Cool title, but what’s the news?

India’s future growth trajectory is a matter of serious concern. It is due to the twin balance-sheet problem, of highly leveraged corporate organisations and bad loan-ridden banks. This trajectory will decelerate, if the firms are not able to grow and banks are unable to lend. To solve this issue, do we need the restructuring to address the twin balance-sheet problem, or address deeper causes? Financial misallocation is a bigger issue in the manufacturing section than in services in India. Also, it is more of a problem with large companies than small businesses.

? Okay, so what does it mean? 

First, we need to know the cause of this misallocation. For growth, more efficient firms should generate more output using more factors of production. Unfortunately, less efficient firms happen to gain more bank loans, leaving less room for growth of more efficient firms. This causes financial misallocations. The unrevealed reason behind this is distortion in the land market, with less efficient firms accessing more land and bank loans.

“Access to bank loans is disproportionately tied to access to land, as land and buildings provide strong collateral support for most bank loans.”

Large firms in the organised sector take up most bank loans. Small firms, accounting for 80% of the jobs and about half of the value of land, manage a very small share of bank loans.

? I get it, now tell me why should I care?

The bigger picture : 

We cannot ignore the huge spatial diversity in access to bank loans within India. Bank finance is highly accessible in the leading states, when compared to the lagging regions. States like Gujarat, Haryana and Rajasthan have access to financial loans for over 95% of the organized sector plants. Moreover, the lagging states like Bihar and Uttar Pradesh have a poor access to bank loans. India is counted as one of the most land-deficient countries in the world.

Land and financial misallocation leads to labour misallocation. If land markets are highly distorted, then it is probable that the finance market is also distorted, given the misplaced collateral channel. As expected, the financial misallocation has curbed the growth of the manufacturing sector. Rapidly growing enterprises in asset-intensive sectors need external funds due to their capital growth requirements. If this is lessened due to land and financial misallocation, it could account for the troubles manufacturing firms face in scaling up.

For you personally: 

Including me and you, everyone wants to see growth and job creation. Financial misallocation has restrained the development of manufacturing sector, which would provide us the same. However, it does not create that many issues in the services industry. This is some good news, as services are now a bigger driver of growth and job creation in India. To promote growth in the manufacturing sector, financial misallocation needs to be reduced. Policy makers need to pay more heed to addressing the underlying causes of financial misallocation.

This would include removing land market distortions, improved land-use regulations, and more efficient taxation of properties. For the faster growth of our country, we need to march ahead with stronger policy reforms. This would promote competition and innovation. It would also facilitate more efficient firms to grow faster.

In a nutshell, reduction in financial misallocation would make India one of the fastest growing economies. And we, as dedicated citizens, couldn’t ask for me, could we?

Source: Live MInt

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