[Dec 2007, Volume 4 Quarterly Issue] Pdf File size - The IIPM Think ...
[Dec 2007, Volume 4 Quarterly Issue] Pdf File size - The IIPM Think ...
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REIMAGINING INDIA<br />
can subsequently cause what can be<br />
termed a “policy reversal” by government.<br />
Such policy reversals can arise<br />
under several conditions some of which<br />
are:<br />
• Suppose government is running high<br />
deficits and implements a tight monetary<br />
policy by increasing interest<br />
rates. Due to the inflexibility of the<br />
banking sector in passing on interest<br />
higher incidence of NPA in balance<br />
sheets. This may force the government<br />
to revive the banking sector<br />
through measures like recapitalization<br />
which will be a direct burden on<br />
government budget. As discussed<br />
earlier, the cost of reviving banks is<br />
very high in the case of India. <strong>The</strong><br />
government indeed began a partial<br />
privatization of banks as part of its<br />
economic reform process initially<br />
providing Rs.40 billion from 1991-92<br />
to 1992-93 to 19 nationalized banks.<br />
Subsequently, the government has<br />
spent around Rs.164.5 billion at a<br />
rate of between 0.02 and 0.7 percent<br />
of GDP each year from 1993-99.<br />
Though there was a decline in NPA<br />
from 17.8 percent in 1997 to 11.4 percent<br />
in 2002 they are still very high.<br />
• A second reason for policy reversal is<br />
the existence of weak regulatory and<br />
supervisory framework in the Indian<br />
Banking sector. <strong>The</strong> UTI mutual<br />
funds crisis is an example of this (See<br />
Appendix A.1).<br />
<strong>The</strong> government began a partial privatization of banks,<br />
initially providing Rs.40 billion from 1991-92 to 1992-93<br />
to 19 nationalized banks. Subsequently, ithas spent<br />
around Rs.164.5 billion at a rate of between 0.02 and 0.7<br />
percent of GDP each year from 1993-99<br />
on the state of the financial system.<br />
Standard and Poor’s (Polackova, 1999)<br />
estimate the fiscal cost of a future<br />
banking crisis in India will be around<br />
15 percent of GDP. This is so high because<br />
of the persistent inefficiencies in<br />
the banking system even after a decade<br />
of financial reform (Bhattacharya and<br />
Patel, 2003). Bhattacharya and Patel<br />
(2003) put the estimate of government<br />
guarantees in India as around 12 percent<br />
of GDP. Hence government guarantees<br />
are a crucial part of analysis of<br />
a financial sector especially in developing<br />
economies.<br />
<strong>The</strong> overview of the reform process<br />
brings up the question of policy reversal<br />
which is covered in the next section.<br />
5. Policy Reversal<br />
Most of the financial reforms in the Indian<br />
economy were guided by “.... objectives<br />
of increasing operational efficacy<br />
of monetary policy....” (RBI, 1997,<br />
page I-9). It is argued that under current<br />
inefficiencies (especially high NPA<br />
and the large share of government ownership)<br />
in the banking sector, any efforts<br />
by government to ensure macroeconomic<br />
stabilization (say reduction<br />
in fiscal deficit) or restructuring will<br />
involve an offsetting effect, adversely<br />
affecting the initial policy objectives,<br />
which will transmit mainly through the<br />
financial sector. This offsetting effect<br />
rates rise this will lead to banking<br />
stress. This inflexibility arises mainly<br />
because of the government’s policy<br />
of directed and concessional lending<br />
to priority sectors. Because of a regulated<br />
interest rate regime, the banks<br />
cannot adjust their deposit rates<br />
much, say in the, area of savings deposits.<br />
Thus stress in the banking<br />
sector will be directly reflected in a<br />
6. Conclusion<br />
<strong>The</strong> present paper has reviewed the financial<br />
sector reform process in India<br />
focussing on the banking sector. It can<br />
be safely concluded that financial sector<br />
reform in India is incomplete. <strong>The</strong><br />
banking sector remains inefficient because<br />
of several factors viz. high reserves<br />
and liquidity requirements, a<br />
poor regulatory and supervisory framework,<br />
the presence of implicit government<br />
guarantees, high transaction costs<br />
etc. <strong>The</strong>se inefficiencies can adversely<br />
affect the long-term policy objectives<br />
of a sound fiscal system and can even<br />
lead to policy reversals.<br />
128 THE <strong>IIPM</strong> THINK TANK