Economic growth is driven by investments that yield positive returns, including innovations that make those investments more productive. Putting capital to work is at the heart of capitalism. To grow at the rate required by the government’s goal of making India an advanced economy by 2047, the country needs to do better in putting capital to work, through some combination of increased investment and more effectively deployed investment.
The post-independence Indian growth policy model not only involved government control of production and trade, but also of investment. The control of investment changed alongside liberalisation of production and trade, but often lagged, creating a drag on growth. There were early wins like the modernisation (and liberalisation) of the stock market, but these are relatively minor in their overall impacts. Unlike control of production and trade, which is more often driven by political ideology than good economic reasoning, there are important reasons to be cautious in financial liberalisation — because the financial sector involves a complex ecosystem of promises and obligations, it is subject to what economists call “systemic risk”.
We saw this in the global financial crisis of 2007-2009. Economist Raghuram Rajan, who saw this crisis brewing, coincidentally was asked to chair a committee on Indian financial sector reform in 2007, producing its report the next year. The report’s headline title, “A Hundred Small Steps”, captured the idea of avoiding big bang reforms, with their associated risks and political costs, in favour of a series of nudges in the direction of a deeper, more inclusive, and more effective financial system, to better put capital to work in the cause of Indian economic growth.
The Rajan report was followed by the Nachiket Mor committee report in 2014, and the Deepak Mohanty report in 2015 — both while Rajan was governor of the Reserve Bank of India. These reports detailed plans for greater financial inclusion, through the deployment of digital infrastructure in particular. For Indian households, these changes have been a big success, especially in the realm of payments. For households with income levels that allow discretionary saving, new opportunities have also opened up. But the lowest income households have little flexibility in their resource allocation choices, so financial inclusion has had less impact for now.
Small firms were part of the project of financial inclusion, but progress in small business finance has been slower. Large companies in India benefit from controlling finance in their supply chains, squeezing small business suppliers. Even the government does this to small firms, though less deliberately and more from its own inefficiencies and poor fiscal management. Public sector banks (and non-bank financial companies) have also been poor at this aspect of financial intermediation, for multiple reasons. At the same time, they also did poorly in allocating capital to large firms as well, leading to a non-performing loan crisis around the time of the Mor and Mohanty reports.
Fast forward to 2026, and there is a huge amount of work yet to be done, in the sphere of financial sector reform. A piece in Ideas for India by Amrita Agarwal and Harsh Vardhan summarises the current situation and provides recommendations. They point out that the cost of capital for Indian firms is structurally higher than it needs to be, by 300 to 500 basis points in financial sector language, or 3 to 5 percentage points in everyday terms. This is a staggering effective tax on Indian business. In a world where the cost of capital has been rising, along with the demand, this is like running a race with one’s legs tied together. These authors, both financial sector experts, list the reasons, including poor institutions for financial intermediation, crowding out of the private sector by the government, and legacy systems of inefficient regulation of financial institutions and markets.
Many, if not all of the issues present in 2026 were raised in the Rajan report of 2008. Global events, policy missteps, institutional inertia, and political challenges have all been factors in slowing down progress. The difficulty of reforming a whole ecosystem of financial institutions and markets has also been a factor — why some countries opted for a big bang approach, though often from a more robust starting point. India may have reached that situation where a more rapid and systemic approach to financial sector reform is possible without too much risk. And there are ways of mitigating those risks, both through good policy design and sequencing, and through providing backstops. Global capital will play a crucial role in all of this — both when it is just flows of money, and when it is tied to specific projects, including technical knowledge and experiential know-how.
As Agarwal and Harsh Vardhan put it, allocating capital efficiently is a strategic imperative for India. Or again, “India’s challenge is therefore not only to grow faster, but to finance growth more intelligently.” This requires concerted and coordinated financial sector reforms to lower the price of capital, while simultaneously improving how it is put to work.
Disclaimer: The views expressed are the author’s own and do not reflect the official policy or position of Financial Express.