The efficiency of financial institutions will be a critical determinant of economic progress in India as the cost of capital rises. Efficient investment decisions and the intermediation of savings to productive sectors that build capacity and drive expansion will hold the key.
The Indian economy has entered a next stage of its economic growth. The challenge, today, is not limited to raising finances or expanding the scope of investment, but in the course, how efficiently that money is allocated to different productive sectors and how they are expanding the productive capacities in the economy.
The Indian economy has entered a next stage of its economic growth. The challenge, today, is not limited to raising finances or expanding the scope of investment, but in the course, how efficiently that money is allocated to different productive sectors and how they are expanding the productive capacities in the economy.
The recent financial market and monetary policy developments have made efficiency of capital allocation even more important. The RBI has hiked the repo rate by 25 basis points to 5.5% and is maintaining a policy stance of calibrated tightening. The RBI has re-estimated GDP growth to 7.1% from 6.5% in fiscal year 2027. Inflation in the economy is rising, and expected inflation has risen to 5.2% from 5%. However, quarterly GDP growth projections stand at 7.2%, 6.9% and 6.8% in Q2, Q3, and Q4, respectively. The Ministry of Finance has also re-estimated Q2 GDP growth to 7.35% after 7.8% GDP growth in Q1. These clearly indicate that economic activity remains strong.
The broad-based inflation in the economy is becoming a challenge. The RBI has predicted inflation in Q3 at 6% and in FY27 at 5.2%. There is a risk that inflation may breach the upper threshold of 6% due to rising food inflation, which is spreading to other sectors of the economy.
The Indian economy is caught in a catch-22 situation. GDP growth rates are expected to remain high amid high inflationary pressures. The monetary policy in India is being set in three markets, namely the government bonds market, the debt market and the money market. This is complicating monetary policy.
So, at present, the larger question is whether India can sustain its investment momentum when the cost of capital in India and abroad is increasing. In this situation, the efficiency of capital allocation puts more weight than just credit mobilisation in the financial system.The Rising Cost of Capital and the Investment Environment
The difference between the repo rate and long-term government bond yields provides an important indication of the changing financial environment in the economy. The yield on the 10-year government bond was at 7.19% around November 6, while the policy repo rate was at 5.5%. The yield had peaked at 7.48% in October. The difference doesn't necessarily mean that monetary policy doesn't work. Various factors influence long-term bond yields. Those factors are future inflation and interest rate expectations, government borrowing needs, world financial conditions and the risk premium sought by investors depending on sovereign credit rating.
The Indian economy is caught in a catch-22 situation. GDP growth rates are expected to remain high amid high inflationary pressures. The monetary policy in India is being set in three markets, namely the government bonds market, the debt market and the money market. This is complicating monetary policy.
So, at present, the larger question is whether India can sustain its investment momentum when the cost of capital in India and abroad is increasing. In this situation, the efficiency of capital allocation puts more weight than just credit mobilisation in the financial system.
The Rising Cost of Capital and the Investment Environment
The difference between the repo rate and long-term government bond yields provides an important indication of the changing financial environment in the economy. The yield on the 10-year government bond was at 7.19% around November 6, while the policy repo rate was at 5.5%. The yield had peaked at 7.48% in October. The difference doesn't necessarily mean that monetary policy doesn't work. Various factors influence long-term bond yields. Those factors are future inflation and interest rate expectations, government borrowing needs, world financial conditions and the risk premium sought by investors depending on sovereign credit rating.
Government securities serve as a reference for other securities. High long-term yields have repercussions for the whole financial system. Higher is the yield from Government securities, high is the cost of capital in the economy. As a result, corporate bond or every other type of debt turns expensive. Hence, corporations are forced to use expensive money both for working capital and expansion. This situation adversely affects investment as well as consumption decisions in the economy. Corporations avoid new investments in business and capacity expansion, and technology upgrades, as they have to trade off between benefits and costs. At times, a high cost of capital makes profitable businesses financially unviable. In such an environment, this limits access to sources of funding for businesses with long gestation or lead periods.
.The impact of high cost of capital is not uniform across the economy. Large corporations with access to capital markets such as corporate bonds and equity are better off than small businesses and MSMEs dependent on bank finance. This raises challenges for these small units. So the rising cost of capital is not a problem just for the financial market, but it has wider consequences for the whole economy, negatively affecting investment, industrial competitiveness, employment and productive capacities.Credit Expansion and Productive Investment
In the last one decade, Indian financial system has been witness to consierable progress. A NITI Aayog report finds that corporate bonds grew 12% year-on-year from ₹17.5 trillion in 2015 to ₹53.6 trillion in FY25. A deep corporate bond market in India facilitates more efficient long-term financing avenues for corporations and investment opportunities for institutional investors.
.The impact of high cost of capital is not uniform across the economy. Large corporations with access to capital markets such as corporate bonds and equity are better off than small businesses and MSMEs dependent on bank finance. This raises challenges for these small units. So the rising cost of capital is not a problem just for the financial market, but it has wider consequences for the whole economy, negatively affecting investment, industrial competitiveness, employment and productive capacities.
Credit Expansion and Productive Investment
In the last one decade, Indian financial system has been witness to consierable progress. A NITI Aayog report finds that corporate bonds grew 12% year-on-year from ₹17.5 trillion in 2015 to ₹53.6 trillion in FY25. A deep corporate bond market in India facilitates more efficient long-term financing avenues for corporations and investment opportunities for institutional investors. 
Credit helps expand the capacities in the economy on the one hand, and on the other hand, the same credit facility can be used to finance short-term capital requirements and refinance existing long-term liabilities. Here enters the idea of capital allocation. The financial system performs the task of intermediation by transferring surplus financial resources (savings) to deficit (productive) sectors of the economy. This transfer of capital flows increases economic activities in the form of increased output, better employment conditions and higher productivity. So an economy may witness credit expansion at a high rate, but capacity expansion may not match the rate.
The relationship between financial deepening and economic growth depends not only on the availability of credit but also on the efficiency of financial intermediation (capital allocation). India has made significant progress in capital mobilisation. Now, India needs to focus on improving the efficiency of capital allocation.External-sector Pressures and the Cost of Investment
The external economic environment influences the cost of capital. Higher Brent crude oil prices and a weak currency increase the domestic cost of imported energy, machinery, and other goods. This results in a higher cost of capital. This is very significant for the Indian economy as India is vulnerable to global volatility in energy prices. Crude oil prices have touched a high of $138.21 per barrel and a low of $58.72 per barrel in the last 12 months. This has negatively impacted the rupee. This volatility in oil prices increases uncertainties for policymakers and businesses.
External-sector Pressures and the Cost of Investment
The external economic environment influences the cost of capital. Higher Brent crude oil prices and a weak currency increase the domestic cost of imported energy, machinery, and other goods. This results in a higher cost of capital. This is very significant for the Indian economy as India is vulnerable to global volatility in energy prices. Crude oil prices have touched a high of $138.21 per barrel and a low of $58.72 per barrel in the last 12 months. This has negatively impacted the rupee. This volatility in oil prices increases uncertainties for policymakers and businesses. 
The weakening rupee forced the RBI to take measures to regulate foreign exchange market conditions. In March 2026, it limited the net rupee positions of authorised dealers in the onshore deliverable market to $100 million per business day. In June 2026, the special foreign-exchange swap facility was instituted, which resulted in inflows worth $143.6 billion, of which $133 billion was received from FCNR(B) deposits as of 6th October 2026.
The above-cited measures improved foreign-exchange liquidity. But this is not a sustainable external position. Rather, it is a temporary inflow. The long-term contributions of these measures are dependent on maturity, rollover, associated liabilities, and overall balance of payments position. External competitiveness is the objective of the Indian economy. This can be achieved by making the Indian economy shock-proof through increased domestic productivity, export diversification, energy security and a stronger manufacturing base.Economic Growth and Household Purchasing Power
Strong GDP growth is a significant measure of economic progress, but it is not a holistic indication of overall economic growth and development. Economic growth must be reflected in increased employment opportunities, higher real wages, increased household purchasing power and improvements in living standards. In this context, inflation is very important as high inflation doesn’t affect every household in the same manner. Low-income households are more negatively affected by high inflation than high-income households. Low-income households are forced to spend a higher percentage of income on food and fuel, leading to lower or negligible savings, which in the medium to long term may make them dependent on social security schemes. If the increase in nominal income is lower than that of prevailing inflation in the economy, consumers are forced to consume lower quantities of different commodities. This eventually negatively affects aggregate demand in the economy. So real income holds huge importance for the economy in the long term, as steady increases in household consumption give businesses the confidence to increase production and investment in the economy. This increase creates a cycle of benefits for households, businesses and the economy.
Economic Growth and Household Purchasing Power
Strong GDP growth is a significant measure of economic progress, but it is not a holistic indication of overall economic growth and development. Economic growth must be reflected in increased employment opportunities, higher real wages, increased household purchasing power and improvements in living standards. In this context, inflation is very important as high inflation doesn’t affect every household in the same manner. Low-income households are more negatively affected by high inflation than high-income households. Low-income households are forced to spend a higher percentage of income on food and fuel, leading to lower or negligible savings, which in the medium to long term may make them dependent on social security schemes. If the increase in nominal income is lower than that of prevailing inflation in the economy, consumers are forced to consume lower quantities of different commodities. This eventually negatively affects aggregate demand in the economy. So real income holds huge importance for the economy in the long term, as steady increases in household consumption give businesses the confidence to increase production and investment in the economy. This increase creates a cycle of benefits for households, businesses and the economy.
So, the objective shouldn’t be just to maintain a high rate of GDP growth, but economic progress must translate into increased productivity, job creation, and higher real income for households.Improving the Efficiency of Capital Allocation
Institutional and financial-sector reforms are vital for changing the economic environment in India. The financial intermediation process has to be optimised so that the financial system can harness long-term savings and invest in productive activities at competitive rates.
Four areas where policy attention is necessary.Deepen Corporate Bond Market
The corporate bond market in India has developed significantly. But this development should not be measured in terms of issuance value or number of issues. Rather, the measure of development should revolve around the secondary market liquidity, participation of retail investors, and transparent and unified credible information. Liquidity in the secondary market can improve and make the price discovery mechanism more efficient for accessing long-term finance through multiple channels.Increase Participation of Long-term Capital in Institutions
India has large numbers of pension funds, insurance companies and other long-term investors, such as PPF and EPF. These institutions can play a vital role in infrastructure development and productive capacity building in the economy. To achieve this goal, there is a need for prudent investment regulations for these categories of long-term investors, along with sound governance and the right risk-management arrangements. The goal should be to link long-term domestic savings with long-term investment needs of the economy.Improve the Quality of Bank Credit Allocation.
The creditworthiness of enterprises is better evaluated by the productive potential and repayment capacity of the firms. The GST records, digital payment histories, and cash-flow data of businesses can be helpful in improving the credit assessment, especially for MSMEs and small businesses which often don’t have enough collateral.
This can help to make formal credit more available for all the productive small enterprises, and it can help to redistribute the financial resources in the economy. This can make formal credit more accessible to productive smaller enterprises and improve the distribution of financial resources across the economy. Improve the Productivity of Public Capital Expenditure
India is giving huge importance to public investment, and a large portion of government spending is directed towards public infrastructure development. However, more than the quantum of public capital allocation, project selection, implementation, completion, and the quality of created assets are more important. So the focus of public capital expenditure should revolve around the quantum of capital expenditure, but also the long-term productivity. A prudent project appraisal, transparent procurement, and regular monitoring can improve the economic gains from public capital expenditure.
These reforms are complementary. A deeper bond market, stronger institutional investors, better bank credit assessment and more productive public investment can together improve the efficiency of capital allocation.
At present, the role of monetary policy is very important. Inflationary pressures should be judged based on how inflation is spreading in the economy. Also, India has to secure its import procurement to tame food inflation in the economy along with the fiscal policy initiatives.
The objective should be to maintain price stability without imposing unnecessary costs on productive investment.India's Next Phase of Economic Transformation
Japan Credit Rating Agency upgraded India from BBB+ to A-, with a stable outlook. This indicates significant qualitative improvement in economic growth, fiscal quality, financial-system strength and external resilience. reflects the strengthening of India's economic foundations. However, it will require continuous improvements in the quality of investment and the efficiency of economic institutions.
Mobilisation of resources is not sufficient; the ability to direct funds to more productive activities. It must empower the economy with more jobs, innovations, research and economic value. More than just resource mobilisation is needed for the next step in India's development. It will take institutions that can channel investments into more productive activities and create more jobs, innovations and enduring economic value.
India has made significant progress in expanding its financial markets and increasing investment. The next task is to ensure that these resources generate higher economic returns and contribute to improvements in the living standards of people.
Improving the Efficiency of Capital Allocation
Institutional and financial-sector reforms are vital for changing the economic environment in India. The financial intermediation process has to be optimised so that the financial system can harness long-term savings and invest in productive activities at competitive rates.Four areas where policy attention is necessary.
Deepen Corporate Bond Market
The corporate bond market in India has developed significantly. But this development should not be measured in terms of issuance value or number of issues. Rather, the measure of development should revolve around the secondary market liquidity, participation of retail investors, and transparent and unified credible information. Liquidity in the secondary market can improve and make the price discovery mechanism more efficient for accessing long-term finance through multiple channels.Increase Participation of Long-term Capital in Institutions
India has large numbers of pension funds, insurance companies and other long-term investors, such as PPF and EPF. These institutions can play a vital role in infrastructure development and productive capacity building in the economy. To achieve this goal, there is a need for prudent investment regulations for these categories of long-term investors, along with sound governance and the right risk-management arrangements. The goal should be to link long-term domestic savings with long-term investment needs of the economy.Improve the Quality of Bank Credit Allocation.
The creditworthiness of enterprises is better evaluated by the productive potential and repayment capacity of the firms. The GST records, digital payment histories, and cash-flow data of businesses can be helpful in improving the credit assessment, especially for MSMEs and small businesses which often don’t have enough collateral.This can help to make formal credit more available for all the productive small enterprises, and it can help to redistribute the financial resources in the economy. This can make formal credit more accessible to productive smaller enterprises and improve the distribution of financial resources across the economy.
Improve the Productivity of Public Capital Expenditure
India is giving huge importance to public investment, and a large portion of government spending is directed towards public infrastructure development. However, more than the quantum of public capital allocation, project selection, implementation, completion, and the quality of created assets are more important. So the focus of public capital expenditure should revolve around the quantum of capital expenditure, but also the long-term productivity. A prudent project appraisal, transparent procurement, and regular monitoring can improve the economic gains from public capital expenditure.These reforms are complementary. A deeper bond market, stronger institutional investors, better bank credit assessment and more productive public investment can together improve the efficiency of capital allocation.
At present, the role of monetary policy is very important. Inflationary pressures should be judged based on how inflation is spreading in the economy. Also, India has to secure its import procurement to tame food inflation in the economy along with the fiscal policy initiatives.
The objective should be to maintain price stability without imposing unnecessary costs on productive investment.
India's Next Phase of Economic Transformation
Japan Credit Rating Agency upgraded India from BBB+ to A-, with a stable outlook. This indicates significant qualitative improvement in economic growth, fiscal quality, financial-system strength and external resilience. reflects the strengthening of India's economic foundations. However, it will require continuous improvements in the quality of investment and the efficiency of economic institutions.Mobilisation of resources is not sufficient; the ability to direct funds to more productive activities. It must empower the economy with more jobs, innovations, research and economic value. More than just resource mobilisation is needed for the next step in India's development. It will take institutions that can channel investments into more productive activities and create more jobs, innovations and enduring economic value.
India has made significant progress in expanding its financial markets and increasing investment. The next task is to ensure that these resources generate higher economic returns and contribute to improvements in the living standards of people.
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