Comment on “Recent Developments in Indian Central Banking: Flying through Turbulence but Aided by Some Tailwinds”

Abstract

My comments on Ray and Mohan (2025) are focused on three aspects.

First, while India's recovery since COVID has been especially noteworthy in 2023–24, it has been a “K-shaped” recovery nevertheless. Depending on which part of India one talks about, it is either booming (urban and formal sector) or it still remains scarred from the pandemic (rural and informal sector). Since the pandemic, an operating profit-to-sales gap has opened up widely between large firms (+1.5%) versus small firms (−0.5%). While large manufacturing firms have been able to retain their size, small manufacturing firms have contracted by 14%. Small firms and establishments are important in India as they contribute to over 40% of overall labor in India. Separately, 40% of labor in India is also in agriculture. Both small firms and agriculture tend to have a greater presence in rural India. Hence, while wages in urban India have remained elevated far in excess of the inflation rate, rural wages even if increasing nominally have been outpaced by inflation for most of 2022. This fall in real rural wages has interacted with other shocks to weather and commodity prices to create a weak rural, informal, small-firm economy.

Given these observations, the stability of consumer price inflation in India at 6% over the past 4 years, 2% above the mandated 4% target for the Monetary Policy Committee in India, must be viewed in light of the cumulative erosion of the purchasing power of those that have experienced negative real wage growth. In sum, it would be good for Ray and Mohan to touch upon the issue of real wage growth in India, its distribution, its likely effect on consumption, and what inflation and monetary policy has done or can do about it in the challenging years since COVID. Indeed, has monetary policy contributed to the K-shape of the recovery in the first place?

Second, a range of initiatives has been undertaken by the Reserve Bank of India (RBI) since 2017 to resolve the nonperforming assets (NPAs) of the Indian banking system, capitalizing on the Insolvency and Bankruptcy Code (IBC). These have now come to fruition in that gross and net NPAs of scheduled commercial banks were down in September 2022 to 5% and 1.3%, respectively, from peaks of 11.2% and 6.1% in 2018. Nevertheless, there are critical views of the IBC that stem from the facts that: (i) debt in India continues to perform closer to equity, recovering only 39% for resolutions under the IBC, which makes recoveries for bank loans in India virtually half of the global average; (ii) the average time to resolution since the filing of a case has been 561 days, about twice what was originally envisaged; and (iii) a phenomenal 45% of the cases under the IBC get liquidated. The contrasting salubrious view of the IBC arises from the observations that: (i) as a result of the banking sector clean-up, capacity utilization of distressed sectors has improved and overall risen to close to 75% at present from a low 60% prior to 2017, when there was an over-supply of zombie firms in these sectors; and, (ii) fresh slippages into nonperforming loans has declined due to an important deterrence effect of the IBC, whereby the loss of control for business owners and individual promoters has led to a de-leveraging of the Indian corporate sector, with debt to GDP of the corporate sector having declined over a decade from 78% to 50%.

Therefore, I agree with the authors that institutional reforms can play a crucial role in improving the effectiveness of monetary policy. Can this be substantiated further, for example, by looking at the pass-through of monetary policy via deposit and lending rates?

Third, historically, India's micro, small, and medium-sized enterprises (MSMEs) have struggled to receive formal financing, with only 0.6 million out of 64 million receiving such credit. While the financial system has been creative via micro-finance to get some of the others access to credit, it has been estimated that there remains a formal financing gap of over $US 3.5trillion when it comes to MSME credit. However, the situation is changing on the ground on the back of “India Stack”. This is an important structural reform of the Indian real economy and the financial sector.

What are the exact implications of this digital plumbing of India and enabling of better credit access to MSMEs for inflation and growth? Some estimates that shed light on these implications would have added to the richness of Ray and Mohan (2025).