financial sector reforms in india-rameshwari

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FINANCIAL SECTOR

REFORMS

THE ROAD AHEAD

By;

Rameshwari Kaul

FasE-09/11



INTRODUCTION

Growth in Real GDP Averaged at 6% per Yearduring 1980-2005. GDP for 2009 is 7%.

India is in an enviable position among developingcountries

Fear of competition is receding ² confidenceamong Indian industries in their ability tocompete in the world market.

Success of IT is spilling over to manufacturing

India·s standing as an economic power in theSouth Asian region and the world has risen

None of this would have happened but forsystemic reforms initiated in 1991



INTRODUCTION

Macroeconomic crisis of 1991

Approach to IMF and the World Bank

Systemic reforms Initiated

Reforms not reversed as they were after the 1966crisis

Collapse of the Soviet Union

China·s rapid growth after 1978



Until the early nineties, corporate financial

management in India was in a bad state.

There were not many important financial

decisions to be made for the simple reason that

firms were given very little freedom in the choice

of key financial policies.

The government regulated the price at whichfirms could issue equity, the rate of interest

which they could offer on their bonds, and the

debt equity ratio that was permissible in

different industries.

Moreover, most of the debt and a significant part

of the equity was provided by public sector

institutions.



PRESENT SITUA TION

finance managers today have to choose from an

array of complex financial instruments; they can

now price them more or less freely; and they have

access (albeit limited) to global capital markets.



FIN A NCI AL SECTOR REFORMS

Financial sector reforms are at the centre stage of

the economic liberalization that was initiated in

India in mid 1991. This is partly because the

economic reform process itself took place amidsttwo serious crises involving the financial sector:

The balance of payments crisis that threatened

the international credibility of the country and

pushed it to the brink of default

And the grave threat of insolvency confronting

the banking system which had for years

concealed its problems with the help of defective

accounting policies.



Moreover, many of the deeper rooted problems of the Indian economy in the early nineties werealso strongly related to the financial sector:

Large scale pre-emption of resources from thebanking system by the government to finance itsfiscal deficit.

Excessive structural and micro regulation that

inhibited financial innovation and increasedtransaction costs,

Relatively inadequate level of prudentialregulation in the financial sector.

Poorly developed debt and money markets.

Outdated (often primitive) technological andinstitutional structures that made the capitalmarkets and the rest of the financial systemhighly inefficient.



FIN A NCI AL SECTOR REFORM

CAUSED:

Mixed picture in different segments Sea change compared to financial repression of

pre-reform era Interest rates largely deregulated Greater competition from private banks and foreign

banks Government pre-empts reduced significantly Establishment of autonomous Board of Financial

Supervision Residential norms on capital adequacy Improved debt recovery and restructuring mechanism Government SecuritiesMarket with primary dealers

as market matures Delivery Version Payment System Establishment of Clearing Corporation of India



Improvements in reach and depth of banking sector,its balance sheet, capital structure, net profits andNPAs.

New financial products introduced Government Security Market has experienced

increases in market size, lower yields and longer

maturities Monetary Policy more independent and based on

indirect instruments Turnover in foreign exchange markets increased Despite achievements problems remain Risk Assessment mechanisms not up to standard

Not ready for Basel-II Public ownership a major problem Success in reforming of equity markets Creation of SEBI, National Stock Exchange Transactions costs fall and markets are integrated

nationally



THE ROAD A HEAD

DEREGULA TION-Economic reforms have not onlyincreased growth prospects, but they have also mademarkets more competitive. This means that in orderto survive companies will need to invest continuouslyon a large scale.

GLOBALIZ A TION-Globalization of our financialmarkets has exposed issuers, investors andintermediaries to the higher standards of disclosureand corporate governance that prevail in moredeveloped capital markets.

INSTITUTION ALIZ A TION-Simultaneously, theincreasing institutionalization of the capital marketshas tremendously enhanced the disciplining power of the market. Large institutions (both domestic andforeign), in a sense, act as the gatekeepers to thecapital market



T AX-REFORMS-Tax reforms coupled with

deregulation and competition have tilted the

balance away from black money transactions. It

is not often realized that when a company makes

profits in black money, it is cheating not only the

government, but also the minority shareholders.

Black money profits do not enter the books of

account of the company at all, but usually go into

the pockets of the promoters.



POST-REFORM PERFORMA NCE

GDP GROW TH

Sources:MOF (2005a), Annex Table 1.6, * RBI, (2005c)

http://mospi.nic.in/t1.htm

Period/

Average

Annual

Growth Rate

(%)

1950-

1980

1980-

1990

1991-

1992

1992-

1997

1997-

20022002-03 2004-05

2005-06*

Projection

2005-06**

Apr-Sept

Real GDP 3.50 5.9 1.3 7.1 5.5 4.0 6.9 7.0-7.5 8.1

Population 2.2 2.1 2.0 1.9 1.7 1.7 1.6 1.6 1.6

Read GDP

per capita 1.3 3.8 -0.7 5.2 3.8 2.3 5.3 5.9 6.5



PERCENT AGE OF POPULA TION

LIVIN

GIN P

O V ER

TY

RURAL URBAN NATIONAL

August 1951 ± November 1952 47.4 35.5 45.3

September 1961 ± July 1962 47.2 43.6 46.5

July 1973 ± June 1974 56.4 49.0 54.9

July 1977 ± June 1978 53.1 45.2 51.3

1983 45.7 40.8 44.5

July 1987 ± June 1988 39.1 38.2 38.9

July 1993 ± June 1994 37.3 32.4 36.0

July 1999 ± June 2000 27.1 23.6 26.1

Target for 2007

(Tenth Five-Year Plan)

21.1 15.1 19.3



DOMESTIC S A VINGS

& INV ESTMENT

Puzzling dominance of direct saving in physical assets

Current account surplus for 3 years in a row

Unhealthy accumulation of reserves

1990-1991 1995-1996 2001-2002 2003-2004

Gross Domestic Savings 23.1 25.1 23.5 28.1

Public 1.1 2.4 -2.8 -0.3

Household: 19.3 18.2 22.8 24.3

Financial 8.3 8.9 11.2 11.4

Physical 11.0 9.3 11.6 12.9

Corporate 2.7 4.5 3.5 4.1TOTAL PRIVATE 22.0 22.7 26.3 28.4

Net Capital Inflow 3.2 1.7 -0.4 -1.8

Gross Domestic Investment (Adjusted for errors and omissions)

26.3

(0.1)

26.8

(0.2)

23.1

(-1.0)

26.3

(3.3)

Public 10.4 7.7 6.0 5.6

Household 11.2 9.3 12.6 12.9

Corporate 4.6 9.6 5.1 4.5

TOTAL PRIVATE 15.8 18.9 18.1 17.4



ROAD A HEAD-CA PIT AL STRUCTURE

At the beginning of the reform process, the Indian

corporate sector found itself significantly over-

levered. This was because of several reasons:

Subsidized institutional finance was so attractive that

it made sense for companies to avail of as much of it

as they could get away with. This usually meant the

maximum debt-equity ratios laid down by the

government for various industries.

In a protected economy, operating (business) riskswere lower and companies could therefore afford to

take more risks on the financing side.

Most of the debt was institutional and could usually

be rescheduled at little cost.



The reforms changed all of this. The corporate sector

was exposed to international competition andsubsidized finance gave way to a regime of high realinterest rates.

One of the first tasks for the Indian companies wassubstantial deleveraging.

Fortunately, a booming equity market and theappetite of foreign institutional investors for Indianpaper helped companies to accomplish this to a greatextent

Over the longer term, economic reforms have alsobeen reshaping the control dimension of the leverage

decision.

An equity issue clearly involves loss of control, and asdiscussed under the section on corporate governance,reforms have increased the power of the minorityshareholders.



CONCLUSION

As one looks back at the last six years of reforms, it is

evident that India has undertaken financial sector reforms

at a leisurely pace and that there is a large unfinished

agenda of reforms in this sector .

Effective monetary management had enabled pricestability while ensuring availability of credit to support

investment demand and growth in the economy

Viewed in this light, the success in maintaining price and

financial stability is all the more creditworthy.

financial sector reforms in india-rameshwari

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