Industrial Structure, Financial Liberalization & Industrial Finance in India: An Assessment.

AuthorDas, Santosh Kumar


The critical role that finance plays in the process of industrial development received considerable attention with the seminal work of Greschenkron (1962) who, while explaining the process of industrialization in Europe in a historical context, highlighted that the banks did play critical role in the process of industrialization. Since then, financial policy as an instrument of industrialization has been designed world over to achieve faster rates of industries.

Absence of availability and access to affordable finance has been identified as one of the key holding blocks in the path of industrial development in India (Bhattacharjee & Chakrabarti, 2013; Khanna, 2013; Das, 2015). It was perceived that the underdeveloped financial sector due to state control was the primary reason behind unavailability of adequate financial resources for industrial sector. Financial liberalization was argued to be appropriate policy measure which will be instrumental to India's industrialization. It was expected that following reforms in the financial sector, a developed financial sector will be able to fulfil the financial needs of the industrial sector.

Following financial reforms, the structure of the Indian financial system has undergone significant transformation. Though it still continues to be primarily a bank driven financial system, there have been attempts to establish a vibrant mechanism for resource mobilization and allocation. This change in approach had serious implications for industrial finance. While with liberalization and opening up new sources of finance emerged; however, the earlier existing public financial institutions like the Development Finance Institutions (DFIs) were converted into universal banking due to insufficient government funding (Ray, 2015). While the universal banking (commercial banks) system provided only working capital, the term loans that was earlier recognized as key in reducing the financial constraints of the firms significantly went down. Even the working capital provided by the universal banking system is not sufficient enough to meet the growing credit demand of the Indian industries.

With the deregulation of directed credit program, the flow of bank credit to industrial sector went through restructuring with dilution of priority sector lending program. The structure of the newly emerged financial system following financial liberalization while brought new opportunities in terms of access to finance for a few industries, which are large in nature and registered with the stock exchanges; on other side reduced the access to finance to several Small and Medium Enterprises (SMEs). The SMEs were highly dependent on the DFIs as one of the key accessible sources of finance, which are no longer available to them (currently there are few operational DFIs). While the large firms now could borrow from both internal and external sources with low interest cost, the SMEs are increasingly faced with financial constraints. While there has been diversification of the sources of industrial financing in India (even if it is not sufficient), still the size and the location of the firm / industry play a determining role when it comes to accessing finance. Therefore, as the current financial system excludes many firms from accessing finance, is not adequate for many (industry as a whole). In this scenario, a few firms / industries have access to different sources of finance both internally and externally; on the other hand, a large number of firms (including new firms) do not have access to any form of finance. Against this backdrop, this paper has attempted to study the impact of financial liberalization on industrial development in India by analyzing the relationship between the structures of the financial and industrial sectors. It has been studied by analyzing whether financial liberalization has succeeded in removing credit constraint on the Indian industry.

Structure of Industrial Sector

The industrial sector in India is diverse in terms of location, size and the type of ownership. As per the Sixth All India Economic Census, in terms of number of establishments by broad economic activity, the total number of establishments in the manufacturing sector was 10329822 which is 17.66 percent of the total number of establishments in the country. Out of the total number of establishments, 5442870 (52.69 percent) are located in the rural areas and the rest 4886952 (47.31 percent) are in the urban areas (Table 1).

More than 93 percent of the total manufacturing establishments are small in size (Table 2). About 5 percent of the manufacturing establishments are employing more than 6 people and not more than 9 people. The number of large establishments are relatively less in the manufacturing sector. The share of establishments employing more than 100 workers does not even add up to 1 percent of the total manufacturing establishments. Establishments employing more than 5 workers tend to locate in the urban areas, where as smaller establishments, having 1-5 workers are predominantly located in the rural areas. More than 50 percent of the establishments, having employment size between 1 and 5 are located in rural areas, and 42.65 percent of the small establishments are located in the urban areas. With the increase in the size of the establishments in terms of employment size, for relatively large proportion of the manufacturing establishments, the urban areas are the preferred locations of their operation.

The distribution of establishments in the manufacturing sector by type of ownership suggests that about 95 percent of the establishments are owned by private proprietors (Table 3). While less than 1 percent of the total manufacturing establishments are owned by the government, the rest of the establishments are owned by private entities in different forms. These private entities included private partnership (0.88 percent), private company (0.41 percent), private self-help group (0.13 percent), Private co-operative (0.08 percent), and private not-profit institutions (0.09 percent).

Financial Structure in Post Liberalization Period

The financial liberalization brought several major changes in the institutional structure of the financial sector in India. These include increased share of private and foreign banks even the public sector banks continue to dominate, greater importance of the financial markets, greater integration with the global financial markets. From an industrial financing perspective, on the one side, the primacy of the existing Developmental Financial Institutions (DFIs) declined substantially. On the other, market-based financing gained importance with greater envisaged role of capital market as provider of finance for industry.

Decline of DFIs

During the early years of Independence, the DFIs played a critical role as providers of long term finance at all India level, and also term lending institutions of the states operating within the states (Nayyar, 2015). During this period several term lending institutions, at national and regional (state) level were established. The importance of these specialized term lending institutions remained intact through the period of bank nationalization till the first decade into the post liberalization period (Fig. 1). The share of total disbursement by DFIs in the Gross Fixed Capital Formation (GFCF) of the manufacturing sector reached almost 50 per cent in 2000-01. Between 1970-71 and 1994-95, disbursement by the DFIs increased from 10 percent to close to 50 percent. The important role that the DFIs played during this period is evident from another indicator, which is...

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