China Research

A discussion forum on emerging markets, mainly China – from a macro, micro, institutional and corporate angle.

Bank Productivity Changes in two Asian Giants

December 5, 2012

Summary

After centuries of quiescence, the last two decades have witnessed very rapid economic growth in the world’s two most populous countries, China and India. Finance plays a crucial role in growth and in both economies the banks dominate the provision of external finance during the period of studied.

For China bond and equity market capitalisation was 26% and 45% respectively in 2002, compared to 115% and 137% for the US. In India, the comparable figures are 36% and 43%. The main aim of the paper is to look at recent productivity advances in Chinese and Indian banks.

First, this study focuses on trends in total factor productivity (TFP) changes in their banking sectors between 2000 and 2007; annual fluctuations are also examined. Second, the components of TFP growth are analysed, along with variations within and between the two countries, and across banks that differ in size, ownership, and listing characteristics. Third, we assess how closely estimates from non-parametric (Data Envelopment-DEA) and parametric (Stochastic Frontier-SFA) analyses concur and what this implies for their relative merits. Finally, we address the question of how TFP growth is related to standard measures of individual banks’ financial performance such as return on equity.

This study adds to knowledge by providing explicit comparisons of bank TFP growth in these two giant emerging markets. It brings more recent data into play: one advantage of looking at the period 2000-7 is that most major bank reforms have had a chance to “bed down” by this time. It is the first banking study outside the OECD area to compare and contrast the DEA and SFA approaches. It also adds to the literature by assessing the empirical relationship between TFP change and share prices.

The main findings are first, that TFP growth is largely driven by technical progress/innovation. It is somewhat faster in China than in India and strongest in large banks, though in China, there may be some deceleration with a shift in the underlying components. Second, the influence of ownership varies between the countries and listing is similarly ambiguous. Foreign banks display slower growth than locally owned banks in both countries. Third, for India, the period covering the early 2000s is found to be broadly in line with the aggregate TFP growth findings of most studies that covered the 1990s. Fourth, the Divisia (using SFA) and Malmquist (using DEA) TFP changes are not notably different in aggregate, but often generate pronounced differences in estimates of different components that drive TFP growth. Fifth, TFP advances are found to exert important influences on bank-specific equity prices.

JEL classification: G21, G28, D24
Keywords: productivity change, China, India, stochastic frontier; data envelopment analyses

Read more about the whole paper after its publication; we will get back to this issue.

 

 

 

 

 

 

Xiaoqing (Maggie) Fu
Associate Professor of Finance, Interim Associate Dean of Graduate School, Faculty of Business Administration, University of Macau

 

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India – A Promising Nation for the World

September 5, 2012

India is a promising emerging market for the world today. The world output is expected to grow at around 3.5% in 2012 where the major contributors are likely to be emerging economies like India and China. Indian and Chinese economic growth rates in the past five years inspired investor’s world over to consider them as the next investment destination. Despite, the low growth rates of 6.5% last year in India and lower growth rate projection of 5.5% in 2012 in India and about 8% in China, the future seems to be hopeful yet challenging for both these countries.

India is a young nation that promises much more than what is evident in the through international lens of statistical barometers. It is presently going through the legislative reform process for making it a more accountable and transparent nation to its people through introduction of several pending bills. Adaptive to the global developments, the country has advanced its governance structure in a reformative manner that is approachable by the common man by means of e-governance.

The right to information act has empowered the common man. Further, the introduction of Value Added Tax, Direct Tax Code and e-filing has enhanced the transparency into the system, bringing it closer to the international standards. The government incentives like the NREGA scheme and national policy for manufacturing or schemes for social sector development and infrastructure development schemes is likely to give boost to the economic growth. Fiscal measures taken by the government are made keeping in mind their commitment to the fiscal responsibility and management bill.

Serious credit crunch
India despite such fiscal measures is unable to achieve its potential levels of growth in industry, agriculture and services sector. They need the necessary credit impetus to grow. Credit flows are needed in each sector to enhance the investment multiplier promising higher growth rates. Indian banks have been resilient to the global financial crisis but today face serious liquidity crunch. The central bank of India while reviewing the third quarter’s economic situation has identified that inflation rates are high for the given low economic growth rates, high current account deficits and high fiscal deficits. Given the challenges the bank has decided to keep the CRR (Cash Reserve Ratio) to 4.75% and SLR (Statutory Liquidity Ratio) to 23% so as to induct liquidity in the Indian market.

Lately, the chairman of one of the largest PSU banks in India, SBI, has demanded that CRR requirement may be scraped providing greater liquidity to the banks. It is difficult to believe that such a demand could be made by the country’s largest public sector undertaking (PSU) bank. CRR is an essential liquidity maintained by the central bank that acts as a bulwark for the financial system. Removing the CRR requirement would put the banking sector into great danger. Banks need to monitor their investment and act in a more socially responsible manner especially the PSU banks. There is a need for the banks to participate in the economic development process by initiating and encouraging investment in areas with long gestation periods or less than market benchmark returns.

The Reserve Bank of India alone cannot do much to improve the situation. The banks need to adopt a socially responsible role by making credit available at low cost. The agriculture, industry and services sector is unable to achieve its full potential due to lack of low cost credit. The actions of the Reserve Bank of India with respect to CRR and SLR are less likely to yield results given the deregulated state of banking in India. Banking priorities presently are not aligned with the economic development priorities especially when PSU banks take pride in declaring their profits over their declaring their contribution to the economic growth through credit disbursal. Unfortunately, the government units are not defining their performance through their contribution to the social benefits which is an area less researched in the world.

Disinvestment and deregulation are good for a country as long the directed flows do not cause market imperfections or inefficiencies of oligopoly or monopoly causing a dead weight loss to the economy. It is a myth to believe that monopoly and inefficiencies only arise in government sector. They may develop well in private markets as well, to reduce such inefficiencies it is needed that government may introduce competitive market structures and monitor them carefully.

Regulations in the Indian banking sector were dropped primarily with the belief that the competition in the sector would enhance the consumer’s position. However, despite the deregulations and entry of new players, the market continues to be supply driven rather than being demand driven. Banks have become large conglomerates with forward and backward linkages. Banking is the need for all economic transactions today but has the country provided for a sufficient competitive market structures that that support credit growth.

Necessary policy improvements
India is one country that has a large set up of informal financial markets that still continues to support the economy. To achieve a higher growth potential it is needed that markets may be made more competitive, regulations more stringent, contracts enforceable and government set ups more accountable. To aid this it is needed that there is consolidated effort of fiscal and monetary policies to support economic events. Political and economic will to align sectorial growth rates with economic development priorities.

How do we do it all? The government needs to bring back its disinvestment agenda to reduce its fiscal deficits with proposed conversions of retained earnings into equity shares. Plug all leakages of savings that go into unproductive investments like speculative investment in real estate or investment in gold or foreign currency. Tap the flow of income even the smallest by making banking a habit.

Demonitise the economy, it will reduce black money and ills of the parallel economy! Make transactions accountable by necessitating the use of income tax number known as the PAN number even in the smallest transaction! Direct the flow of saving to banking channels by removing the KYC norm on small balance account holders with low or no banking transactions!

A mere deregulation in diesel prices or reduction in subsidies would not help much in the fiscal position of the government. It would be better to concentrate on the economic issues rather than industry specific issue or specific transfer payments. Tax evasions need to be controlled. Tax incentives to motivate investments need to be given. Government needs to control cost and time overruns in infrastructure and other projects that increase government expenditure and inflation. Banks need to be reminded of their main business of lending and must not play with the public money by investing or speculating in the stock market. Legal systems need to promise foreign and domestic investors protection for their investment and manpower. Imports of unproductive resources like gold need to be reduced or curtailed. Make governance more easy and accessible through e-grievance addressal cells.

The potential
India with its young population size, highly qualified manpower, rich political base, progressive outlook and rich natural resources needs more unity and coherence in its economic growth and development story. One sector alone cannot push the growth rates. Agriculture needs another green revolution. Industry needs a fresh line of credit and services needs newer and higher grounds of performances to develop. Further, a future recovery in the world economy will bring greater hope for India as trade and investment ties would improve.

 

 

 

 

Yamini Agarwal
Professor and Vice Chairman (Academics)
Indian Institute of Finance (IIF), Delhi

 

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India: the Economic Outlook in the Near to Medium Term

June 5, 2012

The international economic climate is of course not good. The problems of the Eurozone are festering and as long as they remain like that, there will always be a sense that some kind of bad event may pop up around the corner. However, given the amount of liquidity that has been pumped in by the ECB a crisis of the 2008 is unlikely. India, as also other developing countries are negatively impacted on account of the European problems in three ways. First their export markets are diminished, second global financing for projects is harder to obtain and finally both domestic and overseas investor confidence is affected adversely. Of course, this general malaise is tempered by the situation of individual developing economies and the actions that they individually take on various fronts.

About India, there is a surfeit of concern about the economic outlook – some real, others imaginary. Over the past few years, self-flagellation has seemingly become high fashion in the media and other forum of discourse. Being modest about one’s achievements is both prudent and in good taste; as indeed is being contrite about one’s failures. However, self-mortification without end is a waste of time and a waste of opportunity. Since the elite are well provided, the foregone opportunities will inevitably be at the expense of the not elite.

Over the past few years, three categories of real problems have reared up. The first from a build-up of macro-economic tension: They include inadequate recovery in the momentum of private investment in infrastructure after the global crisis of 2008–2009, compounded by a fiscal position under stress. Domestic inflation has also been much above comfort levels. These factors generate negative feedback to business confidence. The second category includes a variety of problems in the operational or executive domain. Some of them have been resolved in the last one year and others are in various stages of being resolved. The third is in the sphere of politics, where developments in the past few years have made decision-making harder.

On the macro-economic front, fixed investment rates had risen in the past eight years largely because of a big increase in corporate investment. However, private investment in infrastructure and industry remain subdued. In the fiscal year (FY) ending March 2005 private corporate fixed investment was 9% of GDP, which rose steadily to over 14% in FY2008, just before the global crisis. This resulted in the fixed investment rate peaking at nearly 33% of GDP in that year. Thereafter private corporate fixed investment slipped to 10% of GDP in the subsequent four years and overall fixed investment is down to little over 29% in FY2012. It is not that a fixed investment rate of 29–30% is something to mock at, since it can give us 7.5–8.0% overall growth. But the fixed investment ratio has been and could again be about 3–4 percentage points of GDP higher than it is. It would give the necessary lift to all-round activity, expand supply, reduce inflationary pressures and make the fiscal consolidation process easier.

Both inflation and fiscal deficits are well over the comfort level. Pessimism has coloured the atmosphere. One consequence has been the huge increase in household investment allocation to gold. Knock out gold import and it can be seen that the real merchandise trade deficit as a proportion of GDP has not worsened as much as the total. The ratio (excluding gold) was (–) 5% in both FY2006 and touched a high of (–) 7.8% in FY2009. It fell off thereafter and in FY2012 is estimated to be 6.5% of GDP. Thus on the trade front, despite very high crude oil prices, there has not been that much worsening in the trade deficit as is widely believed. That is for normal goods and services. That is, excluding gold the demand for which behaves like an asset, not like a commodity. The corollary is that if we can fix the problem by making it more attractive for Indian households to hold their savings in financial instruments we should be able to significantly reduce our current account deficit from the present very high levels of 3.5–4.0% of GDP.

Then again if we can contain the current account deficit to more manageable proportions and if we take the other necessary measures to improve the state of our economy, capital inflows will be higher and ipso facto financing that current account deficit will be fairly easy.

What we can do internally is to first work towards securing better co-ordination within the governmental system so that investors feel that risks emanating from this source are mitigated. We have had a measure of success here – especially in the coal, electricity and port sectors. Government executive decision making impacts the infrastructure space – energy, roads, railways and ports – the most powerfully and that has been our initial focus. India suffers from a want of the infrastructure that developed nations take for granted. The productivity of our people can only increase through a combination of the building of such assets on the one hand and improved education & the acquisition of skills on the other.

Projects where governmental action can have a proportionately larger impact and which then can positively impact other areas of the economy are being sought to be fast tracked. In the past five years, compared to earlier years, we have been able to build multiples of power generating & transmission capacity, multiples of roads – both highways and rural – greatly improve farm incomes and other livelihood opportunities. We seek to continue to pursue these ends energetically.

There are important issues, such as petroleum product subsidies, that have got caught up in politics and which have a large and material impact on government finance and hence on the economy at large. We have to gain some traction on these issues and one hopes that some of this will indeed transpire, perhaps at least partially, over the next few months.

 

 

 

 

Saumitra Chaudhuri
Member, Planning Commission & Member Advisory Council to the Prime Minister and the Government of India

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