Next Generation Financial reforms for india
| Author | Raghuram G. Rajan/Eswar S. Prasad |
| Position | Professor of Finance at the University of Chicago's Graduate School of Business/Senior Professor of Trade Policy at Cornell University |
| Pages | 23-27 |
Page 23
India has grown by leaps and bounds in recent years and is emerging as a major world economic power. After lumbering along at a pace of about 4-5 percent GDP growth a year in the 1980s and the 1990s, the economy has surged in this decade, posting an average annual growth of 8.5 percent since 2005 (see Chart 1). The challenge now is to maintain this growth momentum and provide benefits as well as economic opportunities to a broad swath of the population.
India's financial system-comprising its banks, equity markets, bond markets, and myriad other financial institutions-is a crucial determinant of the country's future growth trajectory. The financial system's ability to channel domestic savings and foreign capital into productive investment and to provide financial services-such as payments, savings, insurance, and pensions-to a vast majority of households will influence economic as well as social stability.
While India's financial institutions and regulatory structures have been developing gradually, the time has come to make a more concerted push toward the next generation of financial reforms. A growing and increasingly complex market-oriented economy, and its greater integration with global trade and finance, will require deeper, more efficient, and well-regulated financial markets.
A new report advocates a shake-up in india's financial system to underpin growth
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These considerations prompted the Indian government to institute a high-level committee-composed of a select group of financial sector practitioners, businesspeople, academics, and policymakers-to map out a blueprint for financial reforms. After more than six months of intensive work, the committee recently delivered its draft report to the government (available at http://planningcommission.nic.in/reports/genrep/report_fr.htm). In this article, we summarize the key findings of the report and examine its recommendations.
Numerous other government committees over the years have looked into specific aspects of India's financial reforms, but this is the first committee mandated to "outline a comprehensive agenda for the evolution of the financial sector." Indeed, the report argues that there are deep linkages among different reforms, including broader reforms to monetary and fiscal policies, and recognizing these linkages is essential to achieve real progress.
The report has three main conclusions. First, India's financial system is not providing adequate services to the majority of domestic retail customers, small and medium-sized enterprises, or large corporations. Government ownership of 70 percent of the banking system and hindrances to the development of corporate debt and derivatives markets have stunted financial development. This will inevitably become a barrier to high growth.
Second, the financial sector-if properly regulated but unleashed from government strictures that have stifled the development of certain markets and kept others from becoming competitive and efficient-has the potential to generate millions of much-needed jobs and, more important, have an enormous multiplier effect on economic growth.
Third, in these uncertain times, financial stability is more important than ever to keep growth from being derailed by shocks hitting the system, especially from abroad. Although the Indian economy dodged the Asian crisis and the recent subprime crisis, a lot remains to be done to secure the stability and durability of the financial system.
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The report finds that the Indian financial system has made significant strides in recent years. India's stock exchanges, in particular, have developed well and become a vital source of funding for enterprises and an alternative savings instrument for households. Stock market capitalization has risen significantly-aided by financial inflows from abroad-and the technical infrastructure of equity trading is state of the art (see Chart 2).
The Indian government has taken a number of steps to improve the banking system. Banking reforms, which started nearly two decades ago, have increased the efficiency of the banking system, and the ratio of nonperforming loans to deposits is about 1 percent-a remarkably low level. Many of the public sector...
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