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Feed the demand

India?s economic growth has been based on two features: greater integration into global markets and strong domestic consumption. Sustaining growth will require the promotion of both these elements.

india Updated: Feb 10, 2006 03:53 IST

In fiscal 2006, the economy has seen robust growth coupled with stability despite a complex and challenging global environment. The trends for 2006 indicate strong buoyancy in the economy with rising industrial growth, continuation of services sector growth and expected improved agricultural performance following a normal monsoon. Domestic demand has emerged as a key growth driver, as rising household incomes lead to demand for a variety of products and services, which in turn feed economic growth and household prosperity. As we look ahead, we see continued strong growth driven by a set of fundamental factors: the continuing growth of the knowledge economy meeting the global demand for knowledge-based services; the favourable demographic profile with a large part of the population in the working and consuming class; and the growth of industry driven by domestic demand and global competitiveness.

The reforms process has put India on a path of sustainable 7-8 per cent growth. However, to take that trajectory to the next level and make India one of the top three economies in the world, we need to address certain key challenges. India will not have fulfilled its potential without integration of the rural economy and the lower-income urban population into the economic mainstream. Traditionally, rural India has been viewed as a foodgrain producer and evaluated in terms of agricultural production. The holistic development of both the agricultural and non-agricultural rural economy must be a key focus area. Extending access to financial services to all sections of society, including the poorest of the poor, is critical to economic empowerment and productivity.

Lack of infrastructure facilities could act as a constraint to economic growth, by affecting the efficiency of the system and consequently countering India’s comparative cost advantage. Infrastructure development programmes focusing specially on the development of airports, roads, ports, urban infrastructure and power generation should form major policy initiatives. The financial viability of these programmes requires greater cooperation between public and private sectors. Facilitating participation of private players into infrastructure development projects is critical.

The expansion of the economy has led to a greater demand for investible funds. The banking system has played a key role in India’s economic success — by financing industrial investment, working with industry to resolve the problems arising out of globalisation and, of late, meeting the demand for retail financial services that have emerged as a driver of growth. The channelising of savings is, to an extent, distorted by the prevalent interest rate and tax structure, which directs savings away from bank deposits to other instruments. However, banks act as the main channel for transferring savings to investments in productive activities while aggregating and managing risk, especially for sectors like agriculture, small and medium size enterprises (SMEs) and retail which do not have access to debt capital markets. These distortions need to be addressed.

To encourage deposits, bank deposits with maturity of three years or more could be included under the Rs 100,000 tax-saving umbrella. At the same time with the demand for funds growing rapidly, restrictions on foreign inflows need to be looked into, given the abundant global liquidity. Indian businesses have become globally competitive and fears about their survival in the face of global competition are no longer justified. In fact, Indian companies are increasingly making their presence felt at the global level. The ability of the Indian financial system to manage foreign currency inflows has improved significantly and India’s strong forex position and the global competitiveness of Indian industry are sufficient to allow us to increase our exposure to international debt. It, therefore, becomes important to allow greater access to foreign capital as a source for funds in both the equity and debt forms. Banks should be allowed to intermediate in forex flows to channelise foreign capital efficiently.

Despite its growth over the last few years, the Indian financial sector is still small in size compared to countries like China. The growth of the banking sector and compliance with Basel II norms will lead to greater capital raising by banks through various instruments. As of now, expenses incurred by companies while raising equity capital are eligible for tax deductions. Tax deductions to expenses while raising capital through hybrid instruments should be allowed on similar lines. Also, dividends paid out on preferred stock should be made eligible for tax deductions, and payouts on foreign currency capital instruments should be exempted from withholding tax. This would be in line with the special status accorded to bank capital instruments in several domains.

The cost of intermediation is high in India with the heavy use of cash being responsible for this. This has also led to a part of the economic activity being conducted outside the purview of the fiscal system. There is a need to increase the penetration of electronic payments by extending the electronic credit system and moving towards national settlement in payment systems. The use of plastic payment cards may be encouraged through disincentives for the use of cash for large payments.

Overall, India’s economic growth has been based on two features: one, greater integration into the global markets; two, strong domestic consumption demand driven largely by increased household incomes and increased consumption. Sustaining the growth momentum will require promotion of both these elements by strengthening incentives.

The writer is Deputy Managing Director, ICICI Bank

First Published: Feb 10, 2006 03:53 IST