How India's GDP can rise to 9.4%

India could free up to $48 billion of capital a year or 7 per cent of GDP. This could raise the country's real GDP growth to 9.4 per cent a year, a Mckinsey Research Study has said.

The report, titled 'Accelerating India's Growth Through Financial System Reform', focusses on and debates the strengths and weaknesses of the country's banking and financial system.

In a somewhat harsh comment on the banking and financial sector, McKinsey says the Indian financial system intermediates only half the country's total savings and investments, and it channels the majority of funding to the least productive parts of the economy.

The report was specifically prepared by Mckinsey's economics think tank, the McKinsey Global Institute. The MGI reports highlights the fact that Indian banks lend just 6 per cent of their deposits, a much smaller fraction thankbanks in other countries.

Moreover, according to the report, the value of India's corporate bond market amounts to just 2 per cent of GDP. The report says Indian companies rely heavily on retained earnings as a source of funding, much more than companies elsewhere. And, that, Indian companies pay much higher rates in every sector of the economy than Chinese or US companies.

"India's private sector receives just 43 per cent of total credit, while the remaining 57 per cent goes to state-owned enterprises, agriculture and tiny businesses in the unorganised sector," the report says.

The MGI report says this pattern of capital allocation impedes growth because state-owned enterprises are only half as productive as the private corporate sector and so require twice as much investment to get the same additional output, while, productivity in agriculture and the unorganised sector is 1/10th as high.

The report concludes by saying India needs to reduce the role of government in its financial system. Government restrictions on banks and other financial intermediaries limit competition, lower performance and serve to channel the majority of funding to the government itself and to its priority investments, many of them with a social welfare element, it says.

"Reforms to lessen government influence would result in more efficient use of savings and faster growth. That would raise tax revenues, allowing the government to spend directly on welfare programs, rather than diverting resources from the financial system and so holding back growth," it says.