Modi's Great Leap Forward

It's a big bang reform alright but not quite what the reforms brigade has been clamouring for. The government's Jan Dhan Yojana, an ambitious plan for financial inclusion, has the potential to be a game-changer for the banking sector and the economy. It calls to mind Indira Gandhi's much-maligned bank nationalisation move which helped transform India's economic prospects over the decade of the seventies.

Bank nationalisation helped sweep small savings into the financial system and push up the savings rate from 10 per cent at the end of the seventies to over 20 per cent by the beginning of the eighties. That, in turn, caused the investment rate to double and helped lift India's trend rate of economic growth from 3.5 per cent to 5.5 per cent in the eighties. Bank nationalisation had its problems. The achievement on the lending side has not been as impressive as that on the liabilities side: small and marginal farmers and also small firms do not get the credit they need. The expansion of branches and balance sheets undermined viability in the banking system. But these problems could be dealt with over time as the basis for economic growth had been laid.

Jan Dhan Yojana holds out the promise of carrying forward the unfinished agenda of bank nationalisation. Sceptics again say it will add to the existing stresses in the banking system. The banking system will have crores of accounts that are inoperative.The overdraft of Rs5000 per accoun promised, if extended to the 10 crore accounts targeted, will create NPAs of Rs 50,000 crore.Banks may garner deposits but lending will remain an issue.And so on.

Yes, in the short run, there will be issues. Over the long run, however, the potential for transformation is enormous. The new accounts will not be idle for long. Large amounts of cash will flow in through the Direct Benefits Transfer. These could lead to large amounts of floats in the public sector (which is bearing the brunt of the initiative). Overdrafts will not be given overnight to all. Banks will watch the accounts for six months before doing so. Even if we assume that half the accounts get the overdraft and half of the overdrafts turn into NPAs, we are talking of  losses of Rs 12,500 crore over two or three years. That is bearable.

Once large numbers of people are brought into the financial system, banks will find opportunities and ways to lend. What has been the province of micro-finance institutions and Regional Rural Banks will move in a large way into the commercial banks. Banks already have made some headway with banking correspondents. Alliances with mobile operators should enable to them to leverage mobile banking as well. It is conceivable that Jan Dhan Yojana could just the shot in the arm that the public sector banks needed. Let me qualify this by saying that much depends on whether the moves under way in the finance ministry to strengthen both boards and management in the public sector bear fruit.

The goverrnment's initiative does undercut the RBI's attempts to pursue inclusion through new players such as payments banks and small banks. The RBI had taken the view that not much could be expected of the public sector and that private entrepreneurs were needed to infuse life into inclusion.The Modi government clearly has a different view. In a way, the entire locus of financial inclusion as well as bank governance has shifted from the RBI to the finance ministry. That could well be a comment on the present state of relations between the ministry and the RBI.

Above all, by unveiling an initiative that is quite different from what economists have pressed for urgently, Modi has shown his capacity for out-of-the box thinking- and his willingness to be guided by his grassroots understanding of what is required rather than the wisdom of experts.