High Saving, Low Financial Intermediation Manny Del Rio

Awakening Giants Feet of Clay By Pranab Bardhan

China & India China and India are both high savers (and investors) for their respected range per captia income. In 2005, the savings rate was at 42% in China, and 31% in India. They were even higher in 2008, 54% in China and 38% in India. The Chinese rate of saving, is the highest in the world. Investment goods being relatively expensive in China & India by world standards, in international purchasing power parity terms the saving and investment rates in these two countries are overstated.

Domestic Financing Both Countries, have depended primarily on domestic financing of their investments. Household savings form a large part of total domestic savings. Household saving rate in China is high compared to rich countries, but lower than in India. (India’s savers earn a higher rate of return than the repressed rate in China. Households are net lenders to other sectors in both countries, through deposits in banks and post offices. The largest contribution of investments is physical investment, in the form of residential. Ex: (livestock) in rural areas.

Saving and Investment in China (percentage of GDP) 1990 1995 2000 2005 Domestic Savings 38.7 41.2 38.2 42.0 House Holds 20.0 16.4 16.0 Government 7.3 4.8 6.3 6.0 Enterprise 11.4 15.5 Investment 34.7 40.8 36.3 41.0 Household 6.4 2.7 5.5 3.6 5.2 3.5 4.0 24.7 32.9 27.3 31.0 Current account (S-I) 0.4 1.9 1.0

Saving and Investment in China (percentage of GDP) 1990 1995 2000 2005 Domestic Savings 21.8 24.4 24.8 31.1 Households 17 18.6 21.1 21.6 Government 2.4 2.3 -0.8 Enterprise 4.5 7.1 Investment 23.7 23.5 25.3 28.4 9.2 6.7 10.5 11.4 10.2 9.3 7.4 4.4 7.5 Current Account (S-I ) -1.9 0.9 -0.5 2.7

Why are household saving rates high? Precautionary saving, as state or employer supported retirement and health benefits are scarce. Tradition of extended family with mutual support declines. Chinese demographic transition, with the prospect of old-age support from children diminishing with the one child policy and with the working age population relative to dependents going up fast it certainty helped with saving. Saving was also induced by the privatization of urban house in China.

Why are household saving rates high? Cont. The spread of consumer durables, mortgaged housing, and retail credit to finance them came to both countries only very recently. In both countries, the spread of state-owned bank branches and post offices helped mobilize rural savings.

Enterprise Saving in China High enterprise saving distinguishes China from the rest of the world. Reasons for high saving by enterprises include a large share of capital-intensive industry and low dividend policies. Enterprise investment is also ne of the highest in the world. Alternative earnings from investment bank deposits are not attractive for enterprises, as the repressed deposit rate is much lower than the bank lending rate.

Enterprise saving in India Enterprise saving and investment rates are much smaller in India than in China. Savings rate increased between 1990 and 2005, Caused by a decline in corporate tax rates, a decline in cost of debt servicing, and a rise in the ration of retained earnings to profit after tax. India’s enterprise sector is a net borrower, but to a much smaller extent than China’s

Banks in China & India In both China and India, the financial system is dominated by banks, and the banks are largely state- controlled. Bank deposits and currency, form the largest portion of financial assets in both countries, particularly in China. Sate controlled banks have about 85% of banking business as measured by share of deposits. Indian banks lend only 60% of their deposits, compared to 130% for Chinese Banks.

Financial Assets as Percentage of GDP in China and India, 2004 Equity 32 56 Corporate debt 11 2 Government debt 17 34 Bank deposits/currency 160 68 Total 220

Banks in India There is a substantial under lending in India, but bank ownership seems to have had a limit impact on the governments ability to direct credit to specific underserved sectors. Reason banks have not solved issue, is due to the official lending rules are rigid, also the public loan officers do not use whatever little flexibility they have, due to the incentives and constraints they face. Competition from private and foreign banks has driven many changes in the banking sector as a whole.

Recent Reforms Improving prudential norms related to capital adequacy and asset classification The Board of Financial Supervision introduced regulatory norms that were in line with international best practices with regard to income recognition, asset classification, reporting, and loan provisioning. In 2002, bankruptcy laws were revamped to improve the recovery of debts. The new Secured Lending Law allowed banks to recover assets that had been used to secured loans.

Banks in China Most bank lending in China is concentrated among four large state owned commercial banks, which are closely supervised and controlled by the central bank. Banks are often run by politicians and bureaucrats rather than by banking professionals. The biggest weakness of the Chinese banking system is its share of nonperforming loans. (a loan where a payment has not been made for 90 days). Profitability of Chinese banks continues to be below international standards.

Equity (Stock) Markets in India India has had an equity market for a long time, but it was very thin and fragmented. The Bombay Stock Exchange (BSE), the largest of the stock exchanges was closed market, acting mainly in the interest of its members. The 1900s saw many reforms in the equity market, particularly increasing competition, participation, and liquidity, improving transparency in the price discovery mechanism, improving regulation and supervision in general.

Equity (Stock) Markets in China Equity markets play a much more limited role than the banking system in providing financing, and they are often driven by insider training. Financial institutions have relatively restricted access to the market. Government improvements include giving more access to smaller companies and making the decisions on listing companies more transparent. As long as the government remains the primarily participant and regulator of the market, improving efficiency of the Chinese stock markets will remain limited.

Conclusion Overall, these are two high saving countries, with China having a much larger financial pool to draw on. In China the state controlled large banks dominate the whole financial system, paying their depositors a below- market rate, nonperforming loans remain a significant burden, and allocation of capital remains an issue. India’s financial system tends to be more balanced than China’s in terms of banking, equity, and bond markets as source of formal finance. It is better regulated and has less bad loans. With government borrowing, the cost of capital in the Indian economy remains high.

Reference Bardhan, Pranab. Awakening giants, feet of clay: assessing the economic rise of China and India. Princeton, NJ: Princeton U Press, 2013. Print.