In the hype and celebration surrounding India’s GDP growth, many have argued that two important features of those growth numbers tend to be ignored. The first is that recent annual growth figures are high because they reflect a recovery from a sharp collapse of GDP during the COVID downturn. Relative to pre-COVID levels, the rise in GDP post-COVID is by no means impressive. The second is that the new GDP series with 2011-12 as base—the construction of which involved questionable choices of new data sources and changes in methodology—has tweaked the numbers to ramp up both the level and the rate of growth of the estimated figure. India’s relatively high growth post-COVID may partly be a statistical mirage.

But these critical, statistical reflections on recent Indian growth trends do not account for all the “dynamism” that the GDP growth figures since the mid-2000s point to. The more substantive criticism is that much of that growth has ridden on speculative bubbles created by the excess liquidity spawned by financial liberalisation, especially external financial liberalisation. The intensification of that liberalising trend coincided with long-term changes in monetary policy in the advanced capitalist nations, especially the US, with the completion of a shift from relying on fiscal stimuli to spur growth to a reliance on monetary policy instruments and cheap money as a fuel for growth. Monetary easing, or the expansion of money supply and “liquidity”, was used to trigger the credit boom on which economic growth rode. And a policy relying on “quantitative easing” and near-zero interest rates was adopted in response to the Great Recession that the 2008 financial crisis set off. The results of these policies were sharp increases in the volume of yield-hungry, internationally mobile financial capital seeking new avenues for investment.

India was one of the many countries chosen as a target for that investment, resulting in persistent and volatile inflows of such capital. Despite fluctuations, involving the periodic retreat of investors, cumulative net inflows were positive and rising, leading to the huge accumulation of legacy foreign finance in India’s debt and equity markets. Between January 2004 and September 2023, for example, the cumulative net inflow of foreign portfolio investment into India amounted to $262 billion.

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A corollary of that accumulation was a substantial increase in liquidity, or near cash, in the system. Mediated by banks, especially those in the public sector controlled by the state, that hoard of money provided the basis for a credit boom that set off investment and consumption spending, the demand effects of which provided the basis for growth.

Recipe for fragility

There can be little doubt that this type of growth is a recipe for fragility. It is fragile because as the credit that underpins that growth increases, so does the probability of default rise, especially if the system is subject to any shock that affects the capacity of debtors to service and repay that debt. A recent acknowledgement of that came from the Reserve Bank of India. In mid-November, the RBI announced an increase of 25 percentage points in the “risk weights”, or measures of risk, that banks must use when valuing their exposure to unsecured retail loans, credit card receivables, and lending to non-banking financial companies (NBFCs). A higher risk weight would mean that banks would have to set aside larger amounts in high-cost, uncommitted, and liquid assets that can be used to meet potential losses if such loans turn bad. The need to call for larger loss-absorbing buffers does suggest that the central bank wants to rein in retail lending by banks since it senses that the risks associated with such lending are rising. But this could aggravate the problem. Higher risk weighting would push banks to raise interest rates on loans to consumers and NBFCs at a time when base interest rates have been on the rise. That could increase the probability of default.

Inside IKEA’s first city store in Mumbai, in December 2021. As opposed to the earlier investment in the infrastructure sector, current investments are largely in the retail sector. 
| Photo Credit:
HEMANSHI KAMANI/REUTERS

The central bank’s decision is prompted by the fact that in recent times retail lending, or unsecured lending to individuals either directly or through NBFCs, has risen faster than overall commercial bank credit. If we restrict ourselves to just public sector banks, between March 2014 and March 2023, the share of personal loans in total credit outstanding rose from 14.3 per cent to 28.3, while that of lending to “finance” rose from 8.6 to 14.1 per cent. With interest rates having risen in recent times, the probability of default on these loans has risen, pushing the central bank to moderate that increase. If this, and any further action of the central bank, slows down the rapid growth of retail lending, investments in housing and spending on items varying from automobiles and consumer durables to discretionary spending on services of various kinds would fall. That would adversely affect GDP growth.

This is not the first time that India’s policymakers have been faced with this predicament. As has been widely noted, the sharp rise in the non-performing assets (NPAs) on the books of banks in the period after 2014 was on account of the spike in bank lending in the years after 2004, when liquidity in the Indian banking system registered significant increases. In those years, while lending to the retail sector did rise, the striking shift was in bank lending to the infrastructural sector (power, telecommunications, civil aviation, roads, and so on).

The share of infrastructural lending in total lending to industry rose from just 7.3 per cent in 2000 to 35.3 per cent by 2016. Much of that lending went sour, resulting in a sharp rise in NPAs after the RBI issued stricter guidelines for recognition of the quality of assets on the books of banks. A substantial share of those loans had to be written off, leading to losses and the erosion of the capital of banks, which had to be neutralised with recapitalisation measures. That had slowed the pace of bank lending, leading to a loss of growth momentum well before the COVID-19 pandemic struck.

Having burnt their fingers in infrastructure lending, banks shifted focus to lending to the retail sector, on the grounds that default rates there were much lower. But that assessment now seems in question, raising once again the question of the fragility of whatever growth is under way.

Excess liquidity

There is, however, one difference between the earlier credit-driven infrastructural investment-led boom and the more recent retail-credit-driven expansion. The former was substantially driven by the state, while the latter seems to reflect the exercise of choice by banks from the limited options available. The state could drive the infrastructural investment-led boom largely because the banking system in India was predominantly in the public sector. Public ownership does not necessarily hold back banks from lending in areas where liquidity and maturity mismatches imply high risk and probabilities of default. If the state as owner is so inclined, it can push public banks down that road. And some private banks may just follow the public sector.

A combination of factors seemed to have encouraged the state in the years of “excess liquidity” to opt for that direction in banking policy. First, the sheer opportunity that excess liquidity that the large inflows of foreign capital created required banks to substantially expand lending. The ratio of the outstanding non-food credit of scheduled commercial banks to GDP rose from 26 per cent in 2004 to 52 per cent in 2019, before the stimulus lending provided during the COVID pandemic. The second was the “fiscal crisis”, which resulted from a long-term unwillingness to adequately tax either the wealth or the incomes of the superrich and from the self-imposed limits on deficit-financed spending, which meant that the state could not invest adequately in infrastructure. So private investors had to be permitted and persuaded to do so. Given the reticence of private players to risk much of their own capital, banks had to be persuaded to provide a large share of the needed capital.

The signal to public banks that they needed to lend to infrastructure (and possibly that they would be insured against risk with an implicit sovereign guarantee) made a difference. The share of infrastructure in lending to industry rose from 7 per cent in 2000 to 36 per cent in 2020. A wide range of sectors and players benefited, but many—such as Lanco Infratech, Kingfisher, Jet Airways, Anil Dhirubhai Ambani Group, and a host of telecom players—could not survive. While it could be argued that mismanagement and malfeasance played a role in the failure, it is not true that the absence of such traits explains the success of groups such as Reliance Industries and Adani. The more successful groups clearly benefited from supportive policies that helped ease the road to profitability.

Moreover, in their case, the ample supply of cheap liquidity and benign regulatory neglect worked to their advantage. Speculation in equity markets financed with credit delivered huge increases in the share prices of many companies, allowing them to accumulate investible reserves through sale of shares at a premium and to pledge shares with inflated values to borrow large sums from banks. That helped finance rapid expansion in areas that required large commitments of capital. Relying solely on own capital to finance rapid growth in multiple infrastructural sectors was neither attractive nor rational. Bank finance that could be restructured in case of financial difficulties helped. State policies also helped render those investments profitable, despite the burden and cost of debt.

Aircraft of Kingfisher Airlines parked at the Indira Gandhi International Airport in New Delhi in February 2012. The sharp rise in the non-performing assets of banks in the period after 2014 was on account of the spike in bank lending in the years after 2004 in sectors like infrastructure and civil aviation.  
| Photo Credit:
MANAN VATSYAYANA/AFP

In addition, there are suggestions that the Securities and Exchange Board of India (SEBI) tweaked rules and ignored pointers to help entities like Adani Group to access capital from related enterprises abroad for stock transactions that helped inflate share values, violating in the process norms with regard to shareholding structure. Adani Group has, however, dismissed such claims made by diverse sources such as Hindenburg Research and the Organized Crime and Corruption Reporting Project as being false and motivated.

These allegations, howsoever true or false, point to a change in the relationship between state and capital in India. In the immediate post-Independence years, the Indian state made an effort to distance itself from, regulate, and even discipline big business. But the failure to implement measures put in place for the purpose meant that concentration remained high and even increased.

The share of the top 10, 20, and even 100 business groups remained high and even increased, as official committees chaired by Das Gupta (1964) and Subimal Dutt (1969) found. There were also periodic revelations of scams involving collusion of government officials and business groups. But there was no evidence of concerted efforts to promote some or a few business groups as policy.

Neoliberalism’s new turn

Even in the 1980s and after, when state regulation lost its legitimacy, corruption revelations increased, and new business houses such as the Ambani group were alleged to be influencing government policy to help expansion, the promotion of selected business groups was not seen as a conscious policy pursued for either economic or political ends. It was under the United Progressive Alliance (UPA) government, especially its second tenure from 2009 to 2014, that neoliberalism increasingly took the form of promoting sections of big business, even if it involved skewing wealth and income distribution in their favour.

Women with a representative of a microfinance company in a village in Katni district, in Madhya Pradesh. Retail lending has risen faster than overall commercial bank credit.
| Photo Credit:
The Hindu Archives

A benevolent wealth, income, and corporate tax regime together with self-imposed fiscal conservatism weakened the ability of the state to deliver growth and adequate welfare. The state restricted itself to minimal welfare schemes and looked to the private sector to drive growth with state support. But even then, many moves of the government, especially under UPA II, were seen as reflecting the pursuit of neoliberal policies, with attendant corruption, rather than the conscious fashioning of a nexus between state and private capital.

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Unlike that, under the subsequent two terms of the National Democratic Alliance, there is much evidence of a close nexus between the state and select business houses being exploited for mutual political and economic benefit. That nexus has, it appears, hugely increased wealth and income inequality. That, too, takes the shine off the moderate growth the Indian economy has recorded in recent times.

C.P. Chandrasekhar taught for more than three decades at the Centre for Economic Studies and Planning, Jawaharlal Nehru University, New Delhi. He is currently Senior Research Fellow at the Political Economy Research Institute, University of Massachusetts Amherst, US.