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Indira Rajaraman: Wanted - new financial instruments

Financial markets should set out to address two key structural problems: land acquisition and gold imports

Indira Rajaraman 

When foreign capital is not pleased with its playground, it gathers up its marbles and goes elsewhere. Today, India languishes somewhere at the bottom of rankings of emerging markets in terms of their attractiveness to foreign capital.

Financial markets are looking for evidence of official willingness to do something about the twin deficits that plague India: fiscal and external. They are looking for removal of the immediate supply-side impediments to growth, principally the supply of coal for thermal generation, the multiple obstacles in the agriculture sector, and the shortage of skilled labour.

Most of all, they are looking for delivery on governance promises. An official initiative this year to address the coal availability issue with publicised deadlines fizzled out and came to naught. They are looking for a functioning Parliament, which will responsibly transact the business for which its members got elected in the first place. Long-pending financial legislation on the goods and services tax and a multiplicity of other issues is shelved in favour of footling debates. They would like to see firm handling of some rogue public sector behemoths.

But there is actually something the financial sector itself can do — by designing new financial instruments to address two of the key structural problems confronting the Indian economy. One is the land acquisition issue. The other is the appetite for gold, which is fuelling the huge current account deficit.

The Land Acquisition Bill is before Parliament at present. Its provisions have been considered by a standing committee, whose report now stands tabled. The key issue that has to be given centrality of focus is the design of compensation for displaced people.

This is where we need innovative responses from the financial sector for formal, enforceable compensation for displaced people in the form of financial instruments yielding a monthly return, akin in configuration to a reverse mortgage. Here finally is a situation where the mighty expenditure allocations for Aadhar might actually yield some return. If displaced people are given a UID with which they can access this income wherever they go, we will finally give them a meaningful alternative against which they can weigh their choices.

Wanted - new financial instrumentsCash compensation of the one-time variety, in place of a time-stream, is not suitable for sellers of land who are typically not adept at the management of large financial assets in such a way as to generate a recurring income stream. The compensating land option is better in that sense, but it is hard to imagine where such land might be sourced which does not involve the displacement of other people in turn.

Land acquisition for non-agricultural uses involves negotiation between parties unequal in education and financial literacy. Even a time-stream of income has to be explained in great detail, through the mediation of people trusted by the sellers, in order for fairness, and the appearance of fairness, in the deal. It should not be perceived as yet another elaborate confidence trick played by people hungry for land.

Given the difficulties of negotiating with individual property owners, acquisition of land for public purposes (like bus stands) in the past has tended to reach into common lands. There are even cases where irrigation tanks are drained, impoverishing the surrounding farmland and the farmers who once relied on it.

Therefore, easing up the process of negotiating with individual landowners is no longer a luxury. It is an imperative, and the sooner it is facilitated with suitable financial instruments, the closer we will be to releasing the brakes on growth.

On gold, the Indian appetite for it is well known. Gold imports in the first three quarters of 2011-12 amounted to 84 per cent of the current account deficit. About a fifth of this is estimated to be re-exported as jewellery. The remainder is a net new flow that goes into domestic holdings as a store of value. If, by some magical wand, we could reduce gold imports to zero, the current account deficit would diminish to insignificance. The fall of the rupee would have been stemmed without recourse to capital inflows.

We need a way by which to unlock existing stocks of gold in India so as to feed this incremental domestic demand. This calls for a financial instrument which will provide an alternative inflation-indexed cash return for surrendered gold.

Would Indians ever give up the gold they hold, which is handed down through the generations and embodies the inter-generational links of the Indian family? Well, things are changing. With urban life becoming more insecure, and without stay-at-home household members guarding the family residence, safe storage of gold has become increasingly burdensome.

Surrender of gold by individuals does happen, wholly voluntarily, to religious institutions, as a result of which institutional holdings of gold are stupendously large. These were the hoards that drew marauders like Mahmud of Ghazni. Many of these institutions today would like to convert gold contributed by devotees into financial resources with which they could set up health and education centres. An inflation-indexed monthly income financial instrument could be the very answer to their requirement.

The operational requirements of such a scheme are daunting, but not insurmountable. Gold varies in quality and has to be valued at a trusted counter. It may be surrendered as stone-encrusted jewellery, which will pose further valuation problems. But the payback to resolution of these issues is enormous. The fund from the sale of the surrendered gold gets released for financial investment, the income from which will service the indexed income instrument. We will finally have tackled the external deficit head-on, without resort to the capital account. Import of gold will continue to be legal, but can in principle be reduced to zero by recycling the massive stock we already hold within the country. The sooner we do this, the better.

The writer is honorary visiting professor,
Indian Statistical Institute, New Delhi

First Published: Tue, May 29 2012. 00:24 IST