The Role of Banking Sector in the economic growth of India, comparative study with china.

Sharad, Ganjihal

This dissertation is submitted in partial fulfilment of the requirements of Staffordshire University for the award of MBA(Finance) May 2009

ACKNOWLEDGEMENTS

This research work is one of the infinite blessings of GOD to me as I made material contribution towards deep oceans of knowledge already existing. My foremost appreciation and deep gratitude goes to my very kind and generous supervisor, Alison j Maguire and post graduate director Dr. Carole-Eve Williams for their consistent support, encouragement, guidance and sympathy throughout the dissertation work as I was facing the toughest challenge in my life. I would like to take this opportunity to thank all my friends, colleagues who provided me valuable help, confidence and encouragement throughout my research work. Finally my heartfelt thanks to my beloved parents and family members for their sincere prayers, support and encouragement throughout my career.

ABSTRACT

Purpose: The main purpose of this research is to explore the impact of banking sector on the financial development and economic growth of India with perceptive of Chinas financial sector and economic growth rate. Design/Methodology/Approach: The relationship between both the markets is analysed by using Pearson product moment correlation coefficient approach on the Gross domestic product, domestic savings, interest rate of India and China. Furthermore, after getting the value of correlation coefficient r, T-test is applied to get the conclusion for accepting or rejecting the hypothesis. Findings: It is evident that correlation between Gross Domestic Product, M3 and Market capitalisation is very strong and positive on the other hand there exists a weak and negative correlation between Domestic credit provided by the banking sector, Gross Domestic Product and Inflation. Research limitations/implications: It may be observed that regression coefficient correlation in OLS model test was not used due to time constraint and also applying Ttest was limited as only 10 variables were observed to arrive at conclusion.

GLOSSARY

ABC BOC CCB CDRD CRR EG FD FDI GDP GDS ICBC IMF INF M3 MCAP NBFI PPP PSB RBI ROI SLR WTO

: Agricultural Bank of China : Bank of China : China Construction Bank : Domestic Credit Provided by the Banking Sector : Cash Reserve Ratio : Economic Growth : Financial Development : Foreign Direct Investment : Gross Domestic Product : Gross Domestic Savings : Industrial & Commercial Bank of China : International Monetary Fund : Inflation : Money Supply : Market Capitalization : Non Banking Financial Institution : Purchasing Power Parity : Public Sector Bank : Reserve bank of India : Rate of Interest : Statutory Liquidity Ratio : World Trade Organisation

Chapter 1..............................................................................................................................7 EXECUTIVE SUMMARY & INTRODUCTION..............................................................7 1.1 Introduction................................................................................................................7 1.2 Aims & Objectives.....................................................................................................9 1.3 Dissertation Outline.................................................................................................10 1.4 Synopsis ..................................................................................................................11 Chapter 2............................................................................................................................12 LITERATURE REVIEW..................................................................................................12 2.1 Introduction..............................................................................................................12 Diagram 2.1.1: Harrold-Domar role of savings & investment growth......................13 2.2 Theoretical Background ..........................................................................................14 Table 2.2.1: Financial structure and economic growth..............................................15 2.3 The Financial system and Economic growth...........................................................15 2.3.1 Role of Financial System..................................................................................15 Diagram: 2.3.1.1: Growth Cycle................................................................................16 2.4 Financial development and Economic growth in China..........................................17 2.4.1 Household Savings in China.............................................................................17 2.4.2 Banking Sector in China...................................................................................18 2.5 Economic growth in India........................................................................................19 2.5.1 The Financial System in India..........................................................................20 2.5.2 The Financial Market:.......................................................................................20 2.5.3 The Financial Intermediaries:...........................................................................21 Table 2.5.3.1: Financial intermediaries and its role in different financial markets...21 2.5.4 The Financial development in India.................................................................21 2.5.5 The Banking Sector in India.............................................................................22 2.5.6 Liberalization Policy.........................................................................................24 2.6 India Vs China.........................................................................................................25 Chapter 3............................................................................................................................27 RESEARCH METHODOLOGY.......................................................................................27 3.1 Introduction..............................................................................................................27 3.2 Forms of Research Methodologies..........................................................................28 3.3 Research Strategy and Design.................................................................................29 3.4 Data Collection methods and Analysis....................................................................30 3.4.1 Objective 1: ......................................................................................................30 3.4.2 Objective 2: ......................................................................................................31 3.4.3 Objective 3: ......................................................................................................31 3.4.4 Objective 4: ......................................................................................................32 3.5 Advantages of Secondary Data:...............................................................................32 3.6 Limitations...............................................................................................................32 3.7 Ethics Disclaimer:....................................................................................................33 3.8 Synopsis:..................................................................................................................33 Chapter 4............................................................................................................................34 RESEARCH FINDINGS AND DISCUSSION.................................................................34 4.1 Introduction..............................................................................................................34 4.2 Gross Deposit Product Growth (annual Percentage)...............................................34 4.3 Liquid Liabilities (M3) as Percentage of GDP........................................................34

4.4 Domestic credit facilitated by the Banking sector (Percentage of GDP).................35 4.5 Market capitalization of listed companies (Percentage of GDP).............................35 4.6 SPSS results with absolute values & application of T-test .....................................35 Figure 1: Trends in GDP and M3 (Money Supply) in India.............................................36 Table 1: The Regression result of GDP and M3 of India................................................36 Figure 2: Trends in DCRD, Inflation & GDP in India......................................................38 Table 2: The Regression results of DCRD & GDP of India..............................................38 Figure 3: Trends in Inflation and GDP in India.................................................................39 Table 3: The Regression results of Inflation & GDP of India...........................................40 Figure 4: Trends in Inflation & GDP in China..................................................................41 Figure 5: Trends in Market Capitalization and GDP in India............................................42 Table 4: The regression results of MCAP & GDP of India...............................................42 Table 5: The Regression results of India GDP & China GDP...........................................43 Figure 6: Trends in Gross Domestic Savings (percent of GDP), Rate of Interest and GDP in India...............................................................................................................................45 Table 6: The Regression results of rate of Interest (ROI) and Gross Domestic Savings (percent of GDP) of India..................................................................................................46 Table 7: The Regression results of Gross Domestic Savings (percent of GDP) and GDP of India...............................................................................................................................47 Figure 7: Trends in Gross Domestic Savings (percent of GDP), Rate of Interest and GDP in China..............................................................................................................................48 Table 8: The Regression results of Rate of Interest (ROI) and Gross Domestic Savings (percent of GDP) of China.................................................................................................48 Table 9: The regression results of Gross Domestic Savings (percent of GDP) and GDP of China..................................................................................................................................50 Table 10 Financial Development my Income group, worldwide, 1990s (assets capitalization as percentage of GDP).................................................................................50 Synopsis:............................................................................................................................51 Chapter 6............................................................................................................................51 REFLECTIONS ON LEARNING.....................................................................................51 Chapter 7............................................................................................................................54 References:.........................................................................................................................54 Chapter 8............................................................................................................................59 APPENDIX........................................................................................................................59 Diagram 1: The Financial System..................................................................................59 Diagram 2: The Financial System and its Components.................................................59 Table 1: Comparison of macroeconomic variables in the real sector: Average for 1991 2004.............................................................................................................................60 Table 2: Comparison of the banking and financial sector (Averaging for 1991 2004) ........................................................................................................................................61

Chapter 1

EXECUTIVE SUMMARY & INTRODUCTION

1.1 Introduction
It has been long debated in the economic literature that the financial sector played an important role in the economic growth. The results of some modern empirical literature emphasised that well-functioning financial structure played a vital role in economic growth. Many economists have widely explored the relationship between finance and growth and established that financial development has a strong, positive influence on economic growth. This research provides a selective summary of the available literature on the impact of the Banking sector on the growth of Indian economy. In addition to this, the study presents a selective synopsis on financial development and economic growth of India in perspective with China and to understand how the banking sector occupied a vital role in the promotion of economic growth and also conducted a comparative study on the similarities of both the economies. . Long-term sustainable economic growth depends on the ability to raise the rates of accumulation of physical and human capital, to use the resulting productive assets more efficiently and to ensure the access of the whole population to these assets. Financial intermediation supports this investment process by mobilising household and foreign savings for investment by firms; ensuring that these funds are allocated to the most productive use; and spreading risk and providing liquidity so that firms can operate the new capacity efficiently.

During the period of Industrial Revolution in the mid 1800s, the financial system in England thrived in identifying and granting profitable projects. This allowed England to achieve the highest comparative superior economic growth. The economist Walter Bagehot said in 1873 In England, However ,.capital runs as surely and instantly where it is most wanted, and where there is most to be made of it, as water runs to find its level ( Willem, F.D , 2001). The economist Fitzgerald (2006) in his research believed that continual economic growth of any economy in the long run depends on the capacity to ascend the rate of accumulation of human capital in the expansion of the firm or to place in the productive assets. Financial intermediation sustains this investment practice by organizing household and foreign savings for investment (FDI) by various firms; to be assured that these finances are distributed to the most productive use. Historically financial intermediaries such as banking and non-banking institutions played an important role in the investment process by accumulating the funds from household and foreign savings, to make sure that the investment was put in the proper productive use. Its a controversial issue about the relationship between the financial development and economic growth. On the whole, the debate has been balanced whether the financial development drives the economic growth and vice versa. The puzzle is becoming more and more complicated and dynamic in nature about the relationship between the financial development and economic growth. Recently many economists argued that in emerging economies the stock market has the higher impact on the economic development rather than the Banking institutions (Levine and Zervos, 1996). The main objective of my study is to re-examine the puzzle of role of the banking system on the financial development and economic growth. King and Levine (1993) supported the argument that the financial intermediaries facilitate the mobilizing savings, evaluating projects, managing risk, monitoring managers and facilitating transactions and these are all required for the technological

innovation and economic development. In this research we study that the progress in banking sector and financial expansion are positively linked with economic growth using statistical data for China over the period 1980 - 2000. In particularly we examined that the banking sector and the financial growth are extensively related with the present and future rates of economic growth and capital accumulation. India has achieved tremendous growth in the economy since 1980 till 2000. India being the 12th largest economy in the world by market exchange rate and the 4 th largest economy in the world GDP measured by purchasing power parity (PPP) details clearly mentioned in the World Development Indicators (Anon., 2007). During 1980-1990 the average economic growth was 5.9 percent and it had gone up to 6.2% by 1990 2000 GDP growth (Delong, 2001) and the per-capital income steadily growing at 6 percent by 2000. Since Independence, Indian economy has successfully experienced nationalization at different times. In 1990s, the privatization and liberalization has been started to promote the efficiency of the financial system, during this period Indian economy has performed very well because of the best performance of the Banking sector in India.

1.2 Aims & Objectives

This research has been conducted with some aims and objectives based on the past empirical evidences and literature review of the financial development and economic growth. The main aim of this study is to examine the influence of the development of Banking sector on Indian Economy In this process, one of the objective of the research is to find out the link between the financial development and Economic growth in India In addition to this, to find out the impact of Banking and Non-Banking financial institutions on the Indian financial development and Economic growth

 Also to analyze the role of Banking sector in comparison with the other financial intermediaries on the economic growth of India Besides this, to conduct a comparative study on the role of banking sector on the financial development and economic growth of India in context with China Furthermore, to investigate in detail about the relationship between the Economic growth, financial development and Banking sector in China Finally to understand the similarities of both the economies that is (India Vs China) in relation with Economic growth, Financial development and Banking sector. The primary objective of this research is to formally establish the role of banking sector on the economic growth of India in correlation with China. In addition, in terms of its objectives, this research analyze the impact of Banking sector reform which was an essential part of the liberalization process of the economy in the late 1980s in India and to estimate the rate of influence of the Banking sector on the economic growth when compared with the other financial intermediaries. This research also aimed at a comparative study of well developed nation China with the same political and financial situation.

1.3 Dissertation Outline The research on this topic proceeds as follows Chapter 2 cover a brief literature review with emphasis on economic theories and empirical work undertaken on the role of the Banking sector on the financial development and economic growth of India and China. Chapter 3 covers the research methodology in general and also presents the methodology adopted in this research and also highlight the study on the data resources and its limitations. Chapter 4 presents the various trends in the financial sector and economic growth of India in context with China and also provides the empirical results by utilising SPSS regression and interpretation of these results. Chapter 5 finally narrates some conclusions and suggestions for further research.

1.4 Synopsis After the brief introduction on the research topic stating the aims and objectives the study may be proceed further to Chapter 2 which covers literature review with emphasis on Growth models such as Harrod-Domar, Neo-classical and Endogenous growth models, theoretical and empirical evidences suggesting the well based financial system that promotes economic growth, a detailed description of the role of financial development and economic growth of India and China and the impact of banking sector on the economic growth of both the economies and a comparative study of the similarities and salient features of India and China.

Chapter 2

LITERATURE REVIEW

2.1 Introduction The concept of encouraging economic growth is not new. Many economists introduced significant theories of economic growth. Even though the function of the financial system in the process of development has been well accepted, however the relationship between the economic growth and financial development is still the point of continuing debate among economists. At different times many economists have extensively investigated the relationship between finance and growth and found that financial development has a strong, positive impact on economic growth. The economist (Lewis, 1970 p.214) believed that savings are necessary to economic growth. The growth models also prove that economic development can be increased by capital accumulation which can be achieved by a boost in savings. This concept can be supported by an illustration of Harrod-Domar Model developed in 1930s diagram 2.1.1 which states that an economy can grow faster if savings rate are increased. In contrast to this the neo-classical model of growth believes that a raise in capital investment increases the growth rate temporarily because the share of capital to the labour increases, in the long-run growth path, with real GDP will at the same rate.

Diagram 2.1.1: Harrold-Domar role of savings & investment growth

Source: Harrold Domar model 1930s, Economic Growth Economic growth will be stable when capital, labour and output are all steadily growing at the similar rate hence capital per worker and output per worker are invariable. Therefore Neo-classical economists firmly believe that by a raise in the labour supply and by enhancing the productivity of labour and capital this will result in achieving long term trend rate of growth in an economy. Neo-classical theory economists Henry (2007) argue that the rate of capital accumulation may be increased by liberalization of national market which will create additional domestic and foreign investment and thus by raising domestic saving rates which enhance per capita income and capital labour ratio in capital-poor developing countries. According to the Endogenous growth model, economists deem that productivity development can be related to rapid innovation and raise in human capital investment. According to Thirlwall, the good financial system will certainly encourage savings, so that the financial institutions will allocate savings in better productive way. The large and efficient financial markets help economic agents hedge, trade and pool risk, raising investment and economic growth (Rioja and Valev, 2004). In macro level the financial system refers to different group of institutions, public and private individuals which help the household savings from societies into productive

investment. The role of the financial system in the growth of economy has been an ongoing debate in economic literature, research findings demonstrate that efficient financial markets improve the quality of investments & enhance economic growth. Financial markets may also promote growth by increasing the proportion of resources allocated to firms. Endogenous growth theory argues that a higher savings rate leads to higher economic growth (Sinha, 2001).

2.2 Theoretical Background Both theoretical and empirical evidence suggest that the well based financial system promotes economic growth. Most of the theoretical models suggest that there are three different ways by which a financial system influences the acceleration of economic growth under the basis of endogenous growth model (Amar, n.d.). It can increase the productivity of investment An efficient financial sector reduces transaction cost & thus increase the share of savings channelled into productive investment Financial sector development can either promote or reduce savings

Philip Arestis University of Cambridge in 2005 found considerably long-run positive relationship between the financial development and economic growth, where as in the short-run this relationship can be negative in few countries. Exactly to opposite of this argued by (Fabris, 2008) the liquid and proficient financial intermediaries are the key for growth, apart form equity markets or banks. This research will critically evaluate the relationship between financial system and economic growth. The same may be viewed from four different angles to judge the financial structure and economic growth.

Table 2.2.1: Financial structure and economic growth View of Financial structure and growth The intermediary-based view The market-based view The financial services view View of Suggestion Financial market & intermediaries are substitute source of financial services Financial-market & intermediaries are

The law and finance view compliments in the provision of financial services Source: This table was adapted from Financial Structure and economic growth: A NonTechnical Survey by Veronika Dolar and Cesaire Meh.

2.3 The Financial system and Economic growth The financial system of a country greatly influences its economy. The close relationship between financial structure and economic development is reflected in the prevailing institutional arrangement and intermediation process. The main function of the financial structure especially the banking system is to gather funds from the people who has more savings and lend the amount in bulk to people who have productive investment opportunities. The Financial system will progress both quality and quantity of actual investment, this will lead to better per capital income and better standard of living. (Levine, 1997) he argued in this literature that a review in the financial development will definitely have a positive impact on economic growth. Authors including Franklin Allen and Hiroko Oura (2004) emphasized that the financial system played a critical role in igniting industrialization in England by facilitating the mobilization of capital.

2.3.1 Role of Financial System Financial system will help in the mobilization of household savings to corporate sector and distribute capital to different firms. This will help in sharing the risk by household savings and firms. This intermediation is the root cause for the link between financial

development and financial constitution on economic growth. Grahame Thompson( 1998, p.83) defined financial development as the process meant the gradual evolution, in the course of economic development, of financial institutions money, banks and other financial intermediaries, and organised securities markets. Many economists pointed out that in developing countries financial liberalization indeed leads to financial frailty and incidents of crises; however financial liberalisation also has led to higher GDP growth. A large empirical literature has proved that in practice financial systems are important for growth.

Diagram: 2.3.1.1: Growth Cycle Better Financial Institutions

High Savings

Rapid Economic Growth

Better Capital Investment Source: Theory of Economic Growth. 9th ed. London: Novello. Franklin Allen and Hiroko Oura (2004) in his research discussed about few models where financial intermediaries arise to produce information, to generate information and trade to the different investors. In his model he defined that financial intermediaries produce better information, develop resource allocation and promote growth. Hagemann and Seiter (2003, p.55) discussed about a research model in which the financial institution

will generate the best information by properly allocating the resources i.e. funding the firm with the finest technology for the robust economic growth.

2.4 Financial development and Economic growth in China Financial constitution in China has been undergoing remarkable changes. Before the process of the financial sector reform has started in China, Allen, et al., (2008) in their recent research found Peoples Bank of China was the only financial institution in the nation; it guarded 93% of Chinas financial assets. In 1978 China had implemented reform and opening-up policy and has accommodated the Banking institutions which played a vital role in its subsequent development. Therefore the financial structure in China is predominately conquered by the Banking industry. Chow (1994, p.79) in his writings asserted that the latent dynamism of [Chinas] productive sectors will enable the economy to continue growing during the 1990s at rates that would be considered very respectable in most countries. There is a rapid economic growth in China since 1980 till 2000. During this period, the GDP climbed consistently at annual average of 9.8 percent. The GDP per capital increased from $300 in 1984 to $1300 in 2004 and GDP measured in PPP (Purchasing Power Parity) jumped from 4 percent in 1984 to 13 percent in 2004 Rosen (2005).

2.4.1 Household Savings in China The Household savings contributions were extremely significant to gain huge capital investments. An estimation of 30 to 35 percent of their total earnings parked into government banks towards savings at a lower interest rate. The primary reason for higher savings was the lack of social security or public pension schemes. Moreover the government of China was able to finance the top companies in the private sector due to the increase in the domestic savings rate. The important factor behind this

was the continual raise of the interest rate of household savings in the banking system. As the contribution of household savings had increased, the percentage of GDP had gone up from 20percent in 1978 to 22percent in 1994. Trumpbour (2007) in his recent research paper discussed that Chinas central bank had preferred to park several hundred billions dollars in safe custody at low interest yielding treasury bills, thus contributing to the stability of the US economy and to allow the consumers to keep on spending money. Meanwhile, the low, sub-optimal interest rates paid out by Chinas banks reduce upward pressure for the appreciation of the Yuan. Bank loans accounted for more than 85% of total funds raised, Domestic loans have rolled out to be the key external source for financing capital investments, In 1981 state budgetary appropriation financed to 28.1% of the total fixed asset investment, however in mid 2000s the contribution of state budget was only about 10% of state owned companies total funding and subsequently loan size has moved from short term to long term loans.

2.4.2 Banking Sector in China The banking sector in China primarily comprises of state-owned commercial banks and policy banks, the banking segment is mostly controlled by 4 state-owned banks namely the Industrial & Commercial Bank of China (ICBC) specialized in lending to industrial sector, China Construction Bank (CCB) traditionally focused on infrastructure development, Bank of China (BOC) conventionally responsible for foreign exchange and financing of imports & exports and Agricultural Bank of China (ABC) primarily focused on lending to agriculture and rural development contributing about 60-70% of the domestic banking business. At the end of year 2001 80 percent of payment business and 62 percent of saving and lending business was contributed by these Big Four banks and they had approximately 80,000 branches nationwide by the end of 2006.These four banks remained as specialized banks until 1994 when three policy banks were conventional to take over the policy-directed lending functions. Commercial banks equity ownership is

distributed among both the private and state investors, which account for 18 percent of the banking sector assets.

2.5 Economic growth in India The Indian financial system has witnessed phenomenal changes during last five decades. Indian economy may be termed as a Mixed economy where both private and public sectors co-exist. India has instigated economic development of the nation with the commencement of planning commission. The main objective of the Five year plans was to boost domestic savings for the growth of the economy. The industrialisation strategy highlighted on the expansion of heavy industries, however the economic growth achieved in the first three Five-year plans was insufficient to meet the goals of development. Indian economy has witnessed drastic increase in the rate of growth since 1980s, the annual growth rate of the country was 5.5 percent, A high rate of investment was a major factor for the rise in economic growth, there was a move up in investment from 19percent of GDP in 1970s to 25percent of GDP in 1980s. During 1980s Indian government had implemented liberalisation policy and amended several government regulations especially in foreign trade sector, new strategies were adopted to pool up private capital in form of foreign direct investment (FDI), New reforms were formulated to attract foreign investors which contributed to progress of Indian economy discussed by Roland (2007), Since 1992 till 1994, the overall value of imports surpassed that of Indias exports and by 1996 the export figures raised from 0.84 trillion rupees to 1.1 trillion Indian rupees, During 1993 Indian economy had witnessed major growth by the commencement of computer software business and adopted globalisation policy which helped in creating new job market, in the year 1995 Indian government was associated with World Trade Organisation (WTO), During 1990-2005 the annual growth rate of GDP was 5.9percent which was second among the worlds largest economies only after China with 10.1percent.The republic of India since 2004 had accepted free market policy, Service sectors played a vital role by generating 52% of countrys GDP. In 2007 Indian economy was termed as twelfth-largest economy in the world with GDP $1.237trillion and per capita income of $1043, Despite significant high economic growth rate Indian

economy had many pitfalls and socio-economic variance at various levels, on an average 80% of Indian population survived on less than $2 a day.

2.5.1 The Financial System in India The economic growth of the country is reflected by the progress of the financial system. The financial sector acts as an agent and facilitates funds flow to areas of deficit from the areas of surplus. A financial structure is a combination of various financial markets, financial intermediaries and instruments.

2.5.2 The Financial Market: A financial market can be broadly termed as the market where the financial assets are generated or relocated. The financial market can be categorised further into four groups by Kumar (2005). Capital Market: The capital market deals with financing long-term investments, the funds available in this market will be for a year or more. Money Market: The money market is intended as short-term instrument, transactions period generally range from single day up to a year. This market is treated as low-risk and highly liquid due to which it is predominately conquered by banks, government and the financial markets. Credit Market: Credit market aims at providing short, medium and long term loans through banks and various financial intermediaries. Forex Market: This market is regarded as the most advanced and amalgamated market across the world, it directly deals with exchange of currencies and funds transfer will happen based on the exchange rate.

2.5.3 The Financial Intermediaries: The financial institution acts as a proper channel for the transfer of funds between investors and firms through this process certain assets or liabilities are converted into different assets or liabilities. Please refer to the table below to study the various financial intermediaries and role in different financial markets.

Table 2.5.3.1: Financial intermediaries and its role in different financial markets Role Secondary Market to Stock Exchange Capital Market securities Capital Market, Credit Corporate advisory services, Investment Bankers Market Issue of securities Capital Market, Money Subscribe to unsubscribed Underwriters Market portion of securities Issue securities to the investors on behalf of the Registrars, Depositories, company and handle share Custodians Capital Market transfer activity Primary Dealers Market making in government Satellite Dealers Money Market securities Ensure exchange ink Forex Dealers Forex Market currencies Source: Adapted from Kumar D.A, Financial System: Lokamanya Tilak P G College of Management. Intermediary Market

2.5.4 The Financial development in India The significance of the relationship between financial development and economic growth has been distinguished and highlighted in the field of the economic development. Although recent studies on this subject seem to accept the hypothesis that financial development is crucial for successful economic growth Jung (1986). The economist

Patrick observed two possible patterns in the casual relationship between financial development and economic growth. In the first pattern the growth persuades the expansion of the financial organisation whereas the expansion of the financial structure precedes the demand for its services in the second pattern. The financial system in India during the pre-reform period fundamentally catered to the needs of planned development in a mixed-economy framework, in which the government sector had a major role in economic activity. Interest rates on Government securities were artificially pegged at low levels, which were not related to the market conditions. The structure of administered rate of interest were characterised by the in depth research on the lending and the deposit segment which in turn leaded to complexity and multiplicity of interest rates. The financial sector environment in India in the early years of independence was disposed by segmented and under developed financial markets connected with lack of financial instruments. On the other hand, by late 1980s, focussed and availability of bank credit to certain sector at lower interest rates negatively affected the viability and profitability of banks. However after the introduction of liberalisation policy in early 1990s Indian banking sector has grown rapidly and expected to enjoy even greater growth opportunities in the future.

2.5.5 The Banking Sector in India Financial organisations may be defined as economic agents focusing in the buying and selling activities and at the same time may be very often termed as financial bonds and securities. Banks may be classified as a division of the financial institutions, Banking institutions will buy the securities issued by the borrowers and will sell them to the lenders. Murthy, et al., (2008) A bank is an institution whose current operations consist in granting loans and receiving deposits from the public. Definition of Banking as per the Banking Regulation Act, 1949 says-banking means the accepting, for the purpose of lending or investment, of deposits of money from the public, repayable on demand or otherwise, and withdraw able by cheque, draft, order or

otherwise. The Act defined the functions that a commercial bank can undertake and restricted their sphere of activities. Economists have been asking the question whats different about banks. In his famous article, Corrigan (1982) argued that banks are special because: a) They provide transaction services and administer the nations payments system b) They provide backup liquidity to the economy c) They are transmitters of monetary policy The above mentioned argument, we understand that banks grant loans in the itinerary of providing liquidity and they accept demand deposits in providing transaction services and the most distinctive fact is that only commercial banks have the uncurbed authority to issue commercial loans and accept demand deposits. The Indian banking sector played a significant role in the financial development with deposits of more than half a trillion US dollars and contributes about three-quarters of nations financial assets. The Indian banking system has a long and detailed history of more than 200years. The General Bank of India was considered to the first bank to be established in the nation followed by The Bank of Hindustan in the year 1870 however these banks are now obsolete nevertheless the country witnessed the commencement of the Bank of Bengal in Calcutta in 1806 which is now known as the State Bank of India the largest bank of the nation detail given in the Indian Financial System (Anon., 2008). During 1900s the financial market has expanded with the commencement of banks such as Allahabad Bank, Punjab National bank and Bank of India, in the year 1935 Reserve Bank of India which was considered to the Central Bank of India started regulating the banking sector in India. During the period of First World War (1914-1918) functioning of 94 banks failed in the country and the same phase continued till India achieved Independence in 1947. The Reserve bank of India was nationalized and was possessed by the Indian government in the year 1948 and after the enforcement of the Banking Regulation Act RBI got the authorization to standardize, direct and inspect the banks in the country in 1949 and it also instructed that no institute should be started without its

license. In the year 1969,Indian government has nationalised 14 largest public banks resulted in the raise of Public Sector Banks(PSB) share of deposits from 31% to 86% ( Roland, n.d.). The primary purpose of Nationalisation policy was to set up more branches and to mobilise the deposits. During 1980 six more banks were nationalised as a result the public sectors contribution of deposits moved up to 92%. The banking industry estimates indicate that out of 274 commercial banks operating in the nation, 223 banks are in the public sector and 51 fall into private sector including 24 foreign banks that had started their operations in the country. Over the decades, banking sector has grown gradually in size, Since Indian government had adopted the liberalisation policy banking sector had undergone several changes in its structure by the establishment of several private sector and foreign banks accounting for over 80% of deposits and credits.

2.5.6 Liberalization Policy India since its independence had experienced many setbacks due to various tyrannical policies in the banking sector. In the year 1991 the country has witnessed significant amendments in economic policy by the adoption of liberalisation clearly written in the words by (Delong, 2002). The important policy objectives were the expansion of money markets, commencement of treasury bills and interest rate deregulation. During early 1990s, under the leadership of Prime Minister of India Sri P.V.Narsimha Rao the government had set up Narsimham committee which initiated several reforms in the banking sector. The sole intention of the reforms was to standardise direct credit rules, decrease in CRR and SLR legal price regulation, distributing resources and expansion of private sector. The implementation of new reforms resulted in widening the branch network as a result in the year 1991 (Roland, n.d.) and Shirai (2001), the nation witnessed 27 public- sector banks, 26 private sector banks with a network of 60,000 branches, 24 foreign banks with 140 branches and 20 foreign banks with a representative office.

2.6 India Vs China The economic growth of any nation is predominately influenced by its financial development. The economies of China and India experienced the higher growth rate in the recent years after the implementation of major financial reforms since 1970. India and China are being treated as global engines of growth (Basu, 2007). Both the countries are been popularly known as global giants in the World economy. Das (2007) discussed comparatively study on the growth part of China and India as, since 1978 China has began its progress en route for a pro-market economy with a growth rate of 3.6percent while Indian economy had observed a very low rate of 3percent to 5percent until the financial reforms in India have been initiated since 1991 China had a major influence of Soviet style command on its economy while India has adopted mixed economy. The role and impact of various financial reforms on economic growth are not similar in both the countries. The government of China had major focus on the investment in the infrastructure which resulted in high growth rate by increase in capital accumulation while India during the process of the financial reforms concentrated on the elevation of private investment by minimising public investment. The per capita GDP of the both the nations observed remarkable progress, During 1991 Indian economy observed a steep raise in the per capita income from 1486.48 to 2885.89 by 2004 however the per capita GDP of China was 1720.85 and it was gradually increased to 5418.87 by the end of year 2004.The average growth rate of per capita GDP of India was 3.91percent which is three times lesser than China with 9.10percent which was mainly attained by capital accumulation and a incredible elevate rate of savings. The average domestic rate in China and India was 39.08percent and 21.86percent respectively. The gross capital formation rate of China was 36.73percent while India was 22.93percent. The rate of gross fixed capital accumulated by India was 22.34percent whereas China was 33.67percent. The most distinguishable element of the financial system in both the Indian and Chinese economies is the supremacy of the banking sector which was considered as the most crucial financial institution for the

transformation of household savings into capital investment for several industries and firms which is more predominant in China than India. The banking sector in China was solely influenced by public sector banks (PSB) whereas Indian economy had the privilege of mobilisation of savings not only by public sector banks but also the functioning of Non banking financial institutes (NBFI) such as development banks, export and import banks, mutual funds and insurance companies. Chinas banking sector has more bank deposits in the form of household savings in comparison to India. The lending ratio and the bank deposits interest rates are believed to inferior in both the economies mean while the ratio of assets of the total banking sector is significantly higher in China in context to India which was almost double the figure. The stock exchange in China is introduced very recently whereas in India it showed its presence since 19th century the average number of companies listed on Indian stock exchange is more than of China, the stock market trading volume and average market capitalisation is drastically more in Indian economy than Chinese. Conversely the market capitalisation growth rate of China is four times higher than India. The liquidity ratio and turnover ratio is remarkably more in China when compared with India. The inflow of foreign direct investment (FDI) acts as an important growth mechanism for the development, promotion and surface of new market economies in both the countries. The average net FDI inflow to GDP ratio for China was 3.88percent which was considered to be higher than India with 0.60percent. On the other hand the growth rate of FDI inflow of India was 54.25percent nearly two times more than China 29.05percent. After the study of the literature review in this research topic, we proceed further to next Chapter in which we discuss about Qualitative and Quantitative research methodologies, inductive and deductive strategies and we adopt deductive strategy in this research as it aspire to assess and determine the fundamental relationship between dependent and independent variables. We also discuss about research design, Data collection methods and analysis.

Chapter 3

RESEARCH METHODOLOGY

3.1 Introduction This chapter aims to describe the method chosen for the completion of study in order to achieve the research objectives. The chapter looks at the research methodologies, strategy and design. In addition, it includes information about the sources of data. It fully explores the research techniques and methods of data collection and highlights why these were more suited for this research. The primary motive is to layout the best methodological approach and to research taking into account the limited resources and time constraints. The main purpose of this research is to ascertain the impact of banking sector on the financial development and economic growth in India in context with China. Several economists had defined the term research in different ways. According to Cohen and Manion (1994, p.5) Research is a combination of both experience and reasoning and must be regarded as the most successful approach to the discovery of truth. The term methodology may be considered to be the comprehensive of research design, hypothetical structures, the collection and analysis of literature applicable to the area of study and reasonable inclination for meticulous form of activities of data gathering. Karlinger defines methodology in a more comprehensive way as Methodology research is controlled investigation of the theoretical and applied aspects of measurement, mathematics and statistics, and ways of obtaining and analyzing data. It can be understood that Methodology is the perception and study of philosophy and methods and their functioning in the desired field of academic research in a detailed and organized manner.

3.2 Forms of Research Methodologies The selection of specific methodology is mainly based on the aim, goal and nature of the research. Few factors such as availability of time and resources also may be taken into consideration to adopt a particular type of research methodology. The study of research methodology can be broadly divided as : Qualitative Research Methodology Quantitative Research Methodology

Bryman defined qualitative research as approach to the study of the social world which seeds to describe and analyze the culture and behaviour of human and their groups from the point of view of those being studied (2004:178). The study of Qualitative research methodology refers to the connotations, ideas, descriptions, features, images, symbols and explanation of things. The primary emphasis of the Qualitative research methodology is to gather, scrutinize and interpret the data by examining people and their behaviour. The purpose of qualitative research is not to build up a new theory however to analyse the existing theory. The Qualitative research is considered to be subjective and it is the examination of what is believed to be a forceful reality. Lynch and Bogen (1997) believed that Qualitative research is based on interpretivism, and interpretive social scientists believe that social reality is based on the overall social behaviour, and the researchers try to understand what meanings people give to reality, not to determine how reality works apart from based on social behaviour these interpretations reported by (Kumar, 1999). Nevertheless Quantitative Research Methodology is solely relied on positivist beliefs and the intention of quantitative research is to set up official relationship between specific variables. Wallace defines quantitative research as Whatever nature really is, we assume that it presents itself in precisely the same way to the same human observer standing at different points in time and space, and we assume that it also presents itself in

precisely the same way across different human observers standing at the same point in time and space (Wallace, 1983, p.461). Most commonly this research method is objective and speaks all about figures, intent real data and is based on descriptive theories. Quantitative research is illustrated as the collection of numerical data and as exhibiting a view of the relationship between theories and research as deductive, and it ends up with objective result (Bryman, 2001, p.62).

3.3 Research Strategy and Design In an academic and realistic study many researchers may not require a strategy in order to execute the assigned research project. The research strategies may be known as structured processes which have been experimented and examined many times in several years. However the findings and outcome in each case may be alike if not identical. Developing a unique research strategy has the singular advantage that it enables the researcher to adopt and adapt the most suitable research methods to understand the phenomenon in question (Eisenhardt, 1989) The concept of research strategies may be classified into two groups such as deductive research and inductive research strategy. The deductive research strategy may be applied in Quantitative research methodology when a specific research already exists and then conduct examinations to determine the validity of logical or theoretical expectations. On the other hand, many researchers may observe a link between social theory and data. The inductive research often revolves around existing observations and target at identifying theories that preside over what is experimental. This strategy is generally exercised in Qualitative research methodology. The primary purpose for conducting research is also vital in selecting the research strategy which is most relevant. The deductive strategy may be adopted if the aim of the research is evaluative while explanatory motive indicate an inductive research strategy. The foremost objective of this study is to ascertain the relationship between theory and data by applying the existing theory and principles. This research is purely based on deductive strategy as it aims to assess and determine the fundamental relationship between dependent and independent variables. Ranjit kumar

(1999, p.74) defined research design as a blueprint or detailed plan for how a research study is to be completed operationalising variables so they can be measured, selecting a sample of interest to study, collecting data to be used as a basis for testing hypothesis, and analysing the results. A research design is an arrangement of conditions for collection and analysis of data in a manner that aims to combine relevance to the research purpose with economy in procedure.

3.4 Data Collection methods and Analysis As pointed out by Gill and Johnson (2002) data can be collected in a variety of ways and from various other reliable sources. Since, the probability of getting secondary data is higher than the primary data the research process would be dealing with gathering of secondary sources of data. A detailed description of the approach, methods and strategies of each individual objective are discussed below:

3.4.1 Objective 1: The objective in this research is to gather as much as information and statistical data on impact of the banking sector on economic growth in India in context with China, which is by virtue, a vast field, and hence a multi method qualitative research method of data collection would be employed. Data from documentaries both written and non-written materials, IMF, World Bank, Reserve Bank of India and Central Bank of China annual reports, publications and journals would be gathered to draw better understanding of the outcome. The data required may be the reports on financial institutions and statistics of annual growth rate in both India and China. In order to achieve the same, a multiple case study approach was followed. Also grounded theory and archival research was embarked to make the information more validated. Archival research of the four major food retailers in UK and two major retailers in India was easy to obtain without any copy right obstacles. Since it is an

explanatory study the cause and effect relations would be deduced after a comparison of the processed information.

3.4.2 Objective 2: The second objective in this research is to analyse the link between financial development and economic growth in India. For this purpose secondary data in the form of annual reports, financial journals and articles. Also existing growth theories such as Harrold-Domar, Neo-classical and Endogenous models are believed to be useful in this research. To evaluate this objective secondary data collated by referring many books related to financial market and economic growth of India and China and also the World Bank, International Monetary Fund, Reserve Bank of India and Central Bank of China annual reports, periodic journals and articles were gathered and analysed. This study adopted Quantitative research methodology as it intends to establish the formal relationship between related variables and to analyze the economic growth trends of both the economies. The main intention for conducting research is also essential in adopting research strategy which is more relevant. In this study, deductive strategy may be implemented as the sole aim is to assess and determine the fundamental relationship dependent and independent variables.

3.4.3 Objective 3: The motive of this objective is to understand the financial system of India and China and to determine the significant role played by the banking sector in the economic growth over other financial intermediaries by collating the secondary data of interest rates, domestic savings and Gross domestic product which was adapted from Fitzgerald, World economic and social survey: Oxford University, we may analyse the fact that change in the rate of interest will boost up domestic savings as a result Gross domestic product of the economy will be increased. The same may be proved by graphical representation and

by applying the Pearsons product moment correlation coefficient and then T-result is applied to arrive at the conclusion whether to accept or reject the null hypothesis.

3.4.4 Objective 4: The focus of this final objective is to examine the role of banking sector played in the financial development and economic growth of India in context with China. A comparative study is also conducted to ascertain the salient features and similarities in both the economies. For this purpose, statistical data for Gross domestic product of both the countries was gathered from World Bank, International Monetary fund, rate of interest and domestic savings of India were collected from Reserve Bank of India on the other hand Chinas interest rates and household savings were collated from Central bank of China and the same was concluded by graphical representation.

3.5 Advantages of Secondary Data: Higher quality data than those collected personally (Stewart and Kamins, 1993; cited in Saunders et al, 2007) Permanence of data (Weijun, 2008) Triangulate findings (Saunders et al, 2007) Abundance of data Churchill (1996) asserts that its good to start with secondary data and move on to primary data when the secondary data lead nowhere. Unobtrusive ( Weijun, 2008) 3.6 Limitations

The main focus in this research would be to pursue a cross-sectional study bearing in mind the time constraint and also subject to the fact that the banking industry will not reveal the data for security purpose to undergone a longitudinal study. Hence this research would be carried out using secondary data which is already available through various sources and would be dealt in detail in further sections. Reliability of the findings could be guaranteed by the mere fact that the participant error or biased views did not take place as secondary data is used. The research findings may vary upon circumstances and industry type.

3.7 Ethics Disclaimer: Research ethics relates to questions about how we formulate the research topic, design the research process and gain access, collect and process data and write the data in amoral and socially responsible way (Saunders et al, 2007). It is highly unlikely to observe any deviations from the above foresaid statement.

3.8 Synopsis: In the light of the above information, it is evident that the author has adopted the deductive strategy in this research and also stated that the research was based on secondary data. After the research study on research design, methodologies and data collection methods in this chapter we move on to the next chapter where we finally conclude about the research findings on how the banking sector played the most vital role on the financial development and economic growth of India in context with China. After the detailed description about research methodologies, strategy, design and data collection methods we progress further to Chapter 4 Research findings where we examine the fundamental relationship between Gross Domestic product and various indicators of financial development and economic growth by graphical representation and to examine the correlation coefficient of variables by applying t-test.

Chapter 4

RESEARCH FINDINGS AND DISCUSSION

4.1 Introduction This chapter is devoted to the presentation and analysis of the information collected. The results of the calculations will be discussed and analysed by the usage of SPSS software application and further will try to relate the theoretical aspects of relationship discussed in the literature review to the primary research findings. This research requires analysing data related to financial development and economic growth empirics of India and China. In order to achieve the same, various secondary statistical data sources were gathered and these data was collated from World Bank( World Bank website), International Monetary Fund (IMF website) and Reserve Bank of India (RBI website).

4.2 Gross Deposit Product Growth (annual Percentage) GDP may be defined as the total market value of all finished goods and services produced in a country in a specific year, equal to total consumer, investment and government spending, plus the value of exports minus value of imports. The annual percentage growth rate of GDP at market price is based on constant local currency.

4.3 Liquid Liabilities (M3) as Percentage of GDP Liquid liabilities are also popularly known as broad money, or M3. They may be broadly defined as the sum total of currency and deposits in the central bank, plus transferable

deposits and electronic currency (M1) plus time and savings deposits, foreign currency transferable deposits, certificates of deposit, and securities repurchase agreements (M2), plus travellers checks, foreign currency time deposits, commercial paper and shares of mutual funds or market fund held by domestic residents.

4.4 Domestic credit facilitated by the Banking sector (Percentage of GDP) The Domestic credit provided by the banking sector consists of all credit to various sectors on a gross basis, excluding credit to the central government, which is Net. The banking sector includes monetary authorities and deposit money banks, as well as nonbanking institutions where data is available.

4.5 Market capitalization of listed companies (Percentage of GDP) Market capitalization is widely known as the capital of a market. Market capitalisation of a particular stock is the sum of number of outstanding shares of the company multiplied by the share price of that particular stock. Market capitalisation is a good pointer of the health of capital markets of an economy. Leading economies of the world have huge market capitalisation in relation to their Gross domestic product (GDP).

4.6 SPSS results with absolute values & application of T-test Pearsons product moment correlation coefficient is used to find out the relationship between selected economies with a variable GDP, DCRD, MCAP, INF, Rate of Interest & Domestic Savings and then T-test is applied to arrive at the conclusion whether to accept or reject the null hypothesis. Following hypothesis are derived in order to examine the significant relationship between the economic growth in India and China.
H 0 : Pr = 0 H 1 : Pr 0

Figure 1: Trends in GDP and M3 (Money Supply) in India

60 50 40 % age 30 20 10 0 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

IndiaYears GDP

M3

Figure 1 depicts that the annual percentage growth rate of GDP and M3 as a percentage of GDP in India. In the year 1993 the annual percentage GDP was 22% where as the M3 was 13% and there was a rapid rise in the GDP by 17% in 1997 while M3 increased by 10%. GDP had mounted up to 50% in 2003 with little fluctuations on the other hand M3 slightly moved up to 26% with little volatile in between 1998-2003. The graph shows a rapid growth rate between 2001- 2003 where M3 has risen from 1996-1997 however continuously gone down from 1997-2001, there after increasing trend remained constant over the coming years. Therefore, it may be concluded that there is a positive correlation between two variables in the long run.

Table 1: The Regression result of GDP and M3 of India

Correlations GDP GDP Pearson Correlation Sig. (2-tailed) N M3 Pearson Correlation Sig. (2-tailed) N 27.000 .531** .004 27 27.000 1.000 M3 .531** .004 27 1.000

**. Correlation is significant at the 0.01 level (2-tailed).

Paired Samples Test Paired Differences Std. Deviatio Mean Pair 1 GDP M3 -7.785635 n 8.35753 5 Std. Error Mean 1.608415 95% Confidence Interval of the Difference Lower -1.109186 Upper -4.479505 t -4.841 df 26 Sig. (2tailed) .004

t(26) p r

= -4.841 = 0.004 < 0.05 = 0.531 (positive)

From the above table it is found that Gross Domestic Product is positively correlated with M3 (Money Supply).The value of r represents a very strong positive correlation between two variables. Since the value oft is less than 1.960 we reject the null hypothesis. Therefore it is observed that Economic growth of a open economy is influenced or determined by M3. The money supply in India has gone up in the modern economy; this in turn will have a positive impact on the growth of bank loans which is considered to be a positive sign for the economic growth as people can easily borrow. In addition, the financial development of India is predominately related to the levels of economic growth.

Figure 2: Trends in DCRD, Inflation & GDP in India

70 60 50 % age 40 30 20 10 0 1993 1994 1995 1996 1997 1998 Year CDRD GDP INF 1999 2000 2001 2002 2003

Figure 2 illustrates that the domestic credit provided by the banking sector (DCRD) measured as a percentage of GDP and percentage change in inflation (INF) as measured by consumer price index and GDP. In 1993 DCRD was 50% while INF was 6%, meanwhile DCRD dwindled by 3% in 1997 and INF was just above by 1% with little fluctuations. DCRD reached its peak with 59% in the year 2002 with constant increase on the other hand inflation dipped to 4%. The above graph demonstrates the increasing trend in domestic credit provided by the banking sector since 1995 and decreasing trend in inflation except in 1998. Therefore we may observe a negative correlation between two independent variables.

Table 2: The Regression results of DCRD & GDP of India

Correlations DCRD DCRD Pearson Correlation Sig. (2-tailed) N GDP Pearson Correlation Sig. (2-tailed) N 11.000 .138 .687 11 11.000 1.000 GDP .138 .687 11 1.000

Paired Samples Test Paired Differences 95% Confidence Interval Std. Mean Pair 1 DCRD GDP 45.9736 4 Deviation 6.09711 Std. Error Mean 1.83835 of the Difference Lower 41.87754 Upper 50.06973 t 25.008 df 10 Sig. (2tailed) .000

Through the regression coefficients it may be inferred that GDP is positively affected from the changes in DCRD and negatively affected from the change in INF, An increase in DCRD leads to high rate of growth in GDP While an increase in INF causes the decrease in GDP. This denotes that both the variables are statistically insignificant. In other words, t-test result represents that both explanatory variables DCRD and INF are insignificant over dependent variables at 5% level of confidence.

Figure 3: Trends in Inflation and GDP in India

12 10 8 % age 6 4 2 0
80 82 84 86 19 88 19 90 19 92 19 94 19 96 19 98 20 00 20 02 20 04 20 06 20 08
India GDP Years India Inf

16 14 12 10 8 6 4 2 0
19 19 19

Figure 3 represents the relationship between Gross domestic product (GDP) and Inflation (INF) of India. In the year 1980 the GDP was 3.6percent where as INF was 11.4percent

19

and the graph represents that there was a high fluctuation in INF and GDP during 1980 -2000. Conversely in the year 2000 2008 INF steadily increased which resulted in tremendous rise in GDP. It may be understood that a gradual rise in the inflation will have a positive impact on the economic growth (GDP) on the other hand economic growth will be negative if the rate of inflation is too high or low.

Table 3: The Regression results of Inflation & GDP of India

Correlations GDP GDP Pearson Correlation Sig. (2-tailed) N Inflation Pearson Correlation Sig. (2-tailed) N 21.000 -.214 .351 21 21.000 1.000 Inflation -.214 .351 21 1.000

Paired Samples Test Paired Differences 95% Confidence Interval Std. Mean Pair 1 GDP Inflation 3.49048 Deviation 3.45918 Std. Error Mean .75485 of the Difference Lower -5.06507 Upper -1.91588 t -1.124 Df 20 Sig. (2tailed) .000

From the above regression table it is found that Inflation is negatively correlated with Gross Domestic Product as the value of r is -0.214 (negative) which shows weak negative correlation between the variables. The significant value of p value is 0.351 > 0.05 which represents that there is a significant difference between the means of two

groups. As the value oft is -1.124 which is greater than -1.960 hence we accept the null hypothesis. Figure 4: Trends in Inflation & GDP in China
16 14 12 % age 10 8 6 4 2 0
80 82 84 86 88 90 19 92 19 94 19 96 19 98 20 00 20 02 20 04 20 06 20 08
China GDP Years China Inf

30 25 20 15 10 5 0 -5
19 19 19 19 19

Figure 4 depicts the Gross domestic product (GDP) and Inflation (INF) of China. In the initial years it may be witnessed that there was a rise in GDP as there was a steady decrease in rate of INF. However in the year 1989 and 1990 there was a high fluctuation in Chinas INF as a result there was a steep fall in GDP of China. Again the weak negative correlation is found between both the variables.

19

Figure 5: Trends in Market Capitalization and GDP in India

90 80 70 60 50 40 30 20 10 0 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

% age

Years MCAP

GDP

Figure 5 portrays the relationship between Market Capitalisation (MCAP) and Gross Domestic Product (GDP). Initially in the year 1993 GDP was 5% and MCAP stood at 34% conversely GDP had slightly lifted up by 2% in 1997 and MCAP rapidly boosted up to 61% with major fluctuations in the due course. GDP increased from 4% to 7% between 2001- 2003 on the other hand MCAP reached its peak to 80% after a series of ups and downs. This graph shows that the market capitalisation of listed companies (MCAP) increased with GDP and vice-versa. Therefore it may be understood that the overall positive correlation exists between two variables.

Table 4: The regression results of MCAP & GDP of India

Correlations MCAP MCAP Pearson Correlation Sig. (2-tailed) N GDP Pearson Correlation Sig. (2-tailed) N 18.000 .393 .107 18 18.000 1.000 GDP .393 .107 18 1.000

Paired Samples Test Paired Differences 95% Confidence Interval Std. Mean Pair 1 MCAP GDP 308.7919 4 Deviation 155.42384 Std. Error Mean of the Difference Lower Upper t 8.429 df 17 Sig. (2tailed) .000

36.63375 231.50149 386.08240

The main findings of the study may be summarized as follows: There is bidirectional causality between real market capitalization and real GDP growth rate. Secondly the results suggest unidirectional causality between market capitalization and volatility to real GDP growth in Indian economy. The value of r is 0.393 which denotes very strong positive correlation between both the variables. The above test results suggest that market capitalization development leads to economic growth. The funds raised by the corporate from the financial markets during the study period thus played the important role for the appreciable growth registered by the Indian economy.

Table 5: The Regression results of India GDP & China GDP

Correlations India GDP India GDP Pearson Correlation Sig. (2-tailed) N China GDP Pearson Correlation Sig. (2-tailed) N 15.000 .063 .823 15 15.000 1.000 China GDP .063 .823 15 1.000

*. Correlation is significant at the 0.05 level (2-tailed).

Paired Samples Statistics Mean Pair 1 India GDP China GDP 5.6800 9.7200 N 15 15 Std. Deviation 1.59607 2.66356 Std. Error Mean .41210 .68773

Paired Samples Test Paired Differences 95% Confidence Interval Std. Mean Pair 1 India GDP China GDP 4.04000 Deviation 3.19057 Std. Error Mean .82380 of the Difference Lower -5.80688 Upper -2.27312 t -4.904 df 14 Sig. (2tailed) .000

Gross Domestic Product of India & China Ho: Pr = 0 H1: Pr 0 In table it is found that annual Gross Domestic Product is positively correlated between India and China. Value of r is 0.063 which shows very strong positive correlation between the variables. The significant level of P-value is 0.823 which means there is no significant difference between the means of the two groups. Since the value of T from the table is -4.904 so we will reject the null hypothesis (Ho) and (-4.904<-1.960), which shows relation between the variables is significant.

Figure 6: Trends in Gross Domestic Savings (percent of GDP), Rate of Interest and GDP in India
14 12 10 % age 8 6 4 2 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Years GDP ROI Gross Domestic Savings (percent of GDP) 35 30 25 20 15 10 5 0

Figure 6 Illustrates that the relationship among the rate of interest (ROI), Gross Domestic Savings (GDS) and Gross Domestic Product (GDP).In the year 1990 ROI was 10% where as GDS was 23.1% and GDP was 6.1%. Since 1991 1995 GDS had gone up as the interest rate increased which in turn resulted in growth of GDP except in the year 1992 and 1993 due to several other factors. However a fall in interest rate may be observed from the year 1997 - 2004 GDS had remained constant or increased slightly as the depositors continued to maintain household savings irrespective of change in interest rates. As the GDS increased GDP also mounted up. In other words a rise in Gross Domestic Savings (GDS) leads to better economic growth (GDP) of India.

Table 6: The Regression results of rate of Interest (ROI) and Gross Domestic Savings (percent of GDP) of India
Correlations ROI ROI Pearson Correlation Sig. (2-tailed) N GDS Pearson Correlation Sig. (2-tailed) N 15.000 .715** .003 15 15.000 1.000 GDS .715** .003 15 1.000

**. Correlation is significant at the 0.01 level (2-tailed).

Paired Samples Test Paired Differences 95% Confidence Interval of the Std. Mean Pair 1 ROI GDS 15.2800 0 Deviation 4.52374 Std. Error Mean 1.16802 Difference Lower 12.77484 Upper T df 14 Sig. (2tailed) .000

17.78516 13.082

In conducting the significantt test it may be concluded that interest rate of deposits are positively correlated with Gross Domestic Savings. The value of r is 0.715 which denotes slightly positive correlation between the variables as the r value is nearer to Zero. Since the value oft is 13.082 > 1.960 so we reject the null hypothesis (Ho) which shows the relation between the variables are significant.

Table 7: The Regression results of Gross Domestic Savings (percent of GDP) and GDP of India
Correlations GDS GDS Pearson Correlation Sig. (2-tailed) N GDP Pearson Correlation Sig. (2-tailed) N 15.000 .322 .242 15 15.000 1.000 GDP .322 .242 15 1.000

Paired Samples Test Paired Differences 95% Confidence Interval Std. Mean Pair 1 GDS GDP 31.51333 Deviation 3.56729 Std. Error Mean .92107 of the Difference Lower 29.53784 Upper 33.48883 t 17.214 df 14 Sig. (2tailed) .000

By applying thet test it may be understood that Gross Domestic Savings are positively correlated with Gross Domestic Product. The value of r is 0.322 which indicates slightly positive correlation between the variables as the r value is nearer to Zero. Since the value oft is 17.214 > 1.960 so we reject the null hypothesis (Ho) which emphasis the relation between the variables are important.

Figure 7: Trends in Gross Domestic Savings (percent of GDP), Rate of Interest and GDP in China
16 14 12 10 8 6 4 2 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
GDP ROI Gross Domestic Savings (percent of GDP)

60 50 40 30 20 10 0

Figure 7 demonstrates the link connecting the Gross Domestic Savings (GDS), Rate of Interest (ROI) and GDP of China. In the year 1990 the rate of interest was 8.64% and GDS was 38.8%, while in 1994 interest rate raised by 2.3% as a result GDS went up to 42.7% and GDP reached its peak to 13.1% with little fluctuations. Since 1997 till 2004 it may be observed that there was steady decline in the interest rates without having any major affect on the GDS as the depositors sustained to maintain good household savings and the graph also represents the increase in GDP whenever there is a rise in GDS. The same may be proved by applyingt test as mentioned below

Table 8: The Regression results of Rate of Interest (ROI) and Gross Domestic Savings (percent of GDP) of China

Correlations ROI ROI Pearson Correlation Sig. (2-tailed) N GDS Pearson Correlation Sig. (2-tailed) N 15.000 .171 .541 15 15.000 1.000 GDS .171 .541 15 1.000

Paired Samples Test Paired Differences 95% Confidence Interval Std. Mean Pair 1 ROI GDS 35.4613 3 Deviation 5.34285 Std. Error Mean 1.37952 of the Difference Lower 32.50256 Upper t df 14 Sig. (2tailed) .000

38.42010 12.706

In conducting the significant t test it may be concluded that interest rate of deposits are positively correlated with Gross Domestic Savings. The value of r is 0.171 which denotes slightly positive correlation between the variables as the r value is nearer to Zero. Since the value of t is 12.706 > 1.960 so we reject the null hypothesis (Ho) which shows the relation between the variables are significant.

Table 9: The regression results of Gross Domestic Savings (percent of GDP) and GDP of China
Correlations GDS GDS Pearson Correlation Sig. (2-tailed) N GDP Pearson Correlation Sig. (2-tailed) N 15.000 .499 .058 15 15.000 1.000 GDP .499 .058 15 1.000

Paired Samples Test Paired Differences 95% Confidence Interval Std. Mean Pair 1 GDS GDP 18.5666 7 Deviation 1.99129 Std. Error Mean .51415 of the Difference Lower 17.46393 Upper 19.66941 T 14.111 df 14 Sig. (2tailed) .000

It may be once again proved that Gross Domestic Savings are positively correlated with Gross Domestic Product. The value of r is 0.499 which indicates slightly positive correlation between the variables as the r value is nearer to Zero. Since the value oft is 14.111 > 1.960 so we reject the null hypothesis (Ho) which emphasis the relation between the variables are important.

Table 10 Financial Development my Income group, worldwide, 1990s (assets capitalization as percentage of GDP)
Banks 81 40 NBFIs 41 21 Stock markets 33 11 Total 155 72

High income countries Upper middle income countries

Lower middle income countries Low income countries

34 23

12 5

12 4

58 32

Source: Adapted from Fitzgerald, World economic and social survey: Oxford University. By analysing the data from the above table 10 it may be conclude that greater financial depth (that is, higher ratios of total financial assets to national income or output) is linked with higher levels of productivity as a result high per capita income. Secondly, that the later were also associated with more sophisticated financial system, which means the shift from banks towards non-bank financial intermediaries and from both of these towards stock markets.

Synopsis: In the light of the above information, it is clear that there exists a fundamental relationship between Gross Domestic product and various indicators of financial development and economic growth. In order to prove this, we utilised the secondary data from IMF and RBI websites and interpreted the data by graphical representation and applied T-test in SPSS to calculate the regression to show the correlation between various financial indicators of India and China which helped to arrive at a final conclusion that Chinas economy performed well because of its rapid development of banking sector which had enhanced household savings, high national savings and interest rates as a result market capitalisation, domestic credit provided by the banks were increased which in turn lead to the high growth rate of Gross Domestic Product. From here we move on further to next chapter Conclusion and Recommendations which outlines the summary of the dissertation topic.

Chapter 6

REFLECTIONS ON LEARNING

Reflection is a process of reviewing an experience of practice in order to describe, analyse, evaluate and so inform learning about practice (Reid, 1993). The author believes that reflection is necessary to learn from the study and experience got while doing the dissertation. The work on this dissertation has been a knowledge understanding in several ways. The author is able to evaluate his own strengths and weaknesses which in turn gave the author a chance to enhance his strengths and try to overcome those shortcomings which are necessary to become a qualified financial manager in competitive business world. Since Author was used to conventional methods of education in the past, independent learning was a novel experience and author found it difficult at the beginning. The author realised that a thorough understanding may be achieved by the analysis of relevant theories, literature, books and journals. Initially at the time of reading author faced difficulty in understanding the concepts of banking sector, financial development and economic growth of both India and China hence the author has to break the concepts into small parts and build up gradually to the whole picture. The concepts of evaluation tools required repeated reading to understand its usage and applications. The author carried out the empirical study to evaluate the performance of banking sector, while analysing the industry, the author was able to learn how the industry has attained growth from the initial stage in spite of many difficulties. The author realised that it is not possible to study an industry on whole, so it is necessary to make limitations for the learning in order to keep the track. It was difficult to collect data and related literature based on Indian context though the University library had a comprehensive list of journals and text books which were based mostly on local authors however author referred several books and publications of overseas writers. The author learned the importance of literature and how it should be used. In this IT savvy world it is the most accepted fact that Internet made the author to collect valuable data required for the study.

Although academic workload, time constraints, financial hardships and interpersonal difficulties caused lot of stress to the author, however author was able to cope up and could successfully complete the study on the research topic in spite of all the short comings. Frequent meetings and discussions with dissertation supervisor had helped the author in improving interpersonal difficulties and also facilitated the author to review his performance periodically. Time management had also been a challenge to the author as managing time properly is considered to be one of the most important trait to be acquired in order to be successful. Hence author started applying the principles of management such as planning, organising, directing and controlling as a result was able to allocate time and resources efficiently and effectively in a systemic manner. During this phase, author has set goals for him self and then prioritized them on the basis of urgency and significance. After prioritizing activities, author made a dissertation outline and set deadlines for each chapter of dissertation. In this way, throughout dissertation the author was able to learn, analyse and improve himself. At the end of the research work, author has witnessed an improvement in his learning style. The author also felt that academic research and independent learning gave him an opportunity to take control of his career and make plans for the future. In addition to this, author is so much motivated theoretically, practically and mentally ready to face any kind of tough situation in the corporate world. From the beginning of the MBA program to the end of research work and writing dissertation, all were enrich learning experiences and by reviewing and evaluating strengths and weaknesses, author is confident that he will reach the peak in the ladder of success.

Chapter 7

References:
Books and Journals Aggarwal, J.C. & Chowdhry, N.K., 1991. Indian Economy crisis and reforms. Delhi: Shipra. Becker, S. & Bryman, A., 2004. Understanding research for social policy and practice: themes, methods and approaches. Policy press. Chow, G.C., 1994. Understanding Chinas Economy. New Jersey: World Scientific. Donnithorne, A., 1967. Chinas Economic System. London: George Allen & unwin. Eisenhardt, K., 1989. Building theories from case study research. Academy of Management Review Gill, J. & Johnson, P., 2002. Research Methods for Managers. 3rd ed. London: with Sgae. Goldsmith, R.W., 1983. The Financial Development of India, Japan and the United States. London: Yale University Press. Hakim, C., 1987. Research Design. London: Billing and Son. Henry, J.F., 1990. The making of neoclassical economics. London: Billing and Sons. Kumar, R. 1999. Research Methodology: A Step-By-Step Guide for beginners. Curtin University of technology. with Sage. Levine, R. 1991. \Stock Markets, Growth, and Tax Policy." The Journal of Finance 46(4): 1445-65. 1997. \Financial Development and Economic Growth: Views and Agenda." Journal of Economic Literature 35: 688-726. Lewis, W.A., 1970. Theory of Economic Growth. 9th ed. London: Novello. Manion, L. Cohen, L. & Morrison, K., 2000. Research Methods in Education. 5th ed. Routledge. Neher, P.A., 1971. Economic Growth & Development. New York: University of British Columbia. John Wiley & Sons.

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Website

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Eugene, N., White, 2003. Historical perspectives on financial development and economic growth/Commentary. All Business online, [internet] 1 July. Available at: http://www.allbusiness.com/north-america/united-states-missouri-metro-areas/10473201.html [Accessed 5th January 2009]. Fabris, N., 2008. The Nexus between Macroeconomics and Finance. Central bank of Montenegro, [internet]. Available at: http://www.bankofengland.co.uk/publications/events/ccbs_cew2008/presentation_fabris. pdf [Accessed on 28 March 2009]. Fitzgerald, V., 2006. Financial Development and Economic Growth: A Critical View. World economic and social survey, [Online] March., Available at: http://www.un.org/esa/policy/backgroundpapers/fitzgerald_draft.pdf [Accessed 30 January]. Hagemann, H. Seiter, S., 2003. Growth Theory and Growth Policy. [e-book] Routledge. Available at: http://books.google.co.uk/books?id=0016gpSjIQEC [Accessed 18 February]. Harrod Domar role of savings & investment growth (1930) [Online image] Available from: http://rapidrevision.co.uk/economics-student/2009/04/16/harrod-domar-model/ [Accessed 20 March 2009]. Henry, P.B., 2007. Stanford University, Brookings Institution, and NBER: Forthcoming Journal of Economic Literature, [Online] December., Vol.XLV, pp. 887 935. Available at: https://faculty-gsb.stanford.edu/henry/Homepage/PDF/Henry-Liberalization-Oct07.pdf [Accessed 2 February 2009]. Jung, W.S., 1986. Financial Development and Economic Growth: International Evidence. The University of Chicago Press, [Online] Jan., Available at: http://www.jstor.org/pss/1153854 [Accessed 17 April]. Kumar, D.A., 2005. An Overview of Indian Financial System. Lokamanya Tilak P G College of Management. [internet] 16 August. Available at: http://www.indianmba.com/Faculty_Column/FC177/fc177.html [Accessed 08 March 2009]. Levine, R., Zervos, S., 1996. Stock markets, Banks, and Economic Growth. The World bank, [internet] Available at: http://wwwwds.worldbank.org/external/default/WDSContentServer/IW3P/IB/1996/12/01/00000926 5_3970625091326/Rendered/PDF/multi_page.pdf [Accessed 17 February 2009]. Murthy, V.B., and Deb., Taru, A., 2008. Theoretical Framework of Competition as applied to Banking Industry. Delhi University, [online]., Available at: http://mpra.ub.unimuenchen.de/7465/1/MPRA_paper_7465.pdf [Accessed on 25 March].

Rioja, F., Valev, N., 2004. Business Publications: management articles and insight. BNET United Kingdom, [Online] Jan., Available at: http://findarticles.com/p/articles/mi_hb5814/is_1_42/ai_n29066978/ [Accessed 10 March 2009]. Robert, G.K., Levine, R., 1993. Finance and Growth. Country Economics Development The World Bank, [internet] February. Available at: http://wwwwds.worldbank.org/servlet/WDSContentServer/WDSP/IB/1993/02/01/000009265_39610 04042036/Rendered/PDF/multi_page.pdf [Accessed 20 February]. Roland, C., n.d. Banking Sector Liberalization in India. Ninth Capital Markets Conference. [internet]. Available at: http://unpan1.un.org/intradoc/groups/public/documents/APCITY/UNPAN024227.pdf [Accessed 2 April 2009]. Roland, C., 2007. Banking sector Liberalization in India. Evaluation of reforms and comparative perspectives on China. [internet]. Available at: http://books.google.co.uk/books? id=530f34Oh9psC&printsec=frontcover&source=gbs_summary_r&cad=0#PPA268,M1 [Accessed 08 May 2009]. Rosen, D.H., 2005. Understanding China to Complete Successfully. Blandin Foundation,
[internet] 16-17 August. Available at: http://transition.blandinfoundation.org/html/VFVC %20Capacity%20Conferenc%2005/Rosen_2005.pdf [Accessed 4 April 2009].

Shirai, S., 2001. Assessment of Indians Banking Sector reforms from the perspective of the governance of the Banking System. Associate professor of Keio University. [internet]. Available at: http://www.unescap.org/drpad/publication/fin_2206/part4.pdf [Accessed 6 April 2009]. Sinha, T., Sinha, D., 1998. Economics Letters: cart before the horse? The saving-growth nexus in mexico. Social Science Research Network, [Online] 20 Oct., Available at: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=132531 [Accessed 25 March 2009]. Trumpbour, J., 2007. China: Banking Reform and Economic Development Revisited. Harvard Law School, Labour & Worklife Program. [internet] 13 September. Available at: http://www.networkideas.org/featart/oct2008/China.pdf [Accessed on 21 February]. Weijun, T., 2008. Research Methods for Business Students. Shanghai Jiao Tong University. [internet]. Available at: http://www.drtang.org/lecture/RM/RM_07.pdf [Accessed on 1 May].

Chapter 8

APPENDIX

Diagram 1: The Financial System

Source: Adapted from Kumar D.A, Financial System: Lokamanya Tilak P G College of Management. Diagram 2: The Financial System and its Components

Source: Adapted from Kumar D.A, Financial System: Lokamanya Tilak P G College of Management.

Table 1: Comparison of macroeconomic variables in the real sector: Average for 1991 2004
China 10.14 (2.18) 9.1 (2.05) 3388.4 (1139.04) -1139.04 11.69 (0.86) 9.23 (4.08) 8.38 (2.43) 39.08 (2.03) 5.68 (7.77) 6.1 (6.66) India 5.7 (2.02) 3.91 (2.06 2216.36 (373.91) -373.91 11.6 (0.75) 5.19 (4.93) 5.03 (2.14) 21.86 (1.35) 7.58 (3.74) 6.86 (3.13)

GDP growth rate Per capita GDP growth rate Per capita GDP (PPP - $, 2000) (PPP - $, 2000) Govt. Cn Exp./ GDP Growth rate of general Govt. Cn. Exp. Growth rate of household Cn. Exp Gross Domestic Savings Inflation CPI Inflation GDP deflator

Source: Adapted from Das, P.K., Financial sector development and growth in China and India. Paper JEL classification: O16, O43, O57.

Table 2: Comparison of the banking and financial sector (Averaging for 1991 2004)
China 122.78 (8.02) 112.08 (26.87) 22.99 (9.46) 73.74 (18.45) 119.31 (10.15) 1.05 (0.31) 23.91 (8.4) 112.37 (22.28) 5.57 (3.64) 7.87 (2.42) 2.35 (0.53) 1.92 (4.5) India 52.16 (26.68) 48.47 (7.62) 16.52 (2.42) 36.6 (6.98) 136.61 (7) 0.39 (0.08) 16.91 (2.41) 51.14 (5.03) 9.68 (2.6) 14.13 (2.48) 3.12 (0.26) 6.83 (1.7)

M3 / GDP M2 / GDP Growth of M2 Quasi-liquid Liability / GDP M3 / Bank deposits Bank deposit / GDP Growth of bank deposit Dom. Credit by bank / GDP Bank Deposit rate Bank Lending rate Net interest margin Real rate of interest

Source: Adapted from Das, P.K., Financial sector development and growth in China and India. Paper JEL classification: O16, O43, O57.