The Economic and Political Weekly (EPW) is an important source of study material for IAS, especially for the current affairs segment. In this section, we give you the gist of the EPW magazine every week. The important topics covered in the weekly are analyzed and explained in a simple language, all from a UPSC perspective.

1. Development Banks and the Changing Contour of Industrial Credit in India
2. Revamped Poverty Estimates

1. Development Banks and the Changing Contour of Industrial Credit in India

Introduction

• ​​The credit delivery institutional framework for industry and infrastructure plays a crucial role in the growth momentum of the Indian economy. 
• The gap between the required and actual amount of investment in infrastructure has been widening over the years.
  • As per the Economic Survey 2018, the cumulative infrastructure investment gap will stand at $526 billion by 2040. 
• India gradually shifted from a state-led ­development model to a market-led one in the 1990s.
• Several specialised term-lending institutions with access to concessional finance and primarily lending on a long-term basis were gradually corporatised.
• The long-term credit requirements to the industrial sector was ensured by both, the commercial banks and the NBFCs but a substantial portion of NBFC funding is through public deposits, bank borrowings, debentures, and commercial papers.

Industrial Finance in Pre-independence India

• Industrial finance in British India was characterised by close-knit entrepreneur families owning most of the capital.
• In the absence of a well-developed market to raise external finance, the growth of the industry was largely dependent on the accumulation of funds by industrialists under the managing agency system.
• The nationalisation of banks in India in 1969 and 1980 ushered in a new era of state control over financial resources both in terms of ownership and distribution. 
• The introduction of priority sector lending post-nationalisation resulted in a significant inc­rease in the proportion of bank lending to small industries.
• The restructuring has taken place in the Indian financial sector since 1991–92 with the objective of infu­sing greater competitive forces in the sector and improving the financial health of intermediaries.

Development Banking in India 

The Development Finance Institutions are organizations owned by the government or charitable institutions to provide funds for low-capital projects or where their borrowers are unable to get it from commercial lenders. Development banking in India grew in three main phases.

First Phase:

• DFIs were set up for boosting industrialisation, and these institutions were specifically mandated to assist in forming the industrial base of India.
• Based on the area and nature of the operation, the DFIs can be classified into three broad groups – the term-lending institutions, the state-level DFIs, and the investment institutions.

Second Phase:

• It was the era of liberalization in India and the economy was undergoing many major changes.
• There were a greater number of DFIs operating with a sector-specific focus. 
  • Example: Rural Electrification Corporation, Housing and Urban Development Corporation, National Bank for Agricultural and Rural Development (NABARD), Export-Import Bank of India.

Third Phase:

• The roles of the DFIs were gradually curtailed by the conversion of several DFIs into full-fledged commercial banks/NBFCs.

RBI Report 2004

• The report of the Working Group on the DFIs released by the RBI in 2004 found that the business model of the development banks was unsustainable against the backdrop of the changing nature of the economy. 
• It argued that the sector-specific focus in the lending practices of these banks resulted in excessive risk concentration in their loan portfolio and with growing uncertainties in project lending due to greater interconnectedness of the economy with the world market, the development banking model had rendered itself unviable. 
• As a result, major DFIs like the Industrial Credit and Investment Corporation of India and the Industrial Development Bank of India, have been converted into universal banks. 
• The Industrial Finance Corporation of India has been converted into an NBFC.
• The principal mandate of the DFIs was project or term-lending to the industry as there was a parallel array of DFIs specifically created with the objective of catering to the needs of small-scale and rural industries.
  • For example, the state finance corporations worked as development banks at the state level and the Small Industrial Development Bank of India was established in 1990 as the principal financial institution for promotion, financing and development of the micro small and medium enterprise (MSME) sector.
• The DFIs were also mandated to lend to agriculture and small-scale industries, which were generally not served by commercial banks due to a high-risk perception. 

Industrial Term-lending by Commercial Banks (1990–2018)

• The Basic Statistical Return published by the RBI shows the trend in total credit disbursement to industry and the trend in long-term industrial credit by the state-level DFIs. 
• The long-term credit accounted for almost 18% of total industrial credit accounts, amounting to about 42% of total credit to the industry. 
• The proportion of long-term loans by the scheduled commercial banks (SCBs) in the total industrial credit has gradually increased during 2001–13, which at first glance seems to indicate that SCBs, to some ­extent, have substituted the role of specialised term-lending institutions. 
• If we exclude the credit to construction, electricity, gas, and water due to their lumpy nature of investment from our analysis and only examine the trend in credit to all other industries, the share of construction in the total long-term industrial credit by SCBs has increased from 2% in 1990 to 16% in 2018. 
• The most notable increase in SCBs’ credit to infrastructure happened during 2002–09, which was largely attributed to the government’s increased focus on infrastructure. 
• In India, public sector banks account for the second-largest source of infrastructure financing, after budgetary support. 
• If we exclude credit to electricity, water, gas, and construction, it becomes apparent that the proportion of long-term credit to other industries as a percentage of the total industrial credit has increased only at a modest pace during 2001–07 and gradually declined thereafter.

Sectoral Credit Allocation by the DFI in India

• There was hardly any correlation between the industrial policy and the sectoral credit disbursement by development banks in India.
• The combined share of labour-intensive manufacturing sectors, such as food, beverage, tobacco, mining, textile, paper, and printing in the total ind­ustrial credit disbursement has declined from 34% in 1972 to 19% in 2016. 
• The credit disbursement of the state-level DFIs also primarily catered to the need for a growing service sector-led economy.

Issues in Industrial Lending through Commercial Banks and DFIs

• DFIs and CBs have acted as a countercyclical element during the period of financial crisis by extending credit when other banks restricted their credit expansion in many countries. 
  • For example, the special credit programme introduced by the Brazilian Development Bank to support the working capital as well as the long-term investment of the corporate sector in 2009 helped Brazil navigate the global financial crisis.

• But, it is often argued that public ownership of DFIs results in ­favouritism and inefficiency in their loan decisions. 
  • For example, in the case of Japan, the government-owned JDB coexisted with the Industrial Bank of Japan, which was initially established as a public bank, but became a private sector bank in 1950 and its operation was primarily guided by economic principles where the bank chose projects based on commercial criteria but the lending went to the priority industries specified by the government. 

• The existence of a co-financing arrangement bet­ween the development bank and other private banks also comes with certain challenges.
• In India, apart from a reduction in the number of term-lending institutions, a related challenge is to build up viable lending infrastructure for small entrepreneurs, which too require specialised skills. 
• The diversified lending portfolio of the commercial banks lacks the necessary expertise within their existing institutional setup for the evaluation of small-sized industrial projects.

Conclusion

• A specialized approach is required for specialised lending i.e. long-term project lending to small entrepreneurs, especially in the unorganised sector.
• The market-oriented approach in India poses serious challenges for the corporate bond market which is yet to be developed.
• There are steps that have already been initiated by the regulators to develop India’s corporate bond market, but there is little response with the corporate bond market primarily dominated by a few large NBFCs and state-owned companies. 
• The creation of a professional talent pool within the banking sector with appropriate skillsets for specialised lending becomes crucial. 
• The reform of corporate governance norms and practices of Indian state-run lenders should realize greater professionalism and strengthen their risk management framework.

2. Revamped Poverty Estimates

Context

The Multidimensional Poverty Index (MPI) for the year 2015-16 has been recently released by Niti Aayog on the lines of the Global Multidimensional Poverty Index by UNDP.

Introduction

The MPI captures data to measure Poverty holistically in mainly three dimensions namely health, education and standard of living.

According to the latest index, 25.01% of the Indian population is said to be under the poverty bracket, which was earlier 21.9% based on the Tendulkar Committee method and 29.5% based on the Rangarajan Committee method in 2011-12.

The MPI takes into account 12 indicators and their contribution to poverty at various degrees to measure Poverty, namely

1. Nutrition (28.14%)
2. Years of Schooling (15.14%)
3. Maternal Health (10.4%)
4. Cooking Fuel (9.34%)
5. Sanitation (8.61%)
6. Housing (8.31%)
7. School Attendance (7.39%)
8. Assets (3.58%),
9. Electricity (3.35%)
10. Drinking water (2.23%)
11. Bank account (2.17%),
12. Child and Adolescent Mortality (1.33%)

Analysis of the Report

• The rural poverty metrics were measured to be 32.75% nationally and the urban poverty accounted for 8.81% nationally.
• The top-performing states with less than 10% of their rural population in the poverty bracket are Kerala, Goa, Sikkim, Tamil Nadu, Punjab, Himachal Pradesh, and Mizoram.
• The worst performing states include Bihar, Chhattisgarh, Jharkhand, Assam, Meghalaya, Uttar Pradesh, Madhya Pradesh, and Rajasthan with more than 33% of their rural population in Poverty.
• The share of the urban poor was less than 3% in states like Kerala, Mizoram, Himachal Pradesh, Tamil Nadu, and Sikkim.
• Larger states such as UP and Bihar accounted for around 20% in the urban sector.

Cause of Concern

The wide gap between the Rural (32.75%) and Urban (8.81%) poverty levels is a major cause of worry, as the gap has almost doubled compared to the poverty levels in 2011-12 as per Tendulkar method and has increased a whopping five times compared to the estimates of Rangarajan Committee.

Another reason is the high disparity in the interstate poverty levels. For example, Kerala, a top-performing state, recorded 0.71% and in contrast, Bihar recorded 51.9%. Such a huge difference can have a major impact on the economic and political stability of the nation and also reflects the extent of policy failure.

Conclusion

Overall, the MPI is looked at as an effective tool to measure the impact of Poverty as it accounts for data holistically across multiple dimensions using 12 indicators which gives detailed insights into the causes, factors and disparities of Poverty across the country.

This would be a very helpful tool to plan strategies and design targeted policies to tackle Poverty which has been one of India’s biggest causes of concern since colonial rule.

Read previous EPW articles in the link.

EPW December Week 1, 2021:- Download PDF Here