ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

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Exotic Derivative Contracts

The huge marked-to-market losses on derivatives that are coming to light raise troubling issues about the direction of financial liberalisation and inadequate regulation. The banks are estimated to have a total exposure of a mind-boggling Rs 1,27,86,000 crore or $ 3.16 trillion. If even only 1 per cent of the trade has a problem the marked-to-market losses will be a huge $ 3.16 billion. The genesis of the problem can be traced to two policy decisions - the sharp appreciation of the rupee in the first half of 2007 and the central bank's decision in April 2007 to expand hedging facilities in the foreign exchange market (including allowing small and medium enterprises to hedge even without underlying exposures or a record in exports/ imports). The corporates and banks then recklessly entered into contracts, which have landed them in trouble following the steep depreciation of the dollar against the yen and the Swiss franc.

The Loan Waiver Scheme

Rural India needs a strategy that strengthens the credit structure, increases the number of bank branches and establishes sound relationship banking. Even as banks are encouraged to increase their rural commitments, an essential aspect of the incentive structure for the banking system should be an assured recovery process. A socio-political environment that nurtures expectations of a loan waiver is not conducive for building a healthy financial system, particularly in rural areas where borrowers have weak bargaining power and bank officials are known to be reluctant to lend at the smallest sign of a poor recovery.

Is the Comfort in the External Sector Tenuous?

India's international investment position shows her net external liabilities in the red and on occasion these have grown. That a large proportion of capital inflows are of the "non-debt" variety is no comfort, for much of these inflows - mainly portfolio capital - is extremely volatile. The large foreign exchange reserves have been built not with current account surpluses but with capital receipts, which are a potential source of future trouble and have already put pressure on the rupee and affected exports.

Towards Global Norms in Payment and Settlement Systems

The Indian financial system now encompasses a vast set of payment, settlement and clearance systems. Two recent legislative changes, the enactment and notification of the Government Securities Act 2006 and the passage of the Payment and Settlement Systems Bill 2006 promise to make major improvements in the processing of financial instruments. However, one proposal to shift the entire cheque clearance arrangement to a new corporation is facing hurdles.

Steps to Develop Corporate Bond Market

The Securities and Exchange Board of India has begun to take steps to develop the corporate bond market, which remains underdeveloped in comparison to the equity and gilt markets. The regulator has begun implementing, in a phased manner, the recommendations of the R H Patil Committee. These include measures to ensure greater transparency, disseminate information and aid price discovery. Important as these measures are, more has to be done to promote a vibrant bond market that would mobilise funds for infrastructure.

Missing Elements in Monetary Policy

Missing from monetary policy is a concern for the distribution and cost of credit to the productive sectors. Instead of setting indicative targets for the growth of money supply, deposits and non-food credit - all of which have to deal with imponderables - the Reserve Bank of India's policies should be focusing on credit distribution exercises that have direct implications for the production and investment plans of industries and also for attaining other macro objectives like price stability.

Coping with the Deluge of Capital Inflows

The Reserve Bank of India finds its hands tied in coping with the massive surge in capital inflows. The government, more keen on maintaining a global investor-friendly image, refuses to hear its argument that participatory notes should be banned and a close watch be placed on hedge funds. A larger use of the foreign exchange reserves for infrastructure is also ruled out because of the self-imposed stiff fiscal targets. India has committed itself to participating in the game of globalisation of the financial markets irrespective of the consequences for the macroeconomy

Neglect of the Commercial Bond Market

The extensive developments in the financial architecture have benefited the equity and gilt-edged markets but the corporate bond market continues to be excluded. Although the development of this bond market is essential for mobilisation of the vast funds required for infrastructure, many important recommendations such as those of the R H Patil Committee remain unimplemented. Urgent steps must be taken to create the right enabling environment for primary issues for corporate bonds and to establish the infrastructure for secondary market transactions.

Greater Efficiency and Transparency in Settlement Process

The Clearing Corporation of India, established at the initiative of the Reserve Bank of India, has made concerted efforts at providing institutional infrastructure to ensure orderly development and also broaden and deepen the money, government securities and foreign exchange markets. With a radical transformation in the settlement process in the securities and foreign exchange markets, the organisation has overseen the development of better risk management techniques and has also endeavoured to insulate the financial system from shocks emanating from operational issues.

'Surplus' of Resources in External Sector

The latest balance of payments data show that the current account was in small deficit in 2006-07, as it was in the previous two years. However, if gold and silver imports are excluded, then the deficit turns into a surplus over the past three years. This along with the large capital inflows indicates that India's socio-economic development is constrained not by an inadequacy of resources but for want of organisational and institutional structures that can productively utilise the available resources for expansion of the output base of the real economy.

A Shift in Profile of Bank Lending

In recent years, the asset-liability profile of banks has moved towards longer maturities. Term deposits are increasing and lending is also of the long-duration variety. But this does not mean banks are filling the gap created by the exit of development finance institutions: the share of personal long-term loans in total term lending has risen sharply and that of industry has fallen. While within lending to industry the share of term loans has increased, this is a statistical artefact, more the result of companies shifting to non-bank sources for working capital.

Rural Credit Structure Needs Genuine Revitalisation

The target for doubling of bank credit for agriculture in three years is being obviously met because of a dictate from the government but the quality of such lending will be weak and a large proportion will come back as non-performing assets. Without the expansion of the rural branch network by the financially strong and dominant public sector banks with staff appropriately qualified for dealing with agriculture and micro enterprises, the objective of a rapid credit expansion is sure to be stifled. These banks have to expand their network even as they co-opt cooperatives and other local agencies to supplement their banking business and undertake to expand their credit base in the informal sector.


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