Column: What now, UPA?

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The UPA has a last few months of life in which it can get on with economic reforms, unencumbered by the CPI(M). Financial sector reforms are bound to be high on this agenda. This requires attacking the seven structural flaws of the existing policy framework.

The success story of Indian finance is the equity market, which has achieved a full ecosystem with high levels of liquidity and market efficiency. In contrast, with currencies, commodities and bonds, the markets are deeply flawed. Indian finance is an airplane running on one engine. The critical task is of making these other three markets come to life. This requires work on seven fronts.

1. Mistakes in regulation of institutional investors: Institutional investors in India suffer from three problems: over-prescriptive and irrational rules, resource pre-emption by the government and high entry barriers. As a consequence, even though India is a big country, financial firms in India are tiny by world standards and have not achieved global competitiveness. Solving these three problems requires modifying laws, modifying the behaviour of regulators and modifying regulations.

2. Flawed regulatory architecture: India has an alphabet soup of regulators. Most elements of the regulatory architecture were in place many decades ago (e.g. laws of 1934 or 1952), before knowledge of finance existed. The financial industry has distorted itself to fit within the constraints of the regulatory architecture. This needs to be turned upside down: government must adjust to the requirements of a healthy financial sector.

This requires reforms of the regulatory architecture. RBI needs to become an independent central bank that is held accountable for delivering low and stable inflation. The Budget 2007 announcement about setting up an independent Debt Management Office (DMO) requires commensurate legislation. Banking requires a BRDA. The regulation of all organised financial trading needs to be merged into SEBI. IRDA is already in place; PFRDA requires legal foundations. This would give us a regulatory architecture with one central bank doing monetary policy and four financial regulators.