Financial reforms were introduced in India with the presumption that banking and the capital market were over-regulated and that the discipline of the market would make them more efficient. However, experience suggests that the danger of under-governance has increased. The necessary institutional and legal protections have not yet been put in place while the prudential norms governing the capital market have been removed.
Financial reforms have benefitted mainly the corporate sector. Today, a multinational can get loans at around 8 per cent, while a small scale unit or a small farmer has to pay 12 per cent. The neglect of agriculture and small scale industries is proving to be counter-productive. These sectors are the country’s largest employers. Denying them credit contracts the total demand for industry.
To provide banks sufficient liquidity, the cash reserve ratio and the statutory liquidity ratio have been reduced. As a result, the banking sector is saddled with excess liquidity which is being invested in government securities. Already, the banking system holds such securities far in excess of the SLR of 25 per cent of their total deposits. The Reserve Bank of India has noted this unhealthy appetite for government securities at the cost of credit to productive sectors. But this is not enough. The RBI can impose a ceiling of say, 30 per cent on public sector banks’ investment in securities.
The rate of interest has been slashed drastically. In addition, bank deposit rates have been reduced from 8 per cent to 6 per cent between July 2000 and April 2003. This can affect household savings, the largest component of the gross domestic savings of the economy. Few developing countries can boast of a savings rate of 20 to 25 per cent of the gross domestic product which India has achieved. It would be tragic if we lost this precious national habit.
The corporate sector wants the capital market to be developed and the government has gone out of its way to promote it — tax concessions for investment in equity, throwing open the stock market to the PSBs and so on. But the stock market has failed to respond to the changes adequately. Consequently, mobilization of resources for investment from the primary capital market has fallen. And it is in the capital market where the banks are investing.
Another big change is in the arena of foreign exchange. Over the last one year our foreign exchange reserves have been rising. Early this year the finance minister announced that Indian citizens, companies and mutual funds can invest in equities of recognized companies abroad. There is no ceiling on investments by individuals while companies can invest up to 25 per cent of their net worth and for mutual funds, the limit is $1 billion. Indian companies with branches abroad can acquire immovable property abroad for staff residence. Asset transfer proceeds up to $1 million can now be remitted abroad from India.
These steps have taken India closer to full capital account convertibility. This is risky as it means that foreign portfolio investments can simply come and go at a moment’s notice and thereby affect the basic macro-economic parameters of the economy. Financial ruin of several nations took place primarily because of this.
The Tarapore committee had stipulated three pre-conditions for moving towards full convertibility — reducing the gross fiscal deficit, non-performing assets of the banks and the rate of inflation. In reality, the relevant economic parameters for India are nowhere near the stipulated levels. The committee also recommended a ceiling of $25,000 for investment by individuals. This has been ignored totally.
Non-resident Indian income from bank deposits has been exempted from tax for a long time. Now, the limit of their remittance abroad has been raised to $1 million from $230,000. Need we go on pampering the NRIs like this' The finance ministry seems to be frittering away a precious national asset instead of using it for productive purposes like importing capital equipment for crucial power projects.