ECONOMIC NOTES

august 16, 2014 vol xlIX no 33 EPW Economic & Political Weekly
66
EPW Research Foundation
Anita B Shetty and S L Shetty are with the EPW
Research Foundation (epwrf.mumbai@gmail.
com), Mumbai.
Budget and the Financial Sector
Promises of Profound Changes
in the Framework
Anita B Shetty, S L Shetty
Even as measures to modernise
and revitalise the nancial sector
need to be taken, the government
should not tamper with the
vigilance exercised by the Reserve
Bank of India and the Securities
and Exchange Board of India.
T
hough almost none of the steps
proposed are related to the nitty-
gritty of budgetary transactions
and scal policy issues, Union Finance
Minister Arun Jaitleys maiden budget
speech presents what appears to be a
fairly comprehensive agenda for modern-
ising and revitalising the Indian nan-
cial system that is said to be at the heart
of the growth engine. Some of the meas-
ures proposed in Budget 2014, such as
the uniform know-your-customer (KYC)
norms, unique operation of demat ac -
counts, invigorating the warehousing
e sector to improve post-harvest lending
to farmers through warehouse receipts,
setting up new debt-recovery tribunals
and working out other means of reviving
stressed assets of banks, and expanding
the coverage of insurance penetration
through multi-pronged devices are all
straightforward measures of an adminis-
trative nature that should be welcomed.
Likewise, efforts to revitalise small
savings by introducing a special small-
savings scheme to cater to the needs of
the education and marriage of the girl
child, raising the Public Provident Fund
ceiling from Rs 1 lakh to Rs 1.5 lakh and
introducing a national savings certi-
cate with insurance cover, would help
augment middle-class savings. While
effective regulation of companies and
entities engaged in prize chits (chit
funds) and money circulation schemes is
intended to help prevent the poor and
vulnerable, who put their money into
these schemes, from being duped.
Reiterating Older Measures
A few of the other proposals, such as
the encouragement to banks to extend
long-term loans to the infrastructure
sector with permission to raise such
loans with minimum regulatory pre-
emptions through the cash reserve ratio,
statutory liquidity ratio and priority sec-
tor lending requirements, are not new as
the Reserve Bank of India (RBI) had
already proposed them earlier. Like-
wise, the proposed liberalisation of the
American Depository Receipts (ADRs)/
Global Depository Receipts (GDRs) or the
proposal to revamp the Indian Deposi-
tory Receipts (IDRs) and replace them
with a much more liberal and ambitious
Bharat Depository Receipts system,
appears more like nationalistic hype. A
committee had been set up to review the
ADRs and GDRs scheme of 1993 keeping
in view the need for simplication; the
committee submitted its report in
November 2013. The government had
accepted the report, agreeing to notify
the new scheme after the necessary tax-
related amendments were made.
With respect to the banking sector,
there are two more proposals; one con-
cerns the future of the bank licensing
system and the other, the launch on
15 August of a time-bound mission pro-
gramme for nancial inclusion. There
are hardly any novel elements in these
proposals except for the pretension of
providing two bank accounts in each
household. These accounts will also be
eligible for credit as though the existing
arrangement does not provide for bank
credit. To take up the licensing of new
banks in the private sector, the RBI had
already nalised and released guide-
lines on the subject on 22 February 2013.
A number of questions have been
raised with regard to the viability and
sustainability of such small banking
units. If the working of the local area
banks (LABs) and even regional rural
banks are anything to go by, such sys-
tems of small banks and differentiated
banks are unlikely to be attractive
p ro positions considering the enormous
banking needs of Indian society. Even if
some such banks thrive with the strict
regulatory standards applied to them,
they will remain a minuscule portion of
the entire banking system, as was seen
with LABs that accounted for 0.02% of
the asset size of scheduled commercial
ECONOMIC NOTES
Economic & Political Weekly EPW august 16, 2014 vol xlIX no 33
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EPW Research Foundation
banks at the end of March 2013, i e, after
a decade and a half. It is against this back-
ground that the RBIs annual report for
2012-13 cautions thus:
However, smaller banks should be promoted
only after putting in place adequate safe-
guards in the form of corporate governance
and a stronger resolution framework to
h andle the possibility of higher mortality
(RBI 2013: 89).
The best bet for the success of nancial
inclusion arrangements lies in stronger
and larger banks that have a pan-India
reach and simultaneously serve clients
of different size groups with the policy
of cross-subsidisation.
New Inclusion Plan
The rst three-year Financial Inclusion
Plan (FIP) (2010-13) has ended and the
banks have been advised to draw up
another three-year FIP for the period
2013-2016 suitably disaggregated to
the branch level. The earlier no-frills
accounts have been converted into basic
savings bank deposit accounts with many
liberal facilities such as no requirement
to maintain a minimum balance, easy
withdrawals, etc. Now Jaitley has pro-
posed to open two bank accounts for
each household which would be also eli-
gible for credit. The FIP had already
envisaged regular annual expansion of
banking outreach in the form of rural
brick and mortar branches opened, bank-
ing correspondents (BCs) deployed and
coverage of unbanked villages with pop-
ulation above and below 2,000 through
branches/BCs/other modes. Apart from
no-frills or basic savings accounts,
Kisan Credit Cards and General Credit
Cards have been issued. Against this
background, Jaitleys plan is unlikely to
be any the better than the plan already in
force. FIP (2010-13) had already reached
182.06 million basic saving accounts (RBI
2013: 82). This is against the estimated
117.07 million small and marginal hold-
ers as per the latest Agricultural Census,
or 168 million rural households, as per
the Census of 2011, which suggest that
there are a number of households with
more than one bank account.
What is more, Jaitley has fallen in
the trap of the same narrow FIP of pro-
viding some bank accounts and setting
bureaucratic targets for them. After
quoting eld studies, the previous RBI
Governor, D Subbarao, once expressed
serious misgivings regarding the end
results in these words:
I am also conscious that bulk of our efforts so
far has been from the supply side opening
branches, appointing BCs and opening
accounts that remain largely imperative. If
this is all that happens, the effort is both
fertile and wasteful (RBI 2012).
Instead of bringing to bear some fresh
thinking on the whole question of the FIP,
Jaitley has adopted more of the same
ritual of target settings. For instance, for
agricultural credit the targets were set
at Rs 5,75,000 crore during 2012-13 and
Rs 7,00,000 crore for 2013-14; it has now
been arbitrarily raised to Rs 8,00,000
for 2014-15. Banks merrily report over-
fullment of the targets.
Even with regard to supply-side issues,
it would have been an excellent oppor-
tunity for Jaitley to take a broader view
of FIP by putting together bank lending
under various stand-alone schemes, such
as, agricultural credit, micronance,
and the National Rural Livelihood Mis-
sion (NRLM) along with FIP, to goad
banks to make genuine achievements in
FIP to cover the excluded categories.
Instead, Jaitley has chosen to announce
targets for all of the stand-alone schemes
without questioning for a moment the
quality of their achievements. Yet another
peculiar example is that of allocation to
the Rural Infrastructure Development
Fund (RIDF), which he has raised by
Rs 5,000 crore to reach a total of
Rs 25,000 crore. This RIDF allocation is
out of the banks shortfall under the
priority-sector target for agricultural
credit. We have shown elsewhere (Table 1)
how the gap between the defaults
against priority-sector targets, and RIDF
allocations have grown over the years,
thus depriving the rural infrastructure
programmes of potential funds.
Three Key Measures
What stand out as radical steps involving
a signicant departure from the existing
nancial structure are three propositions
for reform, namely, (i) deepening the
currency derivatives market by eliminat-
ing unnecessary restrictions; (ii) initiating
early steps for a vibrant, deep and
liquid corporate bonds market; and
(iii) strengthening and modernising the
legislative regulatory framework based
on the recommendations of the Financial
Sector Legislative Reforms Commission
(FSLRC) (Justice B N Srikrishna Commis-
sion), which have proposed a nancial
architecture with seven institutions
independent and yet inter-dependent on
each other.
As part of the above third proposition,
apart from promising to complete the
ongoing process of consultations with
all the stakeholders expeditiously, Jaitley
has inserted an intriguing observation
which is sure to add to the differences in
perceptions on the structure of the
Indian Financial Code as recommended
by the Justice Srikrishna Commission.
The observation is: It is also essential to
have a modern monetary policy frame-
work to meet the challenge of an increas-
ingly complex economy.
As we survey the diverse develop-
ments regarding the differing percep-
tions on the issues at hand, it is clear
that serious tensions are likely to arise
between the Government of India and
the RBI as Jaitley proceeds with this
Table 1: Tentative Estimate of Agricultural Credit Default and RIDF Allocations for Public and
Private Sector Banks
Fiscal Year End Amount of Agricultural Credited Defaulted@ RIDF Allocations Difference
Public Sector Bank Private Sector Bank Total for Next Year
2008-09 6,805 6,805 14,000*
2009-10 2,081 2,081 16,000*
2010-11 37,726 13,498 51,224 18,000 33,224
(64.9)
2011-12 66,640 26,961 93,601 20,000 73,601
(78.6)
@ Derived indirectly from the data on priority sector performance presented in RBI's publication Report on Trend and
Progress of Banking in India, 2010-11 (p 85) and 2011-12 (p 75).
* Data reported on priority sector targets appear suspect as Rural Infrastructure Development Fund (RIDF) allocations
made in succeeding years are considerably higher than the credit target defaults.
(Figures within brackets are percentages of difference over the sizes of credit defaulted.)
ECONOMIC NOTES
august 16, 2014 vol xlIX no 33 EPW Economic & Political Weekly
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EPW Research Foundation
Table 2: Derivative Transactions in the Forex
Market (Rs crore)
Year Over-the-Counter Exchange Traded
Forward Transactions Currency Derivatives
2005-06 10,73,689 (20.49)
2006-07 15,51,883 (19.34)
2007-08 33,68,161 (26.47)
2008-09 47,22,998 (27.88) 3,11,389
2009-10 32,45,177 (22.83) 37,27,262
2010-11 42,33,688 (22.10) 84,06,306
2011-12 51,28,924 (23.10) 98,96,414
2012-13 59,48,085 (22.77) 87,10,505
2013-14 58,25,247 (20.48) 69,80,855
Figures within brackets represent percentages to total
forex market turnover.
-: Trading in currency derivatives commenced on
29 August 2008.
Source: SEBI Bulletin and CCIL Rakshitra, various monthly
issues.
Table 3: Secondary Market Turnover in Financial and Commodities Markets (Amount in Rs crore)
Market Segments /Year 2005-06 2008-09 2011-12 2013-14
1 Government Securities Market 25,59,260 62,54,519 72,52,080 1,61,84,826
(69.3) (111.1) (80.5) (142.5)
2 Forex Market (including Exchange 52,39,674 1,72,48,878 3,20,96,026 3,54,26,801
Traded Currency Derivatives) (141.9) (306.4) (356.2) (312.0)
Of which : i) Forward Market 10,73,689 47,22,998 51,28,924 58,25,247
(29.1) (83.9) (56.9) (51.3)
ii) Currency Derivatives * 3,11,389 98,96,414 69,80,855
(5.5) (109.8) (61.5)
3 Total Stock Market Turnover (I+ II) 72,09,892 1,48,71,781 3,56,29,595 5,07,60,995
(195.2) (264.1) (395.5) (447.0)
I Capital Market (NSE) Derivatives 48,24,251 1,10,10,482 3,13,49,732 3,82,11,408
Cash 15,69,558 27,49,450 28,03,889 28,08,489
Total 63,93,809 1,37,59,932 3,41,53,621 4,10,19,897
(173.1) (244.4) (379.1) (361.2)
II Capital Market (BSE) Derivatives 9 11,775 8,08,476 92,19,434
Cash 8,16,074 11,00,074 6,67,498 5,21,664
Total 8,16,083 11,11,849 14,75,974 97,41,098
(22.1) (19.7) (16.4) (85.8)
III Total Derivatives Turnover (BSE+NSE) 48,24,260 1,10,22,257 3,21,58,208 4,74,30,842
(130.6) (195.8) (356.9) (417.7)
4 Corporate Bond Market 1,48,166 5,93,783 9,70,800
(2.6) (6.6) (8.5)
5 Commodities Market 21,34,000 52,48,957 1,81,26,104 1,01,44,795
(57.8) (93.2) (201.2) (89.3)
GDP at current market prices 36,93,369 56,30,063 90,09,722 1,13,55,073
Figures in brackets represent percentages to GDP at current market prices.
*: Trading in currency derivatives commenced on exchanges from 29 August 2008.
Source : CCIL Rakshitra, SEBI Bulletin, FMC website and CSO, compiled by EPWRF.
c onsultation processes. We are sure
J aitley is aware of some of the possible
differences in perceptions. First, RBI
Governor Raghuram Rajan is reported
to have expressed strong reservations
about some of the important recom-
mendations of the Justice Srikrishna
Commission. On the other hand,
Jaitley has expressed himself in favour
of implementing both the legislative
and non-legislative parts of the
recommendations.
Going forward, the government intends to
concretize the institutional structures
through task forces and by examining leg-
islative aspects of the FSLRC recommenda-
tions (Ministry of Finance 2014: 100).
A major area of conict would arise
from the differing perceptions on the
so-called modern monetary policy
framework the usual growth versus
ination debate. It would be interesting
to see how the debate between the
Ministry of Finance and the RBI unfolds
when Jaitley seeks an agreement on the
proposed monetary policy of a modern
vintage framework.
The second reform measure concerns
the promise of revitalising the corporate
bonds market a laudable objective but
in the absence of details one may only
speculate on what is being contem-
plated. The Economic Survey 2013-14
(pp 96-97) has set out a long list of vari-
ous reform measures already imple-
mented, including the permission
granted by the RBI to banks to raise Tier
II capital through corporate bonds and
to allow corporate debt repos. Even so,
while public issues of corporate bonds
have increased from Rs 16,982 crore in
2012-13 to Rs 42,383 crore in 2013-14, the
size of private placements has suffered a
sharp decline from Rs 3,61,462 crore to
Rs 2,76,054 crore during the same
period. Likewise, the secondary transac-
tions in corporate bonds have receded in
recent years.
The latest Financial Stability Report
(RBI 2014) has described the reasons for
the dormancy in the corporate bonds
market. One of the most intractable
problems highlighted is the incidence of
stamp duties on corporate bonds. And
now, Jaitley will face the issues in
the context of the Goods and Services
Tax (GST) which he has promised to
implement this year. As per the existing
framework of the GST under active con-
sideration, of the 13 state and central
taxes to be subsumed, stamp duty is one
of them. There is also a proposal to
exempt the railways and the real estate
sector from the GST, in which case it
would be easy for the central govern-
ment to bring around the state govern-
ments to abolish stamp duty on nancial
instruments like commercial bonds as in
the case of equities. This would be a
major step that Jaitley would be faced
with while revitalising the c ommercial
bonds market.
Currency Derivatives
The most assertive statement in favour
of reforms by Finance Minister Arun
Jaitley concerns his objective of deep-
ening the currency derivatives market
by eliminating unnecessary restric-
tions. This attracts the larger question
of the proclivities of Indian market
players to speculate and hence the
need for regulations and restraints,
which we shall revert to at the end of
this section.
For the present, dealing with the
question of currency derivatives, recent
market developments have provided
interesting lessons for the regulators.
There are three sets of bitter experiences
seen in the foreign exchange market.
First, in its April 2007 policy statement,
the RBI with enthusiasm for reforms,
expanded the hedging facilities in the
forex market. Earlier, hedging had to be
against the underlying exposures based
on actuals or past records. But the April
2007 policy allowed what it called
dynamic hedging by the residents; just a
declaration of an exposure actually in
ECONOMIC NOTES
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EPW Research Foundation
sight was enough to book contracts;
also, contracts could be cancelled and
rebooked. And what is more, in the case
of small and medium enterprises, per-
mission was granted to book forward
contracts without underlying expo-
sures or past records of exports and
imports. They were also allowed to
freely cancel and rebook the contracts.
As a result, the over the counter (OTC)
forward contracts rose threefold from
Rs 15.52 lakh crore in 2006-07 to
Rs 47.23 lakh crore in 2008-09 (Table 2,
p 68). Bitter lessons were learnt from
this episode and the mark-to-market
losses for banks and corporates were
estimated according to market players in
the range of $3 billion and $5 billion.
This was the time when the RBI intro-
duced fresh regulations on the booking
and cancellation of OTC forwards.
Subsequently, they were relaxed and
forward contracts were allowed to be
cancelled and rebooked. But, for the sec-
ond time, following vast uctuations in
the forex market, in December 2011, the
above facility was withdrawn and for-
ward contracts once cancelled, could
not be rebooked. There were also other
restrictions imposed including the
re quirement of using forward facility by
both exporters and importers only on
fully deliverable basis.
Finally, while introducing currency
futures, the RBI and Securities and
Exchange Board of India (SEBI) put in
place various safeguards so as to control
excessive speculation. The RBI banned
proprietary trading by banks in the
c urrency futures/exchange-traded cur-
rency options markets. Such trading was
allowed only on behalf of clients. SEBI
also tightened exposure norms for cur-
rency derivatives to check excessive
speculation by increasing margin re -
quirements and curtailing open posi-
tions on currency derivatives. Thus, the
RBI and the SEBI have shown vigilance
on the orderly development of different
segments of the foreign exchange market
in India (RBI 2013: 52). When such has
been the situation, the restrictions
imposed by the regulatory bodied can-
not be questioned.
On the question of speculative procli-
vities of the market players, undoubtedly,
there is a denitive impression that the
size of the secondary market turn over
appears mindboggling. As shown in
Table 3 (p 68), many markets have turn-
overs of some multiples of the countrys
gross domestic product. It is s uspected
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that every opportunity is taken for arbi-
trage and speculation far beyond the
genuine requirements of hedging and
far beyond the practices prevalent in the
advanced healthy markets. Such activi-
ties in this country are stimulated by the
policies pursued by public authorities.
In fact, public policies stimulate the
generation of unearned and speculative
incomes which in turn become a major
source of inequality (Shetty 2008: 42).
In conclusion, nancial markets un-
doubtedly have a role to play in the
development process. But the vigilance
that the regulating agencies like the RBI
and the SEBI show for curbing specula-
tive trading should not be tampered
with to ensure the orderly development
of the markets.
References
Government of India (2013): Report of the Finan-
cial Sector Legislative Reforms Commission,
March, Chairman Justice B N Srikrishna.
Ministry of Finance (2014): The Economic Survey,
2013-14.
RBI (2012): Monthly Bulletin, August.
(2013): Annual Report 2012-13.
(2014): Financial Stability Report, June.
Shetty, S L (2008): Growing Inequality: A Serious
Challenge to the Indian Society and Polity,
Dr V K R V Rao Memorial Lecture - 6, Institute
for Social and Economic Change (ISEC), 27-28
November.
Union Budget (2014): The Union Budget, 2013-14.