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FDI keeps India's banks on their
toes
By Arun Bhattacharjee
NEW DELHI - By opening up India's private banks
to 100 percent foreign direct investment (FDI), the
government will force fundamental changes across the
entire sector. Introducing foreign control for private
banks will compel competing nationalized banks to
improve their own management and performance and expand
lending at competitive rates. The liberalization,
announced in mid-January, will also challenge the
central bank to manage the expected huge inflow of
overseas money.
Former
Reserve Bank of India (RBI)
director AK Bhatt explains that the new rules for
private banks mark the beginning of real liberalization
and overall reforms in India's banking system.
Throughout India's banking circles, the limited
liberalization is considered a clever move.
By
restricting foreign investment to private banks, the
government has minimized union opposition and political
risks. It is not directly forcing a process change in
the management and banking services of the nationalized
banks, and maintaining the government's option to use
these banks for largesse and political mileage.
Reforming India's banking system has become
essential for better profitability and service-oriented
management, and for greater funding of domestic project
lending that has fallen mainly on the private banks. A
delegation from the Federation of Indian Chambers of
Commerce and Industry, the leading Indian industries
trade organization, complained to Prime Minister Atal
Bihari Vajpayee just before the reforms were announced
that the nationalized banks were not lending for
long-term projects that the government has launched. The
new FDI policy will please the industrial sector, which
prefers external borrowing at interest below domestic
rates, and allow it to avoid the government's cap on
overseas commercial borrowing and acquire more funds.
Feel-good factor
The banking liberalization may also help to maintain the
"feel-good factor" among investors that the government hopes
will lead to success in the general election, due within
90 days. After initially dropping more than 200 points in the
wake of the announcement, the benchmark Bombay stock
market index rebounded to a new high beyond 6,000.
But the new banking policy has created its share
of confusion. Delhi-based economic analyst Tapan Das
Gupta dismisses the complexities, such as restricting
foreign investment companies to only 74 percent FDI, as
cosmetic, since that limit won't change the fact of
foreign control.
The announcement also refrained
from dampening foreign interest across the sector.
Global rating agency Moody's announced on January 28 that it
had raised its shareholdings in the Indian Credit Rating
Agency (ICRA) to 31.05 percent. Moody's higher stake
includes increased holdings in Union Bank of India,
Allahabad Bank, The United Bank of India, Indian
Overseas Bank, Export Import Bank of India, IL&FS,
and HDFC Bank.
Rupee rising
FDI liberalization for private banks will expose the
fast-growing Indian economy - estimated to expand at 8
percent this year - to the problem of managing the huge
dollar inflow. The Indian rupee has been appreciating in
value against the US dollar for the past three months, a
growing problem for RBI, which is purchasing the dollars
without releasing the converted Indian rupee to staunch
inflation. Managing the inflows has lowered the central
bank's stock of gilts to US$8.1 billion from $32.2
billion.
Foreign reserves of more than $107
billion and a fast-growing FDI environment - $7 billion invested
in November alone - have boosted the feel-good factor, but
it has created additional problems for the central
bank. Bhatt, now an adviser to RBI, mentions the
government's withdrawal of the "participatory note"
program that aimed to trace whether the offshore funds
from by Indians or Indian companies were coming back to
India as FDI. RBI suspects domestic investors of using
Mauritius as a base to bring back funds.
RBI
admits the move to introduce the participatory note was
likely responsible for the sharp fall in the market
indices. The stock market not only recovered the ground
it lost in a week, but rose further when the government
announced in late January that participatory notes would
not be required for FDI.
The Report
on Currency and Finance 2002-03 by RBI released last Wednesday hinted that
the government might change policy and allow the rupee
to appreciate at a faster pace against the US dollar,
and further liberalize trade and overseas investment
rules if capital inflow continues to surge.
In all, banking liberalization fits the pattern of
reducing the government's role in the economy. That's creating
a feel-good factor for investors and business, even if
it's creating more headaches for the central bank.
(Copyright 2004 Asia Times Online Ltd. All
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