Real and Financial Sector Linkages in China and India
IMF Working Papers, April 1, 2008
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Bibliographic details
- Authors: Jahangir Aziz
- Published: April 1, 2008
- Series: IMF Working Papers
Summary findings
- The paper uses business cycle accounting to find that the investment wedge—the gap between household's rate of intertemporal substitution and the marginal product of capital—is large and quantitatively significant in explaining China's and India's growth.
- Specific financial sector policies map well to the size and changes in the investment wedge.
- China:
- Nonperforming loans, borrowing constraints, and uncertainty over changes in government guidance in bank lending have implied large transfers from households to firms.
- These transfers have kept capital cost low and encouraged investment.
- India:
- Post-1992 financial sector reforms, particularly the reduction in the funds preempted by the government from the banking system, have played an important role in reducing the cost of capital.
- Simulations:
- For rebalancing growth in China and sustaining high investment rate in India, further financial sector reforms could turn out to be key.
Policy implications and recommendations
- Address nonperforming loans and borrowing constraints to reduce distortions in the investment wedge (China context).
- Clarify government guidance in bank lending to reduce uncertainty and implicit transfers that lower the cost of capital (China context).
- Continue financial sector reforms that reduce government preemption of banking funds to lower the cost of capital (India context).
- Use targeted financial sector reforms as a tool for:
- Rebalancing growth in China.
- Sustaining high investment rates in India.
Subject classification and keywords
- Subject: Bank credit, Capital income tax, Consumption, Financial sector development, Nonperforming loans
- Keywords: capital stock, cost of capital, working capital, WP