A V Rajwade: Banking on deposits

WORLD MONEY

One area where India is way behind the rest of Asia is in the level of bank deposits.

I recently had occasion to read an article contrasting the growth record of Asia and Latin America (Finance and Development, June 2006). In 1950, per capita incomes in Latin America were 2.5 times those in east Asia (excluding China and Japan). Fifty years later, east Asian incomes were higher than in Latin America. The author ascribes this difference in growth performance to several macroeconomic factors:

Fiscal and inflation excesses in Latin America in contrast to the prudent macroeconomic policies in east Asian countries.

The much greater integration of east Asia with the global economy.

The difference in the quality of public institutions.

The appreciation of domestic currencies in real effective terms in Latin America, as an anchor for price stability.

The same issue of Finance and Development throws out some interesting numbers in relation to the financial markets in India and other Asian countries. One number where we seem to be way behind everybody else in Asia (except Indonesia) is the level of bank deposits as a percentage of nominal GDP. It was just above 50 per cent in India at the end of 2004, compared to 175 per cent in China, 70 per cent in Korea, 80 per cent in Thailand and 90 per cent in Malaysia "" all as percentages of nominal GDP. The difference in the banking system's credit to the commercial sector is even starker, thanks to our very high reserve requirements. While one reason for the disparity may obviously be the higher savings rate in much of east Asia, is that the full explanation? In any case, last year, thanks principally to the improvement in the fiscal deficit, our savings rate is now comparable to the average in Asia, which is about 30 per cent.

Is the Indian's stronger propensity to channelise savings into precious metals, particularly gold, the full or only explanation for the earlier difference in numbers? Or, has our monetary policy been unduly rigid historically, thus inhibiting the growth of both credit and deposits in the banking system? To quote one number, across east Asia, the average level of M3 was 140 per cent of GDP at the end of 2005 "" it was 80 per cent in India, and 36 per cent in Latin America. (The inflation experience is also in the same order, contrary to standard monetary theory.) Customarily, in its policy statements, the RBI combines in one paragraph its target for M3 and expectation about bank deposit growth; earlier policy statements also used to ascribe a cause and effect relationship between the two variables. Perhaps the central bank needs to study the issue of comparative monetary aggregates, and their growth impact, in some depth.

Participatory notes
As regards the controversy about P-notes, an issue on which I have dissented from the report of the Committee on Fuller Capital Account Convertibility, a few further thoughts occur to me. Many people believe that resident Indians illegally transfer their money abroad, and this comes back in the market through the P-note route. To my mind, the correct solution is to catch the people who transfer money illegally; to put a bar on such money coming back means that we have no objection if the transferred money is invested elsewhere, so long as it does not come here!

Another worry is that P-notes could be traded and we would then have no idea about who the final investor is. (Even in the absence of trading, a holder could well re-issue them on a back-to-back basis.) This is true. But the same can be argued for all issues of negotiable securities outside India (ADRs, GDRs or bonds). Again, there are many genuine foreign investors who either prefer, or are forced, to invest in the domestic market through the P-note route "" either because they do not want the hassle of registering as an FII, or cannot do so because they do not satisfy some requirement like a three-year history. This apart, should we worry about hedge funds using the P-note route? For one thing, hedge funds with a total capital of $1,500 billion, have become too large to be wished away. And, if not P-notes, there are other derivatives like CFD (Contract for Differences), which can give the same exposure to a market. Hence, the dissent in the report.

IMF/World Bank meetings
The annual Fund/Bank meetings were held in Singapore a couple of weeks ago. One decision was to increase the voting percentages of China, South Korea, Mexico and Turkey "" one wonders whether the last country was rewarded for being perhaps the perpetual borrower of the IMF. Another notable feature was the defeat of the World Bank management's proposals for an anti-corruption crusade. Accordingly, to a Financial Times editorial, this reflected "the widespread lack of confidence in Paul Wolfowitz, the bank's president." In his earlier avatar, Wolfowitz was a prominent neocon and the intellectual father of the regime change in Iraq, now in such a total mess.

Email: avrco@vsnl.com