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Global financial integration refers to financial liberalization and the increasing integration of the domestic financial market with

the world financial markets. With financial integration, developing countries have become increasingly attractive destinations for international investors who are seeking a higher return than what is available in the developed economies while diversifying their risk.

Definition
Financial integration is a process, driven by market forces, in which separate national financial markets gradually enter into competition with each other and eventually become one financial market, characterized by converging prices, product supply and converging efficiency/profitability among the financial services providers.

Financial openness exists when residents of one country are able to trade assets with residents of another country, i.e. when financial assets are traded goods.

A weak definition of complete financial openness, which one might refer to as financial integration, can be given as a situation in which the law of one price holds for financial assets- i.e. domestic and foreign residents trade identical assets at the same price.

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.

A strong definition would add to this the restriction that identically defined assets e.g. a six-month Treasury bill, issued in different political jurisdictions and denominated in different currencies are perfect substitutes in all private portfolios. The degree of financial integration has important macroeconomic implications in terms of the effectiveness of fiscal and monetary policy in influencing aggregate demand as well as the scope for promoting investment in an economy.

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 countrys 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 pricetakers 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 Financial Assets

India
Japan Malaysia South Korea China

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 domesticinternational 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 Japan Regulators of Financial Services
Financial Service Authority (FSA) Financial Service Agency (FSA)

Germany The Federal Financial Supervisory Authority (BaFin) India China USA
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)


Deposits Loans Mar 2000 Mar 2005 Mar 2000 Mar 2005 Public Sector New Private Old Private Foreign

81.9 5.2 7.4 5.5

78 10.9 6.4 4.7

79.3 5.0 7.6 8.0

73.2 13.8 6.2 6.8

Table 5

Bank Lending as percentage of Deposits


(2004)

Country
China

Lending as percent of Deposits


130

UK
Malaysia

114
101

USA
India

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 workforce. Progress is hindered by a multiplicity of Acts, administered by several GoI Ministries, which have subdivided the sector. The pay-as-yougo 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 Brazil
China

3 71
61

South Korea 174

Thailand
Mexico

54
44

Table 7

Equity Market Capitalisation and Traded Values (2005)


Country Market Capitalisation Value Added Listed Domestic Cos.

India USA Japan UK China

71 136 104 139 35

57 172 109 189 63 26

4763 5143 3279 2759 648 1387

Germany 44

*Figures in percent

Table 8

OTC and Exchange Traded Derivatives


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

*US$ billion; ** US$ trillion

Table 9

Mutual Fund Assets Under Management (US$ billion end 2005)


Country India USA France Switzerland UK Netherlands Germany Japan Mutual Fund Assets 64 8,905 1,363 117 547 94 297 470 % of GDP 8 71 65 32 25 15 11 10

Table 10

Issuance of Equity and Debt


Year Equity GOI Issues Securities Rs. Crores Rs. Crores 28,200 (0.9) 1,06,501 (3.4) Debt Issues Publicly placed 4,094 Privately placed 55,408 (1.8)

2004-05

2005-06
2006-07 (Apr-Sep)

36,533 (1.0)
8,205

1,60,018 (4.5)
BE 1,81,875

---

81,846 (2.3)
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
2 145 116 83 73 22 17 1

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 Total USA UK Germany Japan 9.58 14.75 6.76 10.86 2002 Life 4.6 10.19 3.06 8.64 Non- Total life 4.98 4.56 3.7 2.22 9.61 13.37 6.99 10.81 2003 Life 4.25 8.62 3.17 8.61 Non- Total life 5.15 4.75 3.82 2.2 9.17 12.6 6.97 9.52 2004 Life 4.12 8.92 3.11 6.75 Nonlife 5.05 3.68 3.86 2.77

India
China World

3.26
2.98 8.14

2.59
2.03 4.76

0.67
0.96 3.38

2.88
3.33 8.06

2.26
2.3 4.59

0.62
1.03 3.48

3.17
3.06 7.99

2.53
2.21 4.55

0.65
1.05 3.43

Table 15

International Comparision of Insurance Density


Country Total USA 3637.7 2003 Life 1657.5 Non-life 1980.2 Total 3755.1 2004 Life 1692.5 Non-life 2062.6

UK
Germany Japan India China World

4058.5
2051.2 3770.9 16.4 36.3 469.6

2617.1
930.4 3002.9 12.9 25.1 267.1

1441.4
1120.8 768 3.5 12.2 202.5

4508.4
2286.6 3874.8 19.7 40.2 511.5

3190.4
1021.3 3044 15.7 27.3 291.5

1318.0
1265.3 830.8 4.0 12.9 220

Table 16

Insurance Assets Under Management (US$ billion end 2005) Country Insurance Assets % of GDP India 22 3 USA 5,465 44 Japan 2,264 50 UK 1,907 87 France 1,527 72 Germany 1,370 49 Netherlands 385 61 Switzerland 337 91

Table 17

Pension Assets Under Management (US$ billion end 2005) Country Pension Funds % of GDP India 60* 8 Switzerland 469 127 Netherlands 693 110 USA 12,119 97 Japan 3,419 75 UK 1,607 73 France 165 8 Germany 114 4
* Estimate of EPFO, EPS and PF Funds.

Table 18

Asset Allocation of Pension Funds (2005)


Country Domestic International Domestic International Cash Equity Equity Bonds Bonds Others

Japan 29

16

26

11

11

UK
USA

39
47

28
13

23
33

1
1

2
1

7
5

Table 19

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

2005
World

2050

11 G10 23 China 11 Latin America 9 India 8

25 42 37 29 22

Advantages Of Economic Integration


Trade Creation: Member countries have (a) wider selection of goods and services not previously available; (b) acquire goods and services at a lower cost after trade barriers due to lowered tariffs or removal of tariffs (c) encourage more trade between member countries the balance of money spend from cheaper goods and services, can be used to buy more products and services

Greater Consensus: Unlike WTO with hugh membership (147 countries), easier to gain consensus amongst small memberships in regional integration. Political Cooperation: A group of nation can have significantly greater political influence than each nation would have individually. This integration is an essential strategy to address the effects of conflicts and political instability that may affect the region. Useful tool to handle the social and economic challenges associated with globalization

Employment Opportunities: As economic integration encourage trade liberation and lead to market expansion, more investment into the country and greater diffusion of technology, it create more employment opportunities for people to move from one country to another to find jobs or to earn higher pay. For example, industries requiring mostly unskilled labor tends to shift production to low wage countries within a regional cooperation

Disadvantages Of Economic Integration


Creation Of Trading Blocs: It can also increase trade barriers against non-member countries.
Trade Diversion: Because of trade barriers, trade is diverted from a non-member country to a member country despite the inefficiency in cost. For example, a country has to stop trading with a low cost manufacture in a nonmember country and trade with a manufacturer in a member country which has a higher cost.

National Sovereignty: Requires member countries to give up some degree of control over key policies like trade, monetary and fiscal policies. The higher the level of integration, the greater the degree of controls that needs to be given up particularly in the case of a political union economic integration which requires nations to give up a high degree of sovereignty.