On the wrong side of the divide… Montek Singh Ahluwalia and Raghuram Rajan.
On the wrong side of the divide… Montek Singh Ahluwalia and Raghuram Rajan.
Our policymakers are pushing a US-UK economic model, driven by financial markets rather than banks. But our people, like Germans and Japanese, would have none of it.
At the G20 summit in April 2009 where the world leaders were struggling to stem the financial tsunami, French President Nicolas Sarkozy threatened to wreck the summit in a rumpus over the “Anglo-Saxon model”.
The Anglo-Saxon model was till then a subject of debate in the guild of economists. But post 2008-meltdown, it turned into a political issue between France and Germany on one side, and the US and the UK on the other.
France and Germany blamed the Anglo-Saxon – read the US – model for the mess in the world economy. Sarkozy’s threat to walk out if the Summit did not devise steps to reverse the Anglo-Saxon policies and practices in financial markets led to the G20’s powerful campaign against the tax havens. The G20 also disowned the old Washington consensus which was the mother of the Anglo-Saxon financialism.
The Anglo-Saxon financial model evolved mainly in the US and was followed by the other English speaking nations — Canada, the UK, Ireland, Australia, and New Zealand. The model is “capital market based” — that is finance mediated mainly by stock markets “at arms length”.
The other financial model, known as “Continental” Europe’s, is mainly “bank-based” — that is, finance largely intermediated by banks. The financial model intermediated by banks operates on ‘relational’ basis.
GERMANY, JAPAN, LEAST HIT
The debate brings out a crucial fact not debated in India — namely that the financial model of the West is divided into bank-led model and market-led model. See how it translates into numbers. In 2002, the banks’ share of financial assets was 22 per cent in the US, against 72 per cent then in Germany. In 2011, the banks’ share in the US remained the same, while in Germany it was still high, but declined to 62 per cent — the effect of the Anglo-Saxon financial model on Germany.
Why do Germany and France accuse the US of dynamiting the world of finance? Here is the simplest of evidences. What brought down the world economy was the US sub-prime lending which created the housing bubble in the US — entirely a creation of the market-led financial model.
See how the housing price index inversely moved in the market-led US and the UK and the bank-led Germany. The 1989 housing index rose by 90 per cent between 2000 and 2006 in the market-led US and in the UK by 133 per cent. This house price inflation morphed and marketed as wealth torpedoed the US and UK finances, later the world’s.
But in the bank-led Germany, in the same period, the housing index fell — yes, fell — by 8 per cent. In Japan it fell, by more, 26 per cent. The bank-led Germany and Japan obviously knew more than the market-led US and UK that a housing bubble was incubating. Result. Germany and Japan were least affected by the global financial meltdown.
The world now wonders how Germany escaped the 2008-tsunami. The Bank of Japan proudly declared in 2009 that even as the world finance was in turmoil Japan was safe. So much for the all-knowing arms-length market’s knowledge about finance, as opposed to the relational bank system.
ASIA, EUROPE SIMILARITIES
But in this divide between the bank-led and market-led financial thought and practices, where does the Indian financial model stand?
Indian policy makers Manmohan Singh, Montek Ahluwalia, P. Chidambaram and Raghuram Rajan are all admirers of, or trained in, the Anglo-Saxon economic theories and practices.
In his study along with Zingales (2001) Raghuram Rajan faulted bank-based models and celebrated market-led models. It needs no seer to say that the Indian establishment’s economic thinking is undoubtedly Anglo-Saxon. But are the Indian economic players — the savers, the entrepreneurs and the rest — Anglo Saxon in their outlook? Read on.
A study by Iowa State University in the US sees similarity between the Asian and the European — read Continental — models. It says that the Asian model is “closer in its institutional arrangements to the European model” and “it focuses on high rates of capital formation”.
A Brookings Institution economist Barry Bobsworth (2006) described the Asian savings model as ‘dynastic’ and trans-generational wealth accumulation, while the savings in the US is the ‘personal’ wealth of the saver. And more.
The Asian models trust banks more than stock markets. A paper (BIS Paper No 46, May 2009) by the officials of the Bank of Japan explained why Japanese households prefer bank deposits over risky financial assets, when all financial instruments are well-developed and heavily traded in Japan, unlike in other Asian markets.
In their ‘safe’ saving models Indians seem closer to Japan than to Anglo-Saxons. The bank deposit to GDP ratio was 34 per cent 1990-91, that is before liberalisation began.
In the two decades of liberalisation, bank deposit to GDP ratio almost doubled to 67.2 per cent when the Anglo-Saxon economic thinkers of India were counselling the Indian savers to go stock markets, not banks. (Economic Survey 2011-12).
In the year 2011-12, against the bank deposit of Rs 5.9 lakh crore, Indian savers divested stocks of Rs 2775 crore [net] – See National Income Statistics CMIE (August 2013). The safe bank-led Indian savings is far, far away from the Anglo-Saxon model.
INDIAN FINANCING MODEL
Are things likely to change in future? Doubtful, if the study on Indian infrastructure financing (Global Economic Paper No 187) by Goldman Sachs is any indication.
The study says that household savings is the main source of funding the $1.7 trillion infrastructure investment need in India over the decade ending 2020.
Adding that the “thrifty” Indian households “prefer bank deposits”, it says that the annual financial savings of the household sector in India would top $800 billion by 2016 which is 150 per cent of the total current bank lending. How true is the Iowa State University study that the focus in bank-led economies is high rate of capital formation!
And more. India is not just bank-led. Financial inclusion in India is not limited to banks. According to the Global Financial Stability Report 2005, bank credit to private sector as a percentage of GDP was 38 per cent in India, 140 per cent in China and 156 per cent in the UK.
How then do the Indian businesses get funded? It calls for a deeper probe into small business financing India — without which India would collapse. There is a rainbow model of funding businesses in India, much of which is beyond the reach of organised banking. The National Economic Census 2005 found some 41.8 million non-farming enterprises operating in India providing livelihood and employment to 101 million persons. They grew annually at 4.7 per cent during 1998-2005. Of this, 90 per cent (37.6 million) is financed by families and local sources. They are not financially excluded. They are very much financially included, though not through the banking system. Therefore, financial inclusion in India does not mean banking.
Look at a few of the innumerable examples of informal and huge financial inclusion cited in the bookIndian Models of Economy Business and Management (Prof Kanagasabapathi, PHI Learning Private Limited 2012).
A study of 35 diamond exporters in Surat and Ahmedabad showed that 31 of them received 20-30 per cent of their initial capital from families and relatives. A study of the branded ghee business in Tamil Nadu revealed that almost all of them were funded by their families to start their businesses.
In Sankagiri, a small town in Tamil Nadu which has emerged as the second largest lorry transport cluster in the country, some 80 per cent of the truck owners of today were drivers and cleaners a few years back. Almost 90 per cent of them were from agriculture background and 20 per cent of them actually were engaged in cattle grazing. Only three per cent of the Sankagiri truck operators sourced their funds from banks.
According to a study of Karur in Tamil Nadu, home to two large scheduled banks and 54 branches of nationalised banks, out of the estimated Rs 2400 crore required by the exporters in 2001 only one-third was provided by banks.
In respect of the knitwear export cluster Tirupur, the World Bank noted that “large and diverse non-bank sources of credit including private finance companies, rotating credit unions called chit funds, money lenders, and forms of mutual assistance between friends family or kin” funded the business.
Yet, the entire range of small business financing in India, including the most efficient ones like the Shriram group which has just one per cent NPA, is trivialised and dismissed as non-banking finance — to be curbed rather than promoted.
Actually, we need more of them, not less. We need a regulator who understands them. We need an intense national discourse on the need for rainbow-like financial model for India.
Will the Anglo-Saxon economic thinkers come to terms with the Indian reality? Will they also look at Germany and Japan?
(The author is a commentator on political and economic affairs, and a corporate advisor)