FINANCIAL SECTOR

REFORMS
THE ROAD AHEAD
By;
Rameshwari Kaul
FasE-09/11
 INTRODUCTION
 Growth in Real GDP Averaged at 6% per Year during
1980-2005. GDP for 2009 is 7%.
 India is in an enviable position among developing
countries
 Fear of competition is receding – confidence among
Indian industries in their ability to compete in the world
market.
 Success of IT is spilling over to manufacturing
 India’s standing as an economic power in the South
Asian region and the world has risen
 None of this would have happened but for systemic
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 1966 crisis

 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 which firms
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 SITUATION
 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.
 FINANCIAL 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 amidst two 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 were also strongly
related to the financial sector:
 Large scale pre-emption of resources from the banking
system by the government to finance its fiscal deficit.
 Excessive structural and micro regulation that inhibited
financial innovation and increased transaction costs,
 Relatively inadequate level of prudential regulation in
the financial sector.
 Poorly developed debt and money markets.

 Outdated (often primitive) technological and institutional

structures that made the capital markets and the rest of
the financial system highly inefficient.
 FINANCIAL 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 Securities Market 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 and NPAs.
 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 AHEAD

 DEREGULATION-Economic reforms have not only

increased growth prospects, but they have also made markets
more competitive. This means that in order to survive
companies will need to invest continuously on a large scale.
 GLOBALIZATION-Globalization of our financial markets
has exposed issuers, investors and intermediaries to the
higher standards of disclosure and corporate governance that
prevail in more developed capital markets.
 INSTITUTIONALIZATION-Simultaneously, the
increasing institutionalization of the capital markets has
tremendously enhanced the disciplining power of the market.
Large institutions (both domestic and foreign), in a sense, act
as the gatekeepers to the capital market
 TAX-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 PERFORMANCE
GDP GROWTH
Period/
Average 1950- 1980- 1991- 1992- 1997- 2005-06* 2005-06**
2002-03 2004-05
Annual Growth 1980 1990 1992 1997 2002 Projection Apr-Sept
Rate (%)

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

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

 http://mospi.nic.in/t1.htm
 PERCENTAGE OF POPULATION
LIVING IN POVERTY
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 21.1 15.1 19.3

(Tenth Five-Year Plan)
 DOMESTIC SAVINGS
& INVESTMENT
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 4.1
TOTAL 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 26.3 26.8 23.1 26.3
errors and omissions)
(0.1) (0.2) (-1.0) (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

 Puzzling dominance of direct saving in physical assets

 Current account surplus for 3 years in a row
 Unhealthy accumulation of reserves
ROAD AHEAD-CAPITAL 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) risks were
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 and subsidized
finance gave way to a regime of high real interest rates.
 One of the first tasks for the Indian companies was
substantial deleveraging.
 Fortunately, a booming equity market and the appetite of
foreign institutional investors for Indian paper helped
companies to accomplish this to a great extent
 Over the longer term, economic reforms have also been
reshaping the control dimension of the leverage decision.
 An equity issue clearly involves loss of control, and as
discussed under the section on corporate governance,
reforms have increased the power of the minority
shareholders.
 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 price stability 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.