Oracle IAS, the best coaching institute for UPSC/IAS/PCS preparation in Dehradun (Uttarakhand), brings to you views on important issues.
Syllabus: GS paper 3
'Increase in Gross capital formation is required for long term growth prospects in India'. Discuss the problem plaguing India and suggest some measures.
What is the issue?
- A free fall in the rupee or a massive current account deficit would be symptoms of some other underlying serious issues.
What should be the focus?
- Investment is a fundamental variable among the sources of economic growth.
- These may include people, knowledge bases, institutional capacity or the obvious physical capital itself.
- The efficiency of the process of savings generation and channelizing them into productive investment is crucial for sustained economic growth.
- This is often taken for granted, but focusing on this draws attention to India’s biggest economic problem.
How has India performed in this regard?
- Since the 1991 reform period, India has made considerable progress in facilitating investment.
- It has removed unnecessary and inefficient controls on international and domestic trade and investment.
- It has slowly improved the functioning of its tax system, management of public finances, and monetary policy.
- But there are still some serious issues that hamper the sustainable growth.
What are the concerns?
- India’s biggest economic problem is the inefficient allocation of capital.
- Bad loans in the banking sector have been one symptom of this problem.
- The latest Infrastructure Leasing and Financial Services (IL&FS) crisis, which defaulted on some of its debt obligations.
- The common factor in these cases is the long-term lending for large projects.
- These are subject to high risks, because of their scale and their length of gestation.
- Banks were, in fact, pushed by government in the direction of longer-term loans for fixed capital investment.
- They were diverted away (at least in relative terms) from working capital and household loans.
- Worryingly, this happened in banks without the internal expertise required for assessing the most challenging type of lending.
- The Indian government failed to create a regulatory framework.
- This would have detected the incipient problems in systemically important firms such as IL&FS.
- Poor corporate governance is a major cause to this whole capital allocation mess.
- This includes financial intermediaries such as banks and non-bank financial companies and also the firms that do the borrowing.
- In India, there seems to be a common problem of skimming funds (form of tax evasion), by business borrowers and politicians.
What needs to be done?
- Indian banks should be given more freedom to tap bond markets for funding longer-term loans.
- This will allow markets to send better price signals about bank portfolios.
- There is a dire need for a corporate bond market in India that will allow firms to borrow more directly from savers.
- This does not stop at long-term borrowing, but other short-term borrowing can also benefit from new market platforms.
- As financial markets are broadened and deepened, the demands on regulators increase.
- India’s financial system regulatory architecture also needs to be enhanced.
- This involves not just external oversight by financial regulators but also strong corporate governance, with greater disclosure and transparency.
- Auditors and rating agencies also need to step up and do their jobs better.
- The government can facilitate this by raising and enforcing standards for the private sector monitoring institutions.
- The challenge now is moving beyond improving fiscal policy or monetary policy and addressing the political component too.