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

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? 2

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 3

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 4

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 5

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 6

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 7

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 8

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 9

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 10

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 11

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 ! 12

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

Finance-growth nexus Thanks 14