Archive for June 7th, 2007

How integrated are India’s Financial Markets

June 7, 2007

This is easily one of the best reports so far on India’s Financial Markets. I have summarised 2 chapters so far, G-Sec markets and Equity and Corporate Debt Markets.

In continuation, I just went through this chapter on Financial Market Integration. It is another very good read for those interested in financial markets. 

Firstly what do we mean by integration here? In short, basically we have various types of financial markets, equity, G-Sec, MoneyMarkets etc which with a different function and different instruments and you integrate them. Another kind of integration is between domestic and global markets.

But why do you need to integrate? Well, with more integration you can transmit price signals more efficiently, reduce arbitrage opportunities, achieve higher level of efficiency in market operation of intermediaries and increase efficacy of monetary policy in the economy.

The chapter discusses the theories of integration, how does one measure finacial integration, benefits and risks in a pretty detailed and interesting manner.

I wouldn’t go into theory etc. and just discuss some findings:

Integration between different domestic markets:

  • The integration (as measure by correlation) amongst various financial instruments traded in different markets has improved post 2000.
  • Only equity markets seem to have low correlation with other markets. Money markets, Bond Markets, Forex markets show improving correlation with time.
  • Besides this it also looks at various meaures like interest rate spreads between corp bonds and G-Secs and finds the difference is narrowing. The regression analysis says that spread between 5 year AAA corporate bond and G-Sec over 5 years comes to about 1.05%.
  • It also restresses the importance of a deep and well functioning G-Sec market which enables pricing of various financial instruments and helps in further integration.

Integration between domestic and international markets: 

  • There is a completely opposite picture when we compare Indian markets with its regional counterparts.
  • We see a healthy correlation between equity markets and poor correlation between money and bond markets
  • This suggests that latter markets remain segmented in the region whereas former have become more integrated as we have many cross-listings in other exchanges and stocks are traded elsewhere as well apart from national stock exchanges.

Overall, a pretty good analysis. It could have been better had the analysis got more empirical and try and measure integration in India using more sophisticated techniques it mentions in the report. I also mentioned these techniques in my previous entry where I covered a fantastic survey on Financial Globalization.

Millennium Villages: a new model for development

June 7, 2007

Jeffery Sachs has his own model of development. He says massive aid program could help in reducing poverty in poor nations. He has initiated a program called Millennium Villages where few selected villages would be given aid to achieve Millennium Development Goals. (To know more about these villages click here)

This article is recently attracting a lot of attention which talks about Sachs’ efforts at a village in Kenya called Sauri. It was the first village under the program. Thanks to Dani Rodrik for the pointer. I loved this para:

Africa has been ­drip-­fed aid for decades, Sachs writes in his 2005 book The End of Poverty, but it has never received enough to make a difference. What money has trickled in has been wasted on overpriced consultants and misspent on humanitarian relief and food aid, not directed at the root causes of poverty. The average African, Sachs says, is caught in a “poverty trap.” He farms a small plot for himself and his family, and simply doesn’t have enough assets to make a profit. As the population grows, people have less and less land, and grow poorer. When the farmer has to pay school fees for his children or buy medication, he is forced to sell the few assets he has or else go into debt. But if he had some capital, he could invest in his farm, grow enough to harvest a surplus, sell it, and start making ­money.

So finance is important. Initial capital which is what the aid provides helps the person in a much better way than simply giving him the goods. But then finance alone is not enough. He needs mechanisms which incentivises him to produce the goods and sell in the markets.

Now, providing finance and helping him establish initial business is an easier part, it is creating that flow through of finance and goods that is important. The aid just helps initially and it is this inability of development consulatants to keep the flow going, which has kept Africa in the poverty trap.

And this is where theories espoused by North, Rodrik, Acemoglu come in front that it is institutions that matter the most. How does one go about creating institutions? Acemoglu says it depends on the colonial origins which in turn depend on mortality rates (at places with higher mortality rates, the colonizers set extractive/rent-seeking institutions). Hence Africa continues to suffer. There have been some excepetions like Botswana, South-Africa but more or less the story is similar across Africa. How does one change it? As Rodrik says,there is no one solution. One has to adopt a case by case approach. One model does not fit all. So there are many ideas what leads to growth etc we still struggle with implementation of the same.

The article also confirms this and says at the end:

This is not to say that Sauri cannot change, or that investment in the village is wasted. But if Sauri is to become a useful model for development on a bigger scale, and not just another development expert’s white elephant, Sachs and others working on the project must acknowledge that they are still learning about Africa. Sauri is not yet a ­success.

Lasting changes in Sauri will come about not through distribution of commodities, but through education for children and training for adults. To put it another way, give a man a mosquito net, and when it rips, he’ll come and ask for another one. But show him how using a mosquito net benefits his health and how it will save him money on medication in the long run, and he might just go out and buy one for himself.

Assorted Links

June 7, 2007

1. Dani Rodrik brings about a bang-on metaphor for globalisation – If you are going to open the window, make sure you keep the mosquitos out. “

2. Greg Mankiw point to a superb article that says growing inequality in America could become a serious issue at the US presidential elections in 2008.

3. RBI acts after getting competition from Dubai

4. T.K. Arun says rather convincingly we need new set of policies.

5. ET Editorial says dollar denominated Govt. Bonds can wait. (I had pointed out to this development earlier). It says the need is more to use our forex reserves prudently. It also says corporates don’t really need the benchmark G-Sec rates for pricing their foreign debt as they have been borrowing anyways.

6. BS Edit says for development of Indian infrastructure Finance is not a constraint and the problem is more to do with sectoral policies. I had mentioned about the same earlier as well. The policies have to be such that finance flows to fund the infrastructure projects.

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