Transcript Financial structures, intermediation and growth before and after

Financial structures,
intermediation and growth
before and after
liberalization
The Asian Experience
The financial sector in market
economies
Perception that the state in late late-industrializing countries uses
the financial sector as an instrument in a process of regulated
development. On the other hand, liberalization is seen as ‘freeing’
the financial sector as part of a strategy of market-led
development.
Ignores the possibility that growth in market-mediated economies
requires financial intermediation, irrespective of the nature of the
policy regime.
The financial sector ‘matters’ and the state continues to play a
role.
The role the financial sector plays and the effects that
macroeconomic policies have varies with the nature of financial
intermediation.
Interventionism and fiscal
dominance
As widely recognized, in interventionist regimes the
emphasis is on a fiscally proactive state. State expenditure
not only enhances domestic demand and income with
attendant multiplier effects, but also relaxes supply
constraints and closes imfrastructural gaps.
Issue is how expenditure is financed. Must finally be based
on progressive taxation and appropriation of a part of
private surpluses. But while the tax-to-GDP ratio is being
raised, a proactive fiscal stance must exercise the ability of
the state to borrow to raise government expenditures. The
result is fiscal dominance.
Implications of fiscal dominance
Fiscal dominance implies that monetary expansion is
driven by the fiscal stance and the degree to which
fiscal expenditures are funded with borrowing,
especially, but not solely, from the central bank.
Dominance often ensured through preemption of
bank lending (the SLR in India).
Also ensured through state control over the financial
sector, which provides the basis for allocation of
savings.
Regulation implied
Regulation needed to realize an a priori plan that defines
how high the investment rate should be, how that
investment must be allocated and how much should the
state itself spend and invest. This is true in both domestic
market- and export-oriented economies.
Mechanisms to ensure that credit provision to the private
sector also privileges the investment allocation that the state
favours.
Also mechanisms like development banking that involve
establishing state-directed institutions that can through
direct transfers from the budget or central banks access low
cost resources that are directed to priority projects.
Explaining the transition
In many countries the transition warranted in the first
instance by the the inability to mobilize resources through
taxation, making the state’s role dependent on the ability to
continuously raise borrowing.
Borrowing limited because it is predicated on the ability to
tax in future, but more importantly because debt-financed
expenditure runs up against supply constraints, leading to
inflation or balance of payments problems.
Transition partly an attempt to use the post-1970s surge in
liquidity in the international financial system, to obtain a
temporary reprieve. Translates into a shift in strategy.
The transition: Mark 2
In growth strategies with a strong role for exports (such
as Korea and China) export success (realized through
rather different trajectories) raises costs, strengthens
exchange rates and undermines competitiveness.
Financial liberalization here driven by demands from
countries that are important external markets and the
need for an already influential financial sector to move
into alternative sectors to compensate for business lost
and losses incurred in traditional areas of lending and
investment.
The new stimulus
Problem remains of finding an inducement to
investment and stimulus to growth in the new period.
Government is even more reticent to raise tax revenues
and liberalized regimes emphasis “fiscal consolidation”.
If exports do not provide that stimulus and fiscal space
is limited, there is need to generate it from within the
private sector.
Only way policy can attempt to spur consumption and
investment is through the provision of large volumes of
cheap liquidity.
A role for monetary policy?
An ostensibly ‘independent’ central bank pursuing
inflation targets deregulates the capital account and
sees reason in trying to manipulate interest rates
downwards while allowing liquidity expansion a free
reign. Liquidity expansion also driven by capital
inflows.
Banks awash with liquidity now need to lend more at a
time when government borrowing is under control.
The result is a change in financial sector behaviour and
bank lending practices.
Transition in different contexts
In countries not damaged by the 1997 crisis there is a
sharp increase in credit to GDP ratio. Levels vary, but
direction and speed of movement more or less the
same.
In countries that were hit badly the credit to GDP ratio
declines and is yet to regain pre-crisis levels in some
countries.
So increased lending to the private sector a common
characteristics, but sustainability depends on state of
the financial sector.
The burden of debt
Within the private sector the segments that accessed the
debt that excess liquidity provided varied across countries
and over time in individual countries.
Broadly, the shift can be analyzed in terms of three
alternative sets: households vs corporate entities; investment
vs consumption; and old sectors vs new sectors.
An important result of the transition is the rise in share of
lending to households in many contexts. This did imply that
rather than facilitating investment induced by other stimuli
(like government spending), the financial system was serving
as source of stimulus by driving debt financed private
spending.
Korea: Impact of the transition
•
The shift from investment to consumption and corporates to
households was most marked in Korea after the 1997 crisis.
•
Starting at around Korean Won (KRW) 210 trillion in 1997, the
debt of households in Korea rose to more than KRW 450 trillion
in 2002 and stood at KRW 922 trillion at the end of June in 2012.
•
Household debt to net household disposable income from less
than 100 per cent before the turn of the century, to the 3-digit
mark in 2001, more than 140 per cent in 2006 and 160 per cent in
2011.
•
Collapse of the household savings rate from more than 15 per
cent before the 1997 crisis to around 10 per cent in 2000 and a
low of 2-3 per cent recently.
Korea: Loans to households
The burden
•
According to a 2011 survey conducted by Statistics
Korea and analysed by the Korea Development
Institute, six out of ten households in Korea were in
debt, and more than a third of them were unable to
meet their annual expenses with their incomes.
•
Debt also weighed heavy on current incomes. One in
every 10 households spent more than 40 per cent of
annual income on servicing that debt.
Overall trend
Ever since the early 1960s bank lending to the private
corporate sector in Korea was much higher than in many
countries with extremely high debt to equity ratios.
As South Korean industry lost competitiveness and many of
its chaebols moved abroad, banks that were primed to lend
shifted in favour of real estate and stock markets with the
hope of sustaining their profitability. But that made the
financial system vulnerable to the crisis in 1997.
And when that crisis occurred both the debt-burdened
private corporate sector and the banks over-exposed to them
took a hit. But “recapitalized” by the government.
Post-crisis
But this did not end the lending boom. Increased lending to
the household sector resulted in an increase in the ratio of
household debt to GDP.
South Korea’s halting recovery from the crisis was driven by
debt to the household sector, which touched 150 per cent of
household disposable income by 2013. The danger of
massive default on such debt which could have precipitated
another major crisis forced the government to step in and
set up an 800 billion won fund to buy distressed household
debt from the banking sector at a discount and restructure
or write off a significant part of that debt.
The specificity of China
Financial reform in China is instructive because it involves
the transition from a completely state run and controlled
financial structure, in which taxation and terms of trade
adjustments were the principal “financial techniques” used
to channel surplus incomes (over expenditures) to
investment, to an increasingly market-mediated system with
a structurally more diverse financial sector.
However, the legacy of central planning has meant that the
domestic banking system is still dominantly public. This
experience facilitates an assessment of what the
consequences of a growing reliance on market mediation
are, in a context where initial conditions were substantially
different.
Evolution
The so-called “mono-bank” system created after the
Revolution, in which the PBC was the sole commercial bank
and was characterized by a limited degree of institutional
diversification and barely any decentralization of decisionmaking, was in existence till 1984.
In 1984 the PBC was formally designated as China’s central
bank, and its urban commercial banking functions were
transferred to the Industrial and Commercial Bank of
China (ICBC), making it the largest state-owned commercial
bank. Significantly, commercial banks were handed the
responsibility of financing the state owned enterprises.
Credit growth in China
•
Since the post-crisis stimulus of 2008, total public and
private debt in China has risen to more than 200 per cent of
GDP. Credit to the private sector rose from 104 per cent of
GDP in 2008 to 130 per cent in 2010, before declining
marginally in 2011.
•
Rapid growth of lending by the ‘shadow banking’ system, at
the forefront of which are wealth management products
(WMPs) offering high interest rates. Loans are then
provided to borrowers such as real estate developers to
whom lending by the banks is being restricted. WMPs are
placed at around 10 per cent of total deposits in Chinese
banks, but the rate of growth is high.
Private sector
Outstanding debt of the private non-financial sector rose from 70
per cent of GDP at the end of 1985 to a little more than 115 per
cent by 2008.
Then over the next seven years to 2015, when financial
liberalization was intensified, it shot up to more than 200 per
cent.
In this period household debt rose from 19 to 38 per cent of GDP.
Debt to the private non-financial sector other than households too
obviously rose sharply. What were more or less sequential
developments in India, occurred simultaneously in China. But
there too the overall rise in private debt has resulted in increased
default and rising financial fragility.
A role for the stock market?
By the early 1990s, considerable advance in the process of
establishing new institutions, combined with ownership structures
that could pave the way for a degree of decentralization of decision
making
Shanghai and Shenzhen Stock Exchanges at the end of 1990.
Shares were split into two kinds: A-shares denominated in
renminbi (RMB) and B-shares in US or Hong Kong dollars. Till
2000, the A-share market was not open to foreigners and the Bshare market to domestic investors. Distinction began to ne
diluted in 2001.
Deregulation and liquidity infusion led to the stock market
volatility of 2006-07 and 2015.
Was this an effort to get stock markets to replace banks?
The unusual Indian case
Liberalization traced to 1991. Through the 1990s outstanding debt
to the private non-financials sector in the country was around 30
per cent of GDP. In the early 2000s, this figure rose sharply to
touch 50 per cent by 2007 and 60 per cent by end 2015. Period of
rapid growth.
Initially this credit boom involved retail lending to households in
the private sector, especially for housing. This ended around 2007.
The outstanding debt of households fell from about 10.5 per cent
of GDP in 2007 to 9 per cent by 2010 and has since fluctuated
around that level.
After 2007 bank lending to private corporate sector, including
lending for infrastructural projects that involves major maturity
and liquidity mismatches, has increased substantially.
Personal loans as per cent of total outstanding credit of commercial banks
1996
2000
2007
State Bank of India and associates
9.5
10.7
22.0
Other nationalised Banks
9.1
10.9
15.8
Foreign banks
8.8
17.1
24.8
Regional Rural Banks
10.5
18.8
20.5
Private sector banks
9.7
7.9
37.3
All Scheduled Commercial Banks
9.3
11.2
22.3
Some implications
First, with government borrowing restricted, monetary policy by a
central bank independent of fiscal dominance becomes the
preferred means of macroeconomic management .
Second, the financial sector’s role in promoting growth takes a
whole new turn, with lending to the private sector becoming the
means to stimulating demand. In a deregulated environment debtfinanced private spending substitutes for the role of debt finance
public spending in more interventionist regimes.
Third, this role is facilitated by substantially increased liquidity
infusion by the ‘independent’ central bank that helps sustain a
credit boom which drives private debt financed spending.
Fourth, this trajectory can be sustained only till the damage to the
financial sector is below some threshold.
Conclusion
Move from structural regulation to market mediated
regulation in which accounting standards, disclosure
norms and ‘capital adequacy’ are central, alters not just
the composition of the financial sector, but also the
behaviour of agents, free to innovate by producing new
products.
But this does not mean that the financialsector is
disassociated from the growth process. Its role changes
substantially but the system relies on it, however,
unsuccessfully.