• 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.

• 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?

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.

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.

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.

Table 1 Stock of Financial Assets as % of GDP

(2004)

Country

India Japan Malaysia South Korea China

Financial Assets

160 420 400 235 220

• 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

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

Table 3 Financial Sector Regulators

Country

UK

Regulators of Financial Services

Financial Service Authority (FSA)

Japan Germany

The Federal Financial Supervisory Authority (BaFin)

India China USA

Financial Service Agency (FSA) Banking – RBI Capital Markets – SEBI Insurance – IRDA Pension – PFRDA Banking – China Banking Regulatory Commission (CBRC) Capital Markets – State Council Securities Commission (SCSC) Insurance – The China Insurance Regulatory Commission (CIR) Banking – Federal Reserve Bank Capital Markets – Securities and Exchange Commission (SEC) Derivatives – Commodities and Futures Trading Commission (CFTC)

• 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

Table 4 Indian Banks – Market shares (in percent)

Public Sector New Private Old Private Foreign

Deposits Loans

Mar 2000 Mar 2005 Mar 2000 Mar 2005 81.9

78 79.3

73.2

5.2

7.4

5.5

10.9

6.4

4.7

5.0

7.6

8.0

13.8

6.2

6.8

Table 5 Bank Lending as percentage of Deposits

(2004)

Country

China UK Malaysia USA India

Lending as percent of Deposits

130 114 101 92 61

• 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

• 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

• 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)

• 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

• 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

• 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

• 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.

• 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

• 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

• 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).

Table 6 Debit and Credit Card Penetration

2004

(percent of population)

India 3 South Korea 174 Brazil China 71 61 Thailand Mexico 54 44

Table 7 Equity Market Capitalisation and Traded Values

(

2005)

Country

India

Market Capitalisation

71

Value Added

57

Listed Domestic Cos.

4763 USA 136 172 5143 Japan UK 104 139 Germany 44 China 35 109 189 63 26 3279 2759 648 1387

*Figures in percent

Table 8 OTC and Exchange Traded Derivatives

Country/ Region OTC Derivatives Markets Average daily turnover* India (2005) Not available Exchange-traded Derivatives Markets Annual turnover** 1 USA (2004) 355 819 EU (2004) 1001 487

*US$ billion; ** US$ trillion

Table 9 Mutual Fund Assets Under Management

(US$ billion end 2005)

Country Mutual Fund Assets % of GDP

India USA

64 8,905 8 71

France Switzerland UK Netherlands Germany Japan

1,363 117 547 94 297 470 65 32 25 15 11 10

Table 10 Issuance of Equity and Debt

Year 2004-05 2005-06 Equity Issues Rs. Crores GOI Securities Rs. Crores 28,200 (0.9) 1,06,501 (3.4) Debt Issues Publicly placed 4,094 Privately placed 55,408 (1.8) 36,533 (1.0) 1,60,018 (4.5) - 81,846 (2.3) 2006-07 (Apr-Sep) 8,205 BE 1,81,875 - 47,945 Figures in () are percent of GDP

Table 11 Corporate Bond Markets (2004)

Country

India USA Germany UK Malaysia Thailand South Africa China

% of GDP

73 22 17 1 2 145 116 83

Table 12 Mortgage Balances Outstanding 2005 (Percent of GDP)

India USA UK South Korea Thailand Malaysia Germany 3 51 54 13 9 23 48

Table 13 OTC and Exchange Traded Commodity Derivatives

Country

India USA EU

OTC Commodity Derivatives Trading (Average daily turnover 2004 – US$ billion)

- 4.6

13

Exchange Traded Commodity Derivatives (Annual turnover 2005 – US$ trillion)

0.33

82 49

Table 14 International Comparision of Insurance Penetration

Country

USA UK Germany Japan India China World

2002 Total Life

9.58

4.6

Non life Total

4.98

9.61

2003 Life

4.25

2004 Non life Total Life

5.15

9.17

4.12

Non life

5.05

14.75

10.19

4.56

13.37

8.62

6.76

3.26

3.06

10.86

8.64

2.59

3.7

2.22

0.67

6.99

2.88

3.17

10.81

8.61

2.26

2.98

8.14

2.03

4.76

0.96

3.33

3.38

8.06

2.3

4.59

4.75

3.82

2.2

0.62

1.03

3.48

12.6

6.97

9.52

3.17

3.06

7.99

8.92

3.11

6.75

2.53

2.21

4.55

3.68

3.86

2.77

0.65

1.05

3.43

Table 15 International Comparision of Insurance Density Country 2003 2004

USA UK Germany Japan India China World

Total

3637.7

4058.5

2051.2

3770.9

16.4

36.3

469.6

Life

1657.5

Non-life

1980.2

2617.1

930.4

1441.4

1120.8

3002.9

12.9

25.1

267.1

768 3.5

12.2

202.5

Total

3755.1

4508.4

2286.6

3874.8

19.7

40.2

511.5

Life

1692.5

Non-life

2062.6

3190.4

1021.3

1318.0

1265.3

3044 15.7

27.3

291.5

830.8

4.0

12.9

220

Table 16 Insurance Assets Under Management Country

(US$ billion end 2005)

Insurance Assets % of GDP

India USA 22 5,465 3 44 Japan UK France Germany Netherlands Switzerland 2,264 1,907 1,527 1,370 385 337 50 87 72 49 61 91

Table 17 Pension Assets Under Management Country

(US$ billion end 2005)

Pension Funds % of GDP

India Switzerland 60* 469 8 127 Netherlands USA Japan UK France Germany 693 12,119 3,419 1,607 165 114 110 97 75 73 8 4 * Estimate of EPFO, EPS and PF Funds.

Table 18 Asset Allocation of Pension Funds

(2005)

Country Domestic Equity International Equity Domestic Bonds International Bonds Cash Others

Japan 29 UK 39 USA 47 16 28 13 26 23 33 11 1 1 11 2 1 7 7 5

Table 19 Old-dependency ratio (population above 64 years of age divided by the population between 14-64) 2005

World 11 G10 23 China 11 Latin America 9 India 8

2050

25 42 37 29 22