Indian financial system, unaffected by the Asian economic crisis of 1997, could not distance itself from the global crisis mainly due to the growth impulses driven by externalities. Last eight years, in particular, witnessed greater integration with the globe on all fronts and increasingly aligned to the US and its financial systems and approaches. But when we are attacked by the tsunami, we managed to be at the tail end and what other countries had to do to stand steady we did not have to do. We have more than 85 percent of the financial system in the public sector. Second, we have the key sectors like Steel, Zinc, other Metals and Coal as also the transportation system largely in the public sector. We did not have the derivatives and hedging instruments of the nature that left the others in the lurch. Third, there was no demand recession of the magnitude that the other countries in the globe faced. Still the rural areas where still 65 percent of our population lives, drive the demand growth. Having said that some facts that can be hardly ignored: there is a steep decline in job growth; steep declines have also set in the private sector trumped up by the global recession; the urban and metro retail chains took a severe beating; the real estate and housing boom that irrationally stepped up land values across the country took the first heat-stroke and with them, the dependent SME sector that is seen as the engine of growth. Fourth, Banks that lent heavily for the retail sector and real estate sector started facing the continuous decline in their performing assets. They lost confidence in the resurgence of the demand and also the productive capacities of the manufacturing sector. Most public sector banks even, refused to go with the RBI to pump credit. The two stimuli, injecting more than Rs.4lakh crores liquidity, did not see credit infusion. This high liquidity released only moved to the investments in treasury instruments. As late as the third week of March 2009, Banks declared that they would target only 20 percent in credit growth next year and not 24 percent sought for by the RBI.
Inflation that threatened the financial stability at the beginning of 2008-09 with a growth in double digits has been reined in by a series of well-thought out measures. Now it is disinflation. I prefer to call it as disinflation for two reasons: one, the undependable statistics that went into the Wholesale Price Index that formed the basis for inflation index - and this has been conceded by no less than the Prime Minister of the country, Dr. Manmohan Singh - and two, the decline was only in the index, the rate at which inflation declined rather than the decline in actual prices of most commodities of common consumption. For example, relative to May 2007, the prices of rice and wheat rose by 197 percent and 137 percent respectively by May 2008 and they stayed put till January 2009. In fact, price of rice in Andhra Pradesh rose by 320 percent by March 2009. The rate of domestic savings has been at the peak indicating most people would like to hold to cash. Consumption expenditure standing at 67.8 percent of GDP in 2007-08 has abated a bit during the first nine months but not steep enough to cause alarm. General Elections slated in April and May 2009 has a public-spend of approximately Rs.8000crores and private-spend of at least Rs.20000crores. Implementation of the sixth pay commission wages and salaries would unleash more money into the system. This would mean that at least Rs.28000cr would be unaccompanied by production of goods and services. It is therefore important for the RBI to hold to inflation targeting monetary policy regime as an imperative.
Performance of the farming sector, though constituting 17 percent of GDP but providing sustenance to 60 percent of the population, has been pulling the GDP growth down and the hopes of it rising significantly are not in sight. Manufacturing sector, in the given circumstances, has also been declining. Therefore, the IMF and the World Bank lowered the Indian growth trajectory to just around 6 percent. Even the RBI has lowered its growth expectations. Government of India also conceded that it would not be before the fiscal 20010-11 that India would cross the present declining trend. But the basic question is, on whose shoulders the responsibility lies at the moment to help reverse the trends? Obviously, the financial system.
SIZE IS A CONCERN:
The financial system has to rejig to deliver. With the collapse of giant institutions like Lehman Brothers, AIG and even Citi, it should be an eye-opener for the regulators, size cannot prevent a fall. Regulator's job is to make sure that the vertical and horizontal growth of institutions shall be such that the institutions should not be allowed to go with a feeling that because of their size they are insulated from collapse and that the Government and regulator had to do something to keep them afloat even in the worst event like bankruptcy. This is where the RBI has to reformulate its views and ensure that the organizational structures irrespective of their affiliations do not overboard the governance and do not oversize. The optimal size has to be decided.
The silos-based regulatory system currently in vogue, with the RBI regulating Banks and NBFCs, Stock Markets by the SEBI, Pensions by the Pension Regulatory Authority, Insurance by the Insurance Regulatory Development Authority, and Commodity Futures by the Futures Market Commission has to give way to the establishment of a Super Regulatory Authority that would be in a position to cope with the dynamic and complex nature of financial products that are defacing the boundaries of oversight. India, for example does not have credit risk insurance of the order prevailing in either Italy, or Germany or South Africa. The Credit Guarantee Trust for Micro and Small Enterprises is but a poor cousin of the trade and credit risk. Credit Risk could not be introduced in India as the IRDA was apprehensive of the consequences of credit default. It is perhaps of the opinion that the moral turpitude would reach new dimensions if credit risk is introduced. There are certain other laws impinging on the credit system that would require modifications and certain new laws introduced. The SAFRAESI Act has to be extended to the NBFCs. There is need for introducing a comprehensive Bankruptcy Law/Code. The whole of Negotiable Instruments Act in the context of current level of technologies, and the Payment and Settlement systems need to be rewritten. Quite a few others there and I am limiting myself to these observations for the present. Percy Mistry Committee called for a unified regulatory architecture for resolving issues dealing with segmentation of financial markets into banking, capital markets, insurance, pensions, derivatives etc. Sweden, Singapore, UAE, UK, Republic of Korea to cite a few have already moved into the unified regulatory system.
OPERATIONAL ISSSUES:
The relaxations recently allowed on the ECB front have come at an inopportune time in that the credit markets in the rest of the world stopped extending credit in the wake of the financial turmoil engulfing them. Similar is the announcements relating to Derivative Markets. Warren Buffet, the most reputed investor, is quoted at number of places: "Derivatives were financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal." Over-the-counter derivatives that are off-balance sheet instruments come to surface suddenly when their collaterals fall and when their values become riskier to hold, killing in one stroke rest of the healthy assets of the Banks. The delivery and recipient systems have not reached a level of maturity to play with them. Indian financial system cannot afford the consequences of systemic risks arising from their instrumentality.
Let me go to the most familiar area - Credit Risk that is mostly understood as risk of default. Here the risks arising from asymmetric information have not been dealt with. The Credit Information Bureau India Ltd.,(CIBIL) is the only institution that currently unfolds client's historic information at price. Entry of multiple players with the enactment of Credit Information Services Act of 2005 is put on hold. Trade and Credit information services should enter the competitive domain for the information system to get into a semblance of order.
Credit rating agencies in India that are approved by the RBI are none other than the Fitch, Standard and Poor, Moodys etc., whose ratings busted on the threshold of sub-prime crisis. There is no proof that they are doing their job differently. Until the rating agencies' services are paid for by the financing institutions that make use of the ratings and hold them accountable for the ratings, there is no guarantee that the ratings per se would add to the quality of the credit portfolio the banks carry in respect of the rated assets.
The end game of poverty is no where in sight. Demands continue to surge in attacking poverty with credit instrumentality. Micro Finance institutions though moving apace have a lot of ground to cover. The Rangarajan Committee on Financial Inclusion recommended a series of measures and though the RBI accepted most of them, Banks are slow to move on the front despite quite a few declaring cent per cent financial inclusion of a few lead districts in their fold. Integration of efforts of the Lead Bank Scheme and the priority sector directives for a more dependable information base on the coverage of banking un-banked areas and not-so-credit-worthy persons is yet to begin.
While the Government and the RBI, Insurance and Capital Market regulatory authorities have proved one-upmanship over the other regulatory authorities in reasonably insulating the Indian Financial System from the impacts of the current global crisis, a large gap remains in what is needed to be done. The time to put things in the right shape is now and right away.
Author is an Economist with three decades of banking experience and is currently Regional Director, Professional Risk Managers' International Association (PRMIA), Hyderabad Chapter. He can be reached at yerramr@gmail.com
