Financial reforms are for aam admi, not elitist
The Economic Times, August 20, 2007
CO-AUTHOR of Saving Capitalism from the Capitalists, Dr Raghuram Rajan is a strong advocate of
financial sector reforms which, he says, is far from elitist. In fact, financial sector reforms can touch the
poorest of poor and may even have a solution to farmer suicides, he adds, thrashing traditional mindsets.
The former chief economist at the International Monetary Fund and professor of finance at University of
Chicago’s Graduate School of Business, Dr Rajan is completely at home at Indian School of Business,
Hyderabad, where he is academic fellow 2007 at the Centre for Analytical Finance. Dr Rajan’s interview to
J Padmapriya and Hema Ramakrishnan is peppered with case examples and anecdotes, in true classroom
style. Excerpts:
What are your comments on the Percy Mistry report on Mumbai as a
financial centre? What is your roadmap for financial sector reforms?
There is a lot of good in the Percy Mistry report. The direction that it suggests seems
reasonable. The question is: Is setting preconditions stalling necessary reforms? You
could argue both ways. Sometimes, it makes sense to have a very clear deadline in
mind beyond which we are not going to wait for preconditions. For example: China
set a timeline on when it was going to open up for foreign banks. It put pressure on
its domestic banks to change in anticipation. It might make sense to fix deadline,
giving the financial sector time to adjust.
The report has suggested a timeframe of 18-24 month for freeing capital
controls. Is it feasible?
I haven’t thought deeply about the time for opening. My sense is there is no
dramatic one thing that is necessitating the opening. We have capital flowing in.
Trade credit is another way that capital is flowing in. If you have controls, people will
try and negate those in different ways. So, trade finances of over-invoicing, etc are
time-tested ways of sending capital in and out. Right now, the issue seems to be
capital flowing in. Down the line, it may be of capital flowing out. We need to put in
place a set of structures that make us absorb both capital inflows and outflows.
There is a perception that financial sector reforms do not touch the poor.
I do think there is a worry that financial sector reforms are positioned as something
for the middle class and the rich that don’t touch the poor and the aam admi. That is
completely wrong. There are so many ways that financial sector can benefit them.
For example, the amount of bank lending that goes to large companies and publicsector firms is considerable. In developed countries, large companies don’t borrow
from banks anymore. They borrow from the bond market thereby freeing the banks
to lend to SMEs. Reviving the corporate bond market and getting more players in the
government bond markets will channel more finance to SMEs.
One reason why we don’t have a vibrant bond market is that we don’t have a
bankruptcy court. We have intermediate measures like Sarfaesi which helps
institutions like banks to get their money back. Should we have a bankruptcy court
that protects bond investors? Do we need one for infrastructure projects as they are
complex and involve a variety of financial methods. Fixing the bond market is not an
elite concern. It is a concern that rests on the entire issue of growth in the country.
Let us give it another twist. When you think of farmer suicides, it does seem a
medieval answer to the problem of being overly indebted. In developed countries,
they go to a personal bankruptcy court and say that they can’t pay. Now, you can’t
directly super-impose that in India. But, if we have a proper creditdelivery
mechanism of tracking borrowers and keeping a repayment record, then perhaps it
may be possible for borrowers to file for bankruptcy and accept a downgrade in
credit rating. Basically, it should not mean the end of the world. We need to think of
making the credit system a lot more humane. There are various low hanging fruit in
the domestic financial system that need to be plucked.
In a coalition government, it does get a bit difficult to push crucial reforms.
The last two years has not seen much in this area. Do you agree?
In the financial sector, we are not talking one or two years, but a process spanning a
number of years. Even if there is a disagreement on the extent of FDI or
privatisation of banks, I think there are some non-controversial things that need to
be done anyway. It is important to change the mindset that financial reforms are
elitist and speculative, as opposed to something which is of great value even to the
small farmer. We need to do it in a way that allows private and public sector forces
to be together rather than in opposition to each other.
Is the microfinance industry (MFI) well poised to reach out to the poorest of
poor?
I think MFIs are one part of the solution. Financing the poor has a high transaction
cost. Certainly, banks have suggested innovative ways to reach them by joining
hands with NGOs and self-help groups (SHG), which are exploding in size.
In South Africa, cell phone companies are central to financing the poor, and given
the spread of communication technology here, I think they may well act like
distribution agents.
How do we enlist them in a way that is consistent with safety and stability of the
system? While recognising that there are some valuable benefits to growth in giving
the poor access to finances, there are lots of ideas out there on how to do this. We
have to keep an open mind. We also have to create a much more enabling
environment for MFI. I think you can’t monopolise the field by saying only MFIs
should do this. Maybe some large banks can do it through technology. There could
be non-traditional providers like ITC e-choupal or cell phone companies, which can
provide some link to the chain to get to the final consumer.
You have talked about the low hanging fruit. What are the tough ones for
the government to push?
Undoubtedly, the extent of public sector presence in banks, provident funds,
insurance and pension systems. There is both government presence and government
use of these funds. There are limitations on how these institutions can invest in
different areas. It is public sector presence which is a controversial issue. The whole
game of public sector occupying the commanding heights was because it was felt
that the private sector could not do the kind of things that the public sector was
doing. Can the public sector continue to deliver in a competitive economy? If it can’t
and if those things are important, how best can we deliver?
It is worth looking deeply into these issues and trying to find out what makes sense.
In the long run, there is no reason why you have to have one system to the
exclusion of the other. For example, in france, public-sector banking sector works
well with a vibrant private sector.
What would be the three most important financial reforms that India needs?
One, public sector presence in financial sector has to be addressed. That is the
biggest issue. Two, enable infrastructure like bankruptcy laws and create credit
registries. Three, a regulatory environment that fosters innovation.
(Dr Rajan has since been appointed as chairman of the Planning Commission’s 12-member,
high-level committee on financial sector reforms. The committee’s mandate is to spell out a
comprehensive agenda for the evolution of India’s financial sector)