DR. M. I. BAGSIRAJ calls upon the Union Ministry of Finance to adopt more enabling devices of interest-free banking and balanced budgetary and financial policies to keep our options of financial and physical resource mobilisation as open and as diversified as possible.
The steps taken by FM and RBI to counter immediate short-term threats to our financial institutions and economy arising out of the global liquidity crunch are to be appreciated. Thanks to our Governor and Deputy Governor of RBI for putting together a report before IMF at Washington on October 9 that assesses the risk perception to the Indian and EMEs as well as the immediate steps being undertaken to avert it.
However we must consider not only the ongoing credit crunch, but also the overall financial and economic interests of the country on mid and long term basis. For instance it is obvious that with the credit crunch crisis in USA and Europe the DFI into Indian economy will be slowing down. As a result the growth rate of the economy that has already gone down from 9+% to around 7+% is likely to further go down unless we find alternative sources of DFI. Slowing down of the Indian economy will weaken our medium and long term objectives of economic take-off financial inclusion and poverty elimination.
Our endeavours against terrorism and communalism, most of which is also caused by lack of equal economic and social opportunities, will receive further setback. It has been very surprising to the thinking Indians that at a time when inflation rates were continuously rising, erratic rains were causing havoc and threatening food security, allies were deserting in the election year, terrorism and communalism were raising their ugly heads disturbing the social fabric; the Government at the Centre was obsessed with the atomic energy deal and strategic partnership with the USA. Is it wise to put all or even most of the Indian eggs in American Basket?
Mrs. Indira Gandhi had dared to nationalise the big Commercial Banks in 1967 itself which the British, American and Russian governments are now compelled to consider! Is it not prudent for the present Indian Government, and economy to be more steadfast and aligned to the nearby and more natural allies, Asian and African economies than to the far off American and European economies and culture?
The pitfalls of Global Capitalism are that it promotes aggressive consumerism, cut-throat competition and profit mongering, commercialisation of all values and injustice to the weaker sections of society. Therefore, this model cannot be our only role model. We must consider and adopt alternative routs and approaches to attain our economic and financial objectives. Indian society has to cater to its plural values. It has to do justice to the aspirations of all communities and cultures by providing equal socio-economic opportunities. We must adopt policies that will contain excessive consumerism, cut-throat competition, distortion of values and socio-economic priorities.
By permitting interest-free banking that has been also recommended by the Committee on Financial Sector Reforms (page 104) in its final report, we can open up much needed new source of DFI from the petro-dollar surplus of OPEC countries, that can enhance the rate of India’s economic growth and provide much needed growth stability to our economy and society on the one hand and enable much sought after financial inclusion on the other hand.
The permission of interest-free banking will provide equity-based economic operations that are likely to create more employment opportunities, which are going down at present because of the financial crisis in the USA and Europe that is also panicking the Emerging Market Economies (EMEs). As against the equity-based lending by interest-free banks, the conventional banks have been promoting aggressive consumerism during last 18 years of globalisation by following an easy and cheap credit policy. In fact deficit financing, the legacy of great depression that was adopted as a policy for economic reconstruction after the World War II, had been continuously advocated by World Bank to the developed as well as developing economies till 1980s. It is this policy of deficit financing practised for several decades that is yet to be brought under control by both the developed as well as developing countries, that is the real cause of the threatening financial and economic crisis. Hence will it be sane to continue the policy of aggressive consumerism, easy credit and deficit financing year after year or adopt the policy of balanced budget advocated by Islamic budgetary and fiscal policy that can channelise the nation’s economic resources more justly and more equitably.
The problem of debt-based credit expansion is that it leads to unequal and unjust deployment of the economy’s resources; for instance at a time when the food prices all over the world were going up because of the shortage of food grains and increase in the demand of food items, leading financial institutions in America and elsewhere in the world were engaged in lending more and more to real estate projects. It is the sub prime mortgage lending to real estate projects at overvalued market prices and the consequent decline in their asset values that has led to the bankruptcy of major American financial institutions.
The cut-throat competition and the desire to ensure higher profitability compelled MNC banks’ managements to promote aggressive consumerism by providing easy credit and cost escalating advertisements and brand building. This economic and financial culture has spread to EMEs with globalisation and entry of MNCs including foreign banks. The comparative scarcity of financial resources for priority sectors like agriculture and infrastructure continues to pose supply bottlenecks for faster and sustainable economic growth of developing economies because of diversification of funds for purchase of consumer durables.
One positive feature of ongoing economic growth in India is that it is mostly self-financed, as the national saving rates are high and the current account deficit is under 2%. However because of the spreading global financial crisis and the consequent reduction in FIIs inflow in India from 15.5 bl $ in 2006-07 to -6.42 bl $ in 2007-08 (see Table), our corporate sector is facing shortage of foreign equity funds. Even within the country the ongoing turmoil in stock exchange has led to uncertainty of domestic investments and dismal outlook for IPOs. As a result RBI expects increase in the pressure on Indian banking sector for financing the corporate sector for their ongoing expansion projects. This obvious increase in debt financing does not auger well for the Indian economy because if the debt component of investments by our corporate sector increases, more than equity, their cost of production is bound to go up which will lead to further inflation at a time when inflation rate is already highest around 12%.
Therefore this is the appropriate time for our Ministry of Finance and RBI to introduce relevant changes in the Banking Act and regulatory mechanism to facilitate interest-free banking in India. Thereby the Indian economy will have two types of banking activities – debt-based as well as equity-based. Such an equity-based banking facility will make Indian economy more resilient to the global financial upheavals. It will also reduce the pressure on our stock exchanges. Both our existing banking sector and specialised financial institutions as well as stock exchanges have failed to provide credit accessibility for the unorganised sector. Interest-free banking will enable unorganised as well as organised sectors to draw funds more easily invariably on equity basis. Thus interest-free banking is more likely to facilitate financial inclusion of the unorganised sector and the deprived sections of our economy.
There is also likelihood of some reduction in our foreign exchange reserves on account of the retrenchments triggered by recession in American and European economies.
TABLE
Trends in Capital Flows (US $ million) | |||
Component | Period | 2007-08 | 2008-09 |
Foreign Direct Investment to India | April-August | 8,536 | 16,733 |
FIIs (net)@ | April – Sept 26 | 15,508 | -6,421 |
External Commercial Borrowings (net) | April- June | 6,990 | 1,559 |
Short-term Trade Credits (net) | April- June | 1,804 | 2,173 |
Memo: | |||
ECB Approvals | April-August | 13,375 | 8,127 |
Foreign Exchange Reserves (variation) | April-September 26 | 48,583 | -17,904 |
Foreign Exchange Reserves (end period) | September 26,2008 | 247,762 | 291,819 |
Note: Data on FIIs presented in this table represent inflows into the country and, thus, may differ from data relating to net investment in stock exchanges by FIIs |
Source: RBI on-line Bulletin, October 9, 2008
The EMEs including India have to take note of not only sustaining higher growth rates but also achieving gradual reduction in their poverty levels by facilitating equality of income and earning opportunities which is feasible only if BPL families are provided equal access to credit. Since the existing financial institutions are not adequate to meet the needs of BPL families and unorganised sector, interest-free banking can provide an additional institutional set-up to take care of this issue. Unless the benefits of globalisation are well spread to the lower half of our people as well, the economic as well as social disturbances cannot be contained.
The priorities and problems of developed economies are quite different from the priorities and problems of developing economies. Poverty alleviation together with socio-economic justice, equality, stability and security are our main objectives. Whereas sustaining the economic and political status and upper hand are the chief objectives of American and western countries. Our long term objective being to become an economic super-power after poverty eradication and attaining socio-economic justice, we must keep our options of financial and physical resource mobilisation as open and as diversified as possible. Therefore the tried and tested mixed economic approach may be further strengthened and enlarged by adopting more enabling devices of interest-free banking and balanced budgetary and financial policies. The strengthening of our economic, political and social relations with the Asian and African economies including neighbouring countries must receive more priority than hitherto given.