Economic Reforms Financial Sector Reforms in India

Types of Reforms introduced

A) Economic Reform
B) Financial Sector Reform

The term economic reform broadly indicates necessary

structural adjustments to external events.

It include the function of countrys spending to the level parallel to its income and thereby reducing fiscal deficits. This requires gradual reduction in import and increase in export. These adjustments also requires market change in order to make economy flexible.

The present process of economic reforms was born out of the crisis in the economy, which climaxed in 1991. The crisis compelled the government to adopt a new path-breaking economic policy under which a series of economic reform measures were initiated with the objective to deal with the crisis and to take the economy on a high-growth path.

 Increase Increase Fall Rise Poor

in Fiscal Deficit
in adverse balance of Payment

in foreign Exchange Reserve in Prices Performance of Public Sector

Need for Financial sector reforms

Till the early 1990s the Indian financial sector could be described as a classic example of financial repression .
Monetary policy was subservient to the fiscal Policy.

Resulting into
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 Working capital management was even more constrained with detailed regulations on how much inventory the firms could carry or how much credit they could give to their customers. Working capital was financed almost entirely by banks at interest rates laid down by the central bank Working capital finance was related more to the credit need of the borrower than to creditworthiness.

BACKGROUND OF FINANCIAL SYSTEM REFORM

The pre-reforms period i.e. from the mid 1960s to

the early 1990s was characterized by interest

rates, industrial licensing and controls dominated

by public sector and limited competition.

The government initiated economic reforms in June 1991 to provide an environment for sustainable growth and stability.

PRIVATISATION

LIBERALISATION

GLOBALISATION

ECONOMIC REFORMS

It means to free the economy from direct or physical controls imposed by the government. Prior 1991, government had imposed several types of controls on Indian economy e.g. industrial licensing system, price control or financial control on goods, import license, foreign exchange control, restriction on investment by big business houses, etc. These controls leads to fall in economy growth. Economic reforms were based on the assumption that market forces could guide the economy in a more effective manner than government control.

 Abolition

of industrial licensing and Registration with a few exceptions. Freedom from Expansion and Production to Industries Increase in the Investment Limit of the Small Industries: Freedom to import capital goods Freedom to import technology

Privatisation means allowing the private sector to set up more and more of industries that were previously reserved for public sector. It can take in three in forms: a. Change in ownership: Degree of privatisation judged by the extent of ownership transferred from public to private sector. i) Public Private Partnership ii) Joint Venture

It is defined as a process associated with increasing openness, growing economic independence and Deeping economic integration in the world economy.
Reduction

of trade barriers Free flow of capital Free flow of technology

Reduction

of import duties Encouragement of foreign investment Reducing custom duty Devaluation of currency Partial convertibility

Financial Sector Reforms

Major contours of the financial sector reforms in India

Reduction in CRR and SLR in a phased manner Deregulation of Interest Rate:

Fixing prudential Norms:

Introduction of CRAR: Operational Autonomy Banking Diversification

New Generation Banks, thereby inducing competition Improved Profitability and Efficiency:

First Phase of Banking Sector Reforms 1)Reduction in SLR & CRR 2.) Deregulation of interest rates

3.) Transparent guidelines or norms for entry and exit of

private sector banks 4.) Public sector banks allowed for direct access to capital markets 5.) Branch licensing policy has been liberalized 6.) Setting up of Debt Recovery Tribunals 7.) Asset classification and provisioning 8.) Income recognition

9.) Asset Reconstruction Fund (ARF)

Second Phase of Reforms measures Merger of strong units of banks Adaptation of the narrow banking concept to rehabilitate weak banks

A Narrow Bank in its narrow sense, can be defined as

the system of banking under which a bank places its funds in risk-free assets with maturity period matching its liability maturity profile, so that there is no problem relating to asset liability mismatch and the quality of

assets remains intact without leading to emergence of

sub-standard assets.

What are advantages :

Such

an

approach

can

ensure

the

regular

deployment of funds in low risk liquid assets. With such pattern of deployment of funds, these banks

are expected to remove the problems of bank

failures and the consequent systemic risks and loss to depositors.

What is status of narrow banking in India ? The concept is practically being implemented by the

Indian banking system partly, as a large part of the

deposits mobilized (i.e. more than 46%) by the banks, has been deployed in Govt. securities (against a prescription of 25% in the form of SLR) as it provides a safe avenue of investment but at a very low return. This keeps the level of non-performing assets (rather than advances) low and the requirement of capital adequacy ratio also low, as the risk weight allotted to such

securities is only 2.5% compared to 100% in loan

assets.