China and India, the world's two emerging economic giants, have captured the imagination of investors, industrialists, and economists alike. Their parallel bursts of growth are marked by striking differences, however (Exhibit 1). As powerful as the progress of both countries has been, China's industrial development is clearly outstripping that of its neighbor not only because of China's head start in economic liberalization but also because of a commonly overlooked factor: India's financial system.

India's stock of financial assets, reflecting the degree of monetization in an economy and its supply of intermediated capital, is just one-sixth the size of China's total (Exhibit 2).¹ Whereas China accounts for more than 4 percent of the world's financial assets, India holds less than 1 percent. This difference is only partially explained by the size of the two economies. India's financial depth, a measure comparing a country's financial stock with its GDP, is just 137 percent—far below China's 323 percent.

In the decade to 2003, India's financial stock increased by 12 percent annually—higher than the world average but still well below China's growth rate of 14.5 percent. If these trends...