The Hindu Business Line : Pondering over reforms

At the India Economic Summit in New Delhi, the Finance Minister, Mr P. Chidambaram, sounded hopeful that the pace of financial sector reform would gather speed before the government ended its term. The admission of tardiness and the promise of change may have come across as evidence of proactive management but a quick recap of the economy over the last two years reveals how New Delhi has responded to the challenges that rapid growth has thrown the policymakers’ way. It will also suggest the road-map the government ought to follow at the earliest.

One of the biggest challenges is the surge in capital flows that is turning into a major management problem; the Reserve Bank of India is attempting not only to maintain price stability but also exchange rate stability without affecting capital mobility. That “Impossible Trinity” is currently being managed by an expensive operation of liquidity sterilisation that will cost the government dear through interest payments on the bonds issued to mop up the excess liquidity. Barely a few years into growth, the country’s financial administration seems ill equipped to deal with inflows in a more efficient manner. The second challenge is the institutional one because existing laws or structures appear incapable of permitting the deployment of investible capital for more profitable returns or for infrastructure growth; the Finance Minister’s point about the slow adoption of public-private partnership is a case in point.

The RBI and North Block have been aware that the financial system has to cope with greater market volatility by enhancing its risk management capabilities as a precursor to full convertibility. Leave alone Basel II norms, some public sector banks are still coping with core banking problems. A four-year run of eight per cent growth has left the current government very little time for tinkering. The first set of financial sector changes was injected gradually over a decade of low growth. Then, the main concern was capital adequacy — in foreign exchange reserves and in the banking system. Now the reference point has to be capital efficiency. As Mr Leeladhar, deputy governor of the RBI, noted in a speech in March, banks have to move from mere compliance to a return-on-equity strategy. That objective is apt for the entire gamut of reforms required at this stage, be they in the delivery systems that Mr Chidambaram referred to or in the use of foreign exchange reserves. Reforms need a context and the economy has provided it by outperforming official forecasts. The government has been caught napping by its consequences: surfeit of riches in some regions and the lack of prosperity in others. Creating the framework to deal with both is the need of the hour.

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