Allowing corporates to run banks may be “a risky move,” said the former Chief Economic Advisor (CEA) to the Union Government, Arvind Virmani, on Wednesday. Speaking exclusively to The Hindu, Dr. Virmani, who served as CEA till November 2009, said, “The history of banking tells you that the probability of related lending when banks are owned by industrial houses, as is illustrated by the Robber baron period in the U.S.”

Dr. Virmani, who stepped down as Executive Director at the International Monetary Fund in October, 2012, said although regulatory systems have improved since then “weaknesses of our institutions, which are reflected in the pulls and pressures from political and financial interests, pose significant risks.” He urged the Government to “take (a) calculated risk, but not excessive risk.” “I do not think there are significant benefits from this move,” he remarked. He said there might be more benefits from increasing competition among the public sector banks, which can be achieved by diluting government stake in them.

Dr. Virmani’s comments assume significance in the light of the comments from officials of the Reserve Bank expressing their apprehensions about the move, which follows amendments to the Banking Regulation Act in the last session of Parliament. The actual rules under the legislation, determining which entities will be allowed a banking license have not been issued. Significantly, countries such as the United States and South Korea do not allow industrial houses to establish banks. In other countries, such as Australia, U.K. and Canada also enforce restrictions on the extent of foreign ownership and set limits on voting rights. Even the IMF had warned in January that the benefits from allowing such ownership were outweighed by risks.

Dr. Virmani admitted the move might have been aimed at boosting “investor sentiment” at a time when credit rating agencies are threatening to classify Indian debt to junk status, and at a time when the current account deficit had breached the four per cent of GDP mark.

Asked if the RBI’s move at moderating interest rates would result in improved investment rates, Dr. Virmani said, “We need to simultaneously reduce the fiscal deficit while loosening monetary policy.” Fiscal contraction, through reduced expenditures rather than higher taxes, would improve the chances of higher capital investments, he argued. “While Europe now requires a Keynesian prescription, in India we need a fiscal contraction because the savings rate is down, inflation is high and the current account deficit is widening,” he observed.

Asked what he would expect from the forthcoming budget, Dr. Virmani said although he would suggest a lower of import tariffs on agricultural commodities, “a political consensus within the Government on this may be elusive.”

Dr. Virmani said the Indian economy had shown “clear signs” of slowing down in the last two-and-a-half years. Referring to the estimate of the central statistical Organisation that the Indian economy is likely to grow at only five per cent in the current year, he said: “The measures I had suggested then – increasing FDI inflows – have been adopted two years too late,” he quipped.

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