India should give the Reserve Bank of India the single objective of controlling inflation and open its corporate and government bond markets to more foreign inflows to support growth, a draft committee report said on Monday.
The draft report, by a committee on financial sector reforms set up by the Planning Commission, identified a set of steps to improve financing to poorer sections of the population and to big business, to strengthen financial stability and to foster growth.
The committee, chaired by former International Monetary Fund chief economist Raghuram Rajan, said reform was needed to bring more Indians into the growth process, encourage growth itself and protect the economy from turbulence seen in emerging economies in the past and in developed ones at present.
"Given the right environment, financial sector reforms can add between a percentage point and two to the economic growth rate," it said.
Reforms have moved slowly in India, where banking is predominantly state run and foreign investment in bonds is restricted, but longer-term financing and wider access to credit are needed to fund infrastructure projects and reduce poverty.
The final report will be released in June but the 229-page draft said the central bank should formally have a single objective to stay close to a low inflation number, or within a range, in the medium term and move to a single instrument such as short-term interest rates to achieve that goal.
"The Reserve Bank of India can best serve the cause of growth by focusing on controlling inflation, and intervening in currency markets only to limit excessive volatility," it said.
The twin objectives of monetary policy in India have evolved as maintaining price stability and ensuring adequate flow of credit to facilitate the growth process.
The report said the RBI had the freedom to focus sometimes on controlling the exchange rate and sometimes on controlling inflation, but this confused markets and the public and could push up inflationary expectations and interest rates, hurting growth.
Foreign investment in government bonds and treasury bills is capped at $3.2 billion and in corporate debt at $1.5 billion.
The committee said there were some worries that opening up the market would result in the rupee rising.
The rupee appreciated more than 12 percent against the dollar last year, causing a monetary policy headache for the RBI as it tried to limit the gains.
"Given our concern about appreciation, we should liberalise the bond markets opportunistically, expanding foreign investor limits more when other forms of capital flows are at low ebb," the report said.
Other proposals included:
- sell small underperforming state-run banks to another bank or strategic investor
- be more liberal in allowing takeovers and mergers in banking, including by subsidiaries of foreign banks
- allow holding company structures in the banking sector
- bring all regulation of trading under the Securities and Exchange Board of India
- introduce exchange-traded interest rate and exchange rate derivatives
- rewrite financial sector regulation to focus on broad principles rather than specific rules
- put all deposit-taking institutions under supervision of the central bank
- create a Financial Sector Oversight Agency to monitor large systemically important financial conglomerates, defuse inter-regulatory conflicts and look out for systemic risk.
It also supported other less controversial changes such as trading warehouse receipts to lower the cost of financing in farming, saying smaller moves were also important.
"Instead of focusing primarily on a few large and usually politically controversial steps, we also need to take a hundred small steps in the same direction that will collectively take us very far," it said.
"All this is not to say that we should not tackle the controversial ones... but it is to say progress can be made even otherwise."