Budget 2016 – A Big Bang Thrust for Financial Sector Reforms

The previous budgets have been talking about financial sector reforms for a long time. Indian banking, capital markets, monetary policy have all been calling for drastic changes over the past few years. Typically, changes have been incremental at best. What this budget has done is to make a start towards elaborate financial sector reforms. It has taken a few small but significant steps towards financial sector reforms. Here is how!

Statutory basis for monetary policy framework…

This has been both a necessity; at the same time controversial. The government had, in the past, dwelt on this topic without getting into the finer points. In the current Finance Bill, the government seeks to give a statutory shape to the Monetary Policy Framework and also the creation of a Monetary Policy Committee. One needs to understand why this is important. Firstly, for long monetary policy has been the sole preserve of the RBI. That was fine as long as the core role of monetary policy was to maintain price stability. For a growing economy like India, monetary policy needs to move beyond the realm of price stability and also become an instrument of growth.

That is exactly where the government intervention becomes essential. While the details of the Monetary Policy Committee are to be known, it is clear that it will have representatives from the government and the RBI. This will ensure that the interests of price stability and growth are kept in mind while framing the Monetary Policy. Of course, it remains to be seen whether the RBI Governor continues to exercise his veto power over monetary policy decisions. This budget has also taken a small step towards the Public Debt Management Act where the conflict of interest issue will be resolved by keeping interest rate setting and borrowing program decisions separate.

Taking the financial markets to the retail level…

It has long been felt that retail investors are outside the purview of most financial investments in India. This budget also seeks to remedy this situation. To begin with, RBI will be assigned the task of bringing about more retail participation in government securities market. Today, that is largely an institutional market with banks, insurance companies, pension funds and other institutions dominating the market. The government has also laid out a plan to introduce many simpler derivative products in the commodity markets so that the retail investors can also participate in this market with ease.

In addition, the SARFAESI Act is also being modified so that retail investors can also participate in securitized receivables. Last but not the least, to protect the interest of small depositors the government has put forth plans for a special legislation to deal with illicit deposit schemes with an iron hand. These are likely to go a long way in adding to the integrity of the market place and create a feeling of trust and confidence among the retail investors.

A small leap for the banking sector… 

Prima facie, the allocation of Rs.25,000 crore for the banking sector looks like the tip of the iceberg. But there is a lot more beneath the surface. For example, the banks have now been allowed to classify their reserves arising from revaluation of assets and foreign currency translation as Tier I Capital. That straightaway adds Rs.350,000 crore of recapitalization to bank balance sheets and substantially addresses the problem of stressed assets and weak capital base. The biggest benefit for banks has been indirect. The fiscal discipline will ensure that the RBI will maintain a dovish stance on monetary policy and therefore bond portfolios will benefit due to falling debt yields. It can be said that the PSU banks have been now given a level playing field with respect to private banks.

Relying a lot more on Mr. Market…

The message of the budget 2016 for the financial sector seems to be crystal clear. Rely a lot more on Mr. Market for your funding needs. Banks will have to use this revaluation benefit to revitalize their balance sheet and raise money in the market. The job should become a lot easier for them now. Secondly, the government is also trying to coax exchanges to get listed and NSE and BSE may be off the block soon. This is essential to bring about more transparency and accountability in the functioning of exchanges. Lastly, the government has also laid out a plan to list the general insurance companies. This will be a good test case for valuation of these insurance companies and enable the government to eventually monetize these resources.

In a nutshell, the clarion call of the budget 2016 seems to be to make the financial markets more transparent, resource generating and globally competitive. The budget 2016 is surely on the right track!

Read more about Union Budget 2016 highlights here.

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