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This article was writtenMr K.Subramanian, a Former Joint Secretary, Ministry of Finance, Government of India. |
It's a realistic analysis of both counties' banking system and also gives some answers why China's economy ticks differently from the rest of the world. The article is very long, therefore I limit it to the most interesting parts:
In a recent meeting of the Planning Commission’s Mid-term Review, the Prime Minister ( of India) indicated the total capital to finance infrastructure at Rs.60,000 crores. Given the past performance and the fiscal constraints of the government, it is unclear from where this large volume of capital will flow. Meanwhile, there is deep regret that lack infrastructure is a drag on our growth and investment. Our banks are unable to meet the demand for credit for long term projects. As earlier explained, they find their balance sheets to be unequal to the job what with provisioning requirements of the RBI (which has been reduced to 15 percent in the latest Monetary Policy Review) and the rising volume of NPAs. Under our conditions and, in the absence of a well functioning bond market, banks will not be able to raise funds for long term projects. Even in the U.S. and Europe, the happy days when high value projects, mergers and acquisitions (M&AS) could be funded through banks initially and recouped through bond issues are over. The high tide of private equity is unlikely to revive even if the banking system turns normal.
China story has been different. The political leaders in China looked upon economic growth, infrastructure and job creation as an integrated process. Indeed, infrastructure was the main driver and they were obsessed with it. It was evident to them that for a poor and backward country like China it was necessary to promote infrastructure to promote trade and investment. One may add that they had even over done it. The other driver was the state-owned-enterprise (SOE). China’s economic growth depended on two pillars, viz. SOEs and SOBs which funded SOEs. It may not be known to many that China’s banks were prohibited from lending to private companies. They relied mostly on internal resources and retained earnings. This ban has been lifted only in recent years. Another issue is, notwithstanding all efforts to modernize, open and to integrate the economy with the global economy, Chinese authorities did not give up state ownership of banks and SOEs.
China had witnessed the collapse of former Soviet countries (CIS) under “shock” therapy. It did not want to risk a similar fate. It was determined not to seek foreign assistance and decided to draw on its own national resources, savings. Banking itself was not much developed then and there was distrust dating back to the communist era. Premier Deng had to create trust in the bank and appeal to his people to keep their money with the bank without fear of appropriation. He allowed anonymous accounts and deposits swelled. In a few years, the trust would grow and citizens would open regular accounts in their own names.
The Chinese leaders were not worried about the so-called “efficient market” theories and the abhorrence with which western economists, especially monetarists, looked upon “directed credit.” When there was a shortfall in government revenues, they encouraged the banks to fill the gap by lending to companies which had no capital and to SOEs. Zhou Xiachuan, the Governor of the Peoples’ Bank of China, defended this policy in a major conference in the World Bank. He told the audience of senior officials of the World Bank, “We were advised that this was wrong. But we decided to go ahead.” As he explained, directed lending was necessary “for them to survive in production, to maintain employment, for them to renew technology and to import new equipment, for them to slow-down lay offs, for them to train new skilled workers.” The banks were asked to support the Government’s fiscal over-drawings and, indeed, played a significant role in supporting project programs. The reform of the financial system, in particular, banks was gradual, pragmatic and adaptive. India’s decision to abolish term institutions and entrust term lending to commercial banks was unrealistic and unworkable. Perhaps, India had no choice and had to conform to the IMF stipulated norms. It created a vacuum in development finance.
China’s economy, like India’s, is bank dominated. In the course of its reform over thirty years, China maintained the umbilical connection between banks and economic growth. India snapped the relationship abruptly on the expectation that the links would be forged through market forces. China was pragmatic and maintained a dualist approach. At one level they opened up market opportunities for economic players and, at another, they did not give up control of the state owned banks and enterprises. For instance, to relieve pressure on commercial banks to lend loans to enterprises, they created four policy banks. These are: The Bank of China; the Industrial and Commercial Bank of China (ICBC); the China Construction Bank (CCB); and the Agricultural Bank of China (ABC).
The policy banks were enjoined to lend to SOEs to finance projects. Their lending itself was subject to an elaborate procedure which was dovetailed into Five Year Plans. Unlike in western countries, there are non-market components governing lending.
Deposits of citizens in banks are the major sources of funding. These are channeled through policy (development) banks. The disbursements are vetted by the National Development Reform Commission which is comparable to our Planning Commission. There are administrative procedures to evaluate the cost effectiveness and sustainability of loans/projects. The Communist Party of China (CPC) and the government also keep pressure on SOEs, etc to fund or open operations in newer areas. The central bank – Peoples’ Bank of China – is also a part of this public-investment funding system. Credit plans are drawn in accordance with Plan priorities and become the basis for bank lending. In earlier years, this control was somewhat rigid. Over years, these have turned into “window guidance.” Counties and Town and Village Enterprises (TVEs) are also associated in the process. There are accounts of intense competition (corruption!) to access loans from banks.
Policy banks extend loans and also subscribe to bonds issued by enterprises. The loans and bonds are guaranteed by government and there is no risk of default. Loans are also given on very low rates of interest depending on their priority, etc. Indeed, there are problems of non-performing loans and China’s banks are not unduly concerned about them like Indian banks. The loans in any case are backed by assets in the shape of infrastructure though, for various reasons, they have turned unviable. The Chinese government cleaned up the NPAs by drawing on its forex reserves.
In the decade after China commenced its financial reforms, there used to be global concern over the weakness of its banking system, especially their NPAs. The authorities in China, mostly the PbOC, took several measures to improve their functioning. They held discussions with the Bank for International Settlements (BIS) and introduced the best practices. The process is continuing and it may not be said that China has the best system. But, China can truly claim that it has a system which has been adaptive and has best served its interests, in particular, economic growth and poverty reduction. It has also been highly adaptive.
In a recent interview, Prof. Wendy Dobson, one of Canada’s leading economists, compared India’s experience with China’s. He said, “India has all the institutions that China does not. But they don’t work. India is a sort of gridlock. At the very top, India has absolutely first-rate managers. But in China, there is a very clear set of objectives. They ask what are the binding constraints on our growth? And focus on them.” (DNA, March 22, 2010.)
China could not have maintained its record of growth over two decades at near double digits without the funding provided by its banking system. World Bank documents and studies record the achievements of China and it is acknowledged that the high rate of growth had come through investments in infrastructure. Conventional wisdom relates finance (bank credit) with economic growth. In the case of China, as some economists point out, it is economic growth that strengthens finance or bank credit.
It is not only in economic growth that the banks have played a dominant role. Since 2004, the endeavour of the Chinese authorities has been to rebalance its economy. There are major programs to reduce reliance on exports and increase domestic consumption/demand. There are programs to redress backwardness in the western region. Here again banks have been playing a leading role as instruments of change.