Real and Financial Sector Linkages in China and India

April 1, 2008

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Jahangir Aziz. Real and Financial Sector Linkages in China and India, (USA: International Monetary Fund, 2008) accessed December 28, 2024

Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

In the spirit of what is known as business cycle accounting, this paper finds that the investment wedge-the gap between household's rate of intertemporal substitution and the marginal product of capital-is large and quantitatively significant in explaining China's and India's growth. Specific financial sector policies are shown to map well the size and changes in the investment wedge. In the case of China, nonperforming loans, borrowing constraints, and uncertainty over changes in government guidance in bank lending, have implied large transfers from households to firms that have kept capital cost low and encouraged investment. In the case of India, post-1992 financial sector reforms, particularly the reduction in the funds preempted by the government from the banking system, has played an important role in reducing the cost of capital. Simulations show that for rebalancing growth in China and sustaining high investment rate in India, further financial sector reforms could turn out to be key.

Subject: Bank credit, Capital income tax, Consumption, Financial sector development, Nonperforming loans

Keywords: Capital stock, Cost of capital, Working capital, WP

Publication Details

Pages:

36
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2008/095
Stock No:

WPIEA2008095
ISBN:

9781451869569
ISSN:

1018-5941

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