Non-Banking sources of lending can spur private investment: NCAER Paper

For India to achieve a sustained level of growth, private sector has to invest at a consistent pace in the coming decades.

“Quality of investment has improved in the past decade but it has come at the expense of quantity of investment for firms without access to wider credit markets,” says Prof Amiyatosh Purnanandam (University of Texas, Austin), in his paper “Corporate Investment in India: Lack of Investment Opportunity or Lack of Funds?”.

There has been a recovery in corporate investments post-pandemic, but the author finds that Indian firms invest less when they have lower internal cashflows, a finding which he says is consistent with the presence of financial constraints they face in raising external funds.

The paper finds that access to public equity market doesn’t ameliorate the average Indian firm’s dependence on internal cashflows when it comes to their investment decisions.

 “It is primarily the credit market friction that needs to be addressed for higher growth,” says the paper.

“Wider access to a well-capitalised non-bank lending system can be a potential mechanism to improve investment growth in the country,” it says.

It will especially be beneficial for younger and smaller firms as they face greater difficulties in accessing sources of external funds.

 The paper considers two reform events --Indian Bankruptcy Code, 2016 and clean-up of the Non-Performing Assets (NPAs) of the Indian banking system--after which quality of investments improved.

Firms are picking better projects after the reforms, but they still face considerable financial constraints.

 Interestingly, firms that rely heavily on bank credit are experiencing higher constraint after the reforms, whereas firms with access to broader credit markets, such as bond markets or NBFIs, have seen a relaxation in constraint. Improving access to broader sources of credit seems to be the key to spur corporate investment in India.