Role of finance in economic growth process: A comment

KP Krishnan

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Structure of presentation

• Paul’s summary of the role of finance• Are there lessons from India on finance?• What did we get right & what is still left?• Have the questions on finance changed?• Have the answers for those questions changed?• Next steps for India?

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Evolution of early thinking

• Started with development economists calling for explicit manipulation of financial markets to achieve development objectives

• This is to be done through – subsidies – directed credit and – interest rate controls

• Many countries have done this and are doing this still

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The move towards markets

• Late 1960s and early 1970s saw a movement towards greater market orientation

• Greater economic activity and more efficient allocation of resources achieved through – intermediation– pooling of information and – creation of financial instruments

• Lots of examples of this in many EMEs

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Empirical work on finance & growth• 1990s establishes finance-growth nexus but• Recent work says it is a mistake to draw

causal inferences from the effects of financial deepening on economic growth

• In some contexts financial depth is a determinant of economic growth but in other contexts a precursor of crisis

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Empirical work on finance & growth• Methodological issues on how to measure

the finance-growth nexus?• Conclusion?• Not that finance is unimportant but it is very

difficult to measure financial sector activity properly

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Lessons from India on finance

• The unqualified triumphalism that marks this discussion is not entirely warranted

• If global finance is about flying a 747 we are still cautiously flagging off a Cessna

• A lot of Indian finance is still a waste land e.g. the bond markets

• But there are parts of India where useful things have been done

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What did we get right?

• Serious public policy attention to critical financial infrastructure institutions

• Using modern technology to improving efficiency of pricing

• Consolidation and economies of scale as opposed to fragmentation

• Use of public policy to push standardization, commoditization and dis-intermediation

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What did we get right?

• Pro-active public policy to ensure competitive markets

• Examples– New Pension System (NPS)– Screen based IPO– Exchange traded derivatives & clearing

corporations– Ownership & governance of exchanges

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Finance-growth nexus in India

• Enough data to show that India – has a very small corporate debt market– has a very small level of participation of people in

the equities markets– scores very low on financial inclusion i.e. access of

the poor to required financial products – requires large quantum of infrastructure finance

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Finance questions & answers in India?

• Have the questions in Indian finance & the answers changed pre & post crisis?

• The questions have been posed & answered in the Percy Mistry and Raghuram Rajan reports

• India needs more financial deepening & products and lots of regulatory reform

• This is essential for maintaining India’s growth momentum & greater inclusion of growth

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Finance questions in India

• Exchange traded derivatives are about a fourth of the OTC derivatives in value

• Difficulties in liquidity of the money market in Mumbai are not unusual

• The October 2008 problem of MFs was a result of the absence of a liquid market for many fixed income instruments

• New product (?) approval in 5 years !

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Next steps• Regulatory reform & convergence

• Regulatory coordination & financial stability

• Financial literacy & inclusion

• Banking/insurance legislative changes

• Strengthen Bonds-Currency-Derivatives nexus

• Deepen G-secs market & institutions reforms

Finance-growth nexus

Thanks

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