Academic journal article IUP Journal of Applied Finance

Financial Liberalization and Its Impact on Indian Economy: An Urgent Need for Public-Private Participation

Academic journal article IUP Journal of Applied Finance

Financial Liberalization and Its Impact on Indian Economy: An Urgent Need for Public-Private Participation

Article excerpt

(ProQuest: ... denotes formulae omitted.)

Introduction

In the past one-and-a-half decades, numerous measures have been initiated to liberalize the Indian financial system. Many of these reforms were introduced in response to the need of the moment rather than as a part of a well-articulated strategy. Nevertheless, all these policies were designed to develop an efficient financial system capable of supporting the growth process of economy, and the measures virtually marginalized the Planning Commission which performed an important function in the earlier regime.

Our attempt to develop a market-oriented financial system capable of delivering the desired results are awfully frustrating. Decline in household savings, prolonged demand deficit and comparatively inadequate development of financial system are some typical challenges that Indian economy is confronting after the regime shift. These outcomes may be attributed to our main focus, which is in line with the neoclassical theory, on savings as the ultimate determinant of growth and on ensuring that economy stays close to its full employment growth path. Any intervention by the government may derail our economy. Thus, our policy prescriptions center around two broad issues: The first and the most important one is to what extent private initiatives be supplemented by state intervention to ensure faster growth of the economy. Second, given the structure of the financial system, is there any scope for public authorities to influence or suspend the operation of market forces in order to promote savings, investment and allocative efficiency of our system?

This study reviews the policy of 'less intervention and more development' for an economy that is plagued by demand crisis, less than fuller capacity utilization and excess liquidity-ills that are conspicuously prevalent in the Indian economy. The study refrains from making any detailed analysis of the reasons-interventionists or changed policy environment contributed in the present state of unwarranted economic development, but prefers to focus on the questions: If financial system matters for development, will the continuation of present policy of financial liberalization help us effectively treat the ills of Indian economy; if not, are we the victims of 'doctor is the disease' syndrome? Is it realistic to assume that private, initiative coupled with some enlightened state intervention, can help solve the problem of excess liquidity of our country more effectively? Is there any scope for public authorities to influence or suspend the operation of market forces to deal efficiently with the problems of macroeconomic management? These issues were explored by Rakshit (2005a and 2005b) and Marjit (2005), among others.

Supply and Demand for Funds Under Full Capacity Utilization

Ignoring peripheral aspects of the theory of financial liberalization, the study summarizes some of the essential features of McKinnon-Shaw hypothesis as follows:

On Savings-Investment and Efficiency

Shaw (1973) opines that indiscriminate distortions of financial prices, including interest rates and foreign exchange rates, in the control regime have stopped or gravely retarded the development of LDCs. Thus, the much-discussed alternative development strategy suggested by McKinnon and Shaw requires the developing economies to go beyond the policy of 'intervention' and to rely on market to decide interest on savings and investment. Very succinctly, the theory of financial liberalization suggests that market determined higher interest rates increases incentives to save and invest and raises the average efficiency of investment, hence economic welfare. Theorists also believe that market-centric approach, with all possibilities, ushers in efficiency and stability of financial system by encouraging competition, risk reduction by diversification, etc.

On Elasticity of Demand

The second major assumption of neoclassical approach, most relevant for the present thesis, is: growth in a financially repressed economy is constrained by savings; investment opportunities abound (McKinnon, 1973 and Shaw, 1973). …

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