Context:
Excessive Financialisation and Its Risks to Indias Economy: The Economic Survey 202425 throws up a red flag on financialisation and risks it poses for the economy against the backdrop of the changes going on in the Indian financial sector.
What is Financialisation
- Financialisation refers to the phenomenon wherein financial markets increasingly dictate policy and macroeconomic outcomes.
- This has led to unprecedented levels of public and private sector debt in developed economies, thus posing risks to economic stability.
- The Survey advises India to balance financial sector development and growth without falling into the trap of excessive financialisation as the nation aims at aligning its financial system with its long-term economic goals for 2047 2 Transformative Shifts in India’s Financial Sector.
New Developments
- Emerging Trends
- The financial sector is undergoing significant changes, with a rise in consumer credit and increasing reliance on non-bank financing options.
- Declining Role of Banks
- Traditional bank dominance in providing credit is shrinking. Banks’ share of total credit has fallen from 77% in FY11 to 58% in FY22, while consumer credit has risen from 18.3% to 32.4% between FY14 and FY24.
Credit-to-GDP Ratio and Bank Credit Growth
- Credit to GDP Ratio
- Despite high growth rates of bank credit since 2022, the credit-to-GDP ratio is still below the trend line that suggests recent credit growth is sustainable and does not presage overheating.
- It is an important indicator of the health and growth trajectory of the economy.
Risks from Artificial Intelligence (AI) in Banking
- Transparency Issues
- The Survey questions the use of AI in the banking system raising risks such as lack of transparency, trust issues, and problems in auditing AI driven decisions.
- Other Risks
- Increased use of AI also poses risks to human resources, cybersecurity, and third-party service providers which may damage the integrity and reliability of the financial system.
Reforms Needed for Growth and Stability
- Insolvency and Bankruptcy Code (IBC)
- To maintain a 7-8% growth rate over the next decade, India needs to reform and improve the IBC to enhance operational efficiency and speed up resolution processes, particularly for MSMEs, which face significant legal costs.
- Corporate Bond Market
- The corporate bond market saw significant growth in 2024, with issuances totaling â‚ą7.3 trillion. However, most issuances occurred through private placements, limiting the participation of retail investors. The Survey emphasizes the need for greater access and transparency in this market.
Foreign Direct Investment (FDI) in Services
- Insurance Sector Dominance
- The insurance sector received the highest share of FDI equity inflows in the services sector during the first half of FY25, with 62% of the $5.7 billion in equity inflows.
- FDI Policy Evolution
- The FDI limit in the insurance sector was gradually raised from 26% in 2000 to 74% in 2021, reflecting the sector’s growing importance and attractiveness to foreign investors.
