In the early 1990s, Indian policymakers, confronted with a balance-of-payments crisis, embarked on a drive to transform the socialist economy to a capitalist state, relaxing curbs on foreign direct investment and privatization, while loosening the regulatory straightjacket known as the “License Raj” system.
These moves pushed India’s potential growth rate up from 3%-5% to around 7%-9%, placing the country at the heart of the global economy, and reshaping the financial fortunes for around a billion people.
Twenty years later, the capitalist project still remains a work in progress, shackled by the slow pace of Indian reform, thanks to the complexities of participatory democracy, bureaucratic rigidities and the still-domineering nature of the Indian state, which was designed by colonial masters to control the economic levers of the country.
While New Delhi has sought to reduce the role of the state as a provider of marketable goods and services, aside from the provision of social safety nets, the liberalization drive has stalled over the past five years.
The spectacular victory of the reform-minded opposition party, Narendra Modi’s Bharatiya Janata Party in the general elections earlier this year, and the stewardship of the Reserve Bank of India by Raghuram Rajan, a former IMF chief economist, has unleashed the animal spirits. Optimism abounds over the reform agenda.
Modi has signalled his core priorities as cutting red tape, transforming the tax and labour-market system, negotiating trade deals, and ensuring better co-ordination between the federal government and states to launch infrastructure projects. These are laudable aims. But Indian policymakers must remember a shift in the banking and capital-market landscape will be crucial in the endeavour to allocate capital with efficiency, finance investment and propel an employment-generating manufacturing sector.
Chastened by the global emerging-market-focused storm that has unexpectedly ravaged India over the past one and half years, the RBI should seize on the recent crisis to deliver a positive shock to the state-led financial order.
India’s economic model should aim for a Singapore-like paradox where an activist state vies with a strong private sector. Key to this transformation may be liberalization, rather than privatization per se, where the government shifts its role from day-to-day management of public-sector enterprises to a government-as-investor role.
A litany of reforms are urgently needed. These include cleaning non-performing assets from the system after the 2009-2012 credit party, which was brought to an end by slowing growth and bad governance.
Politically-sensitive reform of the 21 public sector (known as ‘PSU’) lenders – which are under-capitalized, lack operational freedoms and are often ransacked by crony capitalists – is essential. So is liberating the private sector to allocate credit, rather than through government fiat. In addition, new bank licences and a smarter supervisory regime would achieve financial inclusion and address the structural lack of credit supply relative to demand in India’s increasingly complex real economy.
In a bid to sweat yield from their costly and heavily-regulated India operations, foreign lenders for the past 10 years have nursed billion-dollar hangovers from the unsecured consumer loan party.
Today, the large western houses have implemented more conservative lending policies, while maximizing more-stable sources of revenues from transaction banking, risk-advisory and cross-selling to multinational clients in an aggressively over-banked market for investment-banking.
Once the government makes good on reforms, foreign banks may finally be able to cash in on India’s vast promise.