Indias growth strategy and reform

Mritiunjoy Mohanty

Assumptions
First, acute deficiency of material capital
Second, speed of capital accumulation
constrained by low capacity to save
Third, structural constraints on converting
savings into productive investment

Assumptions
Fourth, agriculture defined by diminishing
returns to scale, industry by increasing
returns to scale - absorption of surplus
labour from agriculture
Fifth, primacy to market would lead to
excessive consumption by the rich and
skewed investment priorities - not in
keeping long term requirements of the
economy

Assumptions
Sixth, whereas inequality was bad any rapid
transformation of the ownership structure
inimical to increase in output and savings.

Assumptions
A supply side view of the world
very little keynesian unemployment of
resources
therefore state should aid in increasing and
mobilisation of savings or productive
accumulation.

Assumptions
Growth process sustainable with rapid
public investment
public investment in three possible areas
infrastructure
agriculture
industry

Asumptions
1st FYP focussed on first two
export pessimism and 2nd FYP
closed economy and therefore role of
capital goods seector
textile first strategy

Crisis of 1991
Structural Adjustment
Industry deliscensing and deregulation
Trade bringing tariff barriers
Investment liberalisation of inward investment
Current a/c convertibility
Capital controls
Integration into the global economy

Financial sector and its reforms as a

case
At the time of independence India had a largely privately
owned and reasonably diversified banking system
Intermediation focus rather narrow
Lack of a long term capital market
Neglect of agriculture and rural areas
An attempt to correct both structural and behavioural
lacunae in the system so as aid the process of
industrialisation and growth
RBI sets up DFIs and SFCs as providers of long term
capital
Agricultures needs to met by cooperative banks

 UTI was set up to canalise resources from retail investors

to the capital market
Financial market architecture motivated by the
understanding that intermediation requirement growth and
development was best met by specialized financial
intermediaries who performed specialized functions
To ensure that these specializations were adhered to,
financial intermediaries developed and promoted by the
RBI had significant restrictions on both the asset and
liabilities side of their balance sheets

 despite significant expansion, by end of 1960s, agriculture

still remained under funded and rural areas under banked
share of credit to industry almost doubled, agriculture
received barely 2%
preference for large industry and business houses
neglect of small scale industry and exports
therefore decision to nationalise part of the banking sector
so that allocation of financial resources could take place
according to plan priorities

 in 1975 Regional Rural Banks (RRBs) were set up and in1980

NABARD formed as an apex bank for all cooperative banks in the
country
following with the logic of specialization, the 1980s saw other DFIs
with specific remits being set up e.g. the EXIM Bank for export
financing, the Small Industries Development Bank of India (SIDBI)
for small scale industries and the National Housing Bank (NHB) for
housing finance
long term finance came from DFIs and institutional investors or
through the capital market. However price of capital issues was
regulated by the Controller of Capital Issues
along with nationalization was the restriction of new foreign entrants
into financial markets.

 significant financial deepening with doubling of the

M3/GDP ratio from 24.1% in 1970/71 to 48.5 in 1990/91.
bank credit to the commercial sector as a proportion of
GDP more than doubled from 14.3 to 30.2%
net bank credit to government (including lending by the
Reserve Bank) doubled as well, from 12 to 24.6%
at the end of the 1980s the Indian financial system was
characterized by segmented financial markets with
significant restrictions on both the asset and liability side
of the balance sheet of financial intermediaries as well as
the price at which financial products could be offered
architecture not unique. Similar architecture in many
countries including Japan and France

 segmentation meant that competition was muted, with no

price or non-price competition
the financial system had relatively high transaction costs
and political economy factors meant that asset quality was
not a prime concern
therefore expansion of access had come alongside poor
asset quality
an increase in net bank lending to the government meant
that the asset side of banks balance sheets tended to
become increasingly illiquid
impetus for change from Basel I norms and reforms
following macroeconomic crisis

 financial reform focused on the following:

improving the asset quality on bank balance sheets
increasing competition by removing regulatory barriers to
entry
increasing product competition by removing restrictions on
asset and liability sides of financial intermediaries
allowing financial intermediaries freedom to set their
prices
putting in place a market for government securities
improving the functioning of the call money market

 government security market important

fiscal deficit to be financed by directly
borrowing from the market
monetary policy conducted through open
market operations
large liquid bond market would help the
RBI sterilise, if necessary, foreign exchange
movements

 reforms stood the earlier quantity driven model on its head

de-segment markets and remove asset and liability
restriction of the balance sheets of financial intermediaries
regulatory barriers to entry would be removed and markets
would determine prices
Specialisation, if any, would be market driven rather than
by policy design
financial intermediaries were free to use economies of
scale and scope to achieve efficiency gains and improve
market reach

Continuity and Change

A few specs about the market today (2004)
the government securities market dwarfs every other
market. Its turnover on average is more than 120 times the
BSE turnover and more than 50 times that of the NSE.
second, over time the NSE has clearly grown in
importance vis--vis the BSE. Its turnover is almost twice
that of the BSE.
third, there is large and active call money market
finally, there is a large foreign exchange market as well
with a rising daily turnover it increased from more than
$5 billion to more than $7 billion between April 2003 and
July 2004

 For the period March 2011 to March 2012 the

average daily outright trading volume in the
secondary market for government bonds was 147
billion rupees. The average daily turnover in the
countrys two largest stock exchanges (BSE and
NSE) was 143 billion rupees.
[Calculations on the basis of data from RBI (2012:
Table 5.1). Also see Chakrabarti and Mohanty
(2009)]

In the context of our discussion however there are two restrictions that are of
importance.
First, there are still significant restrictions on foreign participation in the domestic
government bond market, which is the largest part of Indias financial markets, lowering
somewhat the risk of a sovereign-debt crisis and the economy less exposed to the whims
of international bond markets.
Second, domestic banks are disallowed from participating in international financial
markets. But outside of the government bond market and the banking sector, Indias
financial markets are deeply influenced by international capital flows and this is
particularly true of the stock market (see Chandra (2008), Chakrabarti and Mohanty
(2009) and Ghosh and Chandrasekhar (2009)).
The rupee is still not fully convertible on the capital account, to use the jargon of
economics. A fully convertible currency is one where there are no restrictions on the
buying and selling of international financial assets and liabilities. There is one caveat to
domestic banks not being allowed to acquire international assets and liabilities - they are
allowed to lend, within limits, to majority-owned affiliates or wholly owned subsidiaries
of Indian firms abroad (see Nayyar (2008: 125)).