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The Reserve Bank of India now has a task at hand: on Tuesday, the Lok Sabha cleared the Banking Laws (Amendment) Bill that makes it easy for the regulator to hand out new bank licences. This critical piece of legislation went through on the same day that the RBI decided to shift gears in response to growth threats, convincing observers that it will cut rates in the third-quarter policy. Once the banking bill goes through Parliament, it will be impossible for the RBI to claim that it does not have the power to act against recalcitrant bank boards and delay the award of the licences. The significance of the RBI's shift and the legislative approval for the bill are clear to anyone even casually observing the long-term trends in the economy. The limits of bank financing in telecom, power, roads and civil aviation have already been reached because of high exposure to debt and regulatory crossed wires. Existing banks will need to restructure their exposure before they can provide fresh lines of credit to new business ventures.
The alternative of a government supported investment build-up, as the mid-year economic analysis released by the finance ministry on Monday notes, is not possible. The Centre has painted itself into a corner because of its high fiscal deficit. A tight rein on finances from 2013-14 onwards rules out the chance of fiscal sops for investment projects. A possible withdrawal of the remnants of the fiscal stimulus from the economy will add a little more pressure on the concerned sectors. The predicament becomes more difficult for government-sponsored projects like the Delhi-Mumbai Industrial Corridor. Consequently, private sector mega projects, like the Kishangarh-Udaipur-Ahmedabad 555-kilometre road widening project, which rides on the former, will find it difficult to get going.
A clear way out would be the establishment of new banks, which the Banking Laws (Amendment) Bill sets out to facilitate. The licences will not be operational in the near term, but they set the stage for the next leap in financial sector development in India. Permitting new banks allows for a spike in competition that the public-sector-dominated financial sector sorely lacks. This is the most crucial piece of reform that the government has undertaken since September. The fact that neither the anticipated rate cut nor the new licences will be of help in this financial year is a minor irritant. The Companies Bill, when cleared, is also unlikely to affect the soft growth projections for next year. But the pieces may be falling into place for the long term.
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