International Monetary Fund (IMF)
Are we in for a bumpy ride? How bumpy? And for how long?
September 2012 | by John Olivier, Chief Investment Officer
In the run-up to its Singapore Annual Meeting, the International Monetary Fund has highlighted how financial system development has helped drive Asia's recent impressive growth. It is certainly true that a great deal of progress has been made, but the giants in the group, China and India, still face significant risks from their financial systems. They must implement a tough, and politically difficult, reform agenda if they are to unleash their economies' full potential.
In a study of Asian economic development, to be published in the IMF's World Economic Outlook, the fund notes that financial sector development has a "strong and significant impact on productivity growth" and that Asia's financial systems, "still heavily centered on banks, will need to be broadened and deepened, for instance, through efforts to develop the corporate bond market".
Corporate Bond Market
In India, for instance, the value of the corporate bond market amounts to just two percent of its GDP. It is no wonder then that Indian companies rely on retained earnings for nearly eighty percent of the funds they raise and have very low levels of debt by international standards. Although Indian companies have the advantage over their Chinese counterparts of more developed equity markets, the prohibitively high cost of capital continues to compromise their performance.
Regulators in China, at least, have been moving to reform the financial system. Over the past eighteen months, several of the largest commercial banks have listed shares in Hong Kong and others have entered into deals with foreign banks; the commercial paper market has greatly increased in volume, albeit from very low levels; and even the country's lackluster equity market is finally rising, in part due to the government's decision to sell off its portion of formerly non–tradable equity shares.
Nevertheless, there is still much more to do. Transforming China's massive banking system, developing its nascent capital markets and creating the institutional framework, incentives and commercial mindset needed to support a modern financial system will necessarily take time. India's government is considering several major financial–system reforms—most recently proposals to develop the corporate bond market, reform the pension system as well as further liberalize the capital account—but has enacted few, to date. The country's sound equity markets and high performing private banks give it a good base on which to build. With the right policies, India's financial system could evolve in a timely manner.