Political Will is Required to Resolve Economic Problems

Hardly any political party says that the financial sector regulations have been more beneficial to the formal sector compared to informal sector, especially in terms of access to equity finance. Political parties do make agenda over religious, social and civil matters, but they rarely speak on economic injustice of poor and vulnerable workers (known as…

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Hardly any political party says that the financial sector regulations have been more beneficial to the formal sector compared to informal sector, especially in terms of access to equity finance. Political parties do make agenda over religious, social and civil matters, but they rarely speak on economic injustice of poor and vulnerable workers (known as Aam Aadmi) making their livelihood from unorganised sector enterprises. There is a great deal of injustice to the unorganised sector in financial terms due to regulatory imbalances which reflects some impurities in democratic structure of Indian economy.

‘Shine India’ slogans do not feed the Poor and Vulnerable:
During NDA Government the BJP did not notice the economic disparity among formal and informal sectors, rather it was proud to celebrate ‘Shine India’ with some growth in formal sector; but the ballot paper reflected the anguish of Aam Aadmi associated with the unorganised sector who suffered a lot due to unjust regulations.

In a democracy a stage comes where citizens seek democracy in economic reforms along with political and social freedom. This time the UPA Government is happy to announce schemes like loan waiving, pay revision and some enhanced aids to marginalised groups including minorities, but it may face awkward ballot paper scripts because it is yet to correct the discriminatory regulations prevailed for formal and informal sector enterprises which are increasing the economic disparity among formal and informal sectors.

The grants and aids may not feed any family. Just and fair financial regulations are required for true democracy by bridging economic disparity, which has not been an agenda for the UPA Government so far. The regulators have yet to review the effectiveness of financial sector regulations related to more than 93 per cent Indian workers associated with the unorganised sector. There is no Chamber of Commerce or Federation to demand specific regulations so that the poor and vulnerable could improve their livelihood through equity based banking and finance schemes.

The culprit for inflation and recession:
The financial regulations are designed in such a manner that after liberalisation of capital account, through stock markets the inflow of capital is mostly directed towards the corporate sector; and disallowed the benefits to the unorganised sector. While this capital inflow through capital account jacked up the stock market prices, it also boosted inflation in commodity and derivative trades, and did not help the unorganised sector enterprises to compete with the organised sector under numerous resource constraints. That’s why when during April to December 2007 Stock Market Capitalisation increased by over 100 per cent of GDP value, Inflation rate increased and India’s real GDP growth rate declined. It proved increased stock market capitalisation against inclusive growth.

There is indeed a point for the policy makers to reflect on, whether they desired the same outcome. Let the UPA Government blame global financial crisis or oil prices as the culprits behind economic problems, the suffering of the poor and vulnerable due to unjust economic policies and financial regulations would spell out the truth in near future.

Even Micro Finance Schemes do not favour Poor and Vulnerable:
The objective behind Micro Finance Schemes through Self Help Groups was not to provide economic justice for the poor and vulnerable by providing easy access to finance; but to expand debt based credit market for formal financial institutions by reaching to the poor and vulnerable who had no access to formal sector financial institutions; that too with short term smaller credit amounts on higher interest rates. There have been hardly any voice for just and fair financial regulations for the poor and vulnerable, instead regulations were made to justify increase in interest rate for Micro Finance schemes.

The effectiveness of Micro Finance Schemes in improving the livelihood of the poor and vulnerable is yet not proved. So far the formal financial institutions have been just replacing the business of informal financial institutions; and there is no regulatory progress to allow equity finances for the unorganised sector enterprises required to compete with organised sector enterprises.

Recession is bound to reduce the demands for debt based credit:
The fall in current account balances due to global recession is reducing the demand for output of enterprises; forcing them to cut their output prices. This means the enterprises need more equity finance instead of debt based bank credits to reduce their input costs. If stock market (with falling market capitalisation) is unable to provide more equity finance, banks should be allowed to start dealing in equity based banking and finance so that input costs of enterprises could be reduced, otherwise recession may prolong.

When corporate sector cannot afford debt based credits, there is hardly much scope for banks to induce SMEs for debt based credits because the lower financial risk bearing capacity and stiff competitions with organised sector enterprises restrains them take interest based credits from banks. If demands for interest based credit further declines, difficulties for banks may increase unless they are allowed to transact equity based banking products.

Policy makers should go for Equity based banking:
It is rather unfortunate that instead of rectifying regulatory imbalances and removing the constraints through required regulatory changes, our policy makers just go on saying that ‘the difficulties could spill over into 2009-10’. They should better evaluate the effectiveness of financial regulations to counter the problems associated with recession and make due changes to ensure financial flow towards growth oriented projects.

Unorganised sector enterprises which are least affected by global recession and have better growth prospects due to huge domestic consumerism for their products and services need amendments in financial regulations. They are disallowed to access equity finances or Direct Foreign Investments. The equity based banking, finance and investments to facilitate the unorganised sector enterprises would not only help them compete with organised sector enterprises, but would also promote domestic consumerism by flow of credit to the unorganised sector whose benefits would reach to Aam Aadmi. If regulators could take initiative to promote SHG schemes for the unorganised sector, why can’t they take due steps to promote equity based banking and finance for SMEs?

Banks may find markets to grow:
The equity finances through banks would allow unorganised sector enterprises to increase labour capital ratio and art of technology required to produce qualitative products and services for domestic consumption at comparative prices. There is high scope for products like Mudaraba, Musharaka, Ijara and Shukuk under equity finance to help small enterprises at local levels. These products don’t need stock market technology for investments, and are being proved as popular products in many Islamic banks outside India. Through such products, commercial banks may find new markets to grow under situation while debt based credit demands are declining and stock market is not duly expanding its sphere to SMEs and unorganised sector enterprises.

It is time to drop proposal of stock market for SMEs and allow equity based banking to meet financial need of small companies. If US federal reserves with even 0 per cent bank rate unable to succeed in unfolding the financial crisis, it is not clear how Indian banks would adjust interest rate instruments under market conditions where credit demands is declining due to recession.

Politics should not hinder economic growth:
To allow RBI regulate the equity based banking in India, Indian legislative machinery needs to amend the Banking Regulation Act. However, it appears that the UPA government is hesitating to take required steps with a fear that the introduction of bill on equity based banking may allow NDA to raise the familiar bogey that UPA is appeasing Muslims before election. But we need to ensure that politics must not hinder economic growth in the name of religion. In case of down stock market, if equity based banking is needed by Indian enterprise to get equity finance for cutting input cost during recession, who would oppose bill of equity based banking if it benefits more to Indian economy compared to Indian Muslims.

If consumerism attracts foreign investors to India, it would be much better in part of Indian economy to allow equity banking so that even unorganised sector could grow along with corporate sector by affording higher art of technology, labour capital ratio and infrastructure. Aids, subsidies and grants can’t be alternative to genuine financial sector regulations; and no financial or monetary instrument could help counter recession better than equity based banking and finance.

Political Silence over financial sector reforms may cost UPA Government:
If the UPA government keeps mum over the issue of equity based banking, the cracking Indian stock market will not help the enterprises get due finance to overcome the crisis of recession, and Indian banks will be feeling uneasy to attract more credit demands by minimising the interest rates; and GDP growth rate will keep on falling. Collectively these all may reflect failure of the UPA government to tackle the economic problems at a time when it needed to deliver boldly. And during election, the opposition party may fetch this failure as an issue. Therefore in interest of economic growth and the ruling party, the government should introduce equity based banking system at the earliest so that the economic problems could be resolved; the unorganised sector growth potential could be optimally utilised and benefits may reach to Aam Aadmi who would be well off by the time of coming election.

[Syed Zahid Ahmad is Assistant Secretary General, AICMEU]