Redraft the policy framework

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: Exceedingly well written, the Raghuram Rajan Committee’s draft report is an excellent effort at thinking about the public policy issues affecting Indian finance. Alongside the Percy Mistry Committee report, which focuses on the external dimension, it adds up to a comprehensive picture of where India has to go. The two reports, put together, offer a forward-looking picture that replaces the financial and monetary thinking rooted in a planned economy framework that currently characterises Indian finance.

When policymakers sought to “plan” the Indian economy, their addressed five key elements. Banks were dominated by government ownership, and the resources of all banks, PSU or not, were controlled by the MoF and RBI. Financial markets were either banned outright, or hobbled. An extensive licence-permit raj was in place, under which financial firms had to request government permission for every small change in product or process. Monetary economics was all about funding the fiscal deficit, and after the ways and means agreement of 1997, about exchange rate pegging. Integration with the global economy, however, put this framework under stress; so an integral part of this package deal was capital controls induced by a fear of globalisation.

This repressive framework was enthusiastically implemented by politicians and bureaucrats who claimed that this was all being done to help the poor. This worldview was propagandised in all official documents, was shared by most economists, and permeated the reflexes of the public, including journalists.

Starting from the early 1990s, three key events upset this happy equilibrium. The first was in the real economy. Indian businesses had to grapple with delicensing, competition and globalisation. FDI was welcomed, trade barriers were removed, and the licence-permit raj substantially taken apart. This embrace of foreign technology and capital worked very well. The economic upturn has made it harder to sustain xenophobia. Today, businesses are globalising. And if they buy the best low-cost steel in the world, it is increasingly infeasible to tell them not to obtain the best low-cost financing and financial services in the world.

The second event was the equity boom. With the creation of Sebi and NSE, India got a genuine stockmarket. The government has no say in prices here, and capital allocation is determined by private forecasts about the future performance of firms or industries. Alongside this, mutual funds and insurance companies came about, with a modern regulatory framework. The third major development was the gradual movement towards easing capital controls. While a messy licensing environment continues to be in place, it is now useful to think of India as being effectively “open”—in the sense that money will find its way in and out of the country.

These three developments add up to a sea change in the environment of financial and monetary policy. However, a full rethink of the policy itself was not done. The avenues for progress in finance unleashed in the early 1990s had petered out by the end of the decade. By 2001, when the last major leg of the transformation of the equity market fell into place, finance had settled into sullen stagnation.

What was needed was a new way of thinking about finance and its role in the economy, and a new monetary policy framework. This framework must be designed for India as a fast-growing and fast-globalising market economy. Put together, the Percy Mistry and Raghuram Rajan reports supply this full picture. The Percy Mistry report is international finance focused, and emphasises the international dimension. The Raghuram Rajan report is focused on domestic finance: it addresses critical questions like financial inclusion, credit infrastructure, enhancing competition, policy issues in banking, and the two-way linkages between sound macroeconomic policy and sound financial sector policy.

The latter report combines world class intellectual firepower and original research with the ground reality as seen by the CEOs of financial firms who were members of the committee. It covers a breathtaking range of issues, and, as the preface suggests, has drawn on knowledge from a very wide array of top people. It is an unusually well-written report, and is likely to have considerable influence. The report is particularly effective in documenting how the ancien regime gives a raw deal to poor people, thus undermining a key claim of the socialist framework. It offers concrete and tangible market-based solutions through which poor people will do better.

Put together, the Percy Mistry and Raghuram Rajan reports should alter the Indian approach to monetary and financial economics. It is no longer possible for a rational person to hang on to the old Indian framework of financial and monetary policy in the face of such logic and evidence on the table. The reports have set up the right intellectual environment in which the leadership at Sebi and RBI can now look at policy questions. Both reports call for considerable legislative activism. The finance minister, thus, needs to embark on technical drafting work right away for a new legal framework.