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Modi needs to save Indian capitalism before it goes down Latin American path

Whether India realises its growth potential or gets stuck in a middle-income trap depends on saving ‘capitalism from the capitalists’.

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In the last few years, India achieved the symbolic goal of growing faster than China — at least according to official statistics — and was frequently hailed as the fastest-growing large economy in the world (Figure 1). But, is India’s fast growth sustainable?

Figure 1: India overtakes China in the growth stakes

India’s economy holds great potential, but there is a big risk that this will not be translated into reality. On current trends, India is en route to the Latin American path, in which episodes of fast growth tend to stall in the long run. Signs of Latin Americanisation lie in the consolidation of what has been referred to as ‘oligarchic capitalism’, with its drawbacks of widespread informalisation, rising extremes of inequality, and a corporate-financial nexus of bad assets that risks growth and macroeconomic stability.

Middle-income trap is an essentially political-institutional account, embedded in the nature of the relationship between the state and business, and between the state and society. Indian capitalism has two faces: dynamic, competitive and productivity-oriented; and connected, rent-extracting and corrosive politics.

These features resonate vividly with characteristics of Latin American capitalism. Countries such as Mexico and Brazil had their episodes of fast growth and then got stuck in a mix of low productivity, inefficient social policy, and periodic macroeconomic crisis.

Also read: Here’s how Modi govt can help make India a $5 trillion economy

The problems now

Capitalism in India operates in a system that is characterised by both formal rules and less formal deals. India’s economy has evolved from being a case study in over-regulation to, functionally, a hybrid of rules and deals. Of the business-politics nexus, it can be said that ‘the relationship can no longer be understood as either developmental or crony capitalist: it is both’.

India’s major growth acceleration occurred in the 2000s. However, even as GDP skyrocketed, India’s growth story was dogged by concerns over high-level corruption and rising inequality.

Combining tax data with household survey data, Chancel and Piketty estimate a large increase in the income share of the top 1 per cent, matched by a corresponding decline in the share of the bottom half of the population (Figure 2). The difference in income growth between the top and the rest of the distribution was even greater than in China and the US – both notorious for their inequality rise (Table 1).

Figure 2: The rising concentration of income in India


A more specific manifestation of growing inequality is the rise in wealth of India’s billionaires, almost all of which is fuelled by business success (Figure 3).

Figure 3: The wealth of India’s top ten billionaires rose rapidly between 2014 and 2018

A crucial heritage of the period of heady growth has been a dramatic rise in reported non-performing assets (NPAs) in the banking system. NPAs are products, at least in part, of past state-business links. NPAs were over 14 per cent of gross advances in 2018 for public sector banks, with a still-high 8 per cent for net NPAs (net NPAs are net of provisions) (Figure 4).

Figure 4: A large rise in Non-Performing Assets, especially in public sector banks

Source: DBIE, RBI

This rise in NPAs, alongside recent setbacks to India’s shadow banking industry, is a crucial constraint to the flow of credit and private investment, which has stalled in recent years. Gross capital formation as a percentage of GDP is hovering around 31 per cent, its lowest since 2003 (Figure 5). Reported new investment proposals have also been falling steadily since 2015 (Figure 6).

Figure 5: The rise and fall of India’s investment rate

Source: World Bank information base

Figure 6: The rise and fall in investment proposals

Source: CMIE

Resolving the NPA crisis, an increasingly important policy priority in recent years, is necessary but not sufficient. The informal sector continues to dominate the economy, with over 80 per cent of non-agricultural workers employed by the informal sector and MSMEs, contributing over a third of GDP. Yet the IFC estimates that formal credit channels account for only 16 per cent of debt financing in the MSME sector.

Also read: Monopoly was created 100 years ago to teach the dangers of capitalism

Urgency of action

Why is a focus on the functioning of Indian capitalism so important for the new Narendra Modi government?

For every administration that fails to put in place the institutional and policy preconditions for dynamic, inclusive development, there is a permanent loss in productive and human potential. Failure to act now means another cohort of India’s youth being substantially ill-equipped to participate in productive work.

Even more critical is the risk of further entrenchment of business elites, creating oligarchic capitalism that heightens resistance to future transitions to dynamic, competitive capitalism.

Furthermore, the global economic context is much more anaemic than the ‘sweet spot’ of the early 2000s. Finally, automation is likely to have profound effects on the work opportunities for India’s labour force.

Also read: India’s crony capitalism claims another victim — the RBI

A policy agenda

Whether India realises its growth potential or gets stuck in a middle-income trap depends on both policy choice and institutional design. This requires, in the resonant phrase of Raghuram Rajan and Luigi Zingales, ‘saving capitalism from the capitalists’. Rebuilding state-business relations in an open, competitive rules-based fashion is essential. We outline six complementary areas.

(1) Resolution of NPAs: While the Insolvency and Bankruptcy Code (IBC) has set out a sound framework to resolve NPAs and shift power from promoters to creditors, translating the promise of the IBC into practice remains a challenge. In addition, continued vigilance is required to ensure that tight eligibility guidelines for potential buyers do not translate to increased corporate concentration in key sectors. Underpinning the broader NPA challenge is the need to sustain the autonomy of the RBI.

(2) Competition: Dynamism and innovation require competition. Many sectors are already concentrated, and there are risks of further concentration. This requires an empowered, autonomous competition authority, and also continued innovations in regulation in the wake of technological change.

(3) Better rules: Shifting the balance to rules-based interactions requires better rules. There has been a plausible focus on the ‘Doing Business’ indicators and healthy interstate competition on the rankings. The GST reform should help in the long term, but the costs of participation often still seem to outweigh the benefits, especially for informal firms.

(4) Facilitating implementation: The bureaucracy has in the past been in the production line of converting politician-business deals into the prevailing rules. With the (desirable) anti-corruption motif, there is widespread reference to the ‘chilling’ effects on approval, from both business and bureaucrats. Some reduction in the excessive legal risks for bureaucrats have come with changes in the 13(1)(d) regulation in 2018 but the effects are still unclear. Additional action, such as new third-party processes for contract renegotiation can help.

(5) Inclusion: Deepening institutional support for small-scale and informal enterprises will require a whole suite of policy changes across sectors and along the value chain. Providing more robust support to MSMEs, including those in rural areas, will require enhanced infrastructure provision (along the lines of the Pradhan Mantri Gram Sadak Yojana), a deepening of financial inclusion and access to credit, and finally, a revamping of CSR towards supporting business enterprises instead of government programmes.

(6) Industrial policy: Finally, there is a potentially important role for sector-specific industrial policy. In this regard, India has both successes and failures. The auto industry has benefited from a series of state actions that led to a productive sector strongly integrated with global value chains, notably in Tamil Nadu. By contrast, the Special Economic Zone policy often became associated with land deals. Effective 21st-century industrial strategies require both close cooperation with the business sector and a focus on sector-specific public goods (rather than a bias towards protection or tax breaks), but also sufficient autonomy from business lobbies to avoid consolidation of inefficiency and rent-extraction.

Also read: Modi’s suspect GDP numbers have done real damage to India’s economy

Key to this is the checks and balances that lie at the heart of the accountability mechanisms that underpin state behaviour. These are of two complementary kinds. First, there are checks and balances within the state: fundamentally in the independence of the judiciary and regulatory agencies. Second, there is the pressure from civil society, whether (weakly and imperfectly) via periodic elections, or through ongoing civil society activism over state performance.

There is room to strengthen both the mechanisms of accountability that belong with the state, and those that belong with civil society.

Unless there is a comprehensive agenda of policy and institutional change to create dynamic capitalism, there is a risk of a Latin Americanisation of India’s path that will consolidate a middle-income trap of low productivity growth and entrenched inequality.

Noopur Sen is a consultant at the World Bank. Michael Walton, senior visiting fellow at CPR, has taught at the Kennedy School of Government, Harvard University since 2004.

This is the twenty-third in a series of articles titled “Policy Challenges 2019-2024” under ThePrint-Centre for Policy Research (CPR) collaboration. A longer version of this piece is available on the CPR website at The full policy document on a range of issues addressed in this series is available on CPR’s website.

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  1. Socialist Modi will not save Indian capitalism. There is no Indian politician who can save capitalism. India is meant to suffer with Socialism, India is no place for Capitalism. India will destroy herself with socialism refusing to take to the antidote capitalism for her illness. In medicine, no enemy should be cursed with motor neuron disease. In economics, unfortunately India is cursed with the dreaded disease socialism.

  2. Let us be intellectually honest. A per capita income is not a “ middle income trap “. That term could more correctly be applied to China, with a per capita income of $ 10,000.

  3. Nationalists r opposed to Capitalism hence u find cronies wid d govts. At d end once d cronies have achieved wht d Nationalists need d cronies vil b made zilch. Example id dere in front of us.

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