MGI Research

Accelerating India's growth through financial system reform

| Report

Although India's financial system has a number of bright spots, it falls short on several dimensions. The system intermediates only half of the country's total savings and investment, and it channels the majority of funding to the least productive parts of the economy. India's dynamic private sector receives just 43 percent of total credit, while the remaining 57 percent of credit goes to state-owned enterprises, agriculture, and tiny businesses in the unorganized sector. This pattern of capital allocation impedes growth because these sectors are 10-50 percent as productive as the private corporate sector.

MGI found that Indian banks amounted to just 61 percent of deposits, a much smaller fraction than banks in other countries, suggesting that they could play a far greater role in driving growth. In addition, the value of India's corporate bond market amounts to just 2 percent of GDP. Moreover, Indian companies pay significantly higher interest rates in every sector of the economy than Chinese or US companies.

These shortcomings, along with others documented in the report, impose a heavy cost on India's economy. MGI calculates that an integrated program of financial system reforms could free up $48 billion of capital per year, equivalent to 7 percent of GDP. Even more important, these reforms would raise real GDP growth to 9.4 percent a year. This would increase household incomes 30 percent above current projections by 2014, lifting millions more households out of poverty.

The report offers a roadmap of reforms to capture this opportunity, makes the case for significantly more liberalization of the financial sector, and discusses the political challenges of such liberalization.