Role of finance in economic growth process: A comment

1. Role of finance in economic growth process: A comment KP Krishnan

2. 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?

3. 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

4. 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

5. 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

6. 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

7. 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

8. 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

9. 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

10. 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

11. 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

12. 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 !

13. 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

14. Finance-growth nexus Thanks