Impact of financial sector reform

THE FINANCIAL sector reforms encompassing the Reserve Bank of India's fiscal deficit funding, deregulation of interest rates, regulation of banks and credit delivery through banks have a bearing on the fiscal management at the State-level.

Interest rates have been deregulated to a significant degree not only to facilitate more effective monetary policy, but also because the administered interest rate regime proved to be inefficient and costly, without necessarily ensuring credit flow to the deprived. The RBI's recommended approach does not preclude subsidisation by the Government. However, it disfavours the in-principle excessive use of the banking system to cross-subsidise, especially as credit seepages are not controllable.

The RBI favours a financial system that provides incentives to encourage credit flow and ensure the servicing of interest and principal, that is, the bankability of schemes. Thus, the RBI has introduced modified interest rate prescriptions, providing concessions to small borrowers to the size of credit limits, rather than to specified sectors or groups of borrowers.

There are two issues relating to credit delivery on which the RBI's initiative is sought, namely, the regional dimension and the rural-urban divide. The regional variations or inter-State disparities in the credit-deposit ratio existed in the past and persist in the post-reform period also. The variations may be less pronounced in some cases, if ratio of credit plus investments to deposits is considered.

The RBI has been sensitising banks to ensure the flow of credit to all States, while at the same time urging State Governments to create enabling environments for credit flow. Progressively, the instruments available with the RBI to `direct' credit are less in a deregulated environment, especially since financial intermediation through non-banks, including mutual funds and NBFCs, is justifiably expanding. In fact, the unequal distribution of burden of social obligations between banks and non-banks could undermine the health of the banking system so vital to our economy.

As part of the financial sector reforms, there have been significant reductions in statutory preemptions, under the Statutory Liquidity Ratio with respect to banks. The market share of non-public sector banks in the banking system is increasing. There has been diversification of ownership in several large banks. The insurance companies are also coming under competitive pressure, and hence, there are limits to what may be termed as involuntary subscriptions to public debt. Under these circumstances, full subscriptions to borrowing programmes approved by the Government with respect to some States may not be possible if the banks and other market participants do not volunteer to subscribe. At the same time, some States which are favourably perceived by the financial markets do get subscriptions at more favourable rates when they exercise the limited option of approaching the market directly.

(Edited extracts from the address of Dr Y. V. Reddy, Deputy Governor, Reserve Bank of India, at the India States Reform Forum organised by the World Bank at New Delhi on November 24.)