The banking system has turned dysfunctional, incapable of mediating people’s savings to those who would use those savings as capital, that is, to generate fresh income. Accumulated bad loans, slow pace of insolvency resolution, political failure to fix the crisis in the power sector rendering a large amount of generation capacity incapable of producing a single unit of power and the fear of legitimate credit decisions launching criminal investigations have combined to thwart lending. And there is no functional bond market to let companies raise debt directly from savers.
The government needs to fix the banks and create a functional bond market. This alone can raise the rate of investment. Gross fixed capital formation as a share of GDP was down to 26% in Q4 of 2019-20, and 26.9% for the year as a whole. Without raising it by six percentage points of GDP, India cannot shed its low growth trap.
Growth in the ongoing quarter, Q1 of 2021 will be a disaster and the year as a whole will see negative growth, even the RBI has asserted. The government will have to be bold, imaginative and large in its fiscal stimulus. The RBI will have to act directly to create a bond market and not just offer banks more liquidity. India is not condemned to wallow in the slough of despond that Covid-19 has created. But for the economy to emerge and grow, the government will have to show more daring than it has so far.