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TOWARDS GLOBAL INTEGRATION OF INDIA’S FINANCIAL SECTOR

This article discusses the need for urgent reforms and greater integration of India's financial sector with global markets. It highlights the objectives of increasing competition, widening and deepening the reach of the formal financial sector, utilizing savings productively, and managing risks from global market disturbances. The article also addresses issues such as low depth of the financial sector, dominance of public sector banks, and the need for deregulation and consolidation. It suggests reforms for the banking sector, corporate debt market, insurance industry, and the pension sector.

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TOWARDS GLOBAL INTEGRATION OF INDIA’S FINANCIAL SECTOR

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  1. TOWARDS GLOBAL INTEGRATION OF INDIA’S FINANCIAL SECTOR

  2. Financial Sector has been incrementally deregulated and exposed to international financial markets in the last 15 years; • Consequently, elements of the Indian financial sector are close to international standards.

  3. Global financial market conditions are favourable • Are we seizing the opportunity for urgent reforms and greater integration? • How do we decide what is an optimal rate to integrate with global financial markets?

  4. OBJECTIVES • Increase competition and thereby enhance the efficiency of financial intermediation and promote overall savings; • Widen and deepen the reach of the formal financial sector; • Ensure that the country’s savings are utilized most productively; and • Manage the risks stemming from disturbances in global markets to insulate the financial sector and the Indian economy.

  5. CRITERIA FOR COMPETITIVE MARKETS • There should be an adequate number of buyers and sellers such that all market participants are price-takers • The primary market (for all issuance) should have a large number of participants • Valuations in the secondary market should be transparent and liquid enough to allow easy exit • The bid-ask spreads in the secondary markets should be narrow.

  6. ISSUES • The depth of the financial sector is relatively low • About two-thirds of private savings are mobilized by the financial sector. • Productivity of investments should be given greater weightage in allocation of credit.

  7. Table 1 Stock of Financial Assets as % of GDP (2004)

  8. A gradualist approach to “Fuller Capital Account Convertibility” is in order. The risks stemming from potential demand for investments in foreign assets (including real-estate) are not quantifiable and may be unmanageable in times of domestic-international stress

  9. Domestic interest rates are not adequately market determined i.e. there is need for further deregulation of interest rates

  10. Table 3 Financial Sector Regulators

  11. The banking sector has reformed considerably since the early 1990s but is excessively dominated by the public sector which receives 78% of the deposits and makes about 73% of the loans

  12. Table 4Indian Banks – Market shares (in percent)

  13. Table 5Bank Lending as percentage of Deposits(2004)

  14. Efficiency in the banking sector lags international comparators in terms of intermediation costs • Just two domestic private banks have entered this sector in the last ten years

  15. A coordinated effort is needed to hasten consolidation among and international listings of public sector banks and entry of new private sector banks • Separate regulator for banking • We should not mix up insolvency with illiquidity

  16. Indian equity and related exchange traded derivatives markets and to some extent the mutual fund industry compare well with international markets • The over the counter (OTC) interest rate and currency swap markets cannot grow without better market determination of domestic interest rates and further capital account convertibility (FCAC)

  17. The corporate debt market is miniscule and needs a series of reforms including stamp duty rationalization, repos in corporate bonds, settlement and clearing of corporate bonds through the same clearing system as government securities, introduction of credit derivatives, lifting of limits for FII purchases of corporate bonds

  18. Exchange traded interest rate derivatives should be encouraged since this will improve the market determination of domestic interest rates and help the corporate bond market to grow • Exchange traded currency derivatives can wait for next steps towards FCAC

  19. Commodity derivatives markets should be regulated by SEBI • The Companies Act needs to be amended and SEBI strengthened to take over the regulatory responsibilities under this Act

  20. The private equity market should be courted and exit valuation methodologies made transparent and predictable. • The asset backed securities market will not develop without considerable preparatory work particularly on the legal issues involved. Hence, special efforts need to be directed to this end.

  21. In cross-country terms, the Indian insurance industry is small in depth and coverage and there is tremendous potential for growth. Premiums should be deregulated, the requirement to hold at least 50% of assets in government securities should be gradually relaxed as also the ceiling of 26% ceiling for foreign ownership

  22. The pension sector is almost entirely in the public sector and covers only about 16% of the work-force. Progress is hindered by a multiplicity of Acts, administered by several GoI Ministries, which have subdivided the sector. The pay-as-you-go government administered pension systems should be gradually replaced by defined contribution schemes in which pension assets are invested in securities, both debt and equity. The pension sector needs to be comprehensively reviewed, at a GoI wide level, in the light of the potential for it to help boost the equity and bond markets and thereby the entire financial sector

  23. The complex web of legislation that applies to the financial sector needs to be simplified. Further, there are obvious anomalies in certain Acts e.g. those which provide for RBI representation on the boards of public sector banks such as State Bank of India (SBI), National Housing Bank (NHB).

  24. Table 6Debit and Credit Card Penetration2004(percent of population)

  25. Table 7 Equity Market Capitalisation and Traded Values(2005) *Figures in percent

  26. Table 8OTC and Exchange Traded Derivatives *US$ billion; ** US$ trillion

  27. Table 9Mutual Fund Assets Under Management (US$ billion end 2005)

  28. Table 10Issuance of Equity and Debt Figures in () are percent of GDP

  29. Table 11Corporate Bond Markets (2004)

  30. Table 12Mortgage Balances Outstanding 2005 (Percent of GDP)

  31. Table 13OTC and Exchange Traded Commodity Derivatives

  32. Table 14International Comparision of Insurance Penetration

  33. Table 15International Comparision of Insurance Density

  34. Table 16Insurance Assets Under Management(US$ billion end 2005)

  35. Table 17Pension Assets Under Management(US$ billion end 2005) * Estimate of EPFO, EPS and PF Funds.

  36. Table 18Asset Allocation of Pension Funds (2005)

  37. Table 19Old-dependency ratio (population above 64 years of age divided by the population between 14-64)

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