchasing power that allows them to command respect in the marketplace, instead of constantly forcing them to be supplicants.