Making credit available by the organised financial system is more difficult than making other services available. When we try to address the problem of financial inclusion, the issues associated with providing credit must be distinguished from the provision of other services, writes C Rangarajan
We can interpret the term ‘financial inclusion’ in three different ways. One, as making available credit services to the vulnerable sections of society. In fact, it was this interpretation of the term that was initially used when we began engagement with this subject because the National Sample Survey (NSS) results showed that less than 20 per cent of households receive credit from the organised financial system. Having pushed the banking system into rural areas and after opening 40,000 branches in rural and semi-urban areas this came as a surprise. Nearly 75 per cent of rural households still do not have access to credit from the organised financial system. Obviously, then, the first interpretation for inclusion is making credit available to all vulnerable sections.
The second interpretation of the term is making available financial services to all economic activities, whether it is agriculture, industry (large and small) or services. Currently, there are certain economic activities which cannot access the organised financial system.
The third interpretation is what we can call more balanced regional development in the sense that regional disparities in the availability of financial services must be eliminated. NSS data shows that in the north-east and some central states of India, credit made available by the organised financial system covers only 10 per cent of the households or even less. We need to tackle all these three dimensions if we want a truly inclusive financial system.
In the case of services like savings, the bank is just the repository. Anybody can put money into an account and, therefore, what is really needed on the part of banks is to create a mechanism or an institutional arrangement under which the service can reach an individual. But in the case of credit, the bank takes the responsibility of providing credit to somebody and must ensure that credit comes back in to the banking system to create a sustainable or continuous circulation of funds.
Flawed Business Model of Micro-Credit Institutions
Much has been said about credit through microfinance institutions and that the provision of this credit has not necessarily been for productive activities. True, credit can and should also be made available for non-productive activities, particularly when there is a need, but a financial system or a set of financial institutions focused purely on providing consumer credit will not work. Originally, microfinance institutions were supposed to provide credit to borrowers in order to increase their income earning capacity so that they would have the capacity to repay the credit. To the extent this credit goes to improve the health or efficiency of the people and therefore creates or generates income, it is all right, but that is not always the case. This became obvious only after bulk of the credit that was given by microfinance institutions was consumer credit used for buying consumer durables or luxury goods.
Added to this is the problem that there is multiple credit being given by several institutions to the same person. The business model followed by microfinance institutions was basically untenable. Providing credit means it is the responsibility of the institution to ensure that the income earning capacity of the borrower is enhanced so that their ability to repay the credit improves. This is where the question of interest rate also comes in. While one does not want to regulate interest rate, it is in the interest of relevant institutions that they charge a rate of interest which encourages borrowers to repay the loan with interest.
We had in our report on financial inclusion worked out in some detail how the business correspondent (BC) model was going to work. It also indicated the technology that could be adopted in order to make the model successful. What is not being recognised or realised is that there is a cost attached to the system or institution of BCs. If you do not want to meet the cost of employing BCs, then the system will simply not work. It is very difficult to have a brick-and-mortar branch in every remote part of the country. Last-mile connectivity is extremely important and can be achieved through the BC model. However, the model will only work if it is implemented in its true spirit.
As far as mobile banking is concerned, there is a pun on the word ‘mobile’ because earlier, in the 1980s and 1990s, when we spoke about mobile banking, it meant mobile vans going to villages. It was considered an alternative to brick-and-mortar branches. The mobile ‘branch’ providing banking services would go one or two days a week to a particular village. I think that model should continue.
I agree that linking mobile phones to the payments mechanism and evolving appropriate checks and balances is extremely useful. We should work in that particular direction because it opens up immense possibilities. Disbursements, receipts and transfers can be done through an appropriate fail-safe mobile banking system. I am not very sure how the model will help in terms of providing credit, because credit is a decision taken by an authority.
Challenges on the Fiscal Front
The Indian economy is currently passing through a difficult phase. Growth has slowed down. Inflation is soaring. The fiscal deficit is also high, but there is hope that it will decrease because there are serious efforts being made to implement the roadmap for fiscal consolidation. The balance of payments/current account deficit remains high and does not show a tendency to decline. We must also not underestimate the structural changes that have taken place in the Indian economy since 1991. The external environment has not been hospitable for rapid economic growth. After having grown at rates exceeding 9 per cent for three years beginning 2005-06, it came down to 6.8 per cent in the wake of the international financial crisis but in the next two years, it did pick up. The growth rate was 8.4 per cent for 2009-10 and 2010-11. Over a seven-year period beginning 2005-06, the average annual rate of growth of the Indian economy has been 8.3 per cent.
Development has many dimensions. It must be inclusive, it must lead to reduction in poverty and it must be environment friendly
Data that are now available through the survey of industries indicate that the manufacturing sector grew faster than we expected. However, in 2011-12, it came down to 6.5 per cent, and more distressingly the manufacturing growth rate was 2.5 per cent. This has not picked up and 2012-13 is likely to be the second year of low growth of the manufacturing sector.
As we move ahead, we really need to reverse the decline of savings and investment rates. There has been a decline of 3 to 3.5 percentage points both in savings and investment rates. The decline in the investment rate is not as strong as the decline in the savings rate because of the high current account deficit. The savings rate has declined for two reasons. One is the rising fiscal deficit and the other is decline in household savings and financial assets due to inflation.
High Growth Won’t Engender Inflation
There are three major macro-economic concerns confronting us. One is taming inflation. It has come down since the peak of 11 per cent during April 2010 but still remains unacceptably high. When food inflation persists long enough, it gets generalised. We have seen this in the Indian context. There have been periods during which non-food manufacturing inflation touched 8 per cent. Therefore, both monetary and fiscal policy need to act in order to lower inflation. I do not accept the argument that high growth warrants higher inflation. It is this belief, that inflation is endemic in growth, which led to high inflation in the first three decades after independence. We should not fall into that trap again.
The second macro-economic issue is fiscal consolidation. We now have a roadmap for this and need to act on both revenue and expenditure in order to contain the fiscal deficit.
Third, balance of payments. It was 4.2 per cent of GDP during 2011-12 and if indications are correct, our current account deficit will either remain at the same level or may even exceed that of last year. This is worrisome. Our growth rate is still much higher than the growth rate in the developed world. As a consequence, their imports, i.e., our exports, suffer. And since our growth rate is higher, our imports are getting larger.
We have so far not had any serious problem with respect to financing our current account deficit. Capital flows have been adequate, but whenever capital flows are inadequate for a period of time, pressure develops on the rupee. My own view is that taking the year as a whole, we will find that capital flows will be adequate to cover the current account deficit and therefore the rupee may remain more or less at this level the whole year.
Faster rate of growth in agriculture, power and the entire infrastructure sector is absolutely essential. Without it, we may not be able to achieve and sustain the high growth which we are aiming for.
Liberalisation Must Keep Pace
The basic principle of liberalisation, of creating competitive markets with minimal barriers to entry and exit, should be extended to all sectors of the economy. There are still some sectors of the economy, for example coal, where entry of the private sector is not permitted. In the case of the coal sector, until there is a change in policy, the public sector (i.e., Coal India) can at least use the private sector as an agent to open up new mines. Coal produced from these mines must be supplied to Coal India, which can then distribute the coal.
Agriculture as a sector has not been impacted much by reform. Apart from the need for improving agriculture productivity, we really need to look at marketing arrangements. We need to ensure that restrictions and barriers on the movement of agricultural goods are removed and we have to create a single market.
Faster Growth is the Answer
In the recent past we have been able to introduce a number of social safety nets like expanded food security system, universal health insurance and universalisation of education. These were made possible by the additional resources raised when growth was strong. Growth is imperative. If we grow at 8 per cent per annum, calculations show that by 2025 India’s per capita GDP will increase from the current level of $1,600 to $8,000-10,000. Only then will we be classified as a truly middle income country.
But development has many dimensions. It must be inclusive, it must lead to reduction in poverty and it must be environment friendly. These need to be built into the growth process. In my view, equity and growth should not be posed as opposing considerations; they must be weaved together to produce a coherent pattern of development and therein lies, if I may say so, economic statesmanship.
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