Now that the election is done and dusted, all eyes are on the Budget and the reforms that the government needs to front load. The way a market is structured reveals a lot about the stage of development of the country. Indian regulations for markets and money have evolved piecemeal, solving problems as they came along. But the rules that worked when the economy was at $500 billion are already under stress as India rises to hit $3 trillion. The journey to $5 trillion and then double of that will need new rules of the game. Here are three areas that are crying for change.
One, as India moves from a financially repressed economy, the rules around forced investment into government bonds will need to change. Financial repression is when the government uses its dominant position to put in rules of the game such that it appropriates a bulk of the savings of the nation. It also means that the government, through the central bank, uses its power to set interest rates that are below the inflation rate. In the first case, household money finds its way to government bonds through banks and insurance firms. In the second, the government is able to inflate away its debt. Look at the rules for Indian banks and insurance companies and you see a text book case of financial repression. Banks are currently forced to keep 19% of their deposits in government securities as part of the statutory liquidity ratio (SLR) requirement and another 4% currently as the cash reserve ratio (CRR) requirement with the RBI. So of every ₹100 of deposits that a bank collects, it cannot put ₹23 to use (for lending). Insurance rules are similar. A bulk of the ₹32 trillion assets under management of Indian insurance firms buy government bonds. Notice how tough basic reforms have been in both banking and insurance in India, while stock market reform has been much easier. But this was the paradigm of a low-income, low-tax-paying and low-growth economy. A faster growth with more people paying taxes that result in a higher tax-GDP ratio will give the government the elbow room to relax these regressive rules that punish household savings. The Narendra Modi government should rethink these rules specially since an inflation-targeting central bank will keep inflation under the lid and the Fiscal Responsibility and Budget Management (FRBM) will keep deficits under control—the need for forced household savings will reduce. A rethink in investment rules in insurance, in particular, will open the door for change that stops the huge mis-selling that is in turn driven by high commissions. To read this piece click here