State control in the financial sector: Azadi of the financial sector

Source: The post is based on the article “Azadi of the financial sector” published in the Business Standard on 16^th August 2022.

Syllabus: GS 3 – Effects of liberalization on the economy, changes in industrial policy and their effects on industrial growth.

Relevance: About the state control in the financial sector.

News: While celebrating the 75th anniversary of India’s Independence, one needs to remember that in the field of financial economic policy, 44 of these 75 years were a period with a highly repressed financial system.

How did India achieve excessive state control in the financial sector?

Excessive state control is justified by the government through the philosophy of self-reliance,

All across the financial system, state domination was achieved through a) A combination of bans and public sector ownership. b) most routine activities of financial markets were prohibited by law, and c) cross-border engagement was mostly banned. For instance,

-Banking, insurance and mutual funds were the preserve of public sector banks, Life Insurance Corporation of India/General Insurance Corporation of India and Unit Trust of India, respectively.

-Capital Issues (Control) Act of 1947:  This law is applicable to securities markets. Under this law, the government decided which company could raise capital in the public market using which instrument and at which time.

What is the outcome of excessive state control in the financial sector?

The domestic investment was clogged within the domestic savings on questions of both raw magnitudes and risk tolerance. It was a picture of low freedom in financial sector.

In 1991, the government tried to push in favour of greater economic freedom, reduced central planning, and increased regulatory capacity. These reforms have played an important role in the real sector growth of the last three decades.

What is the outcome of low state control in the financial sector?

a) New industries like the software industry are financed by a new set of financial players, b) Activities like a loan against a car or a loan against a house, which were once relatively unusual, have become commonplace, c) The government can balance the balance sheets by tapping into the near-infinite pool of foreign investment

Achievements in the equity market: a) The emergence of the full ecosystem of finance in the equity market. These include the initial public offering (IPO) market, the equity spot market, derivatives trading, algorithmic trading, etc. b) Equity as a source of financing: Between 1991-92 to 2019-20, equity as a source of capital for large private non-financial firms went up from 24% to 37%, c) market capitalisation of listed Indian firms rose from about 5% of gross domestic product (GDP) in 1980 to about 100% of GDP at present.

What are the challenges faced at present due to state control in the financial sector?

1) The present access of households and micro, small and medium enterprises to formal finance, insurance penetration and density, pension assets as a percentage of GDP is low. This shows that India continues to be underbanked, underinsured and inadequately covered by old age income security measures.

2) Forward-looking speculative decision-making is absent in large parts of the financial system, 3) The long arm of central planning has only grown, where minute details of products and processes are controlled by the state. In many cases, there are controls on the persons appointed into leadership roles in these financial firms. All this creates subservient employees in private firms who work within the written and unwritten wishes of the regulators.

What should be done to reduce state control in the financial sector?

Important elements of Financial Sector Legislative Reforms Commission (FSLRC) recommendations were implemented in 2015 and 2016, such as inflation targeting at the Reserve Bank of India and the merger of Forward Markets Commission with the Securities and Exchange Board of India.

But still India needs to go further to implement the balance and unleash financial sector.