India's Financial Evolution: From Scale to Structural Effectiveness
The Union Budget for 2026-27 marks a pivotal moment in India's economic narrative, signaling a profound recognition that the nation's financial challenges extend far beyond mere scale. This budget introduces a sophisticated array of measures designed to transform the very architecture of India's financial system, moving decisively away from a narrow focus on credit expansion towards building a more resilient, market-based ecosystem.
The Structural Shift in Financial Policy
Key initiatives outlined in the budget reveal a strategic pivot. The introduction of a market-making framework for corporate bonds, development of total return swaps and bond-index derivatives, incentives for large municipal bond issuances, and the creation of mechanisms like the Infrastructure Risk Guarantee Fund and CPSE-linked Real Estate Investment Trusts (REITs) collectively aim to deepen long-term, market-based finance. These measures are not incremental adjustments; they represent a fundamental attempt to improve risk distribution beyond the traditional banking sector and mobilize patient capital for nation-building projects.
This emerging policy shift moves decisively away from volume-driven credit expansion, focusing instead on enhancing market infrastructure, boosting liquidity, and encouraging broader institutional participation. It acknowledges that while India's economic story is often celebrated through impressive macroeconomic indicators—trillion-dollar GDP milestones, record tax collections, and booming equity markets—a less comfortable reality persists for large segments of the economy where finance still fails to function optimally.
The Depth Versus Scale Conundrum
Recent debates surrounding credit growth, capital markets, housing finance, and financial regulation have crystallized a critical question: Does India require a larger financial system or a more effective one? Superficial data might suggest scale is the priority. India's non-financial corporate credit-to-GDP ratio remains at approximately 55–60%, significantly below China's nearly 180% and most advanced economies. This gap is frequently misinterpreted as evidence of financial underdevelopment.
However, true financial depth transcends the mere quantity of credit. What ultimately matters is the structure of finance: who receives credit, at what maturity, how risks are distributed, and whether domestic savings are efficiently transformed into productive capital. The International Monetary Fund's Financial Development Index provides crucial clarity on this distinction. India has made undeniable progress, with the index rising from about 0.12 in the early 1980s to approximately 0.54 by 2020—a fourfold increase. Yet this improvement was largely driven by gains in efficiency, liberalization, and market functioning rather than sustained balance-sheet expansion.
Since the mid-2010s, momentum has noticeably slowed. The depth of financial institutions has stagnated, reflecting weak growth in long-term credit. While equity market liquidity and turnover have boosted efficiency scores, market depth remains constrained. India's corporate bond market stands at only 18–20% of GDP, far below China's 40–45% and the 80–120% typical of advanced economies. This reveals a financial system that has largely exhausted the easy gains from reform but has yet to transition to the next developmental stage built on long-duration risk capital.
Household and Corporate Financial Imbalances
Household balance sheets starkly illustrate the structural problem. Nearly 80% of Indian household wealth is concentrated in real estate and gold, with bank deposits accounting for much of the remainder. Property is perceived as safer, transaction costs discourage asset churn, and long-term financial products often appear complex and opaque to average investors. This creates a paradoxical situation: India saves substantially, yet these savings do not reliably transform into productive investment.
Corporate finance reveals a similar imbalance. India's corporate credit ratio—credit to non-financial firms as a share of GDP—stands at only about 50%. In China, it exceeds 110%, while in advanced economies it typically ranges between 70% and 100%. Shallow corporate bond markets force firms to over-rely on banks and internal accruals. This matters profoundly because bond markets provide essential long-term funding, price discovery, and risk dispersion. When underdeveloped, banks are compelled to carry risks that should be spread across diverse investors, making lending cycles volatile and credit allocation excessively cautious.
Budget Measures Targeting Market Infrastructure
The 2026-27 budget explicitly acknowledges these structural constraints by focusing on the post-issuance ecosystem of corporate debt. The proposed market-making framework, combined with total return swaps on corporate bonds and derivatives based on corporate bond indices, seeks to improve liquidity, enhance price discovery, and facilitate better risk-sharing. These functions are essential foundational steps if bond markets are to effectively complement bank lending in providing the necessary risk capital to achieve the ambitious Viksit Bharat vision for 2047.
The sharpest contrast with mature financial systems lies in institutional investor depth. Pension and insurance assets in India together amount to less than 30% of GDP. In countries like Canada and the Netherlands, these patient capital pools exceed 150–200% of GDP. Such capital finances critical infrastructure, housing, and energy transitions without overwhelming banks or public budgets. India's lack of comparable depth explains why long-term projects remain excessively dependent on banks and the state, and why genuine financial deepening often stalls.
Building Long-Term Risk Capital Channels
The budget attempts to address this institutional gap through complementary asset-creation and risk-mitigation mechanisms. The Infrastructure Risk Guarantee Fund is designed to partially de-risk long-term infrastructure lending, while the proposed recycling of Central Public Sector Enterprise real estate assets through dedicated REITs aims to expand the supply of stable, yield-generating instruments suited to institutional portfolios. These measures strategically seek to align long-term domestic savings with long-maturity investment needs.
India has excelled at transactional liquidity—digital payments have transformed daily economic life, making payments a near-frictionless public utility. However, balance-sheet liquidity, essential for the capacity to absorb and distribute financial risk, remains underdeveloped. In mature financial systems, economic shocks are cushioned across multiple layers involving banks, bondholders, insurers, pension funds, and capital markets. In India, risk still flows disproportionately back to banks and ultimately the sovereign. This structural weakness explains why credit booms are often followed by painful clean-up cycles. Capital was not absent; sophisticated risk-sharing mechanisms were.
The budget's comprehensive measures aim to deepen market infrastructure, expand the repertoire of financing instruments, and channel long-term funds into infrastructure and real estate sectors. This should gradually strengthen the broader bond-based financing ecosystem, creating a more resilient financial architecture capable of supporting sustainable, high-quality growth for decades to come.
