Finance Minister P Chidambaram and Reserve Bank of India Governor Raghuram Rajan, in the United States for the annual meetings of the World Bank and the International Monetary Fund, made a number of public appearances, partly to provide clarity on the domestic economic situation and policy responses to it as well as the future agenda for reform. It was only to be expected that Dr Rajan's road map would concentrate on financial sector reforms, many of which he had earlier championed as chairperson of the Committee on Financial Sector Reforms. But, with Mr Chidambaram also emphasising the agenda for this sector, a presumably unintended impression may be created that addressing financial sector issues could substantially solve the economy's problems and get it back on to a desirable growth trajectory. This is clearly not the case and, if the basic purpose of these articulations is to restore investor confidence, it is important that the wider reform agenda be laid out.
The financial sector does indeed need reform. The overall plan to bring more competition into the sector, to strengthen the transparency of borrowers' history, use innovative financial instruments to push inclusion and so on are all important components of a strategy that will help make the financial system more accessible, more efficient and safer. And, while many of these initiatives may look easy on paper, their implementation will require dealing with several entrenched interests, making it an extremely challenging exercise. Dr Rajan's liberal views on foreign banks, for example, may not find favour with whichever political configuration forms the next government. But, on the other hand, measures that increase transparency will help all players make more informed and, consequently, efficient decisions on both resource allocation and pricing. The banks themselves should be fully behind this. Overall, while the merits of individual components of the strategy can be debated, the pursuit of the broad objectives of penetration, efficiency and safety will certainly contribute to better economic performance.
But the financial sector, while critical, does not operate in a vacuum. Its ultimate contribution to the growth process is that it helps allocate capital more efficiently, thereby raising the productivity of capital. However, there are other factors that also impact capital productivity, many of which simply do not fall within the ambit of the financial sector. The significant deterrents to employment growth in the organised sector, for example, prevent many opportunities for efficient deployment of capital from being exploited. Bankruptcy procedures, which straddle many administrative jurisdictions, are critical to the efficiency of financial intermediation. As is well known, India suffers some serious deficiencies in this regard, despite significant reforms having been done in the early 2000s. In short, there is a long list of factors that come in the way of realising the full benefits of a well-thought-out financial reform agenda. Unfortunately, there is little articulation of how the government intends to deal with these. Perhaps the most important lesson from the high growth period of 2003-08 is that the momentum is generated not by one set of reforms alone; it comes when significant progress has been made across a variety of fronts.
