Financial sector outlook appears bright, but needs tight vigil on vulnerabilities: Eco Survey

New Delhi: The outlook for India's financial sector appears bright, but there is a need to keep a tight vigil on vulnerabilities as India can ill-afford the over-financialisation of the economy at this stage, said Economic Survey 2023-24 tabled in Parliament on Monday.

The Indian financial sector is at a "turnpike moment", it said, adding that the dominance of banking support to credit is being reduced, and the role of capital markets is rising.

For a country that aspires to be a developed nation by 2047, this is a long-awaited and welcome development, it said.

"Being reliant on and exposed to the capital market, however, comes with its challenges and trade-offs. As India's financial sector undergoes this critical transformation, it must also brace for likely vulnerabilities and prepare itself with regulatory and government policy levers to intervene and hedge, as required," it said.

Even as banks, non-banks and corporates battled balance-sheet excesses, the consequences of the credit boom of the first decade of the new millennium and the inevitable bust that followed in the second decade, the broad industry kept advancing the cause of financial inclusion and financial deepening, it added.

"Moving forward, healthier corporate and bank balance sheets will further strengthen private investment. The positive trends in the residential real estate market indicate that the household sector capital formation is increasing significantly," it said.

For a developing economy such as India, it said, the financial sector needs to support the banking sector and fill the gap in capital required for the economy's growth. "Therefore, the financial sector should expand at a pace that is in lockstep with economic growth. In particular, India can ill-afford the economy's over-financialisation at its current development stage," it said.

As India embarks on the vision to become a developed country by 2047, it is imperative that financial intermediation costs decline globally, the survey prepared by Chief Economic Adviser V Anantha Nageswaran and his team said.

It further said the financial sector needs to support capital formation and promote trade, business, and investments in MSMEs, enabling them to scale.

"It also needs to provide insurance protection and retirement security to all citizens. The share of insurance and pension fund assets in GDP stands at 19 per cent and 5 per cent, respectively, in India, compared to a high of 52 per cent and 122 per cent in the US and 112 per cent and 80 per cent in the UK, leaving scope for further improvements," it added.

The survey said that the next big step in the coming years is likely to be towards artificial intelligence/machine learning (AI/ML), decentralised finance, the Internet of Things (IoT), etc, which have a vast potential to disrupt the digital payments ecosystem.

Further, it said the vision is for India to evolve as a ‘fintech nation’ with the highest number of fintech firms and the highest fintech adoption rate by incumbents fuelled by digital public infrastructure.

"An approach should be evolved for common user data, eg KYC, across regulators. In the medium term, efforts should be made to move towards data-based lending instead of judgment-based lending, especially for small businesses," it said.

The survey recommended that financial sector firms – public or privately owned – must become customer-centric.

Without that, most quantitative metrics will remain elusive, it added.