Description
Documentation about the current situation of banking sector, non banking financial sector, debt market, objectives to be adopted and policy recommendations.
The Indian Financial Sector: Policy recommendations for the future
Table of Contents 1. Introduction..................................................................................................................................1 2. The Banking sector......................................................................................................................1 Table 1: Progress of the Indian banks 1991-2001...........................................................................1 3. The Non-Banking Financial Sector.............................................................................................4 3.1 Pension Reforms........................................................................................................................4 3.2 The Debt Market........................................................................................................................5 4. Limitations of the study...............................................................................................................7 Bibliography....................................................................................................................................8
i
The Indian Financial Sector: Policy recommendations for the future
Abstract The objective of the paper is to identify the current weaknesses in the financial sector and develop a set of recommendations that help create an efficient one. The report focuses on two areas, which are the banking sector, the non-banking financial sector (NBFC). Within the NBFC the report looks into problems with the pension fund and the state debt. The major problems with the banking sector are identified as non-performing assets, cooperative banks and policy lending. To rectify the problems it is recommended that the banks be given greater autonomy with regard to loan retrieval and that the co-operative banks be brought under the Banking Regulation act. The major problems with the pension funds are poor corporate governance and service levels. It is recommended to move to a centralized structure that allows for a greater control of the funds, and also eventually move to a system that reflects the risk averseness of an individual. On the issue of mounting state debt, it was recommended that the state exit from all non-core areas, and the public sector undertakings be privatized. However detailed recommendations regarding disinvestments are out of the scope of the paper.
ii
The Indian Financial Sector: Policy recommendations for the future
The Indian Financial Sector: Policy recommendations for the future 1. Introduction The objective of the paper is to identify the weaknesses in the Indian financial sector and develop a set of recommendations that will help create an efficient one. The scope of the paper is to provide recommendations for the major problems based on an in depth analysis of these problems rather than to provide an extended analysis of all the issues facing the sector. The paper analyzes the banking and non-banking sectors presenting for each: • • • A historical perspective and the current scenario The major objectives and The recommendations.
2. The Banking sector 2.1 Current Situation In 1991 several banks were near insolvency due to a large percentage of non-performing assets (NPA) relative to their advances and poor resource allocation and risk management practices. In light of this The Reserve Bank of India (RBI) tried to improve the banks’ operational efficiency, and its regulatory and supervisory functions. By 1995 the progress was visible (Table 1). Table 1: Progress of the Indian banks 1991-2001 Year 1992-93 1994-95 2001-02 CAR 8% SLR 38.5% 29.5% 25% CRR 14% 15% 5% NPA/Total Loans 24% 20% 5-13% PAT (3500) 1100
Source: “India’s Economic Reforms: Vijay Joshi and I.M.D Little” & RBI
Though the progress in the banking sector can be claimed to be exemplary major problems still remain. These are discussed below: 1) The NPA problem1: The NPA in PSU banks is 10-15% of their loans way above the international norm of 2-5%. Recognizing the urgency of the problem the finance ministry (FM) has introduced the NPA ordinance and establishing an asset restructuring company
1
According to the RBI notice the NPA’s in 2002 have increased by 11% and 80% of these are due to public sector banks. The recent increase in the NPA in the private banks has been due to the merger of ICICI with the ICICI bank.
1
The Indian Financial Sector: Policy recommendations for the future
(ARC) to buy the NPA and recover them. These moves are hoped to provide the banks with enough muscle power to recover its debts. 2) The Co-operative banks (CB) problem: The RBI has tried to be strong handed in its dealings with the CB’s2. However these policy regulations have been subject to frequent changes due to strong political dissent on the matter3. Furthermore even though it is stated that the CB’s are to receive managerial autonomy the RBI stipulates that 60% of the loans have to be directed to priority sectors, providing little room for autonomy! The effect of these policy changes has been that the NPA/Total Advances in UCB’s has increased by 10% to 21.9%, between 1999 and 2002. Table 2 shows that the lower level Co-operatives face a more serious problem than either the UCB’s or the SCB’s. Table 2: Composition of Gross NPA's (as on March 31, 2001) (Rs.crore) Asset Quality Total NPAs % Of NPAs to loans outstanding StCB1 3,889 13.0 CCB2 9,371 17.9 SCARDB3 PCARDB4 2,567 2,005 20.4 23.9
1: State Co-operative Banks. 2: Central Co-operative Banks. 3:Scheduled Central Agricultural Rural development Banks. 4: Primary Central Agricultural Rural development Banks Source: NABARD.
3) Priority sector lending: Joshi and Little (1996) question the very purpose of priority sector lending. According to them the arguments of social equity and efficiency (through technology up gradation) are unfounded because the credit mechanism does not reach the ones it is intended to. A majority of the loans are cornered by the large to medium farmers at subsidized rates who re-lend it to smaller farmers at exorbitant interest rates (of between 30100% p.a.) to make a margin for themselves. Furthermore on the argument of technological up gradation they cite that the farmers substitute the cattle for tractors but with negligible increase in output. Even though only 35% of the loans in 1995 went to the priority sector it contributed for 55% of the over dues, while the non-directed credit accounted only for 29%.
2
The major changes in this regard have been, adoption of the Capital-Risk-weighted-Asset-Ratio, giving more operational autonomy, conduct of audit by chartered accountants rather than government officials stipulating more stringent cut-off limits on the NPA and profitability to continue operations. 3 For example the CB’s with 15% NPA may now escape the weak tag, even after the RBI had only recently announced a 10% cut-off limit.
2
The Indian Financial Sector: Policy recommendations for the future
2.2 Objectives to be adopted The objective of any bank is to efficiently collect funds from short-term savers (individuals, corporate) and allocate to long-term institutions in the best interest of the depositors and the bank. The primary function of the government is to monitor and regulate. The recommendations in the section to follow are guided by this primary objective. 2.3 Recommendations In dealing with the CB’s and the priority sector lending it is critical to understand using the CB’s as sources of directing credit are purely populist measures that create more distortions than efficiency. It is recommended to bring down the issuing of directed credit by the CB’s in a phased manner, and use the money saved to create better employment generating opportunities One of the recommendations in this direction is the adoption of the Grameen Bank model followed in Bangladesh where the Non-Governmental Organization (NGO) formed self-helpgroups (SHG) to help both finance people without assets and help them set up industries like fisheries and village bakeries. The bank only funds and monitors the NGO’s and the NGO’s undertake the activity of setting up SHG’s and directing credit. This will help build a system of checks and balances into the present system. As regards to the CB’s problem it is recommended that they be brought under the ambit of the Banking Regulation Act and their disclosure norms be set at par with the industry. Furthermore no subsidized credit should be provided to them4. The UCB’s should be brought under the NPA ordinance and the RBI should work towards providing them more powers to help recover their bad loans. This is expected to gradually transform the CB”s into a competitive entity, instead of a source of priority sector funds. The problem of NPA’s can be traced back to the ill-framed industrial policy and the company policy that make company exit impossible. It is recommended that an administrator replace the management the moment the company is declared sick and the assets are restructured. Equity in the company can replace some of the debt. In case the net present value of the company is lower than the debt value and the liquidation value then the assets of the company can be sold to recover a part of the assets. Furthermore to make it more convenient to recover assets it is
4
Proponents of the view that the small-scale industry will be affected by not giving them subsidized credit may take solace in the fact that 40% of the credit for small-scale industries actually came from the informal market and only 32% from financial institutions while the rest from own funds. The impact of the move is thus vastly exaggerated.
3
The Indian Financial Sector: Policy recommendations for the future
recommended that laws like Urban Land Ceiling Act be done away with in all states 5. These rules should help provide the banking system with more teeth to ensure loan recovery and good corporate governance. 3. The Non-Banking Financial Sector 3.1 Pension Reforms 3.1.1 Current situation For a pension fund in India the government stipulates the percentage of funds to go into each instrument. (Chart 1) Chart 1: Percentage of EPF to each instrument
Deter. by Trustees 20%
Central Gov. Bonds 25%
Securities of PFI,PSU's and IDFI's 40%
State Gov. bonds 15%
The state’s dependence on the pension funds has increased by 43.6% in recent years. Given the fact that the state and center deficit accounted for around 10% of the GDP, the danger in breaking the link between the state/ center and the pension funds becomes immediately visible6. The problems are:
5
In Mumbai alone there are no less than 58 mills and the land they occupy between them in Central Mumbai is worth between Rs.15,000 - 20,000 crore. But mill owners are effectively trapped into inaction, or illegal means of land transfer. The National Textile Corporation as a whole has 71 sick mills and as a whole owes Rs.1,200 crore to banks and financial institutions! 6 The Central Government pension liability as a percentage of GDP has risen from about 0.5 per cent in 1993-94 to 1% in 2000-2001. The state sector dependence on the pension funds has increased by 43.6% on an average in recent years. These level of dependence are thought to be unsustainable as mentioned by the then finance minister Mr. Yashwant Singh in his budget speech.
4
The Indian Financial Sector: Policy recommendations for the future
1) Poor governance. There is no central database about pension recipients, basic facts about age distribution are missing and in several cases pensions continue to be awarded to deceased people. 2) Tax arbitrage: 82.3% of the withdrawals from the pension funds are pre-mature. This is due to the existence of easy tax arbitrage7. 3.1.2 Objectives to be adopted The short-term objective is to impart a good governance structure to the EPF. The long-term objective should be to develop the pension fund into a system that reflects the risk characteristic of the investor, giving him a choice of fund managers or portfolio allocation choice. 3.1.3 Recommendations To accomplish the short term objective it is necessary to technologically upgrade the present EPF system to remove the possibility of an arbitrage. It is proposed that the each individual investor have one account that is centrally managed. Moving from one company to another will not cause any transfer of money, reducing the number of transactions. Furthermore the premature withdrawal system should be replaced by the individual account system described above. To achieve the longer term objective it is recommended that the EPF start offering a choice of fund managers offering portfolios of varying risks. The equity stake in these portfolios should only be in indexed funds. The customer gets a choice of the fund manager and portfolio characteristics. 3.2 The Debt Market 3.2.1 Current Situation Considerable progress has been made in the field on managing the Central Fiscal deficit, however the state deficit remains a problem. The deteriorating state of the state finances is evidenced by the rising interest burden and the greater dependence on pension funds. Table 3: Selected ratios for the state government (in %) Market loans/ total debt
7
1991-92 15
1997-98 17.4
1998-99 17
The withdrawals from the Employees Provident Fund (EPF) are tax-exempt. An employee may take advantage of the poor technology in the EPF office to shift between two jobs that the EPF is unable to link up, and pocket the tax benefits of doing so. This is further facilitated by the low rates of return on the pension funds.
5
The Indian Financial Sector: Policy recommendations for the future
Interest burden Internal debt/ total debt Provident fund /total liabilities Guarantees/ Revenue receipts
Source: The RBI
13.6 17.4 15.4 46
17.6 21.4 17.8 44
17.9 21.6 18.3 42
The major problems with the state debt are: 1) Guaranteeing loans: Presently the state guarantees loans for major infrastructure projects and other PSU. According to the present norms the states does not need to provide for this in the liabilities of the state. However the guarantees are extended to PSU’s that are currently operating at a negative rate of return (ROI). Given the declining loans from the center8, the state will be forced into guaranteeing more loans and coupled with the fact that the revenue receipts are decelerating the gravity o the situation becomes eminent. Chart 2: Total outstanding of the states
1999 1998 1997 1996 1995 1994 1993 1992 40317 52792 48649 49034 42682 65495 79627 73902
2) Market borrowing program: Under the current program the state is allotted a share of the total amount that the state as a whole can raise from the market. The loans are raised at a fixed interest rate and a fixed maturity, which are the same for all states. The states have been given authority to raise up to 35% of their loans at market-determined rates. This is clearly distortionary. The borrowing is independent of the underlying finances of the state. This removes all fiscal responsibility from the state and therefore can lead to more inefficiency. 3.2.2 Objectives to be adopted The long-term objective should be to make the state more fiscally responsible.
8
Loans and advances from the Central Government which constitute a predominant share of total liabilities, have declined significantly from 67.2 per cent in 1990-91 to 60.8 per cent in 1997-98 and estimated at 60.1 per cent in 1998-99
6
The Indian Financial Sector: Policy recommendations for the future
3.2.3 Recommendations It is clear that to avert the immediate danger of cascading payments of guarantees the steps would have to include making the PSU’s profitable or divest the state share in these PSU’s. The latter is recommended since it will disconnect the state from its non-core responsibility of managing companies and leave it in more able hands. It is also recommended that the states move to a better system of governance that can lead to an increase in the revenue receipts (especially the direct component) and allocate resources in a prioritized manner9. Clearly the recommendations in this direction are out of the scope of the current discussion. 4. Limitations of the study There are several factors that go into determining the success of a financial sector which have not been discussed in this paper. These include capital market regulations, regulation of central government borrowing, infrastructure development banks and flow of foreign funds. They are no doubt important issues, however the discussion on these issues is restricted by either the enormity of the problem in these sectors or the priority that they deserve. The recommendations in this paper are limited in their analysis and depth primarily due to the constraint on space. Any recommendation that goes beyond this level will clearly require more detail, which is beyond the scope of the paper. Number of words (Excluding charts and tables =1716)
9
A fantastic example of this is the fact that the total loans received has decreased in 1999 due to reduced recovery from the power plants, however in the state budget the loans to be meted out to the power plants actually increased by over 13%! This and other examples are indicative of the large number of distortions in several industries.
7
The Indian Financial Sector: Policy recommendations for the future
Bibliography 1) RBI Documents a. “Budget Estimates: 1998-99” b. “Developments in Co-operative Banking” c. “Report of the Task Force to Study the Cooperative Credit System and Suggest:Measures for its Strengthening”. August 2, 2000. d. Dr. Reddy Y.V “Developing Bond Markets in Emerging Economies: Issues and Indian Experience”. e. Dr. Reddy Y.V. “Fiscal Reforms at State-level :Review and Prospects”. f. Dr. Reddy Y.V. “Managing Public Debt and Promoting Debt Markets in India” g. Financial Sector Reforms and Monetary Policy Measures”. h. Kamesam Vepa “Co-Operative Banks in India :Strengthening through Corporate Governance”. i. Kamesan Vepa “Credit Through Co-Operatives: Some Thoughts” j. Mitra Saumi K. “Expenditure Budget Review” (Press Information Bureau) k. Tahir Mohammad “Development of Bond Market in India” l. Venu M.K. “The Chilean Model” 2) Internet sites a. “Gujarat co-ops tarnish UCBs”. www.economictimes.com. November 16, 2002 b. “Non-Performing Assets“. www.hinduonline.com c. “NPAs: Private banks set to beat PSU rivals”. www.economictimes.com. November 16, 2002 d. Dasgupta Samik “Banks with up to 15% NPAs may escape 'weak' tag”. www.economictimes.com . November 16, 2002 e. Jain K.C. “Urban Land (Ceiling and Regulation) Repeal Ordinance, 1999 : rationale and gray areas”. www.ebc-india.com f. Krishnamurthy Suresh “Thinning spreads, bulging NPAs” Nov 10, 2002 g. Lavi Mohan R “The NPA antidote”. www.economictimes.com. Jul 18, 2002 h. Sanganee Hetal Mumbai builders want Ulcra scrapped September 23, 2002 i. Shah Ajay “Issues in pension system reform in India”. August 1, 2000
8
doc_568517795.doc
Documentation about the current situation of banking sector, non banking financial sector, debt market, objectives to be adopted and policy recommendations.
The Indian Financial Sector: Policy recommendations for the future
Table of Contents 1. Introduction..................................................................................................................................1 2. The Banking sector......................................................................................................................1 Table 1: Progress of the Indian banks 1991-2001...........................................................................1 3. The Non-Banking Financial Sector.............................................................................................4 3.1 Pension Reforms........................................................................................................................4 3.2 The Debt Market........................................................................................................................5 4. Limitations of the study...............................................................................................................7 Bibliography....................................................................................................................................8
i
The Indian Financial Sector: Policy recommendations for the future
Abstract The objective of the paper is to identify the current weaknesses in the financial sector and develop a set of recommendations that help create an efficient one. The report focuses on two areas, which are the banking sector, the non-banking financial sector (NBFC). Within the NBFC the report looks into problems with the pension fund and the state debt. The major problems with the banking sector are identified as non-performing assets, cooperative banks and policy lending. To rectify the problems it is recommended that the banks be given greater autonomy with regard to loan retrieval and that the co-operative banks be brought under the Banking Regulation act. The major problems with the pension funds are poor corporate governance and service levels. It is recommended to move to a centralized structure that allows for a greater control of the funds, and also eventually move to a system that reflects the risk averseness of an individual. On the issue of mounting state debt, it was recommended that the state exit from all non-core areas, and the public sector undertakings be privatized. However detailed recommendations regarding disinvestments are out of the scope of the paper.
ii
The Indian Financial Sector: Policy recommendations for the future
The Indian Financial Sector: Policy recommendations for the future 1. Introduction The objective of the paper is to identify the weaknesses in the Indian financial sector and develop a set of recommendations that will help create an efficient one. The scope of the paper is to provide recommendations for the major problems based on an in depth analysis of these problems rather than to provide an extended analysis of all the issues facing the sector. The paper analyzes the banking and non-banking sectors presenting for each: • • • A historical perspective and the current scenario The major objectives and The recommendations.
2. The Banking sector 2.1 Current Situation In 1991 several banks were near insolvency due to a large percentage of non-performing assets (NPA) relative to their advances and poor resource allocation and risk management practices. In light of this The Reserve Bank of India (RBI) tried to improve the banks’ operational efficiency, and its regulatory and supervisory functions. By 1995 the progress was visible (Table 1). Table 1: Progress of the Indian banks 1991-2001 Year 1992-93 1994-95 2001-02 CAR 8% SLR 38.5% 29.5% 25% CRR 14% 15% 5% NPA/Total Loans 24% 20% 5-13% PAT (3500) 1100
Source: “India’s Economic Reforms: Vijay Joshi and I.M.D Little” & RBI
Though the progress in the banking sector can be claimed to be exemplary major problems still remain. These are discussed below: 1) The NPA problem1: The NPA in PSU banks is 10-15% of their loans way above the international norm of 2-5%. Recognizing the urgency of the problem the finance ministry (FM) has introduced the NPA ordinance and establishing an asset restructuring company
1
According to the RBI notice the NPA’s in 2002 have increased by 11% and 80% of these are due to public sector banks. The recent increase in the NPA in the private banks has been due to the merger of ICICI with the ICICI bank.
1
The Indian Financial Sector: Policy recommendations for the future
(ARC) to buy the NPA and recover them. These moves are hoped to provide the banks with enough muscle power to recover its debts. 2) The Co-operative banks (CB) problem: The RBI has tried to be strong handed in its dealings with the CB’s2. However these policy regulations have been subject to frequent changes due to strong political dissent on the matter3. Furthermore even though it is stated that the CB’s are to receive managerial autonomy the RBI stipulates that 60% of the loans have to be directed to priority sectors, providing little room for autonomy! The effect of these policy changes has been that the NPA/Total Advances in UCB’s has increased by 10% to 21.9%, between 1999 and 2002. Table 2 shows that the lower level Co-operatives face a more serious problem than either the UCB’s or the SCB’s. Table 2: Composition of Gross NPA's (as on March 31, 2001) (Rs.crore) Asset Quality Total NPAs % Of NPAs to loans outstanding StCB1 3,889 13.0 CCB2 9,371 17.9 SCARDB3 PCARDB4 2,567 2,005 20.4 23.9
1: State Co-operative Banks. 2: Central Co-operative Banks. 3:Scheduled Central Agricultural Rural development Banks. 4: Primary Central Agricultural Rural development Banks Source: NABARD.
3) Priority sector lending: Joshi and Little (1996) question the very purpose of priority sector lending. According to them the arguments of social equity and efficiency (through technology up gradation) are unfounded because the credit mechanism does not reach the ones it is intended to. A majority of the loans are cornered by the large to medium farmers at subsidized rates who re-lend it to smaller farmers at exorbitant interest rates (of between 30100% p.a.) to make a margin for themselves. Furthermore on the argument of technological up gradation they cite that the farmers substitute the cattle for tractors but with negligible increase in output. Even though only 35% of the loans in 1995 went to the priority sector it contributed for 55% of the over dues, while the non-directed credit accounted only for 29%.
2
The major changes in this regard have been, adoption of the Capital-Risk-weighted-Asset-Ratio, giving more operational autonomy, conduct of audit by chartered accountants rather than government officials stipulating more stringent cut-off limits on the NPA and profitability to continue operations. 3 For example the CB’s with 15% NPA may now escape the weak tag, even after the RBI had only recently announced a 10% cut-off limit.
2
The Indian Financial Sector: Policy recommendations for the future
2.2 Objectives to be adopted The objective of any bank is to efficiently collect funds from short-term savers (individuals, corporate) and allocate to long-term institutions in the best interest of the depositors and the bank. The primary function of the government is to monitor and regulate. The recommendations in the section to follow are guided by this primary objective. 2.3 Recommendations In dealing with the CB’s and the priority sector lending it is critical to understand using the CB’s as sources of directing credit are purely populist measures that create more distortions than efficiency. It is recommended to bring down the issuing of directed credit by the CB’s in a phased manner, and use the money saved to create better employment generating opportunities One of the recommendations in this direction is the adoption of the Grameen Bank model followed in Bangladesh where the Non-Governmental Organization (NGO) formed self-helpgroups (SHG) to help both finance people without assets and help them set up industries like fisheries and village bakeries. The bank only funds and monitors the NGO’s and the NGO’s undertake the activity of setting up SHG’s and directing credit. This will help build a system of checks and balances into the present system. As regards to the CB’s problem it is recommended that they be brought under the ambit of the Banking Regulation Act and their disclosure norms be set at par with the industry. Furthermore no subsidized credit should be provided to them4. The UCB’s should be brought under the NPA ordinance and the RBI should work towards providing them more powers to help recover their bad loans. This is expected to gradually transform the CB”s into a competitive entity, instead of a source of priority sector funds. The problem of NPA’s can be traced back to the ill-framed industrial policy and the company policy that make company exit impossible. It is recommended that an administrator replace the management the moment the company is declared sick and the assets are restructured. Equity in the company can replace some of the debt. In case the net present value of the company is lower than the debt value and the liquidation value then the assets of the company can be sold to recover a part of the assets. Furthermore to make it more convenient to recover assets it is
4
Proponents of the view that the small-scale industry will be affected by not giving them subsidized credit may take solace in the fact that 40% of the credit for small-scale industries actually came from the informal market and only 32% from financial institutions while the rest from own funds. The impact of the move is thus vastly exaggerated.
3
The Indian Financial Sector: Policy recommendations for the future
recommended that laws like Urban Land Ceiling Act be done away with in all states 5. These rules should help provide the banking system with more teeth to ensure loan recovery and good corporate governance. 3. The Non-Banking Financial Sector 3.1 Pension Reforms 3.1.1 Current situation For a pension fund in India the government stipulates the percentage of funds to go into each instrument. (Chart 1) Chart 1: Percentage of EPF to each instrument
Deter. by Trustees 20%
Central Gov. Bonds 25%
Securities of PFI,PSU's and IDFI's 40%
State Gov. bonds 15%
The state’s dependence on the pension funds has increased by 43.6% in recent years. Given the fact that the state and center deficit accounted for around 10% of the GDP, the danger in breaking the link between the state/ center and the pension funds becomes immediately visible6. The problems are:
5
In Mumbai alone there are no less than 58 mills and the land they occupy between them in Central Mumbai is worth between Rs.15,000 - 20,000 crore. But mill owners are effectively trapped into inaction, or illegal means of land transfer. The National Textile Corporation as a whole has 71 sick mills and as a whole owes Rs.1,200 crore to banks and financial institutions! 6 The Central Government pension liability as a percentage of GDP has risen from about 0.5 per cent in 1993-94 to 1% in 2000-2001. The state sector dependence on the pension funds has increased by 43.6% on an average in recent years. These level of dependence are thought to be unsustainable as mentioned by the then finance minister Mr. Yashwant Singh in his budget speech.
4
The Indian Financial Sector: Policy recommendations for the future
1) Poor governance. There is no central database about pension recipients, basic facts about age distribution are missing and in several cases pensions continue to be awarded to deceased people. 2) Tax arbitrage: 82.3% of the withdrawals from the pension funds are pre-mature. This is due to the existence of easy tax arbitrage7. 3.1.2 Objectives to be adopted The short-term objective is to impart a good governance structure to the EPF. The long-term objective should be to develop the pension fund into a system that reflects the risk characteristic of the investor, giving him a choice of fund managers or portfolio allocation choice. 3.1.3 Recommendations To accomplish the short term objective it is necessary to technologically upgrade the present EPF system to remove the possibility of an arbitrage. It is proposed that the each individual investor have one account that is centrally managed. Moving from one company to another will not cause any transfer of money, reducing the number of transactions. Furthermore the premature withdrawal system should be replaced by the individual account system described above. To achieve the longer term objective it is recommended that the EPF start offering a choice of fund managers offering portfolios of varying risks. The equity stake in these portfolios should only be in indexed funds. The customer gets a choice of the fund manager and portfolio characteristics. 3.2 The Debt Market 3.2.1 Current Situation Considerable progress has been made in the field on managing the Central Fiscal deficit, however the state deficit remains a problem. The deteriorating state of the state finances is evidenced by the rising interest burden and the greater dependence on pension funds. Table 3: Selected ratios for the state government (in %) Market loans/ total debt
7
1991-92 15
1997-98 17.4
1998-99 17
The withdrawals from the Employees Provident Fund (EPF) are tax-exempt. An employee may take advantage of the poor technology in the EPF office to shift between two jobs that the EPF is unable to link up, and pocket the tax benefits of doing so. This is further facilitated by the low rates of return on the pension funds.
5
The Indian Financial Sector: Policy recommendations for the future
Interest burden Internal debt/ total debt Provident fund /total liabilities Guarantees/ Revenue receipts
Source: The RBI
13.6 17.4 15.4 46
17.6 21.4 17.8 44
17.9 21.6 18.3 42
The major problems with the state debt are: 1) Guaranteeing loans: Presently the state guarantees loans for major infrastructure projects and other PSU. According to the present norms the states does not need to provide for this in the liabilities of the state. However the guarantees are extended to PSU’s that are currently operating at a negative rate of return (ROI). Given the declining loans from the center8, the state will be forced into guaranteeing more loans and coupled with the fact that the revenue receipts are decelerating the gravity o the situation becomes eminent. Chart 2: Total outstanding of the states
1999 1998 1997 1996 1995 1994 1993 1992 40317 52792 48649 49034 42682 65495 79627 73902
2) Market borrowing program: Under the current program the state is allotted a share of the total amount that the state as a whole can raise from the market. The loans are raised at a fixed interest rate and a fixed maturity, which are the same for all states. The states have been given authority to raise up to 35% of their loans at market-determined rates. This is clearly distortionary. The borrowing is independent of the underlying finances of the state. This removes all fiscal responsibility from the state and therefore can lead to more inefficiency. 3.2.2 Objectives to be adopted The long-term objective should be to make the state more fiscally responsible.
8
Loans and advances from the Central Government which constitute a predominant share of total liabilities, have declined significantly from 67.2 per cent in 1990-91 to 60.8 per cent in 1997-98 and estimated at 60.1 per cent in 1998-99
6
The Indian Financial Sector: Policy recommendations for the future
3.2.3 Recommendations It is clear that to avert the immediate danger of cascading payments of guarantees the steps would have to include making the PSU’s profitable or divest the state share in these PSU’s. The latter is recommended since it will disconnect the state from its non-core responsibility of managing companies and leave it in more able hands. It is also recommended that the states move to a better system of governance that can lead to an increase in the revenue receipts (especially the direct component) and allocate resources in a prioritized manner9. Clearly the recommendations in this direction are out of the scope of the current discussion. 4. Limitations of the study There are several factors that go into determining the success of a financial sector which have not been discussed in this paper. These include capital market regulations, regulation of central government borrowing, infrastructure development banks and flow of foreign funds. They are no doubt important issues, however the discussion on these issues is restricted by either the enormity of the problem in these sectors or the priority that they deserve. The recommendations in this paper are limited in their analysis and depth primarily due to the constraint on space. Any recommendation that goes beyond this level will clearly require more detail, which is beyond the scope of the paper. Number of words (Excluding charts and tables =1716)
9
A fantastic example of this is the fact that the total loans received has decreased in 1999 due to reduced recovery from the power plants, however in the state budget the loans to be meted out to the power plants actually increased by over 13%! This and other examples are indicative of the large number of distortions in several industries.
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The Indian Financial Sector: Policy recommendations for the future
Bibliography 1) RBI Documents a. “Budget Estimates: 1998-99” b. “Developments in Co-operative Banking” c. “Report of the Task Force to Study the Cooperative Credit System and Suggest:Measures for its Strengthening”. August 2, 2000. d. Dr. Reddy Y.V “Developing Bond Markets in Emerging Economies: Issues and Indian Experience”. e. Dr. Reddy Y.V. “Fiscal Reforms at State-level :Review and Prospects”. f. Dr. Reddy Y.V. “Managing Public Debt and Promoting Debt Markets in India” g. Financial Sector Reforms and Monetary Policy Measures”. h. Kamesam Vepa “Co-Operative Banks in India :Strengthening through Corporate Governance”. i. Kamesan Vepa “Credit Through Co-Operatives: Some Thoughts” j. Mitra Saumi K. “Expenditure Budget Review” (Press Information Bureau) k. Tahir Mohammad “Development of Bond Market in India” l. Venu M.K. “The Chilean Model” 2) Internet sites a. “Gujarat co-ops tarnish UCBs”. www.economictimes.com. November 16, 2002 b. “Non-Performing Assets“. www.hinduonline.com c. “NPAs: Private banks set to beat PSU rivals”. www.economictimes.com. November 16, 2002 d. Dasgupta Samik “Banks with up to 15% NPAs may escape 'weak' tag”. www.economictimes.com . November 16, 2002 e. Jain K.C. “Urban Land (Ceiling and Regulation) Repeal Ordinance, 1999 : rationale and gray areas”. www.ebc-india.com f. Krishnamurthy Suresh “Thinning spreads, bulging NPAs” Nov 10, 2002 g. Lavi Mohan R “The NPA antidote”. www.economictimes.com. Jul 18, 2002 h. Sanganee Hetal Mumbai builders want Ulcra scrapped September 23, 2002 i. Shah Ajay “Issues in pension system reform in India”. August 1, 2000
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