Financing India's Aspirations1
Namaskar! Good morning,
I am honoured to be here today. This initiative by the CII - the Summit
on Financing 3.0 - is perhaps the first of its kind and assumes timely
significance in positioning itself as a beacon of light illuminating India's
leap towards its future. At the outset, therefore, I would like to express
my deep appreciation of CII's role in shaping India's industrial and
business landscape since 1895 as arguably the most visible business
association in the country today. It is only befitting that I pay tribute to
the CII's extraordinary contributions by dwelling on our ambitions as a
nation and the role of finance in actualising them.
II. An Aspirational Vision of India
There is a palpable pulsation in the mood of the nation. It is widely
believed that this is India's century. A window of opportunity has opened
up for striking out on a path that secures for every Indian the best living
standards in the world. In the tradition of classical economics, it is a
productive workforce that is the true source of value creation; capital is
only an organising factor, boosting the productivity of labour and
1
Keynote Address delivered by Michael Debabrata Patra, Deputy Governor,
Reserve Bank of India (RBI) at the Financing 3.0 Summit: Preparing for Viksit
Bharat organised by the Confederation of Indian Industries (CII) on September 3,
2024 at Mumbai, India. Valuable comments received from Sunil Kumar, Snehal S
Herwadkar, Samir Ranjan Behera, Dhanya V, Rajas Saroy, Sambhavi Dhingra,
Gautam, and editorial help from Vineet Kumar Srivastava are gratefully
acknowledged.
creating conditions for its growth. In that classical sense of the supply
side of the economy, every sixth working person in the world is an Indian
benefiting from a population that is the youngest in the world. The
United Nations projects India's working age population to grow at 9.7
million per annum.2 This cohort is expected to peak at 68.9 per cent of
the total population by the 2030s3.
On the demand side, India will skill this rising workforce at a rapid pace,
given that we are already producing the largest number of STEM4
graduates in the world - over 20 lakh every year, 43 per cent of whom
are women5. India is also at the forefront of the digital revolution, among
the world's leaders in information and communication technology usage
and in start-up ecosystems. Projections suggest that artificial
intelligence (AI) could contribute around US$ 1 trillion to the Indian
economy by 20356. As the ambition to become a global manufacturing
hub and an export powerhouse materialises, the employability of the
working age population will go up and India will experience rising
incomes and prosperity. In the International Monetary Fund (IMF),
economists have showed that reaping the demographic dividend could
add about 2 percentage points per annum to India's per capita GDP
growth over the next two decades.7 In fact, recent research confirms
the linkages between demographic dividends, digital innovation and
2
Government of India, Economic Survey, 2018-19, Volume 1, Chapter 7.
3
Ernst and Young, 2023, India@100: Reaping the Demographic Dividend, April 11.
4
Science, technology, engineering, and mathematics (STEM).
5
Government of India, Interim Union Budget, 2024-25.
6
Ministry of External Affairs, 2020, India Launches Hub to Drive AI Innovation in
BFSI Sector.
7
Aiyar, S. and Mody, A., 2011, The Demographic Dividend: Evidence from the
Indian States, IMF Working Paper WP/11/38.
economic growth8. Sustained by higher saving and investment rates
associated with the rise of India's working age ratio, it will become
possible to traverse between the GDP levels of today and 2047, as
recently envisioned by Niti Aayog9 and break out into per capita income
levels associated with an advanced economy. From a time-varying
perspective, a burst of speed is required for just about a decade;
thereafter, sheer momentum will propel India forward even at lower
growth rates. On the way, we will need to build up world class physical
infrastructure and a conducive environment for unleashing innovation
energies while moving towards being a greener, cleaner and healthier
nation. India will also contribute to reshaping the world order to achieve
an equitable, inclusive and sustainable future for humanity.
III. Finance and Growth Revisited
Key to the fulfilment of this vision of 'India Tomorrow' is the role of
finance. An animated debate has coursed through the years on the
relationship between growth and finance. Economists have argued that
it follows either a supply leading or a demand following sequence. In
the former premise, financial sector development precedes economic
development. For instance, financial depth or the size of the financial
sector relative to a country's economic size is found to be a strong
predictor of subsequent economic growth, physical capital
accumulation and improvements in economic efficiency10. In the latter
proposition, it is held that the economy should develop and then the
financial sector follows. Also, there is a recognition that this relationship
may not be linear across countries and periods. At relatively low levels
of development, this mutually reinforcing sequence may be
transformative, but may taper off at higher levels of development11.
Advancements in endogenous growth theory support both hypotheses,
emphasising the role of finance and financial intermediaries in
facilitating investments in innovation and education, lowering
transaction costs and managing risks, thereby accelerating the growth
process.12
The reality is that both strands intertwine and mesh in a manner that
they are indistinguishable. While a well-functioning financial sector is a
precondition for the efficient allocation of resources and the exploitation
of an economy's growth potential, it is also axiomatic that the demand
for financial services depends upon growth and the formalisation of
various sectors of the economy. On the flip side, business and financial
cycles feed, reinforce and amplify each other. There are also leads and
lags. In early August, we saw a bloodbath in financial markets
worldwide - reminiscent of Black Monday of 1987 - when incoming
data were read as portending imminent recession, triggering a
10
King, R.G. and Levine, R. (1993). Finance and Growth: Schumpeter Might be
Right. The Quarterly Journal of Economics 108(3), 717-737; Levine, R. and Zervos,
S. (1998). Stock Markets, Banks, and Economic Growth. The American Economic
Review 88(3), 537-558.
11
Huang, H. and Lin, S. (2009). Non-linear Finance-Growth Nexus. The Economics
of Transition 17(3), 439-466.
12
Levine, R., (2004). Finance and Growth: Theory and Evidence, NBER Working
Paper No. 10766; Romer, P.M., (1990). Endogenous Technological
Change, Journal of political Economy, 98(5, Part 2), S71-S102.
widespread sell-off and a global unwinding of carry trade. Analogously,
the global inflation surge in the wake of the war in Ukraine provoked a
synchronised and aggressive tightening of monetary policy and
financial conditions, resulting in bank failures and deposit runs in some
jurisdictions in March 2023.
IV. Situating Finance in National Accounting
In the circular flow of income and expenditure that describes the
working of an economy, transactions in goods, services, compensations
and taxes are matched by flows of saving and investment, which
represent inter-sectoral transfers of lendable resources. In India, the
household sector typically generates surplus saving relative to its
investment which it lends to other sectors. Recently, net financial saving
of households has almost halved from its level in 2020-21 due to
behavioural changes underway in the form of unwinding of prudential
savings accumulated during the pandemic as well as shifts from
financial assets to physical assets such as housing. Going forward,
boosted by rising incomes, households will likely build back their
financial assets - 15 per cent of GDP was observed during the early
2000s up to the global financial crisis. This process has already begun
- households' financial assets have increased from 10.6 per cent of
GDP during 2011-17 to 11.5 per cent during 2017-23 (excluding the
pandemic year). Their physical savings have also risen in the post-
pandemic years to over 12 per cent of GDP and could rise further - they
had reached 16 per cent of GDP in 2010-11. Accordingly, households
will remain the top net lenders to the rest of the economy in the coming
decades. The private corporate sector has drastically reduced its net
borrowings from the rest of the economy13, reflecting a combination of
rising internal accruals and subdued capacity creation. Looking ahead,
its net borrowing requirement is likely to rise on the back of a revival in
the capex cycle. These financing requirements will largely be met by
households and external resources. Net dissaving of the public sector
has been moderating albeit unevenly; this sector will remain a net
borrower in the economy in view of the critical role envisaged for fiscal
policy in shaping India's future.
If the nation as a whole has a deficit, it borrows from the rest of the
world and the inflow of foreign savings helps finance its investment
needs. For India, domestic savings have largely financed the overall
investment requirements of growth, with external financing playing a
supplemental role as reflected in largely modest current account
deficits. As the productive capacity of the economy rises and its ability
to absorb foreign resources expands, the volume of external financing
and its composition may undergo fundamental shifts, but in the light of
past experiences, external debt sustainability will remain a policy
priority.
Given natural endowments, including the workforce and its thrift and
productivity, it is the rate of investment that provides the turning points
in the economy's growth trajectory as well as its structural shifts. As the
economy modernises in the quest of its vision as outlined earlier, market
financing will likely grow in depth and sophistication. The institutional
architecture of financial intermediation may become more diversified
while exploiting niches of specialisation and leveraging on technological
solutions.
Historically, phases of growth accelerations in India have been
accompanied by higher gross domestic investment rates. A key
determinant of the desired investment rate, apart from the overall rate
of growth, is the efficiency of capital use in terms of the number of units
of capital required to produce one unit of GDP. The lower this
incremental capital output ratio (ICOR), the higher the productivity of
capital or the marginal efficiency of capital. In most developed countries
the ICOR is in the neighbourhood of 3. Over the period 2012-19, the
ICOR in India averaged 5.0, but in the last three years, it eased to 4.0.
As these efficiency gains rise, the workforce gathers skills and the
economic structure acquires sophistication and technological progress,
it is possible to envisage the ICOR in the range of 3.5 to 4. Accordingly,
the required investment over a decade of high growth would be in the
range of 33-38 per cent of GDP per annum. This is by no means
infeasible if the peak of about 39 per cent achieved in 2010-11 can be
reckoned as the potential. It is possible to finance this desired
investment rate with saving rates in the range of 32-36 per cent of GDP,
again achievable considering the peak of 37.8 per cent achieved in
2007-0814. Looking ahead, this aspiration is premised on an
improvement in saving potential among all major constituents -
households on the back of a growing skilled workforce; businesses
benefiting from the thrust on manufacturing and exports; and
governments maintaining the consolidation that is underway. The
contribution of external financing can change in magnitude and
composition, as stated earlier.
In the rest of my address, I hope to draw on available estimates to track
some strategic facets of the evolutionary contribution of finance to
India's aspirational goals.
V. Infrastructure
Infrastructure plays a critical role in expanding national production
capacity, social welfare, and economic development. Spending on
infrastructure engenders a GDP multiplier of 2.45 in the year of capital
expenditure and 3.14 in the next15. With an infrastructure investment
requirement of at least 8-10 per cent of GDP annually16, India's
infrastructure gap has been estimated at 4.1 per of GDP per annum,
rising to 5.3 per cent when adjusted for climate requirements17. Over
the period 2024-30, it is estimated that infrastructure investment will
need to rise to US$ 1.7 trillion (₹143 lakh crore), with about US$ 0.4
trillion in green investments.18 Going forward, the private sector will
move into centre-stage for infrastructure spending, especially in energy
and transportation. The sources of financing will be diverse, ranging
15
Discussion on Union Budget 2022-23 in the Rajya Sabha, February 11, 2022;
Bose, S. and Bhanumurthy, N. R., 2015, Fiscal Multipliers for India. Margin: The
Journal of Applied Economic Research 9(4), 379-401.
16
RBI internal estimates.
17
Asian Development Bank, 2017, Meeting Asia's Infrastructure Needs, February
1.
18
CRISIL (2023). India's infrastructure spending to double to ₹143 lakh crore
between fiscals 2024 and 2030, compared with 2017-2023. Press Release.
October 17.
from debt and equity issuances in the domestic capital markets to
external commercial borrowings and foreign direct investment (FDI).
VI. Micro Small and Medium Enterprises
Micro, small, and medium enterprises (MSMEs) are crucial to India's
economic and social progress - it is estimated that the MSME sector
accounts for around 30 per cent of India's GDP, 45 per cent of exports
and 62 per cent of employment in the business sector.19 MSMEs are
expected to grow in number in the coming years. The overall finance
demand of India's MSMEs is around US$ 1,955 billion. Of this, the
demand for debt-based finance is pegged at US$ 1,544 billion,20 with
half coming from those that prefer financing from informal sources or
from financially unviable enterprises. This leaves a debt demand of US$
819 billion, of which US$ 289 billion demand is currently fulfilled by
formal credit lenders like banks. The remaining unfulfilled demand of
US$ 530 billion makes up a huge addressable market for banks,
FinTechs and NBFCs.
VII. Skilling
Scaling up for the future will require a multi-faceted approach,
prominently involving skilling human resources in line with the
acceleration in technological transformation. According to the World
Economic Forum, 44 per cent of workers' skills globally would be
disrupted in the following five years21. To skill the workforce of the future
effectively, India needs to invest nearly ₹2-3 lakh crore per annum over
the next 6 years.22 This would include infrastructure, training centres
and partnerships with private sectors.
Financing skilling requirements could combine performance-based
investment instruments such as bonds intended to finance
development programmes with a pre-agreed social outcome;
redeemable skill vouchers enhancing chances of wage employment;
private equity/venture capital funding for tech-based training platforms,
e-learning start-ups and the like; direct support from multilateral
agencies, social and private foundations in the form of social
development programmes and projects; and working capital financing,
trade receivables discounting systems in tie ups with banks to offer
institutional credit to trainees and service providers.23 The Union
Budget 2024-25 has highlighted a larger role for the private sector in
skilling the labour force. As of now only 36 per cent of companies
conduct enterprise-based training.24 The budget proposal for facilitation
of internship opportunities for youth in top 500 companies can increase
skilling opportunities for the labour force alongside meeting skill
demand from industries.
VIII. Climate
Fulfilling India's updated nationally determined contributions (NDCs) to
adapt to climate change will require investment of ₹30 lakh crore (US$
0.36 trillion) over the period 2024-2030.25,26 India's 'National Green
Hydrogen Mission', which aims at a production capacity of 5 million
metric tonnes per annum, will involve an initial outlay of ₹19,744 crore
or US$ 2.4 billion27. Furthermore, the financing requirements to achieve
the goal of becoming independent of fossil fuel imports by 2047 and
achieving net zero by 2070 are estimated at US$10.1 trillion28.
Drawing on the recent experience, sovereign green bonds (SGrBs) can
be used to finance or refinance green projects. SGrBs could also
provide a benchmark for the pricing of green bonds by private
enterprise in order to attract globally mobile environment, sustainability
and governance (ESG) funds. The inclusion of the renewable energy
sector, upto certain limit, under priority sector lending (PSL) by the
Reserve Bank of India (RBI) and the "Framework for Acceptance of
Green Deposits" is expected to facilitate bank funding of green
activities/projects. In conjunction, the RBI's draft disclosure framework
on climate-related financial risks will work towards curtailing the
misplacing of assets and misallocation of capital due to inadequate
25
PIB, 2024: "India needs ₹30 lakh crore investment during FY 2024-2030 to meet
its COP Climate Pledges", IREDA CMD at World Bank Webinar, Ministry of New
and Renewable Energy, February 15.
26
This investment will be required in manufacturing capacity for solar photovoltaic
cells, electrolysers, wind energy equipment, batteries, transmission and conversion
of waste to energy.
27
PIB, 2023, National Green Hydrogen Mission, Ministry of New and Renewable
Energy, January 3.
28
Council on Energy, Environment and Water (2021). Investment Sizing India's
2070 Net-Zero Target. November 18.
information. With 100 per cent FDI under the automatic route for the
renewable energy sector and relaxed norms for external commercial
borrowings for companies raising funds for green projects under the
automatic route, the flow of climate finance, both domestic and
international, is expected to increase, once a green taxonomy is
developed and aligned with global standards.
IX. Digitalisation
India is undergoing rapid digital transformation. In the banking sector,
digital banking platforms, mobile banking apps and online services are
reducing cash dependency and furthering financial inclusion. Several
FinTech companies and digital lending platforms offer quick and hassle-
free loans to individuals and businesses, using data analytics and AI to
assess creditworthiness.
The success of the Unified Payments Interface (UPI) has been a game-
changer, making it one of the fastest-growing digital payment platforms
globally. Other developments include the central bank digital currency
(CBDC) project or e₹ which has the potential for transforming not only
the payments landscape, but also the wider financial system. Digital
supply chain finance (DSCF) is another emerging segment which seeks
to integrate digital financial services into the supply chain, facilitating
smoother transactions, reducing risks and enhancing overall efficiency.
Digital technologies are also being used in insurance, capital markets
and in expanding rural and urban connectivity and access to digital
financial services.
According to the Ministry of Electronics and Information Technology,
India could become a US$1 trillion digital economy by 2025, with digital
financing needs of around 2.3 per cent of GDP.29 Extrapolating from
this near-term goal, the size of India's digital economy in 2047 would
be in the range of US$ 5.4 to 6.9 trillion, and the digital infrastructure
financing gap would work out to around US$ 124-159 billion by 2047.30
X. Conclusion
To conclude, India will need a transformation in its institutional
architecture for intermediating the needs of finance of its aspirational
trajectory. The emphasis would be on financing physical, social and
digital infrastructure, skilling, green energy, innovative manufacturing
and MSMEs. At its core will have to be a robust corporate bond market
with adequate secondary market trading liquidity and breadth. External
financing will play an increasingly vibrant role in propelling investment
and bringing in new technologies, provided the absorptive capacity in
respect of external funding expands with the pursuit of reforms that
enhance export potential and attract FDI. In India's quest for higher
levels of development, financing should be seen as a facilitator, not an
obstructer. As Walter Bagehot, the enunciator of the core dictum of
central banking, wrote in his Lombard Street, 'the less money lying idle,
the greater is the dividend'.31 Circling back to where I began on the
relationship between finance and growth, I can do no better than to
quote the late Anand Chandavarkar, among the finest upholders of the
hallowed tradition of practitioners of the economics profession in the
RBI32: "the debate about whether financial intermediation and
development is a "demand-following" or a "supply-leading"
phenomenon is comparatively subsidiary to the question: whether
(countries) have the necessary insight and economic statesmanship to
adopt appropriate policies?"
Thank you.
32
Chandavarkar, A., How Relevant is Finance for Development?, IMF e-Library,
https://www.elibrary.imf.org>article-A004-en. Jagdish Bhagwati described Anand
Chandavarkar as "in a class by himself, a bibliophile, an intellectual, a gifted writer,
and a superb economist, and all this without arrogance and with a lot of grace and
charm."