Energising the real economy

THE book under review by Dr. Bimal Jalan, is actually a collection of his speeches and lectures delivered between September 1998 and January 2002, at New Delhi, Mumbai, Kolkata, Bangalore, Hyderabad and Colombo in Sri Lanka. The present compilation includes seven essays and six short comments, on topics covering mainly the financial and the banking sectors, with some reflections on present management practices, as well as the contribution of science and technology to development, via the IT sector boom. In a span of 255 pages, Dr. Jalan has covered a wide range of issues, problems, prognosis, policies, measures, prescriptions, and advice connected with monetary and financial economics and their practice in a developing country like India. In the process, he has revealed his unbounded qualities as a theoretician and an empiricist. Let us see what he has to say in the volume under review.

In the introduction covering 24 pages, the author starts by describing the initial conditions of the Indian economy just before the reforms era began and at the beginning of the new millennium — a juxtaposition of the relative vitality of the real and the financial sectors. This is after almost 10 years of on-going economic reforms. Can Indian economy attain a high rate of economic growth with stability, both internal and external? Is the BOP crisis towards the end of 1980s a thing of the past? Are the upsurge in software exports and the boom in the IT sector transient or going to stay? These questions must be pervading everyone's mind when talking about the real economy. Then there are the financial sides to traverse, to search for the lubricant to energise the real economy. Any mismatch between these two sectors would weaken the functioning of the economy, and would prevent the realisation of the twin objectives of growth and stability. The dovetailing of the real and the monetary-financial sides of the ongoing economic processes is a complex matter to be handled quantitatively, through mathematical model building and econometric techniques. Yet a researcher with a high degree of analytical skill and a profound knowledge of the economy of his existence and livelihood, can unfold and unearth with utmost clarity, some of the technical nuances and subtleties involved in any particular economic process, where real and monetary-financial variables inter-mingle in a continuous fashion.

It goes to the brilliance of Dr. Jalan, to tackle the intricate issues arising from the intimate real and monetary-financial relationships, in a very lucid, compact, and exhaustive manner. In the process he has shown his total mastery of the subject of monetary-banking-financial economics. What has been his concern about the Indian economy? I think in the 13 chapters, Dr. Jalan has been able to touch upon the following issues and problems:

(I) The relative roles of State and the Market in the process of economic development of India. Why the shift to the market has become necessary (though it is not anti-dirigisme ideologically), to exploit the new comparative advantage thrust on the Indian situation, due to developments (both within and outside the country) in "production technologies, international trade, capital movement, deployment of skilled manpower, integration of global financial markets," and the emergence of new sources of growth outside the state sector at "the level of private organisations — software companies — , autonomous institutions — IIMs or IITs — or individuals at the top of their professions in India and abroad". Empirically it has been found that in India the government and the public sector have "deteriorated at all levels — not only in terms of output, profits and public savings, but also in the provision of vital public services in the fields of education, health, water and transport."

Does all this mean that the state ought to become a minimal state, and allow the market forces to exploit the new sources of growth in India? The answer is both yes and no, as far as my reading of Dr. Jalan's book goes. In the essays to follow, the contours of govt. interventions in the new economy have been very well outlined by the R.B.I. Governor. For the real economy to function more efficiently and generate growth impulses, it becomes imperative "to strengthen the capacity of the government to do what it alone can do, i.e. create conditions for growth through higher public investment in areas such as education, health, water supply, irrigation and infrastructure, etc." Here one can see that the emphasis is only on economic and social infrastructure.

In this era of globalisation, according to the author, if the markets are to be integrated (a value judgment is involved), the economy must not tolerate "somnolence, sloth and non-conformity to generally accepted international norms and standards of macroeconomic management, disclosure, transparency and financial accountability." Hence his main worry, "if a country does not put its financial house in order, fresh investments, trade and technology are likely to pass it by." The recommendation is straight forward — "make India's economy more competitive, open and efficient through adoption of appropriate macroeconomic policies and financial standards which conform to international best practices." Here one cannot fail to see the influence of both the neo-classical and the neo-Keynesians on Dr. Jalan. A typical mixed economy approach of the type adopted by non-libertarian development economists. I find that Dr. Jalan is more realistic than idealistic.

The chief concern of the author is to see how the functioning of the real economy is to be improved, particularly at the grass root of democracy. Thus he says "an urgent programme to revitalise the governance and public delivery systems at all levels of government — centre, state and districts. Without strengthening the ability of the government to do what it alone can do, and narrowing the focus of its activities to what matters most for the future development of the country — education, health, clean environment, and a functioning infrastructure — India cannot adequately seize the opportunities that lie ahead." It is very difficult to disagree with this view, having witnessed how the government has functioned since 1961 at the end of the second five year plan. Irrespective of our ideology, we all accept the fact that "the non-governmental sector now has a dynamism and momentum of its own." Hence the need for second generations reforms, particularly in the financial sector, and to set the government's fiscal house in order.

(II) The role of finance in economic development — a topic not very much emphasised in the pre-liberalisation period, though a financial plan had always accompanied the corresponding physical plan in our five year plan documents. That financial variables can upset the smooth behaviour of the real variables, though recognised much earlier (post second world war) in the developed countries, came to be recognised in the Indian scenario only after the 1991 reforms in the real sector. The 1997 East Asian crisis, though it did not effect India to the extent that it affected the developed financial markets, changed the whole perception about the role of financial system in development. Analysts have started looking at the financial markets more closely, particularly its distinctive characteristics vis-�-vis the product markets and factor markets.

The questions Dr. Jalan asks — How "are financial markets special? Do they require a different set of regulatory or supervisory regimes? What are the relative roles of international and domestic supervisory regimes in ensuring the integrity of financial system in the context of globalisation?" One consequence of worldwide integration of financial markets is that it has made the domestic economy more vulnerable with new risks, to events happening elsewhere. A sudden withdrawal of financial capital from a particular country causes some other countries to derail from the steady path of growth with stability and would impinge on the financial relationship with the rest of the world. As the author says "strong fundamentals alone cannot provide full immunity from a crisis. There is need to take early preventive action, to build firewalls and to keep some safety nets handy. It is clear that when things are going well, the rest of the world shares in a country's prosperity. However, when things go wrong, the price has to be paid primarily by the country concerned. It is, therefore, an important responsibility of the countries themselves to put in place an efficient and safe financial system which can aid and protect the development process at all times — good and bad."

Acting on the recommendations of both the reports of Narasimham committee, C. Rangarajan committee, and Verma committee, a lot has been done to free the financial and the banking sectors from the administrative clutches of the government. Reforms have touched the Bank Rate, CRR, SLR, prime lending rates, deregulation of interest rates, freeing entry conditions, inter-bank rates, call rates, repos, freer capital movements internationally with easier repatriation and servicing, easier accessibility to foreign equity, foreign borrowing through long term debt instruments, market determined foreign exchange rates, allowing domestic public sector banks to raise capital from markets, improved capital adequacy ratios, better prudential limits and standards, better provisioning and capitalisation, better transparency-disclosure-accountability, effective reduction of NPAs (though requires legal reforms — "to ensure expeditious recovery of debt and give adequate legal powers to banks to effect property transfer ... . Which (will) strengthen the enforceability of contracts and allow for the resolution of problems, such as, insolvency, default and breach of contract").

All these developments have led to strengthening and diversification of government securities market, money market, capital market, foreign exchange market, and also led to the growth of the number of financial intermediations — thus leading to "growing inter-links among various segments of financial markets ... . A diversified structure contributes to greater stability of the financial system in the event of unanticipated problems." Like a true development economist with a moral standard (in contrast to the pure neo-classicists) Dr. Jalan also issues a warning note to not get confused between "means" and "ends". The financial sector reforms are only means to an end. In the final analysis, the objective of all reforms in developing countries like India, is "a sustained and rising income for all the people, and removal of poverty, deprivation and illiteracy within a reasonable period of time."

Does all this make for a minimal Government? This is the theme which runs through Dr. Jalan's entire writing: "In developing countries, with massive illiteracy and underdevelopment of infrastructure, governments will continue to have an important and crucial role in creating the necessary conditions for growth through investments in areas such as education, healthy, water supply, irrigation and infrastructure, etc. These and similar tasks cannot be fully taken over by the market. Successful financial reforms must result in strengthening the ability of governments to do what they need to do by helping to generate higher growth, higher revenues, and higher productivity ... by removing the constraints of infrastructure and low human resource development." However, there are other constraints also operating from the side of the government. These require "fiscal empowerment of the state and improvement in public administration."

(III) The need for a new International Financial Architecture (IFA). Reforms in international financial management came to be necessitated after the East Asian financial crisis of 1997 and the recurrence of currency crisis in many Latin American countries. The failure of the existing international institutions like the IMF and the World Bank to resolve the crisis before it could get out of hand, led to a rethinking on the need for a new financial architecture — creating new international financial institutions. This will have a bearing on exchange rates, international reserves, capital convertibility issues including management of capital flows, role of external private sector, transparency codes and standards, arrangements for new international liquidity, and which would work for strengthening the financial system.

In a wide range of international forums and groupings, often at the behest of the United Nations, India has been a participant country. However, as the author comments, "the institutional arrangement for decision making on the new financial architecture still remain too heavily weighted in favour of industrial countries. An important priority... is to find ways and means of broadening the dialogue by making the concerned fora more representative." Even in the Bretton Woods institutions, he pleads for "greater representation to developing countries on the boards of these institutions, and to provide them with a larger voting power." In this new era of technology-based services in the financial sector, the role of financial intermediaries has increased tremendously in mobilising and channelising savings and investments (both domestic and foreign) in the growth process. Hence, "it is no longer possible for developing countries to delay the introduction of strong prudential and supervisory norms, and introduce structural reforms in order to make the financial system more competitive, more transparent and more accountable."

(IV) That commercial banking in India got jeopardised by that single act of 1969, has become a matter of history. Mixing politics and economics to serve vested interests, obviously is never a sound policy. One tends to lose both efficiency as well as fairness. Should the 1969 policy be reversed now? Yes, according to Dr. Jalan. But how and why? "It should be possible for us to grant, by legislation, complete functional and operational independence to public sector banks and institutions with the sole objective of providing the best service at the least cost. This will enable them to compete among themselves as well as with other private sector institutions. If, in practice, this is not a feasible option, then the only alternative is for public sector banks to be transformed into widely held private banking corporations, subject to transparency, regulations and accountability to shareholders."

In making the banking sector more vibrant, efficient, competitive, and transparent, financial reforms initiated at the behest of the various committee reports on the banking sector have worked in four different directions. (a) By lowering the CRR and SLR, resources have been freed to be used in the non pre-empted direction. This would imply less of political interference in the granting of loans and credits. (b) Infusion of a more competitive environment through measures like, "relaxation of entry and exit norms, reduction in public ownership in banking industry and letting banks access capital market for meeting their fund requirement." This would improve the capital base as well as the performance of the banking industry in India. (c) Strengthening market institutions by allowing greater freedom to financial intermediaries. The emphasis is on "gradual" liberalisation of interest rates, development of money, capital and debt markets and giving operational flexibility to banks in the management of their assets and liabilities subject, of course, to prudential guidelines." Efforts should be made to lower the concentration of bank lending to one or two major sectors, to prevent them from being affected by "asset price bubbles." (d) Deals with the safety aspect of the financial system by strengthening the balance sheets of the banks. But how? — through "measures such as income recognition norms, asset classification, meeting minimum capital adequacy standards through re-capitalisation and devising a supervisory framework." This has to be in line with the Basle Core Principles for effective banking supervision.

One baffling question remains — why, even in the present scenario, when private financial institutions have made so much improvement, nevertheless, the public still have a preference for public sector financial institutions when it comes to investing their resources? Since the reforms in the financial sector, Indian banking industry is showing a turn-around, though the pace of improvement must be accelerated. An area which requires to be developed is the international presence of Indian banks, particularly when capital movement is so fluid and fast. In this regard the RBI's role is very vital, but to achieve this the RBI must become an autonomous entity, shedding its cent per cent dependence on the government. This is of course a political question, but also falls within the ambit of positive macroeconomics.

Dr. Jalan has thrown up lots of ideas in chapters four and five. It would be of immense help to research students specialising in finance and banking. Students of economics can gain tremendously once they go through the entire volume. In particular, I find Dr. Jalan's comments on the following subjects highly illuminating: the present management practices — the question of corporate governance; on science and technology; on globalisation; on information technology and the banking sector; on exchange rate management — the question of fixed verses floating rates and the self-fulfilling expectations of the market participants; on freedom versus regulations — the question of prudential versus capitalisation norms; on monetary policy — the question of single versus variable targets; the question of operational independence, and the cost delaying handling industrial sickness.

India's Economy in the New Millennium, Bimal Jalan, UBSPD, 2002, p.270, Rs. 395.

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