Financial System in India and China – a Comparative Study

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Financial System in India and China – A Comparative Study

By

Dr. Narendra Jadhav and Dr. Janak Raj

Presented at the International Conference on Economic Reforms in India and China – Emerging Issues and Challenges

Organised Jointly by Indira Gandhi Institute of Development Research, Mumbai and China Development Institute, Shenzhen on January 29-30, 2005

Financial System in India and China – A Comparative Study* Dr. Narendra Jadhav1 and Dr. Janak Raj2

Both India and China have introduced significant financial sector reforms with a view to improving efficiency and enhancing stability of their financial systems. This paper attempts a comparative study of financial systems in India and China, especially in the context of the financial sector reforms and identifies the challenges ahead. The study finds that although the financial systems in both the countries continue to be dominated by the public sector banks, there were significant differences in the initial conditions. At the time of initiation of reforms, while India had a reasonably well developed financial system, China had to start virtually from nothing. Not surprisingly, the nature of financial sector reforms undertaken in the two countries have been different in many respects. Initiation of various financial sector reforms has helped over the years in making the Indian financial system quite robust. The financial system of China has also witnessed some improvement, although several challenges remain. The future challenge for the Chinese authorities is to strengthen the banking system and further reform the capital market. The major challenge for the Indian financial system is to bring down the intermediation cost of the banking system. Keywords : Financial system, capital market, financial sector reforms JEL Classification: G20, G21, P34

*

Views expressed in this paper are authors' personal views and not necessarily of the institution to which they belong. 1 Principal Adviser and Chief Economist, Department of Economic Analysis and Policy (DEAP) Reserve Bank of India (RBI). 2 Director, Division of Money and Banking, DEAP, RBI.

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Financial System in India and China – A Comparative Study Dr. Narendra Jadhav and Dr. Janak Raj
The financial system plays an important role in promoting economic growth not only by channeling savings into investments but also by improving allocative efficiency of resources. The recent empirical evidence, in fact, suggests that financial system contributes to economic growth more by improving the allocative efficiency of resources than by channeling of resources from savers to investors. An efficient financial system is now regarded as a necessary pre-condition for growth. This shift in the emphasis along with opening up of domestic economies to international competition has encouraged emerging market economies (EMEs) such as India and China to introduce financial sector reforms. In the wake of the financial crises of the 1990s however, the role of the financial system in growth has been subjected to a critical reassessment. Increased financial integration has exposed the countries to the risk of contagion. It is now widely recognised that stability of the financial system is critical for a sustainable growth. China has been growing rapidly ever since it introduced structural reforms in 1978. Its GDP has grown at an average rate of about 9 per cent per annum since 1978. With the real per capita income rising over five fold, China has been able to get over 200 million people out of poverty (Tseng, 2003). This is indeed a remarkable achievement. China could also successfully weather the East Asian crisis in 1997 and the synchronised global slowdown in 2001. While China’s macroeconomic performance has been quite robust, its financial system has accumulated non-performing loans (NPLs) to a considerable extent. The macroeconomic performance of India has also improved significantly in the post-reform period, i.e., 1992...
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