Why India needs smarter finance: It’s not just about enlarging the country’s financial sector

Measures such as the introduction of a market-making framework for corporate bonds, the development of total return swaps and bond-index derivatives, incentives for large municipal bond issuances and the creation of mechanisms such as the Infrastructure Risk Guarantee Fund and real estate investment trusts (REITs) linked to central public sector enterprises (CPSEs) point to an attempt to deepen long-term, market-based finance and improve risk distribution beyond banks.

These initiatives reflect an emerging policy shift away from volume-driven credit expansion towards improving market infrastructure, liquidity and institutional participation.

India’s economic story is often told through large reassuring numbers: trillion-dollar GDP milestones, record tax collections, booming equity markets and the distinction of being the world’s fastest-growing large economy.

Yet, these headlines mask a less comfortable reality. For large parts of the economy, finance still does not work as it should. Recent debates on credit growth, capital markets, housing finance and regulation raise a major question: Does India need a larger financial system or a more effective one?

At first glance, Indian data on corporate indebtedness seems to argue for scale. India’s non-financial corporate credit-to-GDP ratio remains around 55–60%, far below China’s nearly 180% and well below most advanced economies.

This gap is often interpreted as evidence of financial underdevelopment. However, depth is not simply about the quantity of credit. What ultimately matters is how finance is structured: Who receives credit, at what maturity, how risks are shared and whether savings are transformed into productive capital.

India’s score on the IMF’s Financial Development Index helps clarify this distinction. India has made undeniable progress. The index rose from roughly 0.12 in the early 1980s to about 0.54 by 2020, a fourfold increase.

However, this improvement was driven largely by gains in efficiency, liberalization and market functioning, rather than by sustained balance-sheet expansion. Since the mid-2010s, momentum has slowed. The depth of financial institutions has stagnated, reflecting weak growth in long-term credit. Equity market liquidity and turnover lifted efficiency scores, but market depth remains constrained. India’s corporate bond market is only about 18–20% of GDP, far below China’s 40–45% and the 80–120% typical of advanced economies.

The index thus reveals a system that has largely exhausted the easy gains from reform but has yet to transition to the next stage of development built on long-duration risk capital.

Household balance sheets illustrate the problem starkly. Nearly 80% of Indian household wealth is concentrated in real estate and gold, with bank deposits accounting for much of the rest. Property is perceived as safer, transaction costs discourage churn and long-term financial products often appear complex and opaque. The result is a paradox: India saves a great deal, but those savings do not reliably become productive investment.

Corporate finance shows a similar imbalance. India’s corporate credit ratio—credit to non-financial firms as a share of GDP—stands at only about 50%. In China, it exceeds 110% and in advanced economies, it typically ranges between 70% and 100%.

Shallow corporate bond markets force firms to rely on banks and internal accruals. This matters because bond markets provide long-term funding, price discovery and risk dispersion. When they are underdeveloped, banks are forced to carry risks that should be spread across investors, making lending cycles volatile and credit cautious.

The latest budget explicitly acknowledges this constraint by focusing on the post-issuance ecosystem of corporate debt. The proposed market-making framework, together with total return swaps on corporate bonds and derivatives based on corporate bond indices, seeks to improve liquidity, price discovery and risk-sharing. These functions are essential steps if bond markets are to complement bank lending in providing necessary risk capital to achieve the 2047 Viksit Bharat vision.

The sharpest contrast with mature financial systems lies in institutional investors. Pension and insurance assets in India together amount to less than 30% of GDP. In countries such as Canada and the Netherlands, these pools exceed 150–200% of GDP. This patient capital finances infrastructure, housing and energy transitions without overwhelming banks or public budgets.

India’s lack of such depth explains why long-term projects remain dependent on banks and the state, and why financial deepening often stalls. The budget attempts to address this gap through complementary asset-creation and risk-mitigation mechanisms.

The Infrastructure Risk Guarantee Fund is intended to partially de-risk long-term infrastructure lending, while the proposed recycling of CPSE real estate assets through dedicated REITs aims to expand the supply of stable, yield-generating instruments suited to institutional portfolios. These measures seek to align long-term savings with long-maturity investment needs.

India has excelled at transactional liquidity. Digital payments have transformed daily economic life and made payments a near-frictionless public utility. However, balance-sheet liquidity, essential for the capacity to absorb and distribute risk, remains thin. In mature systems, shocks are cushioned across layers involving banks, bondholders, insurers, pension funds and capital markets.

In India, risk still flows back to banks and ultimately the sovereign. This is why credit booms are often followed by painful clean-ups. Capital was not absent; risk-sharing mechanisms were.

The budget’s measures aim to deepen market infrastructure, expand the set of financing instruments and channel long-term funds into infrastructure and real estate. This should strengthen the broader bond-based financing ecosystem.

The author is professor, Madras School of Economics.