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CHAPTER
STATE OF THE ECONOMY:
GETTING BACK INTO THE
FAST LANE
01
The global economy exhibited steady yet uneven growth across regions in 2024.
A notable trend was the slowdown in global manufacturing, especially in Europe
and parts of Asia, due to supply chain disruptions and weak external demand.
In contrast, the services sector performed better, supporting growth in many
economies. Inflationary pressures eased in most economies. However, services
inflation has remained persistent. Although commodity prices have stabilised,
the risk of synchronised price increases persists. With growth varying across
economies and last-mile disinflation proving sticky, central banks may chart
varying paths of monetary easing. This will lead to uncertainty over future
policy rates and inflation trajectories. This apart, geopolitical tensions, ongoing
conflicts, and trade policy risks continue to pose significant challenges to global
economic stability.

In this global context, India displayed steady economic growth. As per the
first advance estimates of national accounts, India’s real GDP is estimated to
grow by 6.4 per cent in FY25. Growth in the first half of FY25 was supported by
agriculture and services, with rural demand improving on the back of record
Kharif production and favourable agricultural conditions. The manufacturing
sector faced pressures due to weak global demand and domestic seasonal
conditions. Private consumption remained stable, reflecting steady domestic
demand. Fiscal discipline and strong external balance supported by a services
trade surplus and healthy remittance growth contributed to macroeconomic
stability. Together, these factors provided a solid foundation for sustained
growth amid external uncertainties.

Looking ahead, India’s economic prospects for FY26 are balanced. Headwinds
to growth include elevated geopolitical and trade uncertainties and possible
commodity price shocks. Domestically, the translation of order books of
private capital goods sector into sustained investment pick-up, improvements
in consumer confidence, and corporate wage pick-up will be key to promoting
growth. Rural demand backed by a rebound in agricultural production, an
anticipated easing of food inflation and a stable macro-economic environment
provide an upside to near-term growth. Overall, India will need to improve
its global competitiveness through grassroots-level structural reforms and
deregulation to reinforce its medium-term growth potential. 1
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INTRODUCTION
1.1 Global economic conditions are shaped by changing growth dynamics, fluctuating
commodity prices, and evolving monetary policies, which influence domestic inflation,
trade balances, and capital flows. At present, this interconnectedness is complicated by
unusual levels of geopolitical tensions, supply chain disruptions, and climate-related
shocks. Against this background, this chapter is organised broadly into four sections.
The first section outlines the global economic scenario comprehensively, highlighting
growth and inflation trends, policy stances, and key emerging risks and uncertainties.
The second section focuses on the domestic macroeconomic situation, examining
developments from the demand and supply sides. The third section delves into the
emerging trends in public finances, inflation, external sector, financial markets and
employment. The concluding section presents the prospects and outlook for growth in
the presence of global headwinds while capitalising on domestic growth drivers.

GLOBAL ECONOMIC SCENARIO

Steady global growth and varied regional dynamics

1.2 Globally, 2024 has been an eventful year. The year witnessed unprecedented
electoral activity on the political front, with more than half of the global population
voting in major elections across countries. Meanwhile, adverse developments like the
Russia-Ukraine conflict and the Israel-Hamas conflict increased regional instability.
These events impacted energy and food security, leading to higher prices and rising
inflation. Cyberattacks also became more frequent and severe, with growing human
and financial consequences due to the increasing digitisation of critical infrastructure.1
Geopolitical tensions, have reshaped global trade. Geopolitical risks and policy
uncertainty, especially around trade policies, have also contributed to increased
volatility in global financial markets.2

1.3 Nonetheless, global economic growth has remained fairly moderate. The global
economy grew by 3.3 per cent in 2023. The International Monetary Fund (IMF) has
projected growth of 3.2 per cent and 3.3 per cent for 2024 and 2025, respectively. Over
the next five years, global growth is expected to average around 3.2 per cent, which is
modest by historical standards. While the overall global outlook remains steady, growth
varies across different regions.

1 S&P Global. (n.d.). Geopolitical risk. S&P Global. https://tinyurl.com/2yrnnmsp.

2 Reserve Bank of India. (2024). Press release: Minutes of the Monetary Policy Committee Meeting, December 4
2 to 6, 2024. https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=59347.

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Chart I.1: Resilient global growth Chart I.2: Steady growth outlook
trends in 2024 across country groups

4.4
2023 2024 2025 4.2 4.2

3.3 3.2 3.3

1.9
1.7 1.7

World AEs EMDEs

Source: IMF WEO (January 2025)

Source: OECD Economic Outlook, Volume 2024
Issue 2. Note: AEs- Advanced Economies, EMDEs- Emerging
market and developing economies

1.4 Despite higher interest rates, advanced economies (AEs) witnessed stable growth
in the first half of 2024. This was on account of moderating inflation and sustained
employment and consumption.3 However, the growth outlook differs between the
United States (US) and the Euro Area. Growth in the US is expected to remain strong
at 2.8 per cent in 2024 and may decline slightly in 2025, reflecting a moderation in
consumption and exports.4

1.5 In the Euro area, growth is expected to improve from 0.4 per cent in 2023 to
0.8 per cent in 2024 and further to 1.0 per cent in 2025 on the back of improving services
activity. However, growth outcomes in Europe have been varied. Some countries like
Spain, France, Poland, and the United Kingdom have benefitted from the strength of
their services sector. Meanwhile, manufacturing-intensive countries like Germany and
Austria are being weighed down by weak demand.5 Germany’s structural weaknesses,
particularly in manufacturing (Chart I.3), have been noticeable, contributing to the
slackness in Europe’s manufacturing. Political developments in France and Germany
are also adding to policy uncertainty in Europe’s major economies.

1.6 The divergence of the growth trajectories of Europe and the US can also be seen in
Citi Economic Surprises indices for these countries (Chart I.4). These indices compare
actual data releases with analyst expectations. A value above zero indicates the data
3 Euromonitor International. (2024). Global economic outlook: Q3 2024. Euromonitor International. https://
www.euromonitor.com/article/global-economic-outlook-q3-2024.
4 International Monetary Fund. (2024). Regional economic outlook: Western Hemisphere, October 2024. https://
tinyurl.com/2ep72n66.
5 International Monetary Fund. (2024). Regional economic outlook: Europe, October 2024. https://tinyurl.
com/2s377x4z. 3

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Chart I.3: Structural weakness in the Chart I.4: Citi Economic Surprise
German economy Indices indicating unexpected
resilience of the US

Source: Bloomberg

was stronger than analyst expectations, while a negative value indicates weaker actual
data compared to expectations. Between January 2023 and November 2024, data for
the US economy continued to present more ‘positive’ surprises than the EU, compared
to the analyst estimates.

1.7 Within Asia, Japan's growth was hindered by domestic supply disruptions in the early
part of the year, while China’s growth weakened after the first quarter, affected by sluggish
private consumption and investment, alongside challenges in the real estate sector.6
Services sector growth steady; manufacturing faces challenges
1.8 The global composite Purchasing Managers’ Index (PMI) has stayed in the
expansion zone for the fourteenth month in a row (as of December 2024). The services
sector continues to show strength while manufacturing PMI indicated contraction.7

1.9 In 2024, the global manufacturing PMI started strong, moving into expansion for the
first time since mid-2023 and remained so through the first half of the year. By July 2024,
weaker conditions pushed the PMI back into contraction. Following four months of gradual
declines, the global manufacturing sector stabilised in November with an index value of
50.0, indicating no overall change in operating conditions.8 Output growth in consumer
and intermediate goods offset a downturn in investment goods. Increased production was
attributed to stabilising new order intakes and the clearance of backlogs of work.

6 International Monetary Fund. (2024,October 31). Regional economic outlook for Asia and the Pacific. October
2024. https://tinyurl.com/ycka65ub.
7 S&P Global. (2025, January 6). Global growth accelerates as solid service sector expansion offsets manufacturing
weakness. https://tinyurl.com/mr3pkjmh.
4 8 S & P Global. Global manufacturing PMI highlights. https://tinyurl.com/bddkyr27.

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Chart I.5: Global manufacturing stabilises in November 2024

Global Manufacturing PMI Global Services PMI Global Composite PMI

56

54

52
50
50

48

46

44

Source: Bloomberg

1.10 Production trends varied widely across regions in December (Chart I.6 and I.7).
Production rose in 13 of the 30 nations for which December PMI data were available.
The Eurozone saw the steepest contractions, led by France, Germany, and Austria.
North America showed mixed results, with Canada’s growth offset by declines in the US
and Mexico. India reported the strongest expansion of output. The outlook for global
manufacturing also remained subdued in December, with business sentiment dipping to
a three-month low.9
Chart I.6: PMI manufacturing in Chart I.7: PMI manufacturing in
advanced economies emerging market economies
Canada U.S. Brazil Mexico
U.K. Japan China India
European Union Global
Indonesia Emerging Markets
60 60

55 55

50 50

45 45

40 40

Source: Bloomberg

9 S&P Global. (2025, January 2). J.P.Morgan Global Manufacturing PMI: Global manufacturing contracts at end
of 2024. https://tinyurl.com/yn3a2fnm. 5
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1.11 On the global services front, the global Services PMI Business Activity Index rose
to a four-month high of 53.8 in December. This signals expansion for the twenty-third
consecutive month. Expansion was recorded across business, consumer, and financial
services. Financial services experienced the fastest pace of expansion.

Inflationary pressures ease, but risks of synchronised price pressures

persist
1.12 Inflation rates across economies have trended downward steadily, approaching
central bank target levels. This has been the result of tighter monetary policy regimes
across the globe and supply chains adapting to higher levels of economic uncertainty.
As a consequence, price pressures eased in 2023 due to a reduction in fuel prices. In
2024, it was attributed to a broad-based reduction in goods inflation.

Chart I.8: Inflation in advanced Chart I.9: Inflation in emerging

economies market economies

Source: OECD and MoSPI

1.13 However, disinflation seems to have slowed due to the persistence of services
inflation, while core goods inflation has fallen to negligible levels. The IMF World
Economic Outlook (WEO) October 2024 reasons that this is on account of higher
nominal wage growth as compared to pre-pandemic trends. The report notes that there
are early signs that these pressures are abating, thereby aiding the disinflation process.

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Chart I.10: Global shipping prices have moderated from their peak

Shanghai Baltic dry WCI global

400

300

200

100

Source: OECD Economic Outlook, Volume 2024 Issue 2

1.14 However, recent disruptions in global shipping have pushed goods prices up. These
events have also pressurised the global supply chains. This is reflected in higher levels
of the Global Supply Chain Pressure Index (GSCPI) in the quarter ending September
2024. Chart I.10 shows that while container freight rates normalised in 2023, they
experienced a significant surge in 2024. This was due to stronger demand, shipping
route disruptions in the Red Sea, and delays at the Panama Canal, all of which have
partially sustained inflationary pressures.10

1.15 The risk to inflation from increases in commodity prices seems limited in 2025-
2026. After softening in 2024, commodity prices are expected to decline moderately
(Chart I.12). While this easing is a positive sign, the risk of synchronised price increases
remains, especially during periods of global economic stress. Although recent shocks
like geopolitical conflicts and extreme weather have caused price fluctuations, their
impact has largely subsided, leading to more varied commodity prices. However,
escalating tensions continue to pose a risk of synchronised price increases, undermining
the effectiveness of inflation mitigation.11

Easing monetary policy stances amidst divergent expectations

1.16 Taking advantage of the steep decline in inflation, major central banks have
implemented a policy pivot to lower policy rates. Given the differentials in the
trajectories of economic activity across countries, the pace of policy rate reduction is
bound to differ. There is also uncertainty regarding the levels of the year-ahead and
terminal policy rates across economies at the end of the current monetary easing cycle.

10 United Nations Conference on Trade and Development (UNCTAD). (2024). Trade and Development Report
2024. (Page 51) https://tinyurl.com/2c7tjrxu.
11 World Bank. (2024). ‘Commodity Price Synchronization: A New Era?’ https://tinyurl.com/nk59hcpx. 7
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Chart I.11: Price movements across Chart I.12: Commodity prices

commodity groups projected to decline
Total Commodity Index
Energy 2022 2023 2024f 2025f 2026f
Agriculture 180
200
Metals & Minerals 160
140
160
120

Index
100
120
80
60
Index

80 40
20
40 0

Energy

Agriculture
Commodity

Metals and
Minerals
0

Index
Total
Jun-20

Jun-23

Dec-23

Jun-24

Dec-24
Jun-21
Dec-20

Jun-22

Dec-22
Dec-21

Source: World Bank Commodities Price Data (The Pink Source: World Bank Commodity Price Forecasts
Sheet) (October 2024)
Note: ‘f’ refers to forecast

Chart I.13: Increased uncertainty over the long-term level of Federal

Funds rate

Source: Bank for International Settlements (BIS), FOMC. Note: Each dot represents an individual FOMC
member's assessment of the federal funds rate five years from the date of assessment.

1.17 In the short term, the US market expectations of the Federal Funds Rate (FFR)
were much lower than the actual FFR level for both 2023 and 2024. Similar uncertainty
may persist over the course of 2025.12 One way to visualise the uncertainty regarding
the FFR over the long term is through the expectations of policymakers about the ‘long-
run’ policy rate. The Federal Open Market Committee (FOMC) presents a dot-plot of
its members’ assessment of the direction of the policy rate over different time horizons.
Chart I.13 presents the dot-plots that represented the FOMC members’ assessments in
December 2021, December 2023, and December 2024. The dot-plots show that while
12 Ashworth, M., & Gilbert, M. (2025, January 2). Politics, economics and markets create a 2025 three-body
8 problem. Bloomberg. https://tinyurl.com/mppdkbdr.
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the long-run policy rate is likely to be higher, the variance in members’ expectations is
also larger, indicating increased uncertainty over the terminal policy rate.

Chart I.14: Policy rates in advanced Chart I.15: Policy rates in emerging
economies market economies
USA UK
6
Euro Area Japan
5

-1

Source: Bank for International Settlements (BIS)

1.18 The success in inflation control, the consequent easing of monetary policies, and
expectations of lower borrowing costs began to reflect in the downward trajectory of
sovereign bond yields of advanced economies between April and September 2024.
However, renewed global uncertainty over inflationary pressures and the direction of
monetary policies have pushed bond yields up in October - December 2024. Lower
growth prospects and deflationary pressures have pushed Chinese sovereign bond
yields lower, thereby widening the sovereign yield spread between the world’s two
largest economies.

Chart I.16: Sovereign bond yields in Chart I.17: Sovereign bond yields in
advanced economies emerging market economies

Source: Bloomberg
Note: Yield on 10-year sovereign bonds 9
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Geopolitical uncertainties continue to pose risks to the global

economic outlook
1.19 Geopolitical risks remain elevated (Chart I.18) due to ongoing conflicts, which
pose significant risks to the global economic outlook. These risks can influence growth,
inflation, financial markets, and supply chains. An intensification of the evolving
conflicts in the Middle East, or the Russia-Ukraine conflict, could lead to market
repricing of sovereign risk in the affected regions and disrupt global energy markets.
The oil market is well-supplied for now. However, any damage to energy infrastructure
could tighten supply, adding uncertainty to the global economic outlook.13

1.20 Tensions in the Middle East have disrupted trade through one of the critical
shipping routes – the Suez Canal. About 15 per cent of global maritime trade volume
normally passes through the Suez Canal. In response, several shipping companies have
diverted their ships around the Cape of Good Hope, which has increased delivery times
by 10 days or more, on average. These disruptions have led to higher freight rates along
major shipping routes, which in turn impact global trade activity.

Chart I.18: Geopolitical Risk (GPR) Chart I.19: World Trade Uncertainty
Index higher in 2024 Index (WTUI) elevated in 2024
GPR
250
GPR (yearly average)-2023
GPR (yearly average)-2024
200

150

100

50

Source: Economic Policy Uncertainty Source: Economic Policy Uncertainty

https://www.policyuncertainty.com/gpr.html https://worlduncertaintyindex.com/data/

1.21 Heightened risks are also evidenced by other indices, such as the Geopolitical
Economic Policy Uncertainty index, which remains elevated due to global concerns
about economic policies. Similarly, the World Trade Uncertainty Index has risen,
driven by trade tensions and policy shifts in major economies. Trade policy uncertainty
has increased sharply in recent months, though it has not yet reached the levels seen in
2018-19. The stock of import-restrictive measures within G20 economies continues to

10 13 OECD. (2024, December). OECD Economic Outlook, Volume 2024 Issue 2. https://tinyurl.com/m6yn9wz2.
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grow, now affecting 12.7 per cent of G20 imports—more than three times the coverage of
such measures in 2015. If uncertainty persists and trade-restrictive measures continue
to rise, they could increase costs and prices, deter investment, hinder innovation, and
ultimately reduce global economic growth. In light of these developments, Chapter 5
of the Survey on the Medium-Term Outlook elaborates on the global factors and the
importance of strengthening the levers of domestic growth.

DOMESTIC ECONOMY REMAINS STEADY AMIDST GLOBAL

UNCERTAINTIES
1.22 As per the first advance estimates released by the National Statistical Office,
Ministry of Statistics & Programme Implementation (MoSPI), the real gross
domestic product (GDP) growth for FY25 is estimated to be 6.4 per cent. From the
angle of aggregate demand in the economy, private final consumption expenditure
at constant prices is estimated to grow by 7.3 per cent, driven by a rebound in rural
demand. PFCE as a share of GDP (at current prices) is estimated to increase from
60.3 per cent in FY24 to 61.8 per cent in FY25. This share is the highest since FY03.
Gross fixed capital formation (GFCF) (at constant prices) is estimated to grow by
6.4 per cent.

Chart I.20: Despite global uncertainty, India's growth remains close to

decadal average (at constant prices)
10
FY25 Average growth over FY15 and FY24 (excluding FY21 and FY22)
8

0
Agriculture Industry Services GVA GDP
GVA GVA GVA

Source: Calculations based on Statement 13: Annual and Quarterly Estimates of GDP at constant prices, MoSPI
Note: FY25 values are First Advance Estimates.

1.23 On the supply side, real gross value added (GVA) is also estimated to grow by
6.4 per cent. The agriculture sector is expected to rebound to a growth of 3.8 per cent
in FY25. The industrial sector is estimated to grow by 6.2 per cent in FY25. Strong
growth rates in construction activities and electricity, gas, water supply and other utility
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services are expected to support industrial expansion. Growth in the services sector is
expected to remain robust at 7.2 per cent, driven by healthy activity in financial, real
estate, professional services, public administration, defence, and other services. The
analysis of growth trends in this chapter, hereinafter, is mostly based on the trends in
the first half (H1) of FY25, on which the information base is more comprehensive.

Resilient recovery
1.24 The COVID-19 pandemic caused widespread disruptions to economies worldwide.
Economic Survey 2023-2414 compared the post-pandemic trends until Q4 FY24 with
the pre-pandemic trajectory and concluded that the economy grew briskly enough
to avert any permanent loss of output. This section extends the analysis to Q2 FY25
(ending September 2024) with a sectoral view of the economy.

1.25 The overall picture is encouraging. Aggregate GVA surpassed its pre-pandemic
trend in Q1 FY25, and it now hovers above the trend in the H1 FY25 15. The agriculture
sector remains strong, consistently operating well above trend levels. The industrial
sector has also found its footing above the pre-pandemic trajectory. The robust rate
of growth in the recent years has taken the services sector close to its trend levels
(Chart I.21 to Chart I.24).

1.26 A closer look at industrial sub-sectors reveals a spectrum of performances (Chart

I.25). Construction has been a standout, gaining momentum since mid-FY21 and soaring
approximately 15 per cent above its pre-pandemic trend—an impressive feat driven by
robust infrastructure development and housing demand. The utilities sector, including
electricity, gas, water supply, and other services, reached its pre-pandemic trend by
the end of FY23 and has consistently stayed above these levels. Manufacturing, while
steadily recovering, remains slightly below its pre-pandemic trajectory. Meanwhile,
mining continues to operate below its pre-pandemic trend.

1.27 The recovery within the services sector has been uneven (Chart I.26). Financial,
real estate and professional services have taken the lead, surpassing pre-pandemic
trend levels by the end of FY23. Public administration, defence, and other services
followed suit, exceeding the trend for the first time in Q1 of FY25 since the onset of
the pandemic. However, trade, hotels, transport, and communication services are
gradually catching up with the pre-pandemic trend. These contact-intensive sectors
faced challenges due to lockdown, restricted demand for travel, and reduced demand
for hospitality, entertainment, and personal services.

14 Economic survey 2023-24, Chapter 1 – State of the Economy, Box I.1: Growth in GDP, GVA, and their components
ensure no permanent losses in demand and output. https://tinyurl.com/r8ykzwj6.
15 H1 refers to the first half of the corresponding Financial Year that is April to September.

12
 40

20
30

15
45

25
35

4
6
10
12

8
14
Sep-11
Sep-11

2.5
7

1
4
5.5
Sep-12
Sep-12
Sep-11
Sep-13 Sep-13
Sep-14 Sep-14
Sep-12
Sep-15 Sep-15
Sep-16 Sep-16
Sep-13 Sep-17 Sep-17
Sep-18
Sep-18
continues

Sep-14 Sep-19
Sep-19
Sep-20
Sep-21 Sep-20

above the trend level

Sep-15 Sep-21
Sep-22
Sep-23 Sep-22
Sep-16 Sep-24 Sep-23
Chart I.21: Aggregate GVA recovery

Sep-24

Chart I.23: Industrial GVA operating

Sep-17
3
4
6

5
7

Sep-18

5
25

20

10
15
Sep-11
Sep-11
Sep-19 Sep-12
Sep-12
Sep-13
Sep-13
Sep-20 Sep-14
Sep-14
Sep-15 Sep-15
Sep-21 Sep-16 Sep-16

manufacturing GVA gradually recovering

Sep-17 Sep-17
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Sep-22 Sep-18 Sep-18

its trend

Sep-19 Sep-19
Sep-20 Sep-20
Sep-23
Sep-21 Sep-21
Sep-22
Sep-22
sustained at higher levels

Sep-24

Chart I.25: Construction GVA operating well above trend levels, and
Sep-23
Chart I.22: Agriculture GVA

Sep-23
Sep-24
Sep-24
Chart I.24: Services GVA is close to
State of the Economy

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Chart I.26: Uneven recovery within the services sector

10

Source: Calculations based on Statement 13: Annual and Quarterly Estimates of GDP at constant prices, MoSPI
Note: i) FREPS- Financial, real estate and professional services ii) TTHCSB – Trade, transport, hotel,
communication and services related to broadcasting iii) PADOS - Public administration, defence & other services.
All de-seasonalised variables are derived from National Accounts variables at constant (2011-12) prices.

Growth in H1 FY25 driven by agriculture and services sector

1.28 The real GVA grew by 6.2 per cent in H1 FY25. A strong growth momentum in Q1
FY25 was followed by a subdued performance in Q2 FY25. The agriculture and services
sectors emerged as key growth drivers during this period. However, the overall growth
was tempered by moderation in industrial growth, particularly in manufacturing, which
faced challenges from slowing global demand and supply chain disruptions.

Improved agricultural prospects in FY25

1.29 Agriculture growth remained steady in H1 FY25, with Q2 recording a growth rate
of 3.5 per cent, marking an improvement over the previous four quarters. Healthy
Kharif production, above-normal monsoons, and an adequate reservoir level supported
agricultural growth. As per the first advanced estimates of agricultural production for
2024-25, total Kharif food grain production is estimated at a record 1647.05 lakh metric
tonnes (LMT), higher by 5.7 per cent compared to 2023-24 and 8.2 per cent higher
than the average food grain production in the past five years. The estimated increase is
mainly on account of the rise in rice, maize, coarse grains and oilseeds output. A normal
southwest monsoon in 2024 has improved the water levels in reservoirs, ensuring
sufficient water for irrigation during the rabi crop production. As of 10 January 2025,

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rabi sowing of wheat and gram was 1.4 per cent and 0.8 per cent higher, respectively,
compared to the previous year. Improved agricultural prospects also bode well for
softening of food inflation pressures over the course of the year.

Manufacturing sector growth moderates but shows positive

expectations
1.30 The industrial sector grew by 6 per cent in H1 FY25. Q1 saw a strong growth of 8.3
per cent, but growth moderated in Q2 due to three key factors. First, manufacturing
exports slowed significantly due to weak demand from destination countries, and
aggressive trade and industrial policies in major trading nations. Second, the above-
average monsoon had mixed effects - while it replenished reservoirs and supported
agriculture, it also disrupted sectors like mining, construction, and, to some extent,
manufacturing. Third, the variation in the timing of festivities between September
and October in the previous and current years led to a modest growth slowdown in
Q2 FY25.

1.31 Disaggregated data reveals that while many manufacturing sub-sectors

experienced growth, others faced challenges, likely due to global and seasonal factors.
Oil companies suffered due to inventory losses and lower refining margins, while steel
companies faced price pressures and lower global prices. The cement sector faced
weak demand in Q2 due to heavy rains and lower selling prices. However, with the
conclusion of the monsoon season and the expected pick-up in government capital
expenditure, sectors such as cement, iron, and steel are expected to see a recovery.
Further, mining and electricity are expected to normalise after the monsoon-related
disruptions.16

1.32 Despite various challenges, India continues to register the fastest growth in
manufacturing PMI, which is also reflected in Chart I.7 of the previous section. The
latest Manufacturing PMI for December 2024 remained well within the expansionary
zone. The expansion rate for December 2024 exceeded its long-term average, driven by
new business gains, robust demand, and advertising efforts. Meanwhile, international
orders grew to a four-month high midway through the third fiscal quarter, signalling
recovering external demand, as reported by companies.

16 RBI Governor’s Statement: December 6, 2024 https://tinyurl.com/4j6xwp2r. 15

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Chart I.27: Global slowdown impacted manufacturing in Q2 of FY25

PMI manufacturing New Export Orders

60

58 56.4
56

54
54.7
52

50

48

Source: Compiled from various monthly HSBC India Manufacturing PMI reports

1.33 According to the RBI's Industrial Outlook Survey, manufacturing firms reported
improved demand conditions in Q3 FY25 and expect further improvements in Q4 FY25
and Q1 FY26. The survey also reflected better expectations for production, order books,
employment, capacity utilisation, and the overall business environment during Q4
FY25 and Q1 FY26.

Chart I.28: Improvement in business expectations

Source: RBI’s Quarterly Industrial Outlook Survey

Note: * indicates expectations for the upcoming quarter; The survey results are summarised through a measure
called Net Response, constructed as the difference between the proportions of respondents giving ‘optimistic’
and ‘pessimistic’ replies.

Robust growth in the services sector

1.34 The services sector continues to perform well in FY25. A notable growth in Q1 and
Q2 resulted in 7.1 per cent growth in H1 FY25. Across sub-categories, all the sub-sectors
16 have performed well. The robust performance of the services sector is also reflected

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in high-frequency indicators (HFIs). PMI services have been in an expansionary zone

during H1 FY25, supported by growth in new orders, rise in output, improvement in
sales and enhanced employment generation. The hospitality sector performed well,
with hotel occupancy rates in H1 FY25 similar to the previous year. Average daily
rates and revenue per room increased due to higher corporate and leisure travel. Air
cargo activity grew in double digits, while port traffic remained stable. Information
Technology (IT) companies also performed better than the previous quarter.17

Analysis of GDP by expenditure categories

1.35 India’s GDP at constant (2011-12) prices grew by 6.7 per cent and 5.4 per cent in
Q1 and Q2 FY25, respectively. This implied a real GDP growth of 6.0 per cent in the first
half of the current fiscal.

Chart I.29: GDP growth in H1 FY25 at Chart I.30: Highest share of private
6.0 per cent consumption in H1 across all years

Source: Calculations based on Statement 13: Annual and Quarterly Estimates of GDP at constant prices and
Statement 14: Annual and Quarterly Estimates of GDP at current prices, MoSPI

1.36 From a demand perspective, Private Final Consumption Expenditure (PFCE)

firmed up in H1 FY25, growing by 6.7 per cent YoY. While National Accounts data is
not disaggregated by geography, indicators such as 2-wheeler and 3-wheeler sales and
tractor sales signal that rural demand contributed to private consumption growth. This
is also reflected in the January 2025 round of National Bank for Agriculture and Rural
Development (NABARD’s) Rural Economic Conditions and Sentiments Survey, where
78.5 per cent of rural households reported an increase in their consumption expenditure
during the last year.18 The impulse from rural demand is expected to continue in the
second half of the fiscal year with the returns from a bumper Kharif crop and higher
MSPs for a prospectively good Rabi crop.
17 Reserve Bank of India. (2024, December 24). RBI Bulletin December 2024. https://tinyurl.com/rur6xe8u.
18 NABARD, Rural economic conditions & sentiments survey. (January 2025) https://tinyurl.com/3cu6pfk9. 17

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1.37 On the other hand, indicators of urban demand presented mixed trends.
According to data from the Federation of Automobile Dealers Associations
(FADA)19, the growth of passenger vehicle sales has slowed to 4.2 per YoY cent in
April – November 2024 compared to 9.2 per cent in the corresponding period of
the previous year. Fast-moving consumer goods (FMCG) sales in urban areas, as
per Nielsen IQ, have recorded a moderate growth in H1FY25. However, there is
steady growth of 7.7 per cent YoY in air passenger traffic in April – November 2024.
The 7.3 per cent YoY growth indicated by the First Advance Estimates for PFCE at
constant prices for FY25 indicates a pick-up in the most recent months.

1.38 The moderation in real GDP growth can be traced to a softening of growth in
Gross Fixed Capital Formation (GFCF) from 10.1 per cent in H1 FY24 to 6.4 per cent
in H1 FY25. Q1 FY25 witnessed a slowdown in capital expenditure across different
levels of government on account of the conduct of the general elections. Private sector
investment growth may have remained subdued thus far in FY25 on account of the
domestic political timetable, global uncertainties and overcapacities.

Chart I.31: Steady shares of investment and consumption in GDP

(at current prices)

Source: Calculations based on Statement 14: Annual and Quarterly Estimates of GDP at current prices, MoSPI

1.39 An additional reason for the slowdown in capital formation growth in Q2 FY25
may have emanated from the moderation in residential investment by households in
this quarter, which is on the back of a sharp uptick over the last few quarters. Industry
reports, however, point out that the correction in demand-supply metrics in this sector
is indicative of market normalisation after a period of robust performance. An inventory
overhang of 23 months signals healthy demand momentum in the segment.

18 19 FADA November 2024 Press Release - https://tinyurl.com/2rnwzj2r.

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Chart I.32: Moderating housing sales and launches on the back of a

high base in the top 8 cities20

Source: Various Real Insight Residential reports by Proptiger

1.40 The slowdown in investment activity is likely temporary. Green shoots in capital
formation are visible. Union government capex is up 8.2 per cent in July – November 2024
and is expected to pick up further pace. Early results of the RBI’s Order Books, Inventory,
and Capacity Utilisation Survey (OBICUS) show that the seasonally adjusted capacity
utilisation (CU) in manufacturing firms was 74.7 per cent in Q2 FY25, above the long-
term average of 73.8 per cent.21 A private sector report’s22 analysis of a sample of capital
goods companies indicates that the order books of these companies have registered a sharp
increase of 23.6 per cent in FY24 as against a compund anual growth rate (CAGR) of 4.5
per cent in the preceding four years. Moreover, in H1 FY25, there has been a growth of 10.3
per cent compared to the end of FY24. The RBI’s report on private investments showed

crore for FY24. Along with fresh investment, some of the existing intentions would spill
over and be implemented in FY26.

1.41 On the external front, exports of goods and non-factor services at constant prices
increased by 5.6 per cent in H1 FY25, while imports increased by 0.7 per cent. In Q2
FY25, imports of goods and services at constant prices contracted by 2.9 per cent,
primarily driven by a decline in commodity prices. As a result, net exports contributed
positively to real GDP growth in this period.

1.42 As India’s economy continues to expand, the growth process has been ably
supported by stability on fronts such as inflation, fiscal health, and balance of payments.

20 The top 8 cities refer to Ahmedabad, Bangalore, Chennai, Delhi-NCR, Hyderabad, Kolkata, Mumbai, and Pune.
21 Footnote no. 19, RBI Governor’s Statement: December 6, 2024 https://tinyurl.com/4j6xwp2r.
22 CARE Ratings. (2024, November). India's capex story gives a mixed picture. https://tinyurl.com/54ed858f. 19
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The following section presents a closer examination of these stability factors and
provides valuable insights into the resilience and sustainability of the Indian economy
in the face of global and domestic challenges.

ECONOMY CHARACTERISED BY STABILITY AND

INCLUSIVITY ON MULTIPLE FRONTS

Improving public finances support macro stability

1.43 Since the COVID-19 pandemic, judicious fiscal management has helped to rein
in general government dis-savings (Chart I.33). This assumes greater significance in
sustaining the overall savings in the economy. With private corporate savings hovering
around 14 per cent of GDP, persistent general government dis-savings could have
implied a greater reliance on foreign funding. Prudent fiscal management in the last
four years kept the overall savings-investment gap from widening and ensured a
comfortable financing of the current account deficit, even though the household saving
rate moderated. (Chart I.34 below).

Chart I.33: Containment of general Chart I.34: General government

government dis-savings has GFCF growth has outpaced overall
contributed to macro-stability investment growth
40
Y-o-y growth in investment
30.2 Y-o-y growth in Gen. Govt. GFCF
30 CAGR - investment
CAGR - Gen. Govt. GFCF
18.4 35
20

10 25 24.6
-0.7
0 15
13.1
-2.3 7.9
-10 5
FY19 FY20 FY21 FY22 FY23 FY24
General Government Dissavings -5
Savings by private corporations
Household sector savings -15
Savings FY19 FY20 FY21 FY22 FY23
CAD
Source: Statement 1.9, National Accounts Statistics Source: Statement 1.11, National Accounts Statistics
2024, MoSPI; Table 131: India's Overall Balance of 2024, MoSPI.
Payments, Handbook of Statistics on Indian Economy,
RBI.

Fiscal discipline of the union government

1.44 The Union government’s indicators of fiscal discipline have improved progressively.
Quality of expenditure approximated by capital expenditure as a per cent of total
expenditure of the union, has continuously improved since FY21.
20
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State of the Economy

Chart I.35: Strong focus on fiscal discipline

Source: Union Budget documents. Provisional actuals for FY24.

1.45 During April - November 2024 (Chart I.36 below), three major facts stand out in
union finances. First, following an unprecedented expansion of capital expenditure in the
last four years, it remained subdued during Q1 FY25, owing to general elections. However,
it rebounded after July despite a reduction in non-debt receipts owing to an increase in the
devolution of taxes to states. Until November 2024, defence, railways and road transport
accounted for about 75 per cent of the capital expenditure, whereas significant YoY growth
occurred in power and food and public distribution. Second, despite the gross tax revenue
(GTR) increasing by 10.7 per cent YoY during April-November 2024, the tax revenue
retained by the Union, net of devolution to the states, hardly increased. This was because of
increased tax devolution, which helped the states to manage their expenditures smoothly.
Thirdly, as of November, the deficit indicators of the union were comfortably placed, leaving
ample room for developmental and capital expenditure in the rest of the year.

Chart I.36: Sound and sure footing of union finances in FY25

60
50.2
50 46.0

40 35.0
30
20 10.7 13.6
8.7 8.5 7.8 8.3 8.2 10.6
10 3.3 3.1 4.4
0.5
0
-10
-6.6 -7.5
-20 -12.3 -10.8

-30
-40
-37.0
-50
GTR NRR NTC NDR NTR TD RE IP CE TE RD FD PD GTR NTC NDR NTR TD CE TE
Growth in April to November FY25 over April to November FY24 Growth in July to November FY25 over
July to November FY24

Source: CGA monthly provisional accounts.

Note: GTR- Gross Tax Revenue; NRR-Revenue Receipts (net to Centre); NTC-Tax revenue (net to Centre);
NDR-Non-debt receipts; TD-Tax devolution to States; RE-Revenue Expenditure; IP-Interest Payments; CE-
Capital Expenditure; TE-Total Expenditure; FD-Fiscal Deficit; RD-Revenue Deficit; PD-Primary Deficit.
21
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Varying patterns in state finances

1.46 A review of preliminary unaudited estimates of 27 states23 for the period April -
November 202424 corroborates the second point above (Chart I.37). The GTR of the union
and own tax revenue (OTR) of the states have increased at comparable pace during this
period. However, the overall tax revenue position of the state governments appears better
as of November, because of increased tax devolution by the union. Among the state-specific
taxes, stamps and registration, sales tax, state excise duties, and other taxes and duties
registered positive growth, whereas land revenue25 declined, for states as a collective (Chart
I.38).

Chart I.37: Greater reliance on share Chart I.38: Growth exhibited by

in central taxes most of own taxes

40 38.1 20 14.2 13.1

9.5 8.9
10 4.6
30
0
20 18.4
-10
10.8
10 -20 -14.9

0
Tax Revenue Own Tax State’s Share
Revenue of Union
Taxes
Growth in April to November FY25 over Growth in April to November FY25 over
April to November FY24 (per cent) April to November FY24 (per cent)

Source: CAG monthly provisional accounts26 Source: CAG monthly provisional accounts27

1.47 For 15 states28, OTR accounted for more than half of their total tax receipts (Chart
I.39), the highest being Telangana at 88 per cent, followed by Karnataka and Haryana
at 86 per cent each. Further, states with a higher ratio of own revenue receipts (ORR)
to total revenue receipts also tended to have relatively lower ratios of revenue deficit to
total revenue receipts (Chart I.40).

23 Andhra Pradesh (AP), Arunachal Pradesh (AR), Assam (AS), Bihar (BR), Chhattisgarh (CG), Gujarat (GJ),
Haryana (HR), Himachal Pradesh (HP), Jharkhand (JH), Karnataka (KA), Kerala (KL), Madhya Pradesh (MP),
Maharashtra (MH), Manipur (MN), Meghalaya (ML), Mizoram (MZ), Nagaland (NL), Odisha (OD), Punjab (PB),
Rajasthan (RJ), Sikkim (SK), Tamil Nadu (TN), Telangana (TS), Tripura (TR), Uttar Pradesh (UP), Uttarakhand
(UK) and West Bengal (WB).
24 April to July reference period for Jharkhand; April to September for Arunachal Pradesh and Manipur.
25 Land revenue for Himachal Pradesh included in ‘other taxes and duties’.
26 Share of central taxes for Mizoram and Sikkim included in ‘other taxes and duties’.
27 Ibid.
22 28 Out of 25 States; Mizoram and Sikkim excluded.
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State of the Economy

Chart I.40: Correlation between

Chart I.39: Distribution of reliance on
own revenue collection & revenue
OTR – a diverse scenario across states
account health
0.6

0.4

0.2

0.0

-0.2

-0.4

-0.6

-0.8
0.0 0.2 0.4 0.6 0.8 1.0
Ratio of ORR to TRR
(April to November FY25)

Source: CAG monthly provisional accounts

Source: CAG monthly provisional accounts RD- revenue deficit, ORR-own revenue receipts,
TRR-total revenue receipts.

1.48 For 23 States29, GST was the main source of revenue amongst ORR with the greatest
reliance thereon by Manipur and Nagaland at 78 per cent and 72 per cent, respectively
(Chart I.41). States garnering the highest shares in respective ORRs w.r.t. stamps &
registration, sales tax and state excise duties were Maharashtra, Tamil Nadu and West
Bengal, respectively. Odisha exhibited the highest share of non-tax revenue in ORR at
49 per cent.

Chart I.41: States' own revenue receipts through an assorted lens

100
90
80
70
60
50
40
30
20
10
0

GST Land Revenue Non –Tax Revenue Other Taxes and Duties
Sales Tax Stamps and Registration State Excise Duties

Source: CAG monthly provisional accounts

29 Ibid. 23
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1.49 The revenue expenditure of the states grew at 12 per cent (YoY) during April to
November 2024 (Chart I.42), with subsidies and committed liabilities30 registering a
growth of 25.7 per cent and 10.4 per cent, respectively (Chart I.43). With expenditure
on capital account for states declining by 5.6 per cent, total expenditure grew by 9.5 per
cent. However, 11 states witnessed an increase in capex.
1.50 In the quality of expenditure, measured by capital outlay as a per cent of revenue
expenditure over the five years ending FY24, states31 exhibited considerable variation
(Chart I.44).

Chart I.42: Pick-up in states’ capex Chart I.43: Allocative efficiency

expected in H2FY25 considerations need attention
16
12.0 30 25.7
12 9.5
20
8
10.4 11.7
4 10

0
0
-4 Committed Expenditure on Other
expenditure Subsidy expenditure on
-5.6
-8 Revenue
RE CE TE Account
Growth in April to November FY25 over April to Growth in April to November FY25 over April to
November FY24 (per cent) November FY24 (per cent)

Source: CAG monthly provisional accounts.

RE-revenue expenditure; CE-expenditure on capital account; TE-total expenditure.

Chart I.44: Varying degree of capital outlay as a per cent of revenue expenditure
45
40
35
30
25
20 16.5
15
10
5
0

Source: RBI e-STATES database. Revised estimates for FY24.

30 Interest payments, salary and pension. For Mizoram and Sikkim, expenditure on pension and subsidy; for
Karnataka and Tamil Nadu, expenditure on salaries & wages and subsidies; and for Arunachal Pradesh,
expenditure on subsidies included in ‘other expenditure on revenue account’.
24 31 28 states.
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State of the Economy

1.51 In April-November 2024, 11 States maintained revenue surplus (Chart I.45).The

chart shows that revenue surplus (or lower revenue deficit) is corrleated with higher
capital expenditure.

Chart I.45: Strong correlation between capex and fiscal space

40
OD
JH
UP
20
Revenue ML GJ TR Revenue
MH
surplus & MP SK surplus &
fiscal deficit fiscal surplus
AS
0 CG
Revenue BR UK Revenue
TS KA
deficit & deficit &
fiscal deficit HR fiscal surplus
WB MZ
-20 TN
RJ HP
MN
AP PB KL
-40
-60 -40 -20 0 20 40 60
Fiscal balance as a per cent of TE
(April to November FY25)

Source: CAG monthly provisional accounts. Excludes Arunachal Pradesh and Nagaland.
Note: The size and colour of the bubble represents capital expenditure as a per cent of total expenditure (TE) -
red for less than 7 per cent, yellow for 7 to 14 per cent and green for 14 to 21 per cent.

Inflation – a combination of low and stable core inflation with volatile

food prices
1.52 Retail headline inflation, as measured by the change in the Consumer Price Index
(CPI), has softened from 5.4 per cent in FY24 to 4.9 per cent in April – December 2024.
The decline is attributed to a 0.9 percentage point reduction in core (non-food, non-
fuel) inflation between FY24 and April – December 2024. While the average inflation
in FY25 has trended downward, monthly volatility in food prices and a select few
commodities have been responsible for CPI inflation printing towards the upper side of
the tolerance band of 4 (+/-) 2 per cent.
1.53 Pressures in food prices have been driven by factors such as supply chain disruptions
and vagaries in weather conditions. Food inflation, measured by the Consumer Food
Price Index (CFPI), has increased from 7.5 per cent in FY24 to 8.4 per cent in FY25
(April-December), primarily driven by a few food items such as vegetables and pulses.
Chart I.47 plots headline retail inflation excluding the following commodities – tomato,
onion and potato, (TOP). These commodities together constitute 2.2 per cent of the CPI
basket.

25
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Chart I.46: Food price pressures Chart I.47: CPI inflation excluding
driving retail inflation TOP commodities significantly
lower32

14 CPI inflation
CFPI inflation
12 Core inflation
10

Source: Consumer Price Indices released by Central Statistical Office (CSO), MoSPI

External sector stability safeguarded by services trade and record

remittances

1.54 India’s external sector displayed mixed trends, primarily due to volatile global
conditions. A decline in commodity prices affected India’s merchandise exports
through the petroleum goods channel. Data on merchandise trade shows that India’s
merchandise exports grew by 1.6 per cent YoY in April – December 2024.33 However,
non-petroleum exports (on the same comparison basis) were up by 7.1 per cent. Non-
petroleum and non-gems and jewellery exports rose by 9.1 per cent. Merchandise
imports rose by 5.2 per cent. This growth was primarily driven by an increase in non-
oil, non-gold imports. Gold imports also grew, influenced by higher global prices, early
purchases ahead of festive spending, and demand for safe-haven assets.

1.55 While the outpacing of merchandise imports over merchandise exports widened
India’s merchandise trade deficit, India’s services trade surplus has lent balance to the
overall trade deficit. India's robust services exports have propelled the country to secure
the seventh-largest share in global services exports, underscoring its competitiveness

32 Further, if gold and silver are also excluded, CPI inflation excluding these five commodities (which constitute 3.4
per cent of the CPI basket) is even lower.
26 33 https://www.commerce.gov.in/wp-content/uploads/2025/01/PIB-Release_15012025-final.pdf.
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State of the Economy

in this critical sector. In addition to the services trade surplus, remittances from abroad
led to a healthy net inflow of private transfers. As per the World Bank, India was the
top recipient of remittances in the world, driven by an uptick in job creation in OECD
economies.34 These two factors combined to ensure that India’s current account deficit
(CAD) remains relatively contained at 1.2 per cent of GDP in Q2 FY25.

Chart I.48: Services trade surplus and private transfers lending balance to
the external sector
Merchandise trade balance Services trade balance
100 4
Net private transfers CAB as per cent of GDP (RHS)
80 3
60
2
40
USD Billion

20 1
0 0
-20 -1
-40
-2
-60
-80 -3
-100 -4
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2
FY22 FY23 FY24 FY25

Source: Tables 196 and 197, RBI Handbook of Statistics on the Indian Economy
Note: CAB – Current Account Balance

1.56 Comfortable financing of the CAD by the capital account has ensured external
sector stability. Within capital flows, gross foreign direct investment (FDI) inflows
increased 17.9 per cent YoY in April – November 2024. Gross FDI inflows during April
– November in FY25 are higher than the levels witnessed in the corresponding period
of any previous years except FY21. Net FDI inflow declined over this period, primarily
on account of the uptick in repatriation, which is higher by 33.2 per cent YoY after
a growth of 51.5 per cent in FY24. The rise in repatriation through the channels of
secondary sales and Initial Public Offerings (IPOs) by multinational companies amid
strong stock market performance points to investor confidence in profitable exits for
direct investors.35

34 World Bank. (2024, June 26). In 2024, remittance flows to low- and middle-income countries are expected to
reach $685 billion, larger than FDI and ODA combined. https://tinyurl.com/38esxhzr.
35 “Behind India’s growth over last 10 yrs—increase in repatriations, steady FDI inflows”. https://tinyurl.
com/2tt3pxsf. 27
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Chart I.49: Rise in repatriation even as gross FDI inflows remain robust

Source: Calculations based on FDI figures from RBI Bulletin Table no. 34

1.57 On the other hand, foreign portfolio investment (FPI) flows have been volatile
in the second half of 2024, primarily on account of global geopolitical and monetary
policy developments. Net FPI inflows slowed to USD 10.6 billion in April – December
2024 from USD 31.7 billion during the same period the previous year. The inclusion of
India’s sovereign government securities (G-secs) of certain tenors in the JP Morgan EM
Bond Index induced heightened activity within the debt segment of the FPIs. Further
elucidation of the impact of the inclusion of Indian G-secs in global bond indices can be
seen in Chapter 3.

1.58 As a result of stable capital flows, India’s foreign exchange reserves increased from
USD 616.7 billion at the end of January 2024 to USD 704.9 billion in September 2024
before moderating to USD 634.6 billion as on 3 January 2025. India’s forex reserves
are sufficient to cover 90 per cent of external debt and provide an import cover of more
than ten months, thereby safeguarding against external vulnerabilities.

1.59 Looking ahead, global policy changes could influence India’s external trade. The
evolving trade stance of a few major economies could affect key Indian export sectors
such as chemicals, machinery, textiles, and electronics. In the short term, diversifying
export markets is essential, while medium-term efforts should focus on increasing
market share. Over the long term, India must position itself as a strategic partner
in high-value sectors like biotechnology and semiconductors. Strategic technology
partnerships provide opportunities for enhanced cooperation in key areas like space,
semiconductors, quantum technologies and advanced telecommunications.
28
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Financial sector prospects amid a moderation of growth in credit

disbursal
1.60 The banking and financial sector remains stable and well-capitalised, and is catering
to the financing needs of the economy. While credit disbursal by scheduled commercial
banks (SCBs) is growing in double-digits, there has been a moderation in the growth in
recent months. This is on the back of a high base and also due to regulatory tightening in
sectors where high growth was observed. In view of high growth in certain components
of consumer credit, the RBI had, on 16th November 202336, raised the risk weights on
unsecured retail loans by 25 basis points. However, expansion in the segment continues to
be broad-based, with housing loans as the major contributor. Apart from personal loans,
credit to the services sector is the other major driver of expansion in gross bank credit.
Industrial credit growth is picking up but remains below growth rates in other major sectors.

Chart I.50: Moderation in growth of bank credit to different sectors

Non-food credit Personal loans Credit to MSME
35
Credit to Industry Credit to Services
30

25

20

15

10

Source: Calculations based on credit figures in Table no. 170 - Deployment of Gross Bank Credit by Major
Sectors, Handbook of Statistics on the Indian Economy.

1.61 Stability in the banking sector is underscored by declining asset impairments,

robust capital buffers, and strong operational performance. As per the RBI’s Financial
Stability Report (FSR), December 202437, the gross non-performing assets (NPAs)
in the banking system have declined to a 12-year low of 2.6 per cent of gross loans
and advances. The capital-to-risk-weighted assets ratio (CRAR) for SCBs stands at
16.7 per cent as of September 2024, well above the norm. The profitability of SCBs
improved during H1 FY25, with profit after tax (PAT) surging by 22.2 per cent YoY,
while the Return on Equity (RoE) and Return on Assets (RoA) have improved on a YoY
basis. Macro stress tests suggest that banks' overall capital levels would stay above the
regulatory minimum even in adverse scenarios.
36 https://www.rbi.org.in/scripts/NotificationUser.aspx?Id=12567&Mode=0.
37 Reserve Bank of India. (2024, December). Financial Stability Report.
https://tinyurl.com/zv662e5d. 29
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Chart I.51: Stable banking system indicators

Sep-22 Sep-23 Sep-24

GNPA ROE ROA CRAR

Source: Various editions of RBI Financial Stability Report

1.62 While the long-term stability of the banking system is safeguarded, there was
scrutiny over the short-term dynamics emerging from the mismatch of credit and
deposit growth rates. The RBI FSR’s (June 2024)38 analysis of previous episodes where
credit growth outpaced deposit growth shows that the average duration of such cycles
where credit growth exceeds deposit growth is 41 months. The merger of a bank with
a non-bank has elongated the cycle in this episode. The analysis reveals that credit
growth precedes deposit growth and that convergence is usually achieved through a fall
in credit growth.

1.63 Another area of concern within the banking system is the stress on unsecured
credit, i.e., personal loans and credit cards. As of September 2024, 51.9 per cent of
the fresh addition to the stock of NPAs in the retail loan portfolio emanated from the
slippages in the unsecured loan book.39 The RBI FSR (December 2024) notes that nearly
half of borrowers with credit card and personal loans also have another active retail
loan, often substantial, such as a housing or vehicle loan. When a borrower defaults
on any loan category, financial institutions classify all loans of that borrower as non-
performing. Hence, their larger, secured loans face delinquency risks due to defaults in
smaller personal loans.

1.64 Apart from active monitoring of the banking system, there is a need to be cautious
regarding developments in the Indian and global stock markets. While the Indian
financial sector shows resilience, international market conditions may have some
influence on India. Any correction in the US stock market could have implications
for global markets (See Box II.2 of the Survey for an analysis pertaining to the Indian
market).

38 Reserve Bank of India. (2024, June). Financial Stability Report. https://tinyurl.com/3ba9x6vr.

30 39 Reserve Bank of India. (2024, December). Financial Stability Report. https://tinyurl.com/4wtz3c6u.
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Employment trends
1.65 India's labour market growth in recent years has been supported by post-pandemic
recovery and increased formalisation. As per the 2023-24 annual Periodic Labour Force
Survey (PLFS) report, the unemployment rate for individuals aged 15 years and above
has steadily declined from 6 per cent in 2017-18 to 3.2 per cent in 2023-24. The labour
force participation rate (LFPR) and the worker-to-population ratio (WPR) have also
increased (Chart I.52). In Q2 FY25, the urban unemployment rate for people aged 15
years and above improved slightly to 6.4 per cent compared to 6.6 per cent in Q2 FY24.
Both LFPR and WPR also increased during this period.

Chart I.52: Improvement in employment indicators

Source: Annual PLFS report 2023-24, MoSPI

Note: i) LFPR - labour force participation rate, WPR - worker-to-population ratio, UR- unemployment rate
ii)Statistics presented are by Usual status for persons aged 15 years and above

1.66 The formal sector in India has seen significant growth, with net Employees’
Provident Fund Organisation (EPFO) subscriptions more than doubling from 61 lakh
in FY19 to 131 lakh in FY24. In April -November 2024, net additions reached 95.6 lakh,
driven largely by youth. Workers aged 18-25 years contributed to 47 per cent of the net
payroll additions. This indicates a growing trend towards formal employment, which
enhances workers' access to social security and stability. Government initiatives are
playing a key role in enhancing the formalisation of the job market.

1.67 Technological developments over recent years have generated much discussion
on the impact of Artificial Intelligence (AI) on India’s labour market. The integration
of AI into India's labour market presents an opportunity to enhance productivity,
elevate workforce quality and create employment, provided, systemic challenges are
effectively addressed through robust institutional frameworks. For India, a services-
driven economy with a youthful and adaptable workforce, the adoption of AI offers 31

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the potential to support economic growth and improve labour market outcomes.
Prioritising education and skill development will be crucial to equipping workers with
the competencies needed to thrive in an AI-augmented landscape. By capitalising on
the global infancy of AI, India has the opportunity to prepare its labour force for a future
defined by collaboration between human and machine intelligence. An elucidation of
these dynamics can be found in Chapter 13.

OUTLOOK AND WAY FORWARD

1.68 A steady growth trajectory shapes the global economic outlook for 2024, though
regional patterns vary. The near-term global growth is expected to be a shade lower
than the trend level. The services sector continues to drive global expansion, with
notable resilience in India. Meanwhile, manufacturing is struggling in Europe, where
structural weaknesses persist. Trade outlook also remains clouded in the next year.

1.69 Inflationary pressures have been easing globally, though risks of synchronised
price pressures linger due to potential geopolitical disruptions, such as tensions in the
Middle East and the ongoing Russia-Ukraine conflict. Central banks have adopted more
accommodative monetary policies. However, the pace of rate cuts varies across regions
depending on the growth imperatives and the pace of disinflation, creating potential
divergences in economic recovery.

1.70 On the domestic front, rebounding rural demand augurs well for consumption.
Investment activity is expected to pick up, supported by higher public capex and
improving business expectations. Capacity utilisation in manufacturing remains above
the long-term average, and private sector order books have shown steady growth,
alongside a rise in investment intentions. However, these gains could be tempered by
the global excess capacities in sectors such as steel, leading to aggressive trade policies
in search of demand.

1.71 Going forward, food inflation is likely to soften in Q4 FY25 with the seasonal easing
of vegetable prices and Kharif harvest arrivals. Good Rabi production is likely to contain
food prices in the first half of FY26. Adverse weather events and rise in international
agricultural commodity prices, however, pose risks to food inflation. Global energy and
commodity prices have softened in the recent past, making the core inflation outlook
benign. However, risks remain on account of significant global political and economic
uncertainties.

1.72 In brief, there are many upsides to domestic investment, output growth and
disinflation in FY26. There are equally strong, prominently extraneous, downsides too.
32

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Nonetheless, the fundamentals of the domestic economy remain robust, with a strong
external account, calibrated fiscal consolidation and stable private consumption. On
balance of these considerations, we expect that the growth in FY26 would be between
6.3 and 6.8 per cent.

1.73 Navigating global headwinds will require strategic and prudent policy management
and reinforcing the domestic fundamentals. The Budget 2024-25 laid out a multi-
sectoral policy agenda for sustained growth push. In this context, Chapter 5 elaborates
on the need for deregulation and reforms at the grassroots level to improve the overall
competitiveness of the economy and to lift trend growth rates, supporting higher levels
of economic activity.

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CHAPTER
MONETARY AND FINANCIAL
SECTOR DEVELOPMENTS:
THE CART AND THE HORSE 02
India’s monetary and financial sectors have performed well in the first nine
months of FY25. Bank credit has grown at a steady rate in the current financial
year, with credit growth converging towards deposit growth. There has been
a consistent improvement in the profitability of scheduled commercial banks
(SCBs) as reflected in a fall in gross non-performing assets (GNPAs) accompanied
by a rise in the capital-to-risk weighted asset ratio (CRAR). The government
has also achieved significant progress in financial inclusion, with the Financial
Inclusion Index of the Reserve Bank of India (RBI) increasing from 53.9 in March
2021 to 64.2 at the end of March 2024. Rural Financial Institutions (RFIs) have
been an important player in facilitating India’s financial inclusion journey.
Development Financial Institutions (DFIs) have contributed significantly to the
country’s economic progress by financing infrastructure development projects.

The capital markets have demonstrated strong performance, driving capital

formation in the real economy, increasing the financialisation of domestic
savings, and supporting wealth creation. As of December 2024, the Indian
stock market has recorded new highs, consistently outperforming its emerging
market peers despite geopolitical uncertainties and election-driven market
volatility challenges. Meanwhile, the insurance and pension sectors continue to
perform with the vision of achieving universal coverage and strengthening the
financial ecosystem further.

The financial sector is currently undergoing a transformative period marked by

several emerging trends. Notably, there is an increase in the share of consumer
credit in overall credit extended by banks and a rise in non-bank financing
options. Additionally, equity-based financing has gained popularity, with
the number of initial public offerings (IPOs) increasing sixfold between FY13
and FY24. While these developments herald a new era for the financial sector,
they also introduce potential risks from a regulatory standpoint. The rise in
consumer debt, the expansion of unsecured lending, and the growing number of
young investors underscore the need for bala
balancing growth and stability. Such
regulation should encourage financial sector growth while ensuring stability
and resilience. 35
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INTRODUCTION
2.1 Financial institutions play a pivotal role in shaping a country's economic growth
trajectory by facilitating savings, investments, and credit for economic activities. The
prevailing monetary policies influence the interplay between financial intermediation
and economic growth. This chapter examines the key trends and policy changes
in monetary policy and the financial intermediation ecosystem in India. These
developments are shaped by evolving domestic and global factors, including inflation
trends, economic activity projections, and interest rate movements in major economies
like the US, EU, and Japan.

2.2 The chapter is structured into two parts. The first part of the chapter explores
the evolving monetary policy and key indicators such as Reserve Money (M0), Broad
Money (M3) and Money Multiplier (MM), among others. The second part focuses
on the various developments in the financial sector. It begins with an analysis of the
banking sector's performance and credit availability, including the contributions of
RFIs and DFIs to economic growth. The next section under the discussion on ‘financial
sector developments’ examines capital market trends, particularly the rise in investor
participation in the equity segment. Subsequent sections cover developments in
the insurance and pension sectors, followed by an overview of the role of financial
sector regulators in maintaining financial stability. The chapter also discusses the
government’s mechanism for addressing cybersecurity in the financial sector and the
role of the Financial Stability and Development Council (FSDC). It concludes with a
financial sector outlook, highlighting key challenges for the future.

MONETARY DEVELOPMENTS
2.3 The primary objective of monetary policy is to maintain price stability while also
considering the goal of economic growth, as stable prices are essential for sustainable
growth. The RBI employs various policy instruments, such as manoeuvring the interest
rates, conducting open market operations (OMO), altering the cash reserve ratio (CRR)
and statutory liquidity ratio (SLR), etc, to achieve this stability.

2.4 During the first nine months of FY25 (April 2024-December 2024), the Monetary
Policy Committee (MPC) of the RBI, in its various meetings, decided to keep the policy
repo rate unchanged at 6.5 per cent. Until its August 2024 meeting, the committee
retained its stance on the ‘withdrawal of accommodation’ to ensure inflation aligns with
the target while supporting growth. Considering the prevailing and expected inflation-
growth dynamics, the committee, in its October 2024 meeting, decided to change the
policy stance from the ‘withdrawal of accommodation’ to ‘neutral’. In its December
36 2024 meeting, the MPC announced a cut in CRR to 4 per cent of the net demand and
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time liabilities (NDTL) from 4.5 per cent. The decision is expected to infuse around
1

2.5 Examining the trend in various measures of money supply in the economy, viz.,
different aggregates that reflect varying degrees of liquidity, it is seen that the monetary
base, viz. the most liquid form of money, M0, recorded a year-on-year (YoY) growth of
3.6 per cent as of 3 January 2025, compared to 6.3 per cent a year ago. The growth in
M3, excluding the impact of the merger of a non-bank with a bank (with effect from 1
July 2023), was 9.3 per cent (YoY) as of 27 December 2024, compared to 11 per cent a
year ago. Component-wise2, aggregate deposits were the most significant component
and contributed most to the expansion of M3. Amongst sources3, bank credit to the
commercial sector was a major contributor to the increase in M3. As of 27 December
2024, MM4, i.e., the ratio of M3 to M0, stood at 5.7 against 5.5 a year ago. Adjusted for
reverse repo amounts, analytically akin to banks’ deposits with the central bank, the
adjusted MM was lower at 5.6 as of 27 December 2024.

Chart II.1: Higher Money Multiplier as of December 2024,

indicating higher liquidity in the market

Source: Money Stock: Components and Sources, Publications, Weekly Statistical Supplement, RBI Reserve
Money: Components and Sources, Publications, Weekly Statistical Supplement, RBI

1 RBI press release dated 6 December 2024, ‘Maintenance of Cash Reserve Ratio (CRR), https://tinyurl.com/
pxkhxndd.
2 Components of Broad Money=Currency with the Public + Aggregate Deposits (Demand Deposits with Banks +
Time Deposits with banks + ‘Other’ deposits with Reserve Bank).
3 Sources of Broad Money=Net Bank Credit to Government + Bank Credit to Commercial Sector + Net Foreign
Exchange Assets of Banking Sector + Government's Currency Liabilities to the Public- Banking Sector's Net Non-
Monetary Liabilities).
4 The money multiplier measures the maximum amount of money that a banking system generates with each unit
of central bank money. 37
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2.6 A country’s MM is influenced by two main factors: - the amount of cash individuals
(and businesses) hold and the reserves that banks maintain. When individuals keep
more cash, the banking system cannot create money, resulting in a lower multiplier. In
this case, cash in hand acts as a leakage from the banking system. Similarly, the reserves
that banks hold with the central bank also count as a leakage, further decreasing the
MM. In India’s case, banks hold a portion of their deposits as reserves with the RBI,
known as CRR.

2.7 A higher MM indicates that the banking system is generating a greater money
supply from the money provided by the central bank. In India, recent efforts to promote
financial inclusion have encouraged people to hold less cash in hand relative to their
deposits, which partly explains the increase in the MM. Chart II.2 shows that MM has
been on an upward trend over the years. It declined during the COVID-19 pandemic
as increased economic uncertainty caused individuals to increase their cash holdings,
resulting in a fall. However, after FY22, it has resumed its upward trajectory, reflecting
enhanced liquidity generation in the economy.

Chart II.2: Increase in Money Multiplier over the years

Source: Database on Indian Economy, RBI

FINANCIAL INTERMEDIATION
2.8 Financial intermediaries are critical in implementing and transmitting monetary
policy actions. Policy rates set by the MPC are transmitted to the real economy through
financial intermediaries adjusting their lending and deposit rates. Similarly, the CRR
and SLR requirements influence the lending capacity of the financial intermediaries. All
these policy rates/ratios, in effect, have a bearing on the economic growth, price levels
and financial stability of the economy. The performance of financial intermediaries,
such as banks, capital markets, insurance, pension sector, etc., is discussed in this
38 chapter section.
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Performance of the banking sector and credit availability

Improvement in asset quality of banks

2.9 The GNPA ratio of SCBs has declined consistently from its peak in FY18 to a 12-
year low of 2.6 per cent at the end of September 2024. Lower slippages and a reduction
in outstanding GNPAs through recoveries, upgradations, and write-offs have led to
this decrease. Lower GNPAs and higher provisions accumulated in recent years also
contributed to a decline in net NPAs at around 0.6 per cent at the end of September
2024. Improvements in asset quality parameters were observed across all major bank
groups.

Chart II.3a: Decline in GNPAs of SCBs Chart II.3b: CRAR well above
the required norms

12

10

Source: RBI Financial Stability report, various issues

2.10 The restructured standard advances (RSA) ratio, which is the share of RSA in
total gross loans and advances, for SCBs declined from 1.8 per cent at the end of March
2022 to 0.7 per cent at the end of September 2024. All major bank groups reported a
decrease in this ratio. The CRAR of SCBs has increased in the post-asset quality review
period, which was conducted from August to November 2015. For FY24, around 93 per
cent of the increase in the capital funds was contributed by the rise in Tier-I capital of
banks, indicative of the robustness of capital buffers. At the end of September 2024,
the CRAR of SCBs stood at 16.7 per cent, and all banks met the Common Equity Tier-1
(CET-1) requirement of 8 per cent.
2.11 The profitability of SCBs improved during H1 of FY25, with profit after tax (PAT)
surging by 22.2 per cent (YoY). The cost of funds rose in sync with the tightening
monetary policy cycle. During Q2 of FY25, the cost of funds increased marginally for
SCBs. As the transmission was faster for lending rates relative to deposit rates and the
overall yield on assets remained broadly stable during the last year, the net interest 39
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margin (NIM) has marginally declined across all bank groups. Despite a contraction
in NIM, both return on equity (RoE) and return on assets (RoA) ratios improved in
September 2024. Further, as the GNPAs and slippages declined, the provision coverage
ratio improved further to 77 per cent at the end of September 2024 per cent from 74.9
per cent in March 2023.

Chart II.4a: Return on Assets of SCBs Chart II.4b: Return on Equity of

(Annualised) SCBs (Annualised)

Source: RBI Financial Stability report, various issues

Trends in bank credit

2.12 Against the backdrop of the recent monetary policy tightening cycle in India, bank
deposits continue to exhibit double-digit growth. However, their profile has gradually
shifted towards schemes offering higher returns. Growth in term deposits continues
to outpace the current and savings account deposit growth. As of the end of November
2024, the YoY growth in aggregate deposits of SCBs stood at 11.1 per cent. The growth
in bank credit has started converging towards deposit growth. At the end of November
2024, the growth in overall bank credit moderated to 11.8 per cent (YoY) from 15.2 per
cent a year ago over the same period.5 Moreover, the growth in overall bank credit up to
27 December 2024 in the current financial year moderated to 7.7 per cent.

2.13 In the current financial year, up to 27 December 2024, the growth rate in non-food
credit has been 7.5 per cent compared to a growth of 11 per cent over the same period
last year. The moderation in credit growth can be attributed to an increase in lending
rates (as a result of monetary policy transmission of higher policy rates to higher lending
rates) and the imposition of increased capital requirements for unsecured personal
loans, credit cards and lending to Non-Banking Financial Companies (NBFCs) by the

40 5 The statistics in this section on bank credit exclude the impact of the merger of a non-bank with a bank.
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RBI from 100 per cent to 125 per cent.6

Chart II.5: Trend in credit disbursal by SCBs

Bank Credit YoY growth in bank credit (RHS)
180 20

150

120 15

90

60 10

30

0 5

Source: RBI data on sectoral deployment of bank credit

2.14 Sector-wise, the growth in agriculture credit as of 29 November 2024 in the

current financial year was 5.1 per cent. The growth in industrial credit picked up and
stood at 4.4 per cent as of the end of November 2024, higher than 3.2 per cent recorded
a year ago. Across industries, bank credit to micro, small, and medium enterprises
(MSMEs) have been growing faster than credit disbursal to large enterprises. As of
the end of November 2024, credit to MSMEs registered a YoY growth of 13 per cent,
whereas it stood at 6.1 per cent for large enterprises. Credit growth to the services and
personal loans segments also moderated to 5.9 per cent and 8.8 per cent, respectively,
as of the end of November 2024 in the current financial year. Amongst the services
sector, the moderation has been driven by a slowdown in credit disbursal to NBFCs.
Vehicle and housing loans drove the moderation in the personal loans segment. In
terms of increasing risk weights to NBFCs and credit cards, RBI's policy interventions
contributed to the moderation of credit growth in those segments.

2.15 In December 2024 MPC, the RBI announced an increase in the interest rate
ceiling on Foreign Currency Non-Resident [FCNR(B)] deposits with maturities of 1 to 3
years and 3 to 5 years.7 Accordingly, banks can now garner fresh deposits under these
categories by offering a higher rate of interest. It has also decided to link the foreign
exchange retail platform with the Bharat Connect platform to enhance access to foreign
exchange for MSMEs. These measures will not only help banks attract investible funds
for credit growth but will also help attract more foreign inflows into India. Another

6 RBI notification, ‘Regulatory measures towards consumer credit and bank credit to NBFCs’, dated 16 November
2023, https://tinyurl.com/ns8rbwjm.
7 RBI press release dated 6 December 2024, ‘Interest Rates on Foreign Currency (Non-resident) Accounts (Banks)
[FCNR(B)] Deposits’, https://tinyurl.com/mt9uwtx. 41
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significant measure to improve credit access for small and marginal farmers includes
8

2.16 The credit/GDP ratio is a good statistic to evaluate where an economy stands
in the financial cycle.9 If the ratio is significantly greater than its trend value, it may
indicate a build-up of stress in the lending sector. On the other hand, if the ratio is
lower compared to its trend, it indicates ample room for growth. In the case of India,
there was a positive credit/GDP gap (i.e., the difference between the credit-GDP ratio
and its long-term trend) between 2006 and 2012, indicating excessive credit growth.
This also coincided with the investment boom over that period. A bust followed this in
the credit cycle; higher NPAs impaired the banking sector’s lending ability, leading to a
significant slowdown in credit growth.

Chart II.6: Indian economy witnessing the commencement

of a new credit up-cycle10

Source: Bank for International Settlements (BIS)

2.17 After tiding over this situation and the recovery from the COVID-19 pandemic, an
upward trend in the credit/GDP ratio is observed, with the gap steadily closing. With
credit growth outpacing nominal GDP growth for two successive years, the credit-GDP
gap narrowed to (-) 0.3 per cent in Q1 of FY25 from (-) 10.3 per cent in Q1 of FY23.
Therefore, despite the double-digit growth in bank credit post-April 2022, the credit-
to-GDP ratio is below the trend line, indicating that the recent growth in bank credit is
sustainable.

8 RBI press release dated 6 December 2024, ‘Credit flow to agriculture-Collateral free agriculture’ loans, https://
tinyurl.com/2ehsn7ap.
9 Giese, J., Andersen, H., Bush, O., Castro, C., Farag, M., & Kapadia, S. (2014). The credit-to-GDP gap and
complementary indicators for macroprudential policy: Evidence from the UK. International Journal of Finance &
Economics, 19(1), 25-47, https://tinyurl.com/4pwcehu4.
10 Credit/GDP includes all lending sectors (bank and non-bank) and all borrowing sectors (Household & NPISHs,
42 General Government, Non-financial sector and non-financial corporations)
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2.18 A cross-country comparison indicates that India’s bank credit to private non-
financial sector to GDP ratio is lower than that of Advanced Economies (AEs) such as
the US, UK, and Japan. Compared to emerging market economies (EMEs), the ratio is
also lower. Still, it is higher than that of Indonesia and Mexico.

Chart II.7: Cross-country comparison of bank credit to private

non-financial sector as per cent of GDP11

China Malaysia Japan Thailand UK Brazil South India Indonesia Mexico

Africa

Source: Bank for International Settlements

2.19 Although pockets of stress have appeared lately, as we shall see later, India's
credit landscape highlights the recovery in the credit environment from the crisis of
the second decade, now trying to consolidate itself. At the heart of this growth lies a
strong policy emphasis on financial inclusion, as reflected in the significant rise in RBI’s
Financial Inclusion Index12 from 53.9 in March 2021 to 64.2 by March 2024. The next
section explores the crucial role of Rural Financial Intermediaries (RFIs) in closing the
gap between financial services and underserved regions, thereby advancing financial
inclusion across the country.

Rural Financial Institutions

2.20 RFIs are vital in ensuring inclusive growth through financial inclusion, credit
accessibility, agricultural financing, and empowerment of rural entrepreneurs. These
institutions comprise a network of organisations that provide banking and financial
services in rural areas. This multi-agency system includes Regional Rural Banks (RRBs),
Rural Cooperative Banks (RCBs), SCBs, Small Finance Banks, NBFCs, Micro Finance
Institutions, and local area banks. The system supports rural India through a network
of banking outlets, which include branches and banking correspondents. The National

11 Average of bank credit to the private financial sector as percentage of GDP in the first two quarters of 2024.
12 The index measures progress achieved in financial inclusion across 97 indicators in three dimensions: access,
usage, and quality of financial services. 43

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Bank for Agriculture and Rural Development

elopment (NABARD) oversees the performance and
health of RRBs and RCBs, focusing on aspects such as growth, the composition of assets
and liabilities, business structure (deposits and loans), and profitability indicators.

2.21 RRBs were established in 1975 under the Regional Rural Banks Act of 1976. Starting
from an initial number of five in 1975, they have significantly expanded in reach, branch
count, total deposits, and advances. There were 133 RRBs in 2006. Following certain
mergers, liquidations, and amalgamations to improve their performance, the number
was brought down to 43 in 2023. Their coverage expanded from 523 districts in 2006
to 696 districts, and the number of branches grew substantially from 14,494 in 2006 to
21,856 in 2023. As of 31 March 2024, there were 43 RRBs (sponsored by 12 SCBs) with
22,069 branches, with operations extending to 31.3 crore deposit accounts and 3 crore
loan accounts in 26 states and 3 UTs.13

during FY22 and FY23.14 This recapitalisation scheme included operational and
governance reforms as part of the Sustainable Viability Plan designed to revitalise RRBs.
The plan aimed to achieve several objectives, including credit expansion, business
diversification, reduction of NPAs, cost rationalisation, technology adoption, and
improvements in corporate governance. As a result of this recapitalisation assistance
and the implementation of the viability plan, the performance of RRBs at a consolidated
level has shown significant improvement over time. During FY24, these banks achieved
historic highs across all metrics. The consolidated net profit of RRBs increased from

per cent as of March 2023 to an all-time high of 14.2 per cent by March 31, 2024. The
number of RRBs with a CRAR of less than 9 per cent decreased from 9 as of March
2023 to 4 as of March 2024. Additionally, the number of profit-making RRBs grew
from 37 in FY23 to 40 in FY24, while the number of loss-making RRBs fell from 6 to 3
during the same period.

2.23 Asset quality of RRBs measured by GNPA as a percentage of gross advances

improved from 7.3 per cent in FY23 to 6.1 per cent in FY24, which is the lowest level
in the past 10 years. During the same period, net NPAs declined from 3.2 per cent to
2.4 per cent. Credit expansion contributed to an increase in the consolidated credit-
to-deposit ratio, which rose from 67.5 per cent as of March 2023 to 71.2 per cent as of
March 2024, the highest in 33 years. All RRBs successfully met the regulatory targets
and sub-targets set by the RBI under the Priority Sector Lending (PSL) guidelines
during FY24.

13 NABARD report on ‘Empowering Rural Financial Institutions’, https://tinyurl.com/bdh5384b.

44 14 Ibid note 13.

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Development Financial Institutions

2.24 DFIs are key players in supporting economic progress. Their main objective is
to boost economic expansion through funding infrastructure developments. These
institutions offer extended financial and technical aid across different sectors. DFIs
supply technical assistance, including reports on projects, studies on their feasibility,
and advisory services. By improving access to credit for infrastructure and housing
projects, DFIs encourage more loans to be directed towards these critical areas. DFIs
play a vital role in India by providing long-term funding for key sectors, supporting
economic growth, fostering industrial expansion, improving infrastructure, and helping
develop small and medium-sized businesses.

2.25 The early DFIs were set up in the 1950s to 1960s. They included the Industrial
Financial Corporation of India (IFCI), Industrial Credit and Investment Corporation
of India (ICICI) and Industrial Development Bank of India (IDBI). Over time, these
DFIs became universal banks or commercial banks. As two major DFIs converted
into commercial banks, there were fewer institutions to address the macro needs
of industrial and infrastructure development. Institutions such as Infrastructure
Development Finance Company (1997), India Infrastructure Finance Company Limited
(IIFCL) (2006), and more recently, the National Bank for Financing and Infrastructure
Development (NaBFID) (2021) have focused on funding infrastructure development.
The performance of some of these is discussed in the following paras.

2.26 IIFCL has supported India’s infrastructure development over the past 18 years.
As a long-term financing institution, it is amongst the most diversified public sector
infrastructure lenders in terms of eligible infrastructure sub-sectors and product
offerings. It is mandated to finance green-field and brown-field projects, covering direct
lending, takeout finance, refinance and credit enhancement across all infrastructure sub-
sectors as notified by the government in the Harmonised Master List of Infrastructure
Subsectors.15 As of September 2024, IIFCL had approved cofinancing for over 780

private partnership (PPP) projects, representing about 28 per cent of the country’s
total PPP projects. IIFCL’s total sanctions and disbursements on a cumulative basis

having around 31,000 km of highways (22 per cent of India’s NH capacity), 95 GW of

installed energy capacity (23 per cent of India’s installed capacity), 22 GW of installed
renewable energy capacity (11 per cent of India’s installed renewable capacity) and 880
million tonnes of port capacity (35 per cent of India’s total port capacity).16

15 Harmonised master list of infrastructure sub-sectors, https://tinyurl.com/mbd8629x.

16 Based on the inputs received from the Department of Financial Services. 45
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2.27 Given the need for a long-term capital provider with a holistic sectoral mandate,
as opposed to the niche mandate of other DFIs, the National Bank for Financing and
Infrastructure Development (NaBFID) was established as an infrastructure-focused
DFI through NaBFID Act, 2021. The RBI accorded it an ‘All India Financial Institution’
(AIFI) status on 8 March 2022, making it the fifth AIFI after NABARD, Small Industrial
Development Bank of India (SIDBI), NHB and Exim Bank. NaBFID has both financial
and developmental objectives. Its financial objective is to lend or invest, directly or
indirectly, and seek to attract investment from private sector investors and institutional
investors in infrastructure projects to foster sustainable economic development in
India. The developmental objective of the institution is to coordinate with the central
and state governments, regulators, financial institutions, institutional investors, and
other relevant stakeholders.

and energy sector, including renewable energy, account for over three-fourths of loans
sanctioned. The institution has identified a project pipeline across sectors such as
roads, power generation, renewables, railways, ports, transmission and distribution,
data centres, and social and commercial sectors like hospitals, ropeways, and others. It

FY26. It offers longer tenor loans (15 to 25 years), longer reset on loans (3 to 5 years),
and fixed interest rate loans up to 15 to 25 years, helping infrastructure developers
navigate the interest rate cycle and manage risks therein.17

Use of Artificial Intelligence by banks

2.29 Over the past several decades, banks have consistently adapted the latest
technological innovations to redefine customer interactions. Globally, banks introduced
ATMs in the 1960s and electronic card-based payments in the 1970s. The 2000s saw the
widespread adoption of 24/7 online banking, followed by the rise of mobile banking in
the 2010s. Now the world is in the artificial intelligence (AI)-powered digital age, driven
by decreasing data storage and processing costs, greater accessibility, and connectivity.
These innovations can lead to higher automation and often enhance human decision-
making speed and accuracy when correctly managed to mitigate risks.18

2.30 The use cases of AI and Machine Learning (ML) applications by banks in India
range across areas such as credit underwriting, regulatory capital planning, liquidity
management, fraud detection and prevention, risk assessment and management,

17 Ibid note 16.

18 McKinsey and Company report, ‘AI-bank of the future: Can banks meet the AI challenge?’, https://tinyurl.
46 com/2zsxuyhw.
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portfolio optimisation, pricing models, and chatbots. The rapid pace of technological
evolution in India, particularly in areas like AI, blockchain, and data analytics, has
created new opportunities to reimagine traditional financial services and processes.19 AI
and large language models (LLMs) have enhanced customer service through interactive
chatbots and personalised experiences, while blockchain offers secure, transparent,
and efficient transactions. Moreover, evolving consumer behaviour and expectations,
driven by the rise of digital natives and increasing demand for personalised, seamless,
and convenient financial solutions, encourage established companies and newcomers
to innovate to remain competitive.

2.31 Along with the benefits, using AI in the banking system entails a few risks. The
black-box nature of AI systems can make it difficult to assess the system's reliability or
contest its decisions. This lack of transparency can lead to trust concerns and challenges
in validating the fairness and accuracy of AI decisions, making it challenging to audit or
interpret the algorithms that drive the decisions. Accountability risks include difficulty
in tracing decisions to their source and establishing liability. Other risks include those
related to (i) human resources, such as inadequate human oversight, over-reliance on
AI, and loss of human expertise; (ii) cyber risks; (iii) malicious usages like synthetic
identity frauds, rogue trading, and market manipulation; (iv) system related risks such
as inability to intervene and market correlations; and (v) third-party dependencies and
service provider concentration.20

2.32 International bodies such as the Organisation for Economic Cooperation and
Development (OECD) have outlined core principles governing the use of AI21, which
include inclusive growth, respect for the rule of law, transparency and explainability,
robustness and safety, and accountability. The Hiroshima AI Process Comprehensive
Policy Framework22 established in December 2023, includes a set of guiding principles
and a code of conduct, marking a significant step towards a coordinated global approach
for the responsible development of AI. Different techniques are being adopted by
regulators across the globe, most of which are focused on principles-based guidance.

2.33 Establishing robust AI governance is the first and crucial step in addressing the
challenges that come with the implementation of AI systems. Without an appropriate
governance framework, AI systems may operate without clear guidelines or oversight,
leading to potential abuse or misuse of technology. As vulnerabilities could evolve with
the pace of innovation and degree of AI integration in financial services, regulatory and
supervisory effectiveness may take a backseat if financial regulators’ AI-related skills

19 PwC India report, 'Mapping the FinTech innovation landscape in India’, https://tinyurl.com/k67efs6v.
20 Based on the inputs received from RBI.
21 OECD AI principles, https://tinyurl.com/4sryrmz9.
22 Hiroshima AI process, https://tinyurl.com/4sajs5uf. 47
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and knowledge do not keep pace with developments in this space. Accordingly, the
RBI has proactively engaged with regulated entities and experts to assess the ongoing
developments while effectively communicating its expectations through multiple
engagement forums. It has also created a regulatory sandbox focusing on innovative
technology products/services.23 Further, the RBI announced the establishment of a
committee to create a Framework for Responsible and Ethical Enablement of Artificial
Intelligence (FREE-AI) in the financial sector.24

Efficacy of Insolvency Law

2.34 While financial intermediaries play their part in providing credit to various agents
of the economy for economic activity, debtors may sometimes fail in their endeavours.
This requires a mechanism to rescue them and provide an honourable exit to honest
debtors or an attempt to resolve the stress and get them back into the business. For this
purpose, enacting the Insolvency and Bankruptcy Code, 2016 (IBC/Code) has ushered
in a modern and comprehensive insolvency resolution framework for distressed entities.
By addressing financial distress and NPAs, the Code has had an indelible impact on the
health of the country's banking sector and redefined the debtor-creditor relationship.

2.35 Till September 2024, 1068 resolution plans approved under the Code have resulted

cent of the fair value (based on 964 cases where fair value has been estimated). The
haircut for creditors relative to the fair value of assets was around 14 per cent, while
relative to their admitted claims, it was around 69 per cent.25 Further, until September
2024, 79 corporate debtors (CDs) were closed by sale as a going concern under liquidation.
These 79 CDs had cl

2.36 Resolutions under the Code have spanned across all sectors, from large steel
manufacturing companies and real estate projects to small FMCG companies. Out of
the 12 large accounts referred by the RBI for resolution under the Code, 10 have been
successfully resolved. This highlights that the resolution process under the Code is
designed to be sector-agnostic so that all types of distressed entities can find a viable
solution to their financial distress.

2.37 The deterrent effect of the Code has led to a significant shift in debtor behaviour.
Thousands of debtors are resolving distress in the early stages of distress. They are

23 Das, Shaktikanta (2024), ‘Inaugural Address at RBI@90 Global Conference on Digital Public Infrastructure and
Emerging Technologies’, August 26, Bengaluru, https://tinyurl.com/5yr33njj.
24 RBI press release dated 26 December 2024, https://tinyurl.com/5b5zzmwa.
25 This realisation does not include the Corporate Insolvency Resolution Process (CIRP) cost and many probable
future realisations such as equity, realisation from corporate and personal guarantees, funds infused into
Corporate Debtors (CDs), including capital expenditure by the Resolution Applicants, and recovery from
48 avoidance applications.
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resolving when default is imminent, on receipt of a notice for repayment but before filing
an application, after filing application but before its admission, and even after admission
of the application, and making best effort to avoid consequences of resolution process.
Most companies are rescued at these stages. Till March, 2024, 28,818 applications for

before their admission.

2.38 The outcomes of the IBC in terms of its efficiency and effectiveness are discernible
from various statistics such as the number of resolutions, early resolutions before the
financial distress becomes chronic, and time taken for the processes to complete, etc.
However, beyond these numbers, the Code has other far-reaching impacts through
its interaction with the higher-level systems like the legal, economic, and financial
systems. Some of these systemic benefits of the law, flowing through multiple channels,
as proven by research, are as follows:
• Forex hedging by firms–ResearchResearch shows that the likelihood for currency
mismatches in the corporate sector has reduced after India’s bankruptcy reform.
As per BIS research (2018)26 the introduction of the new bankruptcy law raised
the probability of currency hedging by 13.7 per cent for firms which originally had
a high degree of currency mismatch. Thus, there is an incentive for firms to hedge
currency exposure risk better in the presence of a bankruptcy law.
• Reducing bond credit spreads–Sengupta and Vardhan (2023)27 highlight that
the IBC lowered the credit spreads for bonds issued by non-financial firms from
FY17 to FY20 compared to the bonds issued by the finance firms in FY15 and FY16,
especially when other issue-level determinants of credit spreads are considered.
This shows an encouraging development and reinforces the fact that an effective
bankruptcy resolution regime is critical for bond investors to develop confidence in
the Indian market. Currently, the bond market is skewed towards high-rated (AAA
and AA) bonds, which account for more than 85 per cent of all issuances. Investor
confidence in effective bankruptcy resolution will be crucial to developing a deep
and liquid market for lower-rated bonds.
• Exports–Khan and Chakraborty (2022)28, study a large sample of 4,434 firms
between 2000 and 2020 and find that exporting firms in India have benefitted
from the bankruptcy reform law by helping them better access credit and get out of
financial constraints.
2.39 Macroprudential tools are handy for muting the effects of credit cycles. However,

26 Mohanty, M. S., & Sundaresan, S. M. (2018). FX hedging and creditor rights. BIS Paper, (96b), https://tinyurl.
com/2evkk828.
27 Sengupta, R., & Vardhan, H. (2023). Bankruptcy regime change and credit risk premium on corporate bonds:
Evidence from the Indian economy. Indira Gandhi Institute of Development Research, https://tinyurl.
com/5n8nep6c.
28 Khan, T. A., & Chakraborty, I. (2022, March). Financial constraints and export behaviour: An analysis of Indian
manufacturing firms. https://tinyurl.com/4pvutkhz. 49
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a good bankruptcy regime acts as a backstop during downswings, in turn reducing the
need for costly macroprudential interventions. A continuously evolving and improving
IBC framework is important to achieving a 7-8 per cent growth over the next decade.
India’s growth aspirations require capital to operate at the frontiers of productivity
and efficiency. An efficient bankruptcy system will free up capital, allowing better
production, employment, and growth prospects.

2.40 The next step towards insolvency and bankruptcy reform is to improve operational
efficiencies to speed up the resolution process. This is especially important for MSMEs,
for whom legal costs can prove to be substantial. Improving time efficiencies in the system
comes down to using innovative resolution routes such as the pre-pack arrangements
for MSMEs, inter-disciplinary capacity building of resolution professionals across
legal, financial and industry basics and minimising judiciary delays in proceedings.
Operational efficiencies require a balancing act between fairness and fastness of
resolution. Further, improvements are also required to ensure the timeliness of the
insolvency and bankruptcy processes under the Code. Box II.1 discusses the issue of
delays in the processes under the IBC.

Box II.1: IBC and National Company Law Tribunals

The IBC lays a time limit of 180 days from the date of admission for closure of an insolvency
process, with a provision for extension by 90 days with the approval of the committee of
creditors (CoC) and the adjudicating authority (AA), i.e., the NCLT. The regulations provide
detailed timelines for various processes to be undertaken in the corporate insolvency
resolution process (CIRP) and liquidation processes. This aspect of the insolvency law has
been crucial in determining its performance, and with time, the delays in the completion of
processes have become a concern.

Within three years of implementation of the Code, the difficulties in complying with the
timelines were evident, and it was amended to provide a 330-day outer limit for a CIRP,
including judicial proceedings. Current evidence shows that the 1068 CIRPs, which have
yielded resolution plans (as of the end of September 2024), took an average of 582 days (after
excluding the time excluded by the AA) for conclusion, and the 2,630 CIRPs, which ended
up in orders for liquidation, took on average 499 days for conclusion. This average time for
a CIRP does not include the time taken for an application to be admitted and time periods
that are excluded by the order of the AA for reasons assigned by it. The time excluded by AA
in the cases resolved so far was, on average, 116 days. This constitutes about 64 per cent of
the time intended in the Code to complete the entire process. The exclusion of time done by
the AA helps address compliance with the Code. Still, it does not address the impact on the
erosion of business and economic value of the corporate debtor.
The NCLT/Tribunal was made the AA for insolvency and bankruptcy matters, along with their
pre-existing adjudicatory role under the Companies Act 2013 and the Competition Law. The
government has taken comprehensive measures to strengthen the NCLT. As of September
50
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2024, 30 courts and 16 benches were functioning headed by the President, and 31 each of
judicial and technical members. As of the end of July 2024, the NCLT has, quite notably,
reported as adjudicated 34,690 cases under the IBC against 35,501 cases numbered, i.e.,
close to 98 per cent adjudication and disposed of 29,705 cases. However, there are 2,593
cases awaiting admission and 4,723 pending after admission.29 Further strengthening
the number of courts, benches, and members and ramping up physical infrastructure, as
envisaged in the Union Budget 2024-25, will help improve the disposal rate.30
Further, addressing issues in the insolvency procedures and the Tribunal’s administrative
processes would help to reduce pendency in the long term. Delays in admission are of
particular concern since, until admission, the company continues to be controlled by the
defaulting debtor. While admission is awaited, the opportunities for value shifting, funds
diversion and assets transfers increase, leading to further erosion of the value of the CD.31
While the prescription is admission in 14 days, in FY21, the average time for admission of
153 applications by operational creditors (under section 9 of the Code) was 468. In FY22, an
average of 650 days was taken in the admission of 207 applications.32 Reasons for delay in
admission occur as the AA tries to establish the existence of debt and default, as promoters
file objections. Including evidentiary proof in the form of contracts, GST filings, etc., is all
provided for, but all of this can be contested.
The financial system with digital credit information repositories receipts trading platforms,
and the Information Utility (IU),33 set up under the IBC, is quite robust and should be
harnessed, and a means for verification of debt and default may be enabled, especially for
applications filed by financial creditors. If developed by the market, such a service would
address the problem and may also be monetisable as the applicant creditors will benefit
from early admission of applications. Providing in the Code for the use of IU records as
conclusive proof about the occurrence of a default in general, with necessary exceptions,34
would enable such services.
Tribunals could improve the time taken for admission with the use of technology and the aid
of the court registry for verification, scrutiny, and clearing of defects in the application. The
proposed integrated platform for use by various stakeholders can include such features.35
This would eliminate the need for pre-admission hearings and help reduce the time to
admit an application. In the case of applications filed by operational creditors a voluntary
mediation mechanism, if made applicable, may help address default and hence obviate the
need for admission.
Another source of delays at the AA during the CIRP is the adjudication of inter-locutory
applications.36 It includes procedural requirements like the appointment of an insolvency

29 National Company Law Tribunal, https://tinyurl.com/3x8wcxbx.

30 Para 61 and 62 of the Union Budget, 2024-25.
31 Standing Committee on Finance, Thirty-second report August 2021 Implementation of the Insolvency and
Bankruptcy Code – Pitfalls and Solutions https://tinyurl.com/23m36yze.
32 Insolvency and Bankruptcy Board April 2022. Consultation paper on issues related to reducing delays in the
corporate insolvency resolution process, https://tinyurl.com/43nthke9.
33 https://nesl.co.in.
34 Discussion Paper, January 2023, Ministry of Corporate Affairs, https://tinyurl.com/yc4vmaky.
35 Insolvency and Bankruptcy Board of India, Quarterly Newsletter Jan-Mar 2023 https://tinyurl.com/2e4vwz3n.
36 Insolvency and Bankruptcy Board November 2022. Report of the Colloquium on Functioning and Strengthening 51
of the IBC Ecosystem, https://tinyurl.com/mt6u5ykv.
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professional, appointment of an authorised representative, consideration of delayed claims,

the constitution of the CoC, etc. and frivolous applications. In instances where an objective
criterion to determine the achievement of a procedural milestone can be assessed or when
decisions are arrived at by consensus among stakeholders, it can be taken on record of the
AA. It may not be considered for formal posting before the court. Extending engineering
principles, the process, method, and output of repetitive procedural tasks, which are
amenable for standardisation, should be standardised such as, the use of template-based
submissions and orders. In dealing with frivolous applications, the Tribunal needs to be
more stringent, and using prevention by way of the imposition of high costs would have the
necessary deterrent effect.
Tribunals have addressed the burden on the traditional judicial system by enabling
specialisation in narrower domains to enable speedy relief by reducing formalistic
procedures and complexity. Tribunals are envisaged to reduce costs and improve efficiency.
The same would be possible if the trappings of the traditional judiciary were avoided both in
procedure and stakeholders' mindsets.
The IBC provides a non-adversarial resolution process but has not been enabled in practice
at the NCLT. The design and execution of procedures in the NCLT may be revisited, keeping
the quasi-judicial nature of the mandate as a foundational tenet. Separate Rules for the
NCLT in its role as the AA under the Code may also provide more clarity in dealing with
procedural matters and improve the efficiency in its functioning.

Development in capital markets

2.41 Capital markets are central to India’s growth story, catalysing capital formation
for the real economy, enhancing the financialisation of domestic savings, and enabling
wealth creation. As of December 2024, the Indian stock market has achieved new
highs, with intermittent corrections, in the midst of geopolitical uncertainties, currency
depreciation and domestic market volatility challenges. Investor participation has been
a contributor, with number of investors growing from 4.9 crore in FY20 to 13.2 crore
as of 31 December 2024. This growth, combined with active listing activity and recent
measures by the regulator, viz. Securities and Exchange Board of India (SEBI), to
temper excesses, is expected to foster sustainable market expansion.

2.42 The primary markets continued to witness heightened listing activities and
investor enthusiasm in FY25, notwithstanding the market volatility and geopolitical
uncertainties. As per the E&Y Global IPO trends37, Indian stock exchanges provide
conducive market conditions for foreign conglomerates to list their local subsidiaries,
thereby offering a good opportunity for unlocking value. India's share in global IPO
listings surged to 30 per cent in 2024, up from 17 per cent in 2023, making it the leading
contributor of primary resource mobilisation globally.

2.43 The total resource mobilisation from primary markets (equity and debt) stands

52 37 EY Global IPO Trends Report, https://www.ey.com/en_in/insights/ipo/trends.

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amount mobilised during entire FY24. This also amounts to 25.6 per cent of gross
fixed capital formation of private and public corporations during FY24. The number
of IPOs increased by 32.1 per cent to 259 during April to December 2024 from 196 in
the corresponding period of the previous year, while the amount raised almost tripled

same period.

2.44 Reflecting the buoyant market conditions, Qualified Institutional Players (QIPs)
emerged as the preferred equity fundraising mechanism for the corporates during
FY25, with a 11.4 per cent share in total capital raised. Resource mobilisation through

2.45 The domestic corporate debt market continued to gain significant traction

Private placements remained the preferred channel for corporates, accounting for 99.1
per cent of total resources mobilised through the bond market. Increasing investor
demand and elevated costs of borrowing from banks have made these markets more
attractive for corporates for funding requirements.

2.46 In contrast to the equity market, the debt market in India remains under-
capitalised. As a percentage of GDP, the corporate bond market is only 18 per cent
in India, as opposed to 80 per cent in Korea and 36 per cent in China.38 The market
for corporate bonds comprises high-end bonds, with 97 per cent of corporate bond
issuances concentrated in the top 3 rating categories (AAA, AA+ and AA). Issuers who
are unable to get these ratings are unable to access the bond market. This may explain
why most issuers are NBFCs or public sector undertakings (PSUs).39

2.47 An overwhelming majority of corporate bond issuance happens through the route
of private placement, which actively deters the participation of retail investors. In FY24,

The financial services sector dominates the

40

issuance of corporate bonds at nearly 60 per cent of the total (International Monetary
38 SEBI Annual bulletin, https://tinyurl.com/4rntp3xx.
39 IMF paper, ‘India’s Financial System-Building the foundation for strong and sustainable growth’, https://tinyurl.
com/3xmz39pw.
40 ORF, 2024 -https://tinyurl.com/48fzyvwr. 53
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Fund (IMF), 2023). Outside financial services, real estate and power generation/ supply
comprise the rest. Consequently, corporate bond issuance from manufacturing and
non-energy infrastructure sectors is a very small proportion of the overall bond market.

Trusts (REITs) and Infrastructure Investment Trusts (InvITs).

2.48 If liquidity has to enter corporate bond markets, problems such as entry costs,
information asymmetry, and the absence of a secondary market must be addressed.
For example, insurance and pension funds cannot be invested in bonds that are lower
than AA-rated. This effectively crowds out small players in the corporate bond market.
Liquidity is also bottled through regulations that prevent provident funds from investing
in corporate bonds for more than 3 years. Moreover, insurance funds are not allowed to
invest in debt issued by private companies.

Secondary Market: Positive performance amidst volatility

2.49 Turning to the performance of the secondary markets, since the commencement of
FY25, they have experienced significant volatility driven by various events. These include
the general elections in June 2024, the unwinding of carry trades in Japan in August
2024, the escalation of conflict in the Middle East and the U.S. Presidential Election
(November 2024). Notwithstanding the intermittent corrections, the markets showed
a consistent upward trend until September 2024, scaling new all-time highs. Strong
domestic economic prospects, robust domestic institutional investor inflows, foreign
portfolio investments, anticipated policy pivots from major central banks, etc., drove the
uptrend. However, this trend has moderated since October 2024, driven by economic
stimulus measures in China, the US Presidential elections and valuation concerns. On
account of recent corrections, the benchmark index, Nifty 50, delivered a return (in local
currency) of 4.6 per cent return from April to December 2024. The highest returns (in
USD) were delivered by Hong Kong’s Hang Seng (22.2 per cent), followed by Nasdaq
Composite (17.9 per cent), Singapore FTSE Straits Times (16.2 per cent) and South
Africa’s FTSE/JSE All Share index (13.3 per cent) during the same period.

2.50 However, on a longer-term basis, Indian markets have been among the best-
performing markets in the world. The compounded annualised returns of Nifty 50 for
the past ten years (since March 2014) stand at 8.8 per cent (adjusted for USD), trailing
below few indices, such as the US NASDAQ composite index (15.3 per cent) and US
Dow Jones (9.2 per cent) among a select set of significant markets as of December
2024. The corresponding CAGR of China's Shanghai Composite indices stands at 3.2
per cent. The positive performance of the Indian stock was driven by strong profitability
growth, rapid traction of digital financial infrastructure, expanding investor base and
54 substantial reforms in products and processes. In line with the performance of Indian
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markets, India’s weight in the MSCI-EM index reached a new high of 20 per cent in
July 2024 before settling down at 19.4 per cent at the end of December 2024. This is
only the third highest after China and Taiwan.
2.51 On 23 May 2024, the total market capitalisation of BSE-listed stocks closed above
the USD 5 trillion milestone for the first time. At the end of December 2024, BSE’s

lakh crore. BSE market capitalisation to GDP ratio stood at 136 per cent at the end of
December 2024, rising significantly over the last 10 years.
Table II.1: Market capitalisation to nominal GDP ratio (percentage)
India China Brazil Japan South United United
Korea Kingdom States
Dec-19 77 60 65 121 89 106 158
Dec-20 95 79 68 129 122 92 195
Dec-21 113 80 50 136 127 108 206
Dec-22 105 65 42 126 96 91 157
Dec-23 124 61 44 147 114 71 179
Dec-24* 136 65 37 157 90 84 213
Source: CEIC Database, IMF and WFE
Note: The data has been revised based on the 1st advance estimate of GDP released on 7 January 2025. Projected
figures: GDP figures are taken from IMF projections, and market capitalisation is taken as at the end of Q2 of
FY25 (i.e., Sep-24 end) for the US, India, Japan, Korea, and China, the UK and Brazil market cap figures are as on
the end of December 2024. Market capitalisation was taken country-wise as Brazil (Brasil, Bolsa, Balcão), China
(Shanghai and Shenzhen Stock Exchange), All India, Japan (Japan Exchange Group Inc.), South Korea (Korea
Exchange), United Kingdom (London Stock Exchange) and USA (NYSE and NASDAQ)

Rise in investor participation in capital markets

2.52 The period since the pandemic has seen a surge in individual and household
participation as capital market investors through direct (trading in markets through
their accounts) and indirect (through mutual funds) channels. Healthy corporate
earnings, stable macro fundamentals, efficient and robust technology architecture
facilitating efficient trading, clearing, and depository systems, and trust garnered
by mutual fund ecosystem and online digital investment platforms have encouraged
greater participation in capital markets.
2.53 The incremental addition to demat accounts has been continuously increasing,
with the number of demat accounts rising sharply by 33 per cent to 18.5 crore at the
end of December 2024 on a YoY basis. In the equity cash segment, individual investor
share turnover41 was 35.6 per cent from April to December 2024. There are 11.5 crore
unique investors with demat accounts and 5.6 crore unique investors in mutual funds
as of the end of December 2024. Higher investor participation has engendered a self-
reinforcing cycle of strong market returns, bringing in even more investors. This, in
41 Share turnover refers to the ratio of the value of traded shares of individual category to the total turnover in the
cash market (BSE and NSE). 55
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turn, will eventually transform the securities market into a more diverse, inclusive, and
robust platform for wealth creation.

2.54 The mutual fund industry has grown well in the last few years and is now crucial in
channelling financial savings towards risk capital formation and leveraging technology
and innovation. The rise in retail participation through mutual funds is reflected in the
doubling of unique investors from 2.9 crore in FY21 to 5.6 crore as of December 2024.
The total number of folios (excluding FoF domestic schemes) increased from 17.8 crore
at the end of FY24 to 22.5 crore at the end of December 2024, and retail investors42

with strong market performance, has led to a remarkable increase in mutual funds’

registering 25.3 per cent growth from March 2024.

2.55 The mutual fund segment presently has more than 10 crore Systematic Investment

Monthly average gross SIP flows have more than doubled in the last three years, from

mutual fund ownership in Indian listed companies has risen to a fresh all-time high of
9.5 per cent43 in the quarter ending September 2024, from 8.7 per cent in FY24.

Chart II.8: Trends in SIP Investment

FY22 FY23 FY24 FY25 FY22 FY23 FY24 FY25 FY22 FY23 FY24 FY25
SIP AUM SIP accounts (in crore)

Source: Association of Mutual Fund Industry

Note: Outstanding SIP accounts and SIP AuM are reported at the end of the financial year
SIP contribution pertains to yearly gross contribution through SIP accounts
Data for FY25 is as of December 2024

2.56 Amid the impressive performance of the Indian stock markets, several factors
could potentially pose significant risks. Box II.2 discusses these factors in detail.

42
56 43 Includes passive and active (Source: NSE Market Pulse, November 2024)
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Box II.2: Risks for the Indian stock market in 2025

As we move into 2025, the US financial landscape is characterised by high stock market
valuations, record corporate profits and extremely optimistic investor sentiment. With the
US comprising 75 per cent of the MSCI World Index (as of November 2024), any correction
in its market could have profound ripple effects on global markets, including India,
underscoring the need for heightened vigilance.
US markets at a record high
Notwithstanding accentuated geopolitical tensions, the US equity markets had a solid run
for the second year in a row, outperforming the broader developed market pack. Following
a 24 per cent gain in 2023, the S&P 500 Index is well on course to generate a 20 per cent+
return in 2024. This outperformance came on the back of economic resilience, robust
corporate earnings that have surged to record-high levels (~USD 4 trillion as of the quarter
ending September 2024),44 strengthening rate cut expectations early in the year and an
all-time high investor confidence. That said, the surge in US stock market valuations to an
unattractive zone, currently at their third highest levels as indicated by Shiller’s S&P 500
CAPE ratio (Cyclically Adjusted Price-Earnings Ratio), warrants some caution. Further, the
rally over the last two years has been largely driven by a few mega-capitalisation technology
companies—Apple, Microsoft, Amazon, Alphabet, and Nvidia. This is reflected in a strong
40 per cent+ year-to-date return in the S&P 500 Top 10 Index.
The performance of the S&P 500 Equal Weight Index, which assigns equal weight to all 500
constituents, effectively diluting the impact of the largest companies, is also a good assessment
of the performance of the S&P 500 excluding these companies. The S&P 500 Index has
rallied by a total of 56 per cent in 2023 and 2024, more than double that generated by the
equal weight index. This, along with tapering rate cut expectations, with the US Federal
Reserve’s dot plot now suggesting a 50bps cut in 2025, down from the earlier guidance of
100bps, has added to the potential risks and uncertainties.

Chart II.9: S&P500 vis-à-vis S&P500 (Equal Weight) index (Rebase to 1000)
S&P500 (Equal Weight) Index S&P500 Index
24-Dec-24,
1600
1500
1400
1300
1200
1100
24-Dec-24, 1257.1
1000
900

Source: LSEG Workspace

Note: Data for the S&P 500 Index and the S&P 500 Equal Weight Index is from January 2023, both rebased to
1000 (as of 3 January 2023). Data is till 24 December 2024

44 Data Source: Federal Reserve Economic Data (FRED), National Income: Corporate Profits Before Tax (Without
IVA and CC Adj.), Billions of Dollars, Quarterly, Seasonally Adjusted Annual Rate. https://fred.stlouisfed.org. 57
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Interestingly, investor sentiments this time have been heavily influenced by sustained
demand for high-growth stocks and extreme and unreasonable optimism, as indicated by
an all-time high divergence between the share of respondents expecting an increase in stock
prices and income levels (based on the Conference Board Consumer Confidence Survey).
However, history shows sentiment-driven rallies are often fragile, with confidence shifting
rapidly in response to external shocks, such as geopolitical events, policy changes, or economic
slowdowns. This makes the current environment particularly susceptible to volatility, with
any unexpected developments potentially triggering significant market corrections.

At the same time, questions are emerging about the sustainability of U.S. corporate earnings,
particularly as they are concentrated within a few major technology firms and supported by
strong government spending, up 10 per cent YoY to USD 6.75 trillion45 from October 2023
to September 2024.
Furthermore, investor demand for structured and complex products, where returns are
backed by revenues from unconventional assets such as data centres, music catalogues
and solar panels revenues, has surged to the highest level since the Global Financial Crisis
(GFC).46

Chart II.10: US corporate profits vs. non-tech corporate profits

Source: LSEG Workspace

Note: The technology sector has been identified based on Thomson Reuters sector classification and market
capitalisation as of 26 December 202447

Retail participation in India at record high

Indian equity markets have also had a steady run since the onset of the pandemic, driven
by factors that extend beyond global influences. One such notable factor has been a surge in
retail participation over the last five years, both in terms of investor numbers and trading
activity. The unique investor base at the National Stock Exchange (NSE) surpassed the
10-crore mark in August 2024, tripling in the last four years, and currently stands at 10.9

45 US Treasury website, https://fiscaldata.treasury.gov/americas-finance-guide/national-deficit/.

46 https://www.ft.com/content/5219f962-3499-4928-8c73-5610b7a0109e.
47 This excludes the 85 technology companies within the top 503 companies(S&P500), where corporate profit data
58 has been available for the last 10 years.
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crore (as of 26 December 2024). The number of client codes, indicating a number of investor
accounts at NSE, has risen from a little under six crore at the end of 2019 to nearly 21 crore
as of December 2024.

Regarding activity, the number of individuals that traded at least once a month in the NSE’s
cash market segment increased from ~32 lakh in January 2020 to ~1.4 crore in November
2024. The rise in individuals’ participation in Indian equity markets is also reflected in the
amount of money invested by them. After remaining on the sidelines for the previous 11
years, individuals turned net buyers of Indian equities in 2020, only to strengthen it further
over the ensuing years. In the last five years (2020-24), individuals have invested a net

participation via mutual funds, has more than made up for volatile FPI outflows over the last
five years. Notably, direct and indirect (via mutual funds) ownership of individual investors
at 17.6 per cent (as of September 2024) in the NSE-listed companies is now at par with FPIs.
This gap was as high as 7.1 percentage points in FY21.

Participation of individual investors during the 2008 GFC

and 2020 COVID-19 pandemic

Chart II.11a: Count of active Chart II.11b: Net inflows by

individual investors retail investors

Source: NSE Economic Policy and Research (EPR)

Note: ‘t’ is the month when the event occurred. For COVID-19, t is February 2020, and for GFC, it is August
2008
Active investors are those investors who have traded at least once during the month
Individual investors include individual domestic investors, NRIs, sole proprietorship firms and HUFs
Net flows are calculated as buy traded value – sell traded value in the NSE’s cash market segment
Net flows include investments in securities in EQ, BE, SM, and ST series, including ETFs only

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Chart II.12: Annual trend of net inflows by individual investors

in the NSE’s cash market segment

Source: NSE EPR

Note: Individual investors include individual domestic investors, NRIs, sole proprietorship firms and HUFs
Net flows are calculated as buy traded value – sell traded value
Net flows include investments in securities in EQ, BE, SM, and ST series, including ETFs only
Data for 2024
Till Date is for the period January-November24

Deepening individual participation, coupled with robust gains generated by Indian equities,
outpacing other asset classes, has created significant household wealth over the last few years.

lakh crore in the last five years (2020-2024; as of September 2024).

This rise in retail participation aligns with a steady decline in the 5-year rolling beta between
the Nifty 50 and the S&P 500 in the last four years, suggesting a reduced sensitivity of Indian
markets to U.S. market movements. This decoupling is further evidenced by the increasing
resilience of Indian markets during periods of FPI outflows. For example, in October 2024,
despite FPI outflows of USD 11 billion, the Nifty 50 index was corrected by only 6.2 per
cent, thanks to strong downside support provided by domestic institutional and individual
investors. In contrast, during the March 2020 pandemic-driven market sell-off, FPI outflows
of USD 8 billion triggered a steep 23 per cent market decline.

Even as the resilience demonstrated by the Indian market, supported by growing retail
participation, is promising, the risks associated with a potential US market correction
cannot be overlooked, given historical trends.

What does the history tell us?

Historical data and research suggest that the Indian equity market has been notably sensitive
to movements in the US market. The Nifty 50 has historically shown a strong correlation
with the S&P 500, with analysis of daily index returns between 2000 to 2024 revealing that
in 22 instances when the S&P 500 corrected by more than 10 per cent, the Nifty 50 posted
a negative return in all but one case, averaging a 10.7 per cent decline. On the other hand,
during 51 instances when the Nifty 50 experienced a correction of over 10 per cent, the S&P
500 exhibited positive returns in 13 instances, with an average return of -5.5 per cent.
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This underscores the asymmetric relationship between the two markets, highlighting a more
pronounced impact of the movement in US markets on Indian equities than the other way
around.

Further evidence shows that S&P 500 returns Granger-cause48 Nifty 50 returns, meaning
that changes in the US market are a leading indicator for the Indian market, especially
during shocks, while the reverse is not true. This emphasises that Indian markets tend to
react more to trends originating in the US, reinforcing the need for caution in the event of a
downturn in the latter’s stock market.
Potential risks for India in 2025

Elevated valuations and optimistic market sentiments in the US raise the likelihood of
a meaningful market correction in 2025. Should such a correction occur, it could have a
cascading effect on India, especially given the increased participation of young, relatively
new retail investors. Many of these investors that have entered the market post-pandemic
have never witnessed a significant and prolonged market correction. Hence, if one were to
occur, its impact on sentiment and spending may be non-trivial.

GIFT City
2.57 The International Financial Services Centres Authority (IFSCA) is poised to play
a pivotal role in India's vision for 2047. As a unified regulator, IFSCA is responsible for
developing and regulating financial institutions, services, and products within India's
International Financial Services Centres (IFSCs). With its internationally aligned
regulatory regime, IFSCA aims to create an environment conducive to global financial
institutions operating in India. This, in turn, will facilitate the growth of India's financial
sector, making it a key player in the global economy.

2.58 GIFT IFSC has been witnessing brisk growth, having more than 720 entities across
categories. The international and domestic financial services industry is gravitating to
this unique jurisdiction which benefits from unrestricted currency convertibility as it is
classified as a non-resident zone under the Foreign Exchange Management Regulations.
GIFT-IFSC has continued its ascent as a leading IFSC, improving its rank by five places
in the ‘Global Financial Centres Index 36’ (GFCI 36), rising to 52nd position. It also
achieved a notable jump in the FinTech rankings, climbing four places to rank 45. This
progress reflects the concerted efforts of IFSCA in fostering a robust FinTech ecosystem.

2.59 The vibrant banking ecosystem in GIFT IFSC comprises foreign and domestic
banks set up as branches of the parent bank operating as IFSC Banking Units (IBUs).
As of September 2024, the total asset size of IBUs crossed USD 70 billion, and the
cumulative value of transactions undertaken by IBUs crossed USD 975 billion. Credit
exposure of IBUs stands over USD 51 billion as of September 2024, covering countries
48 Granger causality is a statistical concept that determines if one variable can predict another variable based on
its past values. 61

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like the US, UK, Singapore, UAE, etc., apart from India. Additionally, the cumulative
derivatives trades by IBUs crossed USD 982 billion, while the cumulative non-
deliverable forwards (NDF) bookings reached almost USD 500 billion.

2.60 The asset management ecosystem in IFSC is proliferating. It comprises 128 Fund
Management Entities, 168 Alternative Investment Funds (AIFs), and three Investment
Advisors. By September 2024, AIFs had raised total commitments of USD 12.1 billion.
Further, the insurance ecosystem in IFSC currently comprises 37 entities, including
15 IIOs (IFSC Insurance Offices) and 23 IIIOs (IFSC Insurance Intermediary Offices).
The total (Re)insurance premium booked by IIOs is USD 427 million, and the total (Re)
insurance premium transacted by IIIOs is USD 1,036 million, up to September 2024.

2.61 As of September 2024, 60 entities had registered as FinTechs or TechFins in

GIFT-IFSC, reflecting the region’s dynamic FinTech landscape. IFSCA has conducted
13 hackathons and received 152 applications from 14 jurisdictions under its FinTech
Entity framework, showcasing its commitment to innovation.

Developments in the insurance sector

2.62 The global insurance market is experiencing a dynamic period of growth and
transformation, driven by steady economic expansion, strong labour markets, and
rising real incomes. Despite considerable challenges in 2023, including persistently
high inflation and geopolitical tensions that constrained the global GDP growth, the
insurance sector demonstrated a positive growth rate of 2.8 per cent.49 The changing
macroeconomic environment, climate fluctuations, technological progress, and evolving
customer preferences drive transformation in technology, infrastructure, business
models, and organisational culture within the insurance industry. Global insurers
are actively adopting innovative technologies, expanding their market reach, and
prioritising customer-centric approaches to improve efficiency and address emerging
demands.50

2.63 India’s insurance market has also continued its upward trajectory. Total

a slight decline in insurance penetration51 from 4 per cent in FY23 to 3.7 per cent in
FY24. Life insurance penetration dropped marginally from 3 per cent in FY23 to 2.8
per cent in FY24, while non-life insurance penetration remained stable at 1 per cent.

49 Swiss Re Institute World Insurance Report 2024, https://tinyurl.com/bdfc3ma8.

50 EY August 2024 report, ‘Insurance for All: enhancing insurance coverage across India’, https://tinyurl.com/
ucapam6y.
51 Insurance penetration is calculated as the percentage of insurance premiums paid in a year to the country's gross
62 domestic product.

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Insurance density52 in the country saw a modest rise from USD 92 in FY23 to USD
95 in FY24. Non-life insurance density increased from USD 22 to USD 25, while life
insurance density remained consistent at USD 70. This growth in insurance density
has been on an upward trajectory since FY17. The gross direct premium of non-life

a YoY growth of 7.7 per cent. Health and motor segments primarily contributed to this

While renewal premiums accounted for 54.4 per cent of the total premium received
by the life insurers, new businesses contributed the remaining 45.6 per cent. The life

was due to death claims. The net incurred claims53

lakh crore in FY24.

2.64 With an overall insurance penetration rate of 3.7 per cent, below the global average
of 7 per cent, there is a notable gap in coverage that presents opportunities for insurers
to expand their reach. By targeting tier 2 and 3 cities and rural areas where awareness
and accessibility are limited, insurers can tap into new customer segments and stimulate
growth. Additionally, insurance density in India is relatively low compared to global
standards. Innovative distribution models can facilitate the inclusion of underinsured
customers who are already covered by government schemes such as the Pradhan Mantri
Jeevan Jyoti Bima Yojana, Pradhan Mantri Fasal Bima Yojana, and Pradhan Mantri
Jan Arogya Yojana.54

2.65 The Swiss Re Institute has projected India’s insurance sector to grow at a rate
of 11.1 per cent and is expected to become the fastest-growing market among the G20
nations over the next five years (2024-2028). An expanding middle class, technological
advancements, and supportive regulatory measures will likely drive this growth.55 In the
life insurance segment, there is a noticeable shift towards protection and guaranteed
return savings products, which now cover 40 per cent of households, largely due to LIC’s
extensive network. The non-life insurance sector is expected to double its premium-to-
GDP ratio over the next two decades. However, it will remain below the global average.56

52 Insurance density is calculated as the ratio of insurance premium to population (calculated in USD for
international comparison).
53 Net claims incurred is the total outstanding claims at the end of a financial year. It is calculated by adding the
claims paid during the year to the outstanding claims at the end of the year and then subtracting the outstanding
claims at the beginning of the year.
54 Ibid note 50.
55 Swiss Re Institute Report, ‘India’s Insurance Market: Growing Fast with Ample Scope to Build Resilience’,
https://tinyurl.com/mryxwhve.
56 Morgan Stanley Investor presentation ASIA, 2023. 63
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2.66 Evolving customer expectations and emerging risks, such as climate change
and geopolitical uncertainty, present significant challenges for insurers. Additionally,
increasing life expectancy and a growing elderly population pose underwriting risks
related to longevity and highlight the widening pension gap. Non-financial risks have
gained importance alongside traditional financial risks. The industry must address and
manage concerns related to misselling, delayed claims settlements, AI, cybersecurity,
and third-party interactions. A clear and quantitative understanding of risk appetite
is essential for effective risk management. Insurers must develop strong capabilities
to tackle these emerging risks through rapid innovation while ensuring efficiency and
productivity through simplification, standardisation, and digitisation. 57

Developments in the pension sector

2.67 Ensuring financial security in retirement is essential for individuals and societies,
especially as many countries face ageing populations' social, economic, and financial
challenges. The World Economic Forum (WEF) has highlighted that, for the first time
in history, globally, the number of people aged 65 and over has surpassed the number
of children aged five and younger.58 Retirees face increasing risks due to rising inflation
and higher interest rates, which elevate the cost of government debt and strain the
government’s ability to maintain their current level of services.59

2.68 An IMF staff discussion paper60 has analysed the global trends in rising government
pension expenditure, projecting that public pension spending will increase by an average
of 1 per cent of GDP in AEs and 2.5 per cent in EMEs by 2050. In many advanced
economies, younger individuals must save significantly more and delay retirement by
several years to receive pension benefits comparable to today’s retirees. Additionally,
countries with ageing and shrinking working-age populations are expected to experience
a more pronounced decrease in national savings than those with younger populations.

2.69 According to the Mercer CFA Institute Global Pension Index61, 2024, India’s
overall index value has moderated from 45.9 in 2023 to 44 in 2024. The overall index is
a weighted average of three sub-indices viz. adequacy (40 per cent), sustainability (35

57 McKinsey report, ‘Steering Indian insurance from growth to value in the upcoming ‘techade’, https://tinyurl.
com/3xdtknbj.
58 WEF (2024), ‘How communities can step up to provide long-term care for the world’s ageing population’ https://
tinyurl.com/ys8s7twk.
59 Mercer CFA Institute Global Pension Index 2024, https://tinyurl.com/s3btauhu.
60 Eich, F., Soto, M., & Feher, C. (2014). Public Pension Spending in Advanced and Emerging Market Economies:
Past Trends and Projected Outcomes. Bruce and Virginia MacLaury Senior Fellow, The Brookings Institution
Creating equitable and sustainable pensions is one of the main policy challenges of the twenty-first century.
Policymakers need to be reminded constantly of the challenges that they need to confront. This timely collection
of essays by experts in the field offers an analysis of the core issues which is based on rigorous think, 31, https://
tinyurl.com/mr3sc4y9.
64 61 Mercer CFA Institute Global Pension Index, https://tinyurl.com/y2tk573p.
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per cent), and integrity (25 per cent). A decline in the value of the adequacy62 sub-index
from 41.9 (as per the 2023 survey report) to 34.2 (as per the 2024 survey report) and a
decrease in the net pension replacement rates has driven the moderation in the overall
index. On the other hand, the scores for sustainability63 and integrity64 sub-indices have
improved across the two survey rounds.

2.70 India's pension sector has grown significantly since the introduction of the
National Pension System (NPS) and Atal Pension Yojana (APY). As of September
2024, the total number of subscribers reached 783.4 lakh, showing a YoY growth of 16
per cent from 675.2 lakh in September 2023. The number of APY subscribers, which
includes its earlier version, NPS Lite, rose from 538.2 lakh in March 2023 to 629.1
lakh in September 2024. APY subscribers comprise approximately 80.3 per cent of the
overall pension subscriber base.65

2.71 Disaggregated data from the Pension Fund Regulatory and Development
Authority of India (PFRDA) indicates significant improvements in terms of gender in
the subscriber demographic for APY. The share of female subscribers increased from
37.9 per cent in FY16 to 52 per cent in FY24. Additionally, the age distribution has
shifted to favour a younger cohort, specifically those aged 18-25, whose share rose from
29.2 per cent in FY16 to 45.5 per cent in FY24. However, 93.7 per cent of APY accounts

This overwhelming preference for a low pension amount among APY subscribers can
be attributed to several factors, the most significant being that the target population
primarily consists of low-income households, where daily consumption needs take
precedence over savings. Furthermore, the overall pension coverage for these two
schemes has increased from 0.95 per cent of the total population in FY16 to 5.3 per cent
in FY24. Additionally, the AuM for these schemes as a proportion of GDP have risen
from 0.86 per cent in FY16 to 4 per cent in FY24.

2.72 On 24 August 2024, the government approved Unified Pension Scheme (UPS) for
Government employees that will be implemented along with the present NPS, and will
be effective from FY26. UPS has features of both old and new pension schemes to offer
a wholesome retirement cushion to the employees. The scheme offers a family pension,
62 The adequacy sub-index represents both the benefits of the current pension systems and an assessment of some
important system design features. It is calculated based on these indicators: benefits, system design, savings,
Government support, home ownership, and growth assets.
63 The Sustainability sub-index focuses on the future and uses various indicators that will influence the likelihood
that the existing systems will be able to provide benefits for decades to come. It is calculated based on these
indicators: pension coverage, total assets, demography, public expenditure, government debt, and economic
growth.
64 Integrity sub-index includes many legislative requirements that influence the overall governance and operations
of the system, which affect the level of confidence that the citizens of each country have in their system. It is
calculated based on these indicators: regulation, governance, protection, communication, and operating costs.
65 Based on PFRDA data.
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a guaranteed pension amount, and a minimum pension for all the people working
in government jobs. It guarantees 50 per cent of the average basic pay of the past 12
months preceding the date of retirement as the guaranteed pension for the employee,
provided the employee has served the government for at least 25 years. The minimum

years in the service upon superannuation. In case of death of the pensioner, 60 per
cent of the pension amount (which he or she received right before the demise), will be
offered to the family.66

2.73 Despite this growth, India's pension system has considerable potential for further
expansion. Pension assets, including major schemes like the Employees’ Provident
Fund Organisation (EPFO), account for 17 per cent of the GDP. The NPS contributes
an additional 4.5 per cent of the GDP. In contrast, the average pension assets in OECD
countries exceed 80 per cent of their GDP.67 India's capacity to financially empower its
citizens is anticipated to grow as the economy progresses. Additionally, the extension
of NPS to children through the NPS Vatsalya68 is expected to contribute to this
empowerment. Box II.3 discusses further aspects of the pension landscape in the country.

Box II.3: Securing Retirement: Transforming India's Pension Landscape

By design, the benefits of a robust pension system are realised long into the future. The
system's liabilities (pension payments) become due far later, while there is always a risk
that the assets (contributions from a younger workforce) may change in the meantime.
A potential asset-liability mismatch can result in explosive government debt once the
future payouts become due. For instance, Greece and Italy suffered pension crises as their
populations aged. The UK is predicted to hit a pensions crisis in the next two decades.69

What constitutes an efficient pension system in the case of India?

Considering India's unique demographic and labour market characteristics, the pension
system must embrace principles of sustainability and scalability. Emphasising sustainability
is crucial to ensure that as India moves beyond its favourable demographic window, the
burden of an ageing population does not disproportionately affect the younger generation.
For a pension scheme to be sustainable, the outflows must be adequately linked to the
inflows. In this context, Pay-As-You-Go (PAYGO) schemes70 begin to fail when demographic
profiles change. Furthermore, the nature of inflation indexation is important, especially in
defined benefit schemes. Even small differences in percentage points for indexation can lead
to significant variations in the annuities paid out.

66 PIB press release dated 24 August 2024, https://tinyurl.com/yck3uwjm.

67 3rd Ranjit Kumar Dutta leadership lecture delivered by Dr. Deepak Mohanty, Chairman, PFRDA. Dibrugarh
University, 4 March 2024, ‘Progress of Indian Economy and Prospects of Pension Security’, https://tinyurl.com/bdhtkmud.
68 PIB press release of Ministry of Finance dated 16 September 2024, https://tinyurl.com/pny4tt45.
69 Financial Times 2024, https://tinyurl.com/mr2k8hba.
70 PAYGO schemes are essentially pay-as-you-go arrangements where the young salaried employees bear the price
66 of pension payments for the older generation. Several OECD nations usually follow this.
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Despite significant advancements in the pension sector, 5.3 per cent of the total population is
covered by the NPS and APY combined. This highlights another critical aspect of the Indian
pension system: scalability. Low costs are essential to enhance coverage meaningfully.
Achieving this will require highly competitive, low-cost fund management and minimal
transaction costs, which is particularly vital for small-ticket transactions.

In principle, taking into consideration both scalability and sustainability, India’s pension
system design seems robust and stable. The NPS is one of the lowest-cost pension schemes
globally71 and its framework is based on a defined contribution model, which ensures that
future payouts are determined by market fluctuations, thereby reducing the fiscal burden on
the government. Additionally, the APY aims to address the retirement needs of the unorganised
and informal sectors - first time in India’s pension history. While progress under APY has
been notable, its scalability in practice remains an area for further development. The key issue
moving forward is how to make the pension system more accessible to the informal sector.

Role of financial inclusion in advancing financial literacy: The example of the

Unified Payment Interface (UPI) illustrates how a well-designed platform can serve as a
cost-effective solution for financial inclusion on a large scale. The widespread adoption of
UPI proves that a lack of financial literacy did not hinder its success; rather, the necessity
to utilise UPI encouraged the informal economy to open bank accounts. This suggests
that financial inclusion can indeed precede financial literacy. Thus, a fundamental step in
integrating a significant portion of the informal sector into the pension framework is raising
awareness about pension and financial literacy and utilising modern, application-based
interfaces that allow seamless access to these services.

Behavioural nudges for scalability: A persistent issue with micro-pension schemes

is their low uptake among the poor, who often have a strong urge to allocate limited
funds toward immediate consumption.72 In this context, increasing participation can be
achieved through behavioural interventions. These interventions could involve changing
how information is presented, simplifying the enrolment process (for example, using UPI-
enabled pension payments), and providing timely reminders.

Young people in India may not feel an immediate need to secure an optimal pension plan.
The old-age dependency ratio is about 15.7 per cent, which is significantly lower than in
many EMEs. However, this should not lead to complacency. The best time to repair a roof is
when the sun is shining, not when it is raining.

Financial sector regulators

2.74 Independent regulators are key institutions established as separate “agencies”
at arms’ length from the political system, with delegated powers to implement specific
policies in several sectors. Regulators have been set up in the utility sector (energy,
telecom, airports), competition, social sector (higher education), financial services
(capital markets, insurance, pensions) etc. These regulatory agencies are seen to be
71 Department of Financial Services 2024, https://tinyurl.com/32efw7wf.
72 World Bank 2019, https://tinyurl.com/53uy6655. 67
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mainly designed to have the authority to deal with intricate issues, providing non-
discriminatory access to essential services and guaranteeing “fair and transparent”
regulations. The key benefit sought from an institutional framework based around
these independent regulators/agencies is to safeguard market interventions from the
interference of political and private interests. Further, these independent regulatory
bodies (IRBs) can set up and benefit from a specialised workforce with relevant technical
knowledge of the area of regulation.

2.75 The financial sector is primarily governed through IRBs – RBI, SEBI, IRDAI,
PFRDA and IBBI, with FSDC having a broader financial stability mandate, enabling
inter-regulatory coordination and promoting financial sector development.73 Each IRB
varies in design, the nature of delegated functions, and the degree of autonomy, which
are unique to the socio-political context of its evolution and the regulated domain.
However, certain basic structure elements are common to all regulatory bodies: they
are backed by a statute, are accountable to the legislature, enjoy a certain degree of
autonomy from the government, have legislative, executive and quasi-judicial functions,
and engage in specialised and technocratic decision-making processes.

2.76 Regulations are the basic instruments of law through which the IRBs conduct
their functions and deliver on their objectiveness. The efficiency and effectiveness of
regulatory action are directly dependent on the quality of regulations. The primary
responsibility of these IRBs is the making of regulations, the power for which is
delegated to the IRBs by statute and is an essential component of the autonomy of
IRBs. Box II.4 discusses the regulation-making aspect of the IRBs in the financial sector
space, suggesting the approach of regulatory impact assessment for strengthening this
process.

Box II.4: Institutionalising regulatory impact assessments

in independent regulatory bodies

The regulators in the financial sector space are largely left to regulate themselves in their
mandate of ensuring optimal and adequate regulation and assessing themselves. In the
existing governance architecture, the performance of IRBs in the financial sector is assessed
in the following ways.

Parliament, through the Committee on Sub-ordinate Legislations74 in the Rajya Sabha: It

is mandated to examine if the powers delegated under a law passed by the legislature have
been duly exercised and are within the conferment or delegation and not beyond.

73 Department of Economic Affairs, Government of India. Structure of Financial Stability and Development Council,
https://tinyurl.com/nhbd23t3.
74 Rajya Sabha Practice and Procedure Series No. 13, Committee on Subordinate Legislations No.13 pp 3-4. https://
68 tinyurl.com/4vtvwxbh.
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Parliament, through the Standing Committee on Finance, can examine the performance of
specific sectors and the IRBs. The Committee, in 2024, examined the performance of the
insurance sector (66th Report).

Department / Ministry administering the parent statute- These assessments deal with
overall performance, utilisation/expenditure of grants, compliance with parliamentary
procedure and administrative matters regarding the structure and composition of the IRBs.
The quality of regulation usually falls beyond the ambit of regular evaluations.

The Comptroller and Auditor General’s (CAG) mandate includes the various audits of
autonomous entities, including IRBs. However, the scope of CAG’s financial compliance
and financial audits do not include the IRB's regulation-making processes. The quality of
regulation is beyond the scope of these audits.

Judicial review – Once a regulation is challenged, the courts then review, ex-post,
the implementation of the regulations. Such reviews may cover the form, content or
implementation of the regulation. Withstanding judicial scrutiny improves the regulation's
force and vindicates the regulation maker's decisions. However, the gains from such review
are only available after implementation and not during the making of regulations.

The quality of regulations can be broadly assessed based on five criteria: democratic
legitimacy, accountability of the regulator, fair, accessible and open procedures, expertise
and efficiency.75 While these criteria are impacted by many structural and operational factors
in the regulator and beyond, using a ‘fair, accessible and open procedure’ for regulation-
making is more practicable than the others. A systematic procedure for regulation-making
is one way to ensure that the quality of regulations is right.

Regulatory impact assessment (RIA) has been identified as an effective tool when used
as part of the regulation-making process to ensure the quality of regulations. RIA is an
administrative obligation or an instrument of public policy analysis for identifying the
costs of regulation on certain business sectors (Fischer, Miller and Sidney 2007) 76 and has
been promoted by the World Bank (2010).77 OECD laid down the guidelines for the use of
RIAs in 2008.78 By 2016, 32 of the 35 OECD countries had included RIA in their regulatory
frameworks (Deighton-Smith, Erbacci and Kauffmann 2016).79 Globally, countries are
increasingly adopting and revamping RIA procedures, including countries across all income
levels.80

75 Baldwin, Robert., Cave, Martin., and Lodge, Martin (2012). Understanding Regulation: Theory, Strategy and
Practice. 2nd ed, OUP, p. 25.
76 Fischer, F., Miller, G., and Sidney, M. 2007. Handbook of Public Policy Analysis Theory, Politics and Methods.
Boca Raton: CRC Press.
77 World Bank Group, Investment Climate Advisory Services. 2010. Making It Work: ‘RIA Light’ for Developing
Countries, Better Regulation for Growth. Washington, DC: World Bank Group.
78 OECD. 2008. Introductory Handbook for Undertaking Regulatory Impact Analysis. Paris: OECD Publishing.
79 Deighton-Smith, R., Erbacci, A., and Kauffmann, C. 2016. “Promoting inclusive growth through better
regulation: The role of regulatory impact assessment.” OECD Regulatory Policy Working Papers No. 3. Paris:
OECD Publishing.
80 World Bank Group, Worldwide Practices of Regulatory Impact Assessments Case study. 2016. 69
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Financial sector IRBs have been including the elements/aspects of RIA and related
regulatory best practices. The RBI has set a Medium-term Strategy Framework - Utkarsh
2022, and the SEBI indicates regulatory plans as part of its annual reports.81 The IBBI
governs the regulation-making process through the IBBI (Mechanism for Issuing
Regulations) Regulations, 2018. 82 It provides for at least 21 days for public consultations
while proposing/amending regulations, consultations with stakeholders and advisory
committees, and an economic analysis covering the expected costs and benefits to society,
economy, stakeholders, and itself on account of the proposed regulation. It also provides
for a review of all regulations every three years. It is observed that most regulators practice
consultations with stakeholders during regulation-making through discussion papers
shared on their websites. A third-party evaluation of the regulatory performance of the IBBI
was conducted in 2021 (NCAER, 2021).83

There is vast scope for improvement in the regulatory responsiveness in terms of following
participatory processes of the IRBs.84 The second Administrative Reforms Commission85
recommended including reviews of regulations. The Financial Sector Legislative Reforms
Commission86 detailed the process for making regulations as part of the draft financial code.
The proposed process included a detailed cost-benefit analysis of the proposed regulations
alongside the considered alternatives. The Union Budget 2023-2487 recommended that the
financial sector regulators include public consultations as part of the regulation-making
process, issuing subsidiary directions, conducting a comprehensive review of existing
regulations and laying down time limits for various applications under different regulations.

As financial sector regulators take steps to address the review of regulations and shortcomings
in the regulation-making process, it would be an opportune time to institutionalise
a systematic approach such as the RIA. There is vast evidence of the benefits of RIAs in
terms of better quality of regulations and reduced compliance burden, thereby reducing the
cost of compliance for businesses. RIA is also effective in improving the transparency and
responsiveness of the IRBs, thereby improving credibility.

One credible approach to RIA would be to set up an independent agency housed inside
the regulator to evaluate the regulations from all angles. This agency will report to the
Board and not to the management. It can provide an impartial and objective assessment
of the regulatory processes and outcomes, including the economic and social impacts of
regulations. An economic and social cost-benefit analysis of regulations will prove useful to

81 Securities Exchange Board of India Annual Report 2023-24 https://tinyurl.com/mtddd28z.

82 The IBBI (Mechanism for Issuing Regulations) Regulations, 2018, https://tinyurl.com/2x9xnuy5.
83 National Council of Applied Economic Research 2021. Evaluation of the Regulatory Performance of the Insolvency
and Bankruptcy Board of India. https://tinyurl.com/mvvz55xw.
84 Carnegie India Measuring Regulatory Responsiveness in India: A Framework for Empirical Assessment 2019.
https://tinyurl.com/3u5x7tvb.
85 Second Administrative Reforms Commission, Organisational Structure of Government of India, Thirteenth
Report April, 2009 (Para 6.4.8) pp 156-158
86 Report of the Financial Sector Legislative Reforms Commission Vol II: Draft Law, 2013. https://dea.gov.in/fslrc.
87 Government of India, Speech of the Finance Minister, Union Budget 2023-24 Para 99 and 100. https://tinyurl.
70 com/bdemfe54.
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regulators in making them effective and purposeful rather than broad-based, cumbersome,
and inhibiting legitimate economic activity and risk-taking. Such a move will signal that
regulators are willing to live by the principles they expect regulatory entities to follow. This
will strengthen the credibility of the process regulators follow and improve the acceptance
of the proposed measures.

Regulation in the financial sector must strike an optimal balance between the imperative
of stability and the goals of fostering innovation, efficiency, and competition. Given the
country’s low financial literacy and lower-middle-income status, ensuring stability is
essential to prevent systemic risks and protect consumers. However, this should not come at
the expense of stifling creativity, innovation, or healthy market dynamics. At the same time,
an excessive focus on innovation and competition without adequate safeguards can lead to
financial instability, resource misallocation, and erosion of trust in the system. Striking this
balance is particularly critical for India, considering its vast and diverse economy, growing
aspirations, and substantial investment needs to sustain high growth and development.
Regulators must consistently strive to achieve this equilibrium, and the suggestions outlined
in this box, if implemented, will help them pursue and maintain that balance effectively.

Cybersecurity aspects of India's financial sector

2.77 Cyberspace has emerged as a multifaceted and rapidly evolving global environment
where interactions among individuals, software, and services are facilitated by the
widespread proliferation of information and communication technology (ICT) devices
and networks. With innovative technologies and advanced digital tools, cyberspace
has effectively transcended geographical barriers for exchanging information and
communication. However, this digital revolution has concurrently introduced new
challenges and threats, including the illicit use of cyberspace for criminal activities.

2.78 With technological advancements, the Indian financial sector is witnessing a

digital transformation that has enhanced efficiency and accessibility and increased
exposure to diverse cyber threats. These threats, ranging from phishing and ransomware
to Distributed Denial of Service (DDoS) attacks, SMSing, and fake/malicious mobile
applications, pose serious challenges to the financial system's stability. As per the
information reported to and tracked by the Indian Computer Emergency Response
Team (CERT-In)88, the number of observ observed and handled cybersecurity89 incidents
stood at 11.6 lakh, 14 lakh and 13.9 lakh during 2020, 2021 and 2022, respectively.

2.79 The financial sector remains susceptible to cyber threats because it manages
sensitive data and conducts critical transactions. Criminals often target financial

88 Indian Computer Emergency Response Team, Ministry of Electronics and Information Technology, https://
tinyurl.com/yz8tppnp.
89 Cyber security is the application of technologies, processes, and controls to protect systems, networks,
programs, devices and data from cyber-attacks. It aims to reduce the risk of cyber-attacks and protect against
the unauthorised exploitation of systems, networks, and technologies. 71
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institutions to either gain unauthorised access to assets or disrupt financial activities,

jeopardising economic stability. Reports indicate that almost one-fifth of all reported
cyber incidents involve financial institutions, with banks being the most affected.
According to IMF's April 2024 Global Financial Stability Report, cyberattacks have
resulted in extreme financial losses, which have increased fourfold since 2017, amounting
to USD 2.5 billion. Beyond these direct losses, indirect costs such as reputational
damage and expenditures on enhanced security have also significantly risen.90

2.80 National Cyber Security Policy 2013 (NSCP-2013) was released by the Government
in August 2013 for public use and implementation with all relevant stakeholders. The
objective of the policy is to create a framework for comprehensive collaboration and
collective response to deal with issue of cyber security at all levels with in the country.
The FSDC is the apex body for addressing high-level policy issues and fostering inter-
regulatory coordination among key financial sector regulators. The FSDC facilitates
inter-regulatory coordination, financial sector development and the maintenance of
financial stability. In view of the increasing digitalisation of the financial sector, FSDC
has been focusing on cyber security issues as strengthening the cyber resilience of the
financial sector is key to maintaining financial stability.

2.81 India's Tier 1 ranking in the Global Cybersecurity Index (GCI) 2024, with
a commendable score of 98.49 out of 100, signifies a significant milestone in its
cybersecurity journey.91 This recognition places India among the world's 'role-model'
nations in cybersecurity. The GCI evaluates national efforts across five pillars—legal,
technical, organisational, capacity building, and cooperation, highlighting India's
holistic approach. India has strengthened its cybersecurity ecosystem through robust
legal frameworks, targeted education programs, and international collaborations.
By promoting awareness, skill development, and research, the country effectively
addresses current cyber threats while preparing for emerging challenges, reaffirming
its leadership in securing digital infrastructure.

2.82 The RBI, in collaboration with sectoral regulators like Insurance Regulatory and
Development Authority of India and PFRDA, oversees the cybersecurity preparedness
of the financial sector through regular IT examinations and monitoring of compliance
with established guidelines. The primary focus is on the regulations issued by the RBI,
emphasising essential elements, including governance, technology risk management,
IT services management, cybersecurity operations, business continuity, response and
recovery, vulnerability assessments, and third-party risk management. This framework
is designed to fortify cybersecurity risk management and supervision across financial
institutions in India.

90 IMF April 2024 Global Financial Stability Report, https://tinyurl.com/8wa6fpfw.

72 91 PIB press release of Ministry of Communications dated 20 September 2024, https://tinyurl.com/2sxewe8m.
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2.83 The Indian banking sector benefits from a comprehensive and modern regulatory
structure for cybersecurity, guided by both international and national standards.
This framework is anchored by well-recognised international references, such as the
ISO 27001 for Information Security Management Systems, the NIST Cybersecurity
Framework, and the CPMI-IOSCO Cyber Guidance for Financial Market Infrastructures
(FMIs). The RBI has recently introduced regulations on the oversight of IT outsourcing,
including cloud services, as well as standards for the cyber resilience of digital payments.
This comprehensive approach ensures that cybersecurity measures align with global
best practices while addressing the unique challenges of India's financial ecosystem.

2.84 India's strong performance in cybersecurity is driven by a range of initiatives

and measures implemented by the government to enhance cyber resilience and
establish robust frameworks for cybercrime laws and cybersecurity standards. The
country's legal institutions are well-equipped to tackle cybersecurity challenges and
combat cybercrime, ensuring the protection of its digital infrastructure. Additionally,
Sectoral Computer Incident Response Teams (CSIRTs) provide sector-specific
technical support and incident reporting, further bolstering the country’s cybersecurity
capabilities. Education and awareness are central to India's cybersecurity strategy.
Targeted campaigns and educational initiatives have promoted secure online practices
across various sectors, including private industry, public institutions, civil society,
and academia. The integration of cybersecurity into primary and secondary education
curricula underscores the country’s commitment to cultivating a knowledgeable and
well-prepared digital citizenry.92 Moreover, incentives and grants have fuelled skill
development and encouraged research and innovation within India’s cybersecurity
industry. International collaborations and bilateral and multilateral agreements
have further strengthened India's capacity-building and information-sharing efforts,
solidifying its role as a global leader in cybersecurity.

2.85 India’s ascension to Tier 1 in the GCI 2024 clearly indicates the nation’s enhanced
cybersecurity commitments. This achievement reflects the government's dedication to
securing its digital domain and sets a benchmark for other countries.

RISKS PERTAINING TO INDIA’S FINANCIAL SECTOR

2.86 The Indian financial sector is currently at a pivotal moment. The traditional
dominance of banks in providing credit is beginning to decline, and other participants
and products in the financial sector are increasingly filling this role. This shift is a long-
awaited and positive development for a country that aims to become a developed nation
by 2047. Various financial innovations such as UPI, Open Credit Enablement Network
(OCEN) and T+1 settlement have significantly eased access to credit in India. A recent
92 A Study of the Awareness on Cyber Security and Safety among Secondary Students (Class IX to XII), https://
tinyurl.com/4zu4px4u. 73
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initiative by the RBI, the Unified Lending Interface (ULI), can potentially be a game-
changer in MSME financing.

2.87 While there is evidence of increasing reliance on the financial markets as a funding
source, the financial markets must work in tandem with the banking sector to bridge
the capital requirement gap. The financial markets must grow in line with, but not
faster than, the economy's capital needs and overall economic growth. As the country
undergoes this significant transformation, it is crucial to be aware of the potential
vulnerabilities that may arise. India must prepare itself with appropriate regulatory
and government policy measures to intervene and mitigate these risks when necessary.
Additionally, banks need to enhance their capabilities to meet the demands of new-age
households and the digital economy while maintaining their primary credit creation
function. Excessive financialisation can hurt the economy. The costs may be particularly
high for a low-middle-income country like India. Box II.5 discusses this in detail.

Box II.5: Can the growth of the financial sector come at a cost?

Lessons from the global financial crisis of 2008 reveal that uninhibited financial sector growth
can come with a cost to the real economy. Till the run-up to the crisis, however, conventional
wisdom dictated that the financial sector performed best when deregulated.93 To sustain
financial growth but prevent a crisis, regulators must be sensitive to the nuanced relationship
between financial sector growth and the real economy.

Financial sector and the real economy – relationship

A developed financial system reduces transaction costs, allows better price discovery, and
channels the flow of capital into innovative and risky economic activities. Research has
established that finance is a causal driver of growth, not a by-product of the development
process.94 There is evidence that finance aids consumption smoothing and allows firms and
households to absorb shocks.95 Finance is essential for poverty and inequality reduction.96
However, there is an inflexion point at which financial development switches from propelling
growth to holding it back. For instance, BIS research shows that Ireland’s steep rise in private
credit to GDP ratio from 90 per cent in the 1990s to 150 per cent in 2007 shaved away 0.5
percentage points from productivity growth.97 In contrast, by reducing its private credit to
GDP during the Asian financial crisis, Thailand contributed to its productivity growth by 0.5
percentage points.

93 After the crisis erupted, Former Fed Governor Alan Greenspan admitted that he "made a mistake" in trusting
that free markets could regulate themselves without government oversight.
94 Rajan, R. & Zingales, L. (1998). Financial dependence and growth. American Economic Review 88, 559-586,
https://tinyurl.com/ycefwff9.
95 Kast, F. and D. Pomeranz (2018). Savings Accounts to Borrow Less: Experimental Evidence from Chile. NBER
Working Paper 20239, https://tinyurl.com/pmxz3bs4.
96 Beck, Thorsten, A Demirgüç-Kunt, and Ross Levine, 2007, Finance, inequality and the poor, Journal of Economic
Growth 12 (1), 27-49, https://tinyurl.com/446zcsfz,
97 Cecchetti,S. and Kharroubi (2015). Why does financial sector growth crowd out real economic growth? BIS
74 Working Paper No 490. https://www.bis.org/publ/work381.pdf.
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When the economy reaches a state of ‘over-finance’, the financial sector would compete
with the real sector for resources. This competition for resources is especially seen in the
case of skilled labour, which gets absorbed into the financial sector at the cost of the real
economy.98 Often financial sector innovation may result in products that do not add value
to the real economy. Research also shows that rapid financial sector growth tends to favour
high collateral–low productivity projects.99 Often, financial booms are associated with the
growth of sectors such as construction, where the collateral is high, but productivity growth
is relatively low.

Greater levels of financial engineering can create complex products whose risks are not
apparent to the regular consumer. At the same time, these products are designed so that the
lenders have little ‘skin in the game’.100 Ultimately, the proliferation of such products can
lead to an event such as the financial crisis of 2008. In the run-up to the crisis, mortgages
were granted to people with little ability to pay them back. In turn, lenders reduced their
exposure to risk by securitising these mortgages at multiple stages. When the mortgage
bubble burst, it, in turn, took down with it instruments that were highly securitised, leading
to the crises.

The changing influence of financial development on growth can be depicted as a bell-

shaped relationship.101 As research by the IMF shows, several developed nations, such as
Ireland, the USA, and Japan, are past the point where incremental advances in the financial
sector can contribute to growth.102 In contrast, under-developed and developing countries
such as Gambia, Ecuador and Morocco reap dividends to growth through faster financial
development.

Sustaining financial development while mitigating financial stability risks –

role of regulation

Can a developing economy (nations to the left of the peak of the bell curve) reach a
point of over-finance such that advancements to the financial sector hamper its growth
prospects? In the presence of weak institutions and poor regulatory quality, it is possible
for an emerging economy to reach well past its optimal level of financial development.103
Thus, the upper bound to financial development is fixed by the regulatory quality of the
emerging market.

98 Ibid note 97.

99 Ibid note 97.
100 Zingales, L. (2015). Presidential address: Does Finance benefit society? Journal of Finance, 70(4), 1327-1363,
https://tinyurl.com/3zjdztvu.
101 This relationship holds, keeping other determinants of growth (such as institutional quality, technological
growth, capital formation, etc.) constant.
102 Sahay,R. et al. (2015). Rethinking Financial Deepening: Stability and Growth in Emerging Markets, IMF Staff
Discussion Note SDN/15/08, https://tinyurl.com/55kpyrws.
103 Ibid note 102. 75
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Chart II.13: Financial development and growth – a bell-shaped relationship

Source – Rethinking financial deepening, IMF Staff Discussion Note, 2015

As the regulatory quality in the financial sector improves, regulators will need to play a
delicate balancing act between the goals of financial resilience and growth. On the one hand,
building financial resilience would entail higher capital buffers, stricter regulations and
reduced risk-taking. On the other hand, this would lead to lower financial growth by limiting
profitable investments and innovation. For instance, a system where banks maintain high
reserve ratios and only lend to the most creditworthy borrowers may exclude smaller
households and businesses from accessing credit.

Managing the trade-offs between financial resilience and efficiency is especial significant
for EMEs, which have two undertake large-scale financial inclusion and, at the same
time, reduce there vulnerability to crises. In this context, regulatory innovations that use
technology such as unified ledgers and digital infrastructure can help advance financial
efficiency without compromising on resilience. EMEs such as Brazil and Thailand were
making positive steps towards advancing such as technology in there financial system.104 In
India’s case, innovations such as the OCEN framework and the ULI provide access to real-
time information on the risk profiles of debtors and reduce the need for provisioning based
on an overestimation of default risk.

OUTLOOK
2.88 India’s financial sector has performed well amidst unfavourable geopolitical
conditions. On the monetary front, system liquidity, represented by the net position
under the Liquidity Adjustment Facility, remained in surplus during October-November
2024. The financial parameters of banks continue to be strong, reflected in improved
profitability indicators. The gap between the growth of credit and deposits of SCBs has
104 Carstens, A. G., & Nilekani, N. (2024). Finternet: the financial system for the future. Bank for International
Settlements, Monetary and Economic Department, https://tinyurl.com/3h5np8fn.
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narrowed, with deposits keeping pace with loan growth. Capital markets significantly
contribute to capital formation, the financialisation of domestic savings, and wealth
creation. Strong macroeconomic fundamentals, healthy corporate earnings, supportive
institutional investment, robust inflows from SIPs, and increased formalisation,
digitisation, and accessibility have all fuelled the market's continued growth. India's
insurance sector is performing well and is projected to become the fastest-growing
market among G20 nations over the next five years (2024-2028). The pension sector is
expected to grow as the economy transitions from a lower-middle-income to an upper-
middle-income country.

2.89 The financial sector is witnessing a moment of positive flux, with several changes
taking shape. Firstly, there is a rise in the share of consumer credit in overall credit
extended by banks.105 Between FY14 and FY24, the share of consumer credit in total
bank credit increased from 18.3 per cent to 32.4 per cent.106 Secondly, there has been
a rise in non-bank-based financing in recent years. Banks' share in total credit has
declined from 77 per cent in FY11 to 58 per cent in FY22.107 Simultaneously, there has
been a rise in NBFCs and bond market financing. Thirdly, equity-based financing has
catapulted to popularity, with IPO listings growing six times between FY13 and FY24
and India being ranked first globally in terms of the number of IPO listings in FY24.108
Young investors are also driving the equity boom under the age of 30. As a report by
the NSE notes that between March 2018 to September 2024, the proportion of young
investors surged from 23 per cent to 40 per cent.109

2.90 These emerging trends mark the dawn of a new era for India's financial sector.
However, they also bring regulatory challenges and potential risks that cannot
be overlooked. One critical risk to guard against is the dominance of financial
markets in shaping policy and macroeconomic outcomes, a phenomenon known
as 'financialisation.' The consequences of financialisation are evident in advanced
economies, where it has led to unprecedented levels of public and private sector debt—
some visible to regulators and some not. Economic growth in such contexts becomes
overly reliant on rising asset prices to offset leverage, exacerbating inequality and
asset market considerations that may overly influence public policies, particularly
regulatory ones. As India strives to align its financial system with its economic
aspirations for 2047, she should strive to maintain the fine balance between financial

105 Sengupta, R., & Vardhan, H. (2021). Consumerisation of banking in India: Cyclical or structural. Ideas for India,
https://tinyurl.com/3rsh6x6w.
106 RBI Handbook of Statistics, 2024.
107 Sengupta, R., & Vardhan, H. (2022). India’s Credit Landscape in a Post-Pandemic World. IGIDR Working
Papers, https://tinyurl.com/3evtf5th.
108 NSE 2024, Indian Capital Markets: Transformative shifts achieved through technology and reforms, https://
tinyurl.com/5n7sm2d6.
109 SEBI, 2024, https://tinyurl.com/3n7ktss5. 77

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sector development and growth on the one hand and financialisation on the other. It
means that the country has to chart its path with respect to its context, considering the
levels of financial savings in households, its investment needs, and levels of financial
literacy. Ensuring that incentives in the sector are consistent with national growth
aspirations is a policy imperative.

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