It is ironic that the financial services sector that does not itself ?produce? but simply intermediates and reorganises resources plays such a key role in driving growth in key economies around the world. The share of the financial sector in the aggregate profits of US corporates, for example, is as high as 40 per cent. The role of the financial sector in promoting efficiency, productivity and profits cannot be denied but we must also remember that financial crises have been a recurrent feature of free and open capital markets.
These crises normally emerge after a snowballing process of market exuberance marked by too much lending and borrowing results in market imbalances and asset bubbles. They expose the fragility of the international financial system and the huge disparities in wealth. Governments across the world will address this issue of financial sector fragility and instability?if they don?t reform and repair, there might just be another crisis lurking around the corner.
The engine of growth for both the domestic and global economy going forward, I believe, will have to be the ?real? sector of the economy and the macroeconomic policy will have to focus on getting the fizz back into the real sector. I would view the budget from this perspective?I believe that it provides a blue-print for stepping up the momentum of the manufacturing and agriculture sectors. The critics of the budget (and there is no dearth of them) seem to have missed this completely. They have instead focused on issues such as the absence of any concrete statements on greater foreign investment limits in the insurance sector. In the bigger scheme of things and given the challenges we face on the macroeconomic front, these are relatively minor. In any case the budget is not the government?s sole policy statement and the specifics of its FDI policies and divestment programmes are likely to be announced over the next few months, if not weeks. I am happy that the financial markets seem to be realising this.
Let?s turn to a more substantive issue?that of the fiscal deficit and the prospect of government borrowings crowding out. These fears are grossly exaggerated. For one, banks are together sitting on a cash surplus of Rs 1,40,000 to Rs 1,50,000 crore that they are parking with the RBI for a paltry return of 3.25 per cent. A significant portion of the government?s borrowings have already been done and the government?s cash calls on the money markets are likely to be much lower than what a cursory glance at the budget would suggest. The bottom-line?there?s enough money in the system to fund both the government and the private sector?s needs even if private investments were to pick up.
Could the final fiscal gap be larger than projected in the Budget? Is there a risk of running high deficits for a number of years going forward? My reading of the FM?s strategy is the following?he believes in conservative promises and over delivery. The budget?s growth and tax targets (tax revenues are projected at just about 2 per cent over the 2008-09 levels) are remarkably conservative. If the economy recovers and capital markets regain their momentum, the finance minister is likely to get more taxes than he has estimated. Besides, commodity prices can be lower than the levels assumed in the budget and this could lower the subsidy bill. If growth does pick up, the option of raising taxes to plug the fiscal hole increases. Thus the fiscal deficit can come down sharply much faster than most of us expect.
In the current environment, the sensible thing to do is remain focused on growth instead of fretting over too many things. High growth will help fix the deficit; it will attract foreign capital into the economy. The new government?s strategy is to stay resolutely committed to this objective and there is every chance that this is likely to succeed.
The author is CEO, HDFC Bank, winner of FE’s best bank award for strength & soundness