The Hindu Business Line : Financial sector reforms no help to real economy

MOST liberal commentators seem to have given up on reforms. Bound by political correctness, the Prime Minister, Dr Manmohan Singh, recently told the US that economic reforms are on.

The US companies operating in India in their information feeds to Washington will surely be suggesting certain sloppiness. Writing in Financial Times dated July 15, Dr Bimal Jalan says: "India is likely to continue on its present path — with a bit of reform here and there. We are not likely to see any big reforms in crucial areas. This is a pity." The men and women in charge of financial sector reforms since 1991 placed financial sector reforms at the top of the day's work to be done as they thought a free structure could help growth of the real economy.

After more than a decade at tracking policy roll-outs one wonders whether financial sector reforms have at all helped the real economy. There is the view that the financial sector can only do so much in the absence of change in the real economy. One again begs to differ. In one of his speeches, Dr C. Rangarajan said: "The financial sector reforms currently underway in India must be seen as a component of the overall scheme of structural reforms. The overall package is aimed at enhancing the productivity and efficiency of the economy as a whole and also increasing international competitiveness... All these reforms are closely interrelated and progress in one area helps to achieve objectives in others... Importance of the financial sector reforms in this structured package needs to be delineated clearly. Structural reforms in areas such as industrial and trade policy can succeed only if resources are redeployed towards more efficient producers, which are encouraged to expand under the new policies. This reallocation is possible only if the financial system plays a crucial supportive role. The reforms in the banking sector and in the capital markets are aimed precisely at achieving this primary objective." That was in 1996.

In 1999, Dr Bimal Jalan in a talk said: "Earlier, the real economy was supposed to lead and shape the financial system. Today it is the real economy, which is supposed to have become a prisoner of a weak financial system. In other words, proper development of the financial system is no longer regarded as an "ancillary" or an adjunct to the development of the real sector, but as a necessary pre-condition for growth."

Banks, government banks in particular, have cut down on NPAs, mustered more profits and are now bracing for Basel 2 norms. Private and public sector banks have been grabbing triple rated corporate accounts by offering competitive discounts on loans. Some bankers are scared of the competitive kill and prefer an uniform eight per cent (five year) and 7.75 per cent (three year) for corporate loans. That idea did not work last year and may not this year with the markets over-loaded with funds.

Ironically, some of the best corporates (with strong treasuries) have delinked themselves from the banking system by sitting on their cash credit limits. They float low interest bonds (to which banks subscribe) or access overseas funds to finance expansions and acquisitions. Miffed by the top corporates, the banking system partied for a time in the money markets and that seems to be over. Till today, the banking system has been averse to finance farmers or the small and medium sectors. Some of the new private banks cannot think rural as they have little torque. Funding poor farmers or the SME sector through a warren of rural branches should have been by habit as it does not hinge much on structural reforms unlike infrastructure. That has not come about. The public and private investors in infrastructure and the fund providers (banks) are lobbying for reliefs, which palm off the entire risk to New Delhi. That's not the way projects are put up nor banks run.

The banking system is having funds with nowhere to go. Seemingly, financial sector reforms have only helped in the able to turn abler leaving the weak, who need help and form the real economy, weaker.

Is this the best ad for a liberated banking system? Is the economy being short-changed?

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