Transcript Putting China’s Capital to Work: The Value of Financial

McKinsey Global Institute
The Value of Financial System Reform
in China and India
Diana Farrell, Director
McKinsey Global Institute
January, 2007
AGENDA
• China’s Financial System
• India’s Financial System
1
CHINA FINDINGS
• China has made steady advances in modernizing its financial system and in
mobilizing savings, reflected in the doubling of China’s stock of financial assets
relative to GDP over the past ten years. China’s banking sector plays an
unusually large role in its financial system.
• Capital allocation in the system is poor: wholly and partially state-owned
companies continue to absorb most of the funding from the financial system,
while private enterprise, the engine of China’s growth, receives a
disproportionately small share. As a result, China’s investment efficiency is
declining.
• The dominant bank sector, though improving, remains highly inefficient and
potentially vulnerable.
• Reforms that enable a larger share of funding to go to the most productive
companies and improved the operating efficiency of financial system components
would raise GDP by $321 billion annually, or 17 percent.
• China’s financial system’s remaining problems are intricately linked across its
component markets, and will therefore require an integrated approach to reform.
2
CHINA’S FINANCIAL SYSTEM DEPTH IS HIGH GIVEN ITS
GDP PER CAPITA
Stock of bank deposits, bonds and equity, 2004
Percent of GDP
Position in 2004
1994-2004 evolution
for select countries
Mature
500
Japan
450
Malaysia
400
United Kingdom
South Africa
350
300
250
200
150
100
50
0
1,000
United States
China
Emerging
Thailand
Nascent
Chile
Sweden
South
Korea
Singapore
Australia
Canada
Taiwan
Finland
India
Saudi Arabia
Norway
Brazil
New Zealand
Turkey
Czech Republic
Hungary
Philippines
Mexico
Russian Federation
Indonesia
Tunisia
Vietnam
United Arab Emirates
Ukraine
Egypt
10,000
100,000
GDP per capita (at purchasing
power parity), 2004
US $, logarithmic scale
Note: China’s depth would be at 220% of GDP in 2004 according to recent GDP restatement. It is unclear how new
GDP calculation methodology would affect China’s 1994 GDP.
Source: WEFA; BIS; FIBV; WDI; IMF; GFS; McKinsey Global Institute analysis.
3
CHINA’S FINANCIAL SYSTEM IS DOMINATED BY THE
BANKING SECTOR
Equity
Corporate debt
Government debt
2004 financial stock components
Percent, US $ billion
100% =
4,291
247
350
30
33
Bank deposits
1,105
15
8
5
130
675
19,627
22
25
19
35
7
4
11
21
11
9
Depth
GDP multiple
471
43
40
13
19
11
11
214
47,729
34
55
60
21
34
29
30
35
Malaysia
Chile
United States
19
Singapore
21
Hong Kong
30
12
South Korea
32
Japan
33
Mexico
33
Philippines
35
11
India
36
14
Thailand
37
1
Indonesia
43
6
35
China
45
396
1
11
46
1,428
27
12
72
CAGR2
1994–2004
Percent
1,602
20.5
6.5
2.8
12.3
1.0
8.8
3.5
11.0
10.5
6.0
3.4
6.4
9.4
8.7
2.21
1.0
2.1
4.2
1.7
1.5
Note: Numbers may not add to 100 percent due to rounding.
1 Reflects China’s recently restated GDP.
2 CAGR = compound annual growth rate.
Source: McKinsey Global Institute Global Financial Stock Database
1.0
2.4
3.7
4.0
2.3
4.1
4
PRIVATE COMPANIES GET A DISPROPORTIONATELY SMALL SHARE OF
LOANS
State-owned enterprises
Shareholding and
collective enterprises
Private and foreign
enterprises
Comparison of GDP and corporate bank loans
outstanding, 2003
Percent
State-owned enterprises1
23
Shareholding enterprises2
19
Collective enterprises3
6
Private and foreign enterprises4
52
35
27
11
27
GDP5
Corporate
loans
outstanding6
SOEs are defined as wholly state owned.
Most of the shareholding enterprises are partly state owned. Some are state controlled, some are not.
3 Collective enterprises are owned by the population. Many are run like private enterprises, but some are effectively controlled by local political interests.
4 Fully private enterprises include local privately owned enterprises, foreign joint ventures, and wholly owned foreign enterprises.
5 Breakdown of industrial value added by ownership type, 2003, as determined by the Organisation for Economic Co-operation and Development.
6 Total corporate and government bank lending, based on a survey on commercial bank new loans conducted in 2002 by the People’s Bank of China. This is the
most recent publicly available data on lending by company type. In the absence of more recent data, we are making the assumption that new lending in 2002
reflects the stock of outstanding credit in 2004. A higher portion of new lending today may go to private companies, but we have no evidence of this.
Source: OECD; PBOC; McKinsey Global Institute analysis
1
2
5
THE PRODUCTIVITY OF STATE-OWNED FIRMS IS HALF THAT OF PRIVATE
COMPANIES
Average Total Factor Productivity (TFP) of large industrial firms
Direct state control led firms = 100
x2
State
controlled
and
collectives
(48% of
companies)
Direct state control
Indirect state
control, LP1 >50%
Indirect state
control, other
100
146
170
Collective >50%
216
Private, LP1 >50%
Privately
controlled
(52% of
companies)
Private,
individual >50%
Private, nonmainland >50%
Private, other
221
208
192
200
1
Legal person.
Source: OECD (Dougherty and Herd, 2005); McKinsey Global Institute analysis
6
THE EFFICIENCY OF CHINA’S INVESTMENT IS DECLINING
Years
China
1991-1995
Investment required to
produce $1 additional GDP **
3.3
1996-2000
4.6
2001-2003
India
1995-2004*
Japan
1961-1970
South
Korea
1981-1990
4.9
4.1
3.5
3.7
* Fiscal years, finishing in March of the following year
** This metric is known as the “incremental capital-output ratio”
Source: World Bank 2004 World Development Indicators; PBOC, Reserve Bank of India, McKinsey Global Institute analysis
7
60 PERCENT OF NPL REDUCTION IS DUE TO TRANSFER OF BAD LOANS
TO ASSET- MANAGEMENT COMPANIES
Source of NPL reduction for large state-owned commercial banks, 2001–2005
Percent of loan balance
31.1
12.4
8.6
10.1
NPLs at the
end of 2001
NPLs
transferred to
assetmanagement
companies1
NPL resolution NPLs at the
and dilution
end of 20052
due to growth
1 A total of $150 M was transferred between 2001 and 2005, which represents 12.4 percent of the 2005 loan
balance.
2 End of Q3.
Source:
CBRC; PBOC; McKinsey Global Institute analysis
8
WEAK BANK PERFORMANCE IN CHINA CREATES VULNERABILITIES
Root causes of weak
performance
Key vulnerabilities
• Weak governance and lack
• Renewed NPL build-up
of commercial mindset
• Operational weaknesses in
lending and risk management
• Decentralized structure with
local autonomy
• Sharp reductions in liquidity and
profitability, due to concentration
of profits, from:
– Foreign bank entry
– Corporate bond market
development
– Real estate exposure
9
REFORMING CHINA’S FINANCIAL SYSTEM COULD BOOST GDP BY UP TO
$321 BILLION ANNUALLY
Potential benefits of financial reforms in China
US $ billion
Indirect impact
on growth
259
Direct impact on efficiency
2
1
62
14
25
Increased
bank
efficiency
Percent
of GDP
1.3
20
Migration of
more
payments to
electronic
platforms
Increased
Elimination
market debt
of informal
intermediation lending
1.0
Source: McKinsey Global Institute analysis
0.7
0.1
Increased
Direct impacts
equity trading of financial
efficiency
system
reforms
0.1
3.2
Increased
productivity
due to better
capital
allocation
13.4
10
CHINA: AN INTEGRATED PROGRAM OF FINANCIAL REFORMS IS NEEDED
Reforms to improve allocation of capital
1 Improve governance and increase competition in the banking sector
2 Change collateral requirements for small businesses to improve
access to credit
3 Support development of an independent consumer credit bureau and
a corporate rating agency
4 Deregulate the corporate bond market
Reforms to balance the financial system
5 Deregulate bank interest rates ahead of current schedule
6 Spur growth of domestic institutional investors through deregulation
7 Create a more strategic relationship between HKSE and mainland
equity markets
8 Change equity IPO process to allow private companies and SMEs to
compete for funds
Reforms to improve overall system efficiency
9 Accelerate improvements in the payments system
10 Further liberalize the capital account
Source: McKinsey Global Institute analysis
11
AGENDA
• China’s Financial System
• India’s Financial System
12
INDIA FINDINGS
• India’s financial system has lower depth than other fast-growing Asian
economies, indicating a low level of financial intermediation in the economy.
Although the lauded equity market is sizable and growing, the banking sector
dominates but does not lend broadly and the corporate bond market is small.
• An array of financial system policies direct capital allocation in India. As a
result, the fast growing private sector gets little credit while the government in
various forms absorbs the vast majority of the intermediated capital.
• Moreover, the state-dominated banking sector features low competitive
intensity and significant inefficiencies.
• Reforms that enable a larger share of funding to go to the most productive
companies and improve the operating efficiency of financial system
components would raise GDP by up to $48 billion annually.
• Further reforms (financial and economic) could raise India’s real GDP growth
rate to 9.4% annually, on par with China.
13
INDIA’S FINANCIAL DEPTH IS LOW COMPARED TO OTHER
ASIAN NATIONS
Equity
Corporate debt
Gov. debt
Bank deposits
Financial depth, 2004
Financial assets as a percent of GDP
420
400
371
79
161
259
235
214
63
151
96
28
3
20
44
34
11
51
55
Indonesia Philippines
160
70
56
23
24
34
2
68
India
39
13
20
68
26
97
78
Thailand
Korea
Source: McKinsey Global Institute Global Financial Stock Database
50
161
50
74
42
44
119
120
146
187
China
Singapore Malaysia
145
Japan
14
LESS THAN HALF OF COMMERCIAL CREDIT GOES TO INDIA’S PRIVATE
SECTOR
Distribution of commercial credit*
$ Billion, percent
100% =
Private corporate
discretionary
Private corporate
Priority lending**
Agriculture
Household
enterprises &
proprietorships
Public sector
enterprises
122
35
5
7
8
211
30
13
11
7
44
39
1999
2004
* Gross bank credit excluding financial companies; Includes corporate bonds and private placements, loans and
investments from the government to public sector enterprises.
** Estimate of lending to small corporations equals “other” priority sector lending outside of agriculture and SSI
Source: CSO; RBI; MGI; Public Enterprise Survey
15
INDIAN FIRMS RELY HEAVILY ON RETAINED EARNINGS
Sources of funds raised
$ Billion; percent, 2000-05*
100% = 204
2
Equity
Debt
20
1916
2
40
3
562
3
34
39
89
10
78
393
6
6
40
47
52
72
63
India
100
26
35
Internal
funds
91
4
Japan
59
Indonesia South
Korea
55
55
47
Singapore Malaysia US
42
Hong
Kong
* Based on sample of 160 companies per country outside of US. Companies were ranked by gross sales, and 40
companies from each quartile were taken as the sample. US sample…
Source: Bloomberg, MGI
16
INDIAN BANKS LEND A SMALL PORTION OF DEPOSITS
Commercial bank loans outstanding
Percent of deposits, 2004*
131 130
119
G7 average: 118**
114 113
101
81
81
80
79
76
* United states is 2003 data (2004 unavailable)
** Straight average; excludes Luxembourg and Iceland for which data is unavailable
Source: RBI; EIU; McKinsey analysis
Philippines
Mexico
Singapore
Brazil
Japan
Poland
Thailand
Korea, Rep.
United States
Malaysia
Canada
United Kingdom
Chile
China
South Africa
66
61
61
53
Turkey
83
Czech Republic
90
India
93
17
INDIA’S GOVERNMENT AND STATE-OWNED COMPANIES CONSUME 70%
OF SURPLUS SAVINGS
Sources and uses of net savings
Percent of GDP, average 1994-2004
9.0
1.2
3.2
7.0
Household
net savings
to the
financial
system
Source: CSO; McKinsey Global Institute
Net foreign
capital
inflows
Private
corporate
borrowing
Public
sector
borrowing
18
FINANCIAL REFORM IMPACT:
$22 BILLION DIRECT, $26 BILLION INDIRECT
Increasing efficiency
Shift financing mix
Total impact
Direct impact of financial system reform
Indirect impact
$ Billion, 2004
21.8
0.3
25.5
2.3
5.1
6.3
Improved
allocation
of capital
18.9
Capturing
more savings
6.6
7.8
Improved
banking
efficiency
to best
practice
Percent
of GDP
1.1
Fully
implement
electronic
payment
system
0.9
Migrate
informal
lending to
formal
banks
0.7
Reduce
corporate
bond
default
rates to
benchmark
Shift in
financing
mix from
bank
loans to
bonds
Direct
impact
of financial
system
reform
0.1
0.3
3.2
Source: RBI; CSO; McKinsey Global Institute Analysis
3.5
19
FINANCIAL SYSTEM REFORM COULD BOOST GROWTH TO CHINESE
LEVELS
Real GDP
$ Billion 2000
CAGR
2004-2014
1600
Baseline
1400
1200
9.4%
Efficient investment
and financial market
reform
6.5%
1000
800
600
400
200
0
1994
CAGR
1999-2004
5.9%
1999
2004
2009
2014
* Forecasts of investment rates from Oxford Economic Forecasting
** Efficient investment ICOR is the average rate implied if the public sector and households are as efficient as the private
corporate sector between 1999-2004. See exhibit x.x and the technical appendix
Source: CSO, RBI, OEF, MGI
20
INDIA’S REFORM AGENDA MUST ADDRESS ALL PROBLEMS TOGETHER
Reforms to improve capital allocation
1 Lift most priority lending requirements, asset allocation restrictions,
and guaranteed deposit schemes
2 Reduce state ownership in the banking sector
3 Strengthen corporate governance in public sector banks
4 Lift restrictions on foreign ownership in banks
5 Spur development of the corporate bond market
Reforms to hasten development of financial intermediaries
6 Deregulate the insurance industry
7 Ensure pension reforms are enacted without limitations
8 Continue reforms of mutual fund industry
Reforms to capture more household savings
9 Introduce gold deposit scheme to capture value of gold expenditures
Reforms to improve overall system efficiency
10 Faster development of electronic payment system
11 Separate the regulatory and central bank functions of RBI
12 Lift remaining capital account controls
Source: McKinsey Global Institute analysis
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