Indian economy: Sustained Economic Growth #44

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.



Hemant Bhatt

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