India's Rising Cost of Capital: Why Allocation Matters More

The efficiency of financial institutions will be a critical determinant of economic progress in India as the cost of capital rises. Efficient investment decisions and the intermediation of savings to productive sectors that build capacity and drive expansion will hold the key.

The Indian economy has entered a next stage of its economic growth. The challenge, today, is not limited to raising finances or expanding the scope of investment, but in the course, how efficiently that money is allocated to different productive sectors and how they are expanding the productive capacities in the economy.

The recent financial market and monetary policy developments have made efficiency of capital allocation even more important. The RBI has hiked the repo rate by 25 basis points to 5.5% and is maintaining a policy stance of calibrated tightening. The RBI has re-estimated GDP growth to 7.1% from 6.5% in fiscal year 2027. Inflation in the economy is rising, and expected inflation has risen to 5.2% from 5%. However, quarterly GDP growth projections stand at 7.2%, 6.9% and 6.8% in Q2, Q3, and Q4, respectively. The Ministry of Finance has also re-estimated Q2 GDP growth to 7.35% after 7.8% GDP growth in Q1. These clearly indicate that economic activity remains strong.

The broad-based inflation in the economy is becoming a challenge. The RBI has predicted inflation in Q3 at 6% and in FY27 at 5.2%. There is a risk that inflation may breach the upper threshold of 6% due to rising food inflation, which is spreading to other sectors of the economy.

The Indian economy is caught in a catch-22 situation. GDP growth rates are expected to remain high amid high inflationary pressures. The monetary policy in India is being set in three markets, namely the government bonds market, the debt market and the money market. This is complicating monetary policy.

So, at present, the larger question is whether India can sustain its investment momentum when the cost of capital in India and abroad is increasing. In this situation, the efficiency of capital allocation puts more weight than just credit mobilisation in the financial system.

The Rising Cost of Capital and the Investment Environment

The difference between the repo rate and long-term government bond yields provides an important indication of the changing financial environment in the economy. The yield on the 10-year government bond was at 7.19% around November 6, while the policy repo rate was at 5.5%. The yield had peaked at 7.48% in October. The difference doesn't necessarily mean that monetary policy doesn't work. Various factors influence long-term bond yields. Those factors are future inflation and interest rate expectations, government borrowing needs, world financial conditions and the risk premium sought by investors depending on sovereign credit rating.

Government securities serve as a reference for other securities. High long-term yields have repercussions for the whole financial system. Higher is the yield from Government securities, high is the cost of capital in the economy. As a result, corporate bond or every other type of debt turns expensive. Hence, corporations are forced to use expensive money both for working capital and expansion. This situation adversely affects investment as well as consumption decisions in the economy. Corporations avoid new investments in business and capacity expansion, and technology upgrades, as they have to trade off between benefits and costs. At times, a high cost of capital makes profitable businesses financially unviable. In such an environment, this limits access to sources of funding for businesses with long gestation or lead periods.

.The impact of high cost of capital is not uniform across the economy. Large corporations with access to capital markets such as corporate bonds and equity are better off than small businesses and MSMEs dependent on bank finance. This raises challenges for these small units. So the rising cost of capital is not a problem just for the financial market, but it has wider consequences for the whole economy, negatively affecting investment, industrial competitiveness, employment and productive capacities.

Credit Expansion and Productive Investment

In the last one decade, Indian financial system has been witness to consierable progress. A NITI Aayog report finds that corporate bonds grew 12% year-on-year from ₹17.5 trillion in 2015 to ₹53.6 trillion in FY25. A deep corporate bond market in India facilitates more efficient long-term financing avenues for corporations and investment opportunities for institutional investors.

Credit helps expand the capacities in the economy on the one hand, and on the other hand, the same credit facility can be used to finance short-term capital requirements and refinance existing long-term liabilities. Here enters the idea of capital allocation. The financial system performs the task of intermediation by transferring surplus financial resources (savings) to deficit (productive) sectors of the economy. This transfer of capital flows increases economic activities in the form of increased output, better employment conditions and higher productivity. So an economy may witness credit expansion at a high rate, but capacity expansion may not match the rate.

The relationship between financial deepening and economic growth depends not only on the availability of credit but also on the efficiency of financial intermediation (capital allocation). India has made significant progress in capital mobilisation. Now, India needs to focus on improving the efficiency of capital allocation.

External-sector Pressures and the Cost of Investment

The external economic environment influences the cost of capital. Higher Brent crude oil prices and a weak currency increase the domestic cost of imported energy, machinery, and other goods. This results in a higher cost of capital. This is very significant for the Indian economy as India is vulnerable to global volatility in energy prices. Crude oil prices have touched a high of $138.21 per barrel and a low of $58.72 per barrel in the last 12 months. This has negatively impacted the rupee. This volatility in oil prices increases uncertainties for policymakers and businesses.

The weakening rupee forced the RBI to take measures to regulate foreign exchange market conditions. In March 2026, it limited the net rupee positions of authorised dealers in the onshore deliverable market to $100 million per business day. In June 2026, the special foreign-exchange swap facility was instituted, which resulted in inflows worth $143.6 billion, of which $133 billion was received from FCNR(B) deposits as of 6th October 2026.

The above-cited measures improved foreign-exchange liquidity. But this is not a sustainable external position. Rather, it is a temporary inflow. The long-term contributions of these measures are dependent on maturity, rollover, associated liabilities, and overall balance of payments position. External competitiveness is the objective of the Indian economy. This can be achieved by making the Indian economy shock-proof through increased domestic productivity, export diversification, energy security and a stronger manufacturing base.

Economic Growth and Household Purchasing Power

Strong GDP growth is a significant measure of economic progress, but it is not a holistic indication of overall economic growth and development. Economic growth must be reflected in increased employment opportunities, higher real wages, increased household purchasing power and improvements in living standards. In this context, inflation is very important as high inflation doesn’t affect every household in the same manner. Low-income households are more negatively affected by high inflation than high-income households. Low-income households are forced to spend a higher percentage of income on food and fuel, leading to lower or negligible savings, which in the medium to long term may make them dependent on social security schemes. If the increase in nominal income is lower than that of prevailing inflation in the economy, consumers are forced to consume lower quantities of different commodities. This eventually negatively affects aggregate demand in the economy. So real income holds huge importance for the economy in the long term, as steady increases in household consumption give businesses the confidence to increase production and investment in the economy. This increase creates a cycle of benefits for households, businesses and the economy.

So, the objective shouldn’t be just to maintain a high rate of GDP growth, but economic progress must translate into increased productivity, job creation, and higher real income for households.

Improving the Efficiency of Capital Allocation

Institutional and financial-sector reforms are vital for changing the economic environment in India. The financial intermediation process has to be optimised so that the financial system can harness long-term savings and invest in productive activities at competitive rates.

Four areas where policy attention is necessary.

Deepen Corporate Bond Market

The corporate bond market in India has developed significantly. But this development should not be measured in terms of issuance value or number of issues. Rather, the measure of development should revolve around the secondary market liquidity, participation of retail investors, and transparent and unified credible information. Liquidity in the secondary market can improve and make the price discovery mechanism more efficient for accessing long-term finance through multiple channels.

Increase Participation of Long-term Capital in Institutions

India has large numbers of pension funds, insurance companies and other long-term investors, such as PPF and EPF. These institutions can play a vital role in infrastructure development and productive capacity building in the economy. To achieve this goal, there is a need for prudent investment regulations for these categories of long-term investors, along with sound governance and the right risk-management arrangements. The goal should be to link long-term domestic savings with long-term investment needs of the economy.

Improve the Quality of Bank Credit Allocation.

The creditworthiness of enterprises is better evaluated by the productive potential and repayment capacity of the firms. The GST records, digital payment histories, and cash-flow data of businesses can be helpful in improving the credit assessment, especially for MSMEs and small businesses which often don’t have enough collateral.

This can help to make formal credit more available for all the productive small enterprises, and it can help to redistribute the financial resources in the economy. This can make formal credit more accessible to productive smaller enterprises and improve the distribution of financial resources across the economy.

Improve the Productivity of Public Capital Expenditure

India is giving huge importance to public investment, and a large portion of government spending is directed towards public infrastructure development. However, more than the quantum of public capital allocation, project selection, implementation, completion, and the quality of created assets are more important. So the focus of public capital expenditure should revolve around the quantum of capital expenditure, but also the long-term productivity. A prudent project appraisal, transparent procurement, and regular monitoring can improve the economic gains from public capital expenditure.

These reforms are complementary. A deeper bond market, stronger institutional investors, better bank credit assessment and more productive public investment can together improve the efficiency of capital allocation.

At present, the role of monetary policy is very important. Inflationary pressures should be judged based on how inflation is spreading in the economy. Also, India has to secure its import procurement to tame food inflation in the economy along with the fiscal policy initiatives.

The objective should be to maintain price stability without imposing unnecessary costs on productive investment.

India's Next Phase of Economic Transformation

Japan Credit Rating Agency upgraded India from BBB+ to A-, with a stable outlook. This indicates significant qualitative improvement in economic growth, fiscal quality, financial-system strength and external resilience. reflects the strengthening of India's economic foundations. However, it will require continuous improvements in the quality of investment and the efficiency of economic institutions.

Mobilisation of resources is not sufficient; the ability to direct funds to more productive activities. It must empower the economy with more jobs, innovations, research and economic value. More than just resource mobilisation is needed for the next step in India's development. It will take institutions that can channel investments into more productive activities and create more jobs, innovations and enduring economic value.

India has made significant progress in expanding its financial markets and increasing investment. The next task is to ensure that these resources generate higher economic returns and contribute to improvements in the living standards of people.

Dr Rajeev K Upadhyay

India Has a Capital Allocation Problem, Not Just a Cost of Capital Problem

The Reserve Bank of India's October monetary policy decision presents an interesting combination. The repo rate has been raised by 25 basis points to 5.50%. The policy stance has shifted to calibrated tightening. FY27 inflation forecast has been pushed to 5.2%. At the same time, the real GDP growth forecast has been raised from 6.7% to 7.1%.

The RBI is tightening monetary policy despite healthy economic growth to ease broadening inflationary pressures. Inflation in India is becoming more broad-based. Commodity prices remain elevated, and the external environment is becoming less favourable for the Indian economy. Consumer Price Index has been rising by more than 5% every month for a few months. It rose from 4.% in July to 4.8% in August to 5.54% in September 2026. The average core inflation over a few months increased to 4.2%. 37% of commodities in the CPI basket are continuously recording inflation above 4%. So at present, RBI’s concerns are not just confined to food or fuel prices, as price pressures are spreading across a wider range of goods and services.

The external environment adds another layer to the challenge. The yield on India's benchmark 10-year government bond touched 7.498% in late October 2026. This is the highest level in the last four years. Brent crude is trading near $115/barrel. This is adding to concerns about imported inflation and the rupee. These developments in internal as well as external economies are making the financing environment more difficult even before the full effects of tighter monetary conditions are yet to be experienced through the economy.

Higher oil prices and a weak rupee increase the domestic cost of imported energy, machinery and intermediate goods. On the other hand, higher bond yields will raise borrowing costs for the government and private borrowers, making money costlier. The interest rates paid on government bonds, the risk evaluations of corporations, and the risk evaluations of lenders all affect the viability of new investment. As capital becomes more costly, growth depends more on how efficiently capital is allocated. However, the key policy issue is not just about accessing additional capital. It is the extent to which the financial system allocates resources to the most efficient uses.

At this point in time, the RBI can neither ignore these pressures nor can it offset every external shock through monetary policy. This situation raises an important question: can India sustain its investment ambitions in this environment when the cost of capital is rising?

India is entering a phase in its economy where quality of allocation will become more important than the quantity of capital mobilised. The next phase of India's financial reform has to focus on quality of allocation rather than quantity of capital mobilisation.

A Larger Financial System, but Uneven Access

India in recent decades has significantly expanded access to finance. Bank credit has grown. The equity markets have deepened. The corporate bond market has grown three times in the last ten years at an annual growth rate of more than 14%. According to the Economic Survey 2025–26, outstanding corporate bonds increased from ₹17.5 trillion in FY15 to ₹53.6 trillion in FY25. Fresh corporate bond issuances have reached a record ₹9.9 trillion in FY25. By December 2025, outstanding corporate bonds had increased further to approximately ₹58 trillion.

These are substantial changes in the structure of Indian finance, but the corporate bond market in India is still relatively very small compared with the size of the economy in comparison to other emerging economies. Outstanding corporate bonds amount to approximately 15–16% of GDP, while these figures are around 79% for South Korea, 54% for Malaysia and 38% for China.

Concentration of access is also high. It is estimated that the top-rated AAA and AA-rated borrowers represent 85-90% of corporate bond issuance. Market finance is generally available to large established companies, but appears difficult for smaller ones to access, relying on banks, promoters' funds and retained earnings. Even for municipal corporations, it is not easy to raise capital from the bond market.

It is important since economic returns on the investment are not dependent on the size of the firm or credit rating. Young companies may have sizeable growth but little collateral, and short credit history and cash flows. If they are not given the option to expand their business due to heavy reliance on collateral and existing credit histories, they will be unable to do so.

The policy goal, therefore, should be to further broaden access to suitable types of financing while not lowering underwriting standards.

Credit Growth Is Not the Same as Productive Investment

Despite good growth in corporate bond issuance, bank financing of industry is still rising. Year-on-year data on sectoral credit shows a rise of around 23% and 30.3% respectively in the credit of micro and medium industries in June 2026 in comparison with the previous year.

While these are all positive, the overall picture of aggregate credit growth is incomplete. It does not provide information on the amount of financing used for new machinery, technology purchases, capacity increases or productivity enhancements, instead of working capital and refinancing. This is a distinction that is important for the economy to efficiently allocate finances. The two companies can take out the same loan and have vastly different economic returns. If credit is not reliably allocated to the best borrowers based on less favourable collateral, then credit may go to the other borrowers with better collateral even if the other borrowers have better investment opportunities.

India requires improved credit information, cash flow-based lending, and financial disclosures, along with key intangible assets. Digital transaction records can be helpful, but prudent underwriting practices are mandatory.

India should start evaluating its financial deepening in terms of its impact on investment, productivity, jobs and firm expansion, rather than just the expansion of outstanding credit.

Equity Finance and the Missing Middle

Companies that are investing in new products, new technology, or new markets tend to have a lot of uncertainty. It is very difficult for such companies to bear the burden of fixed repayments during the early growth stages. For such businesses, a debt financing approach is not appropriate. This is a risk that equity is more able to withstand.

While India's start-up ecosystem has grown, access to growth capital is still uneven, especially for smaller businesses in non-metropolitan regions and for startups that have come of age, but have not yet become big businesses. The government's planned ₹10,000-crore SME Growth Fund can thus be a useful measure. However, its success is not dependent on allocations but on its design and implementation.

Public capital can play an important role in mobilising private investment, improving professional investment management and assisting companies with credible growth prospects. Funding decisions should be commercially disciplined and must follow transparent and independent evaluation. Transparent reporting of private funds mobilised, job creation, productivity enhancement, and subsequent business performance improves accountability.

The objective should not be to provide subsidies to any small business. It should rather fill the gaps in financing for promising firms that can not obtain appropriate risk capital on reasonable terms.

Four Priorities

The first priority is to deepen the corporate bond market by simplifying proportionate disclosure, enhancing secondary market liquidity and strengthening credit information. Strategic pooled financing and credit enhancement mechanisms can improve access to market finance for viable mid-sized firms. While doing so, it is important to ensure that the interests of investors are protected and that excessive private credit risk is not transferred onto taxpayers.

The second priority is to strengthen institutional investment in the long run. Pension and insurance funds can supply very long-term patient capital. However, this should be used with appropriate risk management and prudent investment rules. Increasing the number of institutional investors would diversify funding sources, as well as it will reduce the dependence on the short-term funding.

The third priority is to enhance credit allocation in banks. Records of GST payments, digital payments, audited accounts and supply-chain information can aid lenders in determining the viability of firms that cannot offer substantial collateral. Credit guarantees should be designed to address identified market failures with clearly defined fiscal costs and must avoid any indiscriminate lending.

The fourth priority is to increase the productivity of public investments. Investment in public infrastructure is helpful in complementing private investment by lowering logistics costs, enhancing connectivity and filling real bottlenecks. However, the quantum of expenditure is not evidence of the success of the infrastructure. The selection, completion rates, maintenance costs, and measurable economic returns on the investments are real indicators of success. Public capital must create productive capacities and improve market functioning rather than replacing private capital.

The GIFT International Financial Services Centre can play an important role in drawing financial activity from abroad and creating specialised financing routes. The volume of transactions taking place at the Centre should not be the measure of contribution. Rather, it should be measured through the centre’s ability to improve domestic investment, market capabilities and financial skills and expertise.

The Larger Economic Argument

Monetary policy and financial-sector reform go hand in hand. A higher interest rate may slow down demand and help contain inflation. However, a high interest rate regime cannot necessarily route savings to the most productive firms. Similarly, financial-sector reform cannot do away with the necessity for macroeconomic stability.

The challenge is to create a system in which viable businesses can have access to a kind of financing which is appropriate to their risks and prospects at a reasonable cost. That means more robust markets, improved information, strong institutions, and more effective public interventions.

India has already demonstrated its capacity to mobilise savings and expand credit. The next stage of reform should focus on what those resources produce.

The next growth advantage will come not simply from attracting more capital, but from allocating it more productively.

Dr Rajeev K Upadhyay 

Conflict at Tata House

There are allegations that the Government of India intends to ruin the Tata Group. It is difficult to discern the basis for such claims, but the data offers a clearer picture than any claim or narrative based on some agenda.

Over the past nine years, the Tata Group’s business has grown from ₹6 lakh crore in 2017 to ₹16 lakh crore in 2026. The market capitalisation of the group companies has risen from about ₹10 lakh crore in 2017 to more than ₹30 lakh crore in 2026. The data clearly indicates that the Tata Group has not weakened over the last decade; on the contrary, it has progressed even more rapidly than before. However, it is true that the Tata Group is back in the news after about two decades. Last time it was in the news in 2008-09 because of the 'Radia tapes' controversy. Typically, the group tends to stay out of the headlines. Unlike many other business houses, the Tata Group prefers to operate quietly, and the nature of its businesses naturally lends itself to this low-profile approach. However, the board controversy started soon after Cyrus Mistry took over as Chairman of the Tata Board in 2012, and was overthrown by Ratan Tata in 2016. Internal conflict regarding control over the board has been simmering since then, and the death of Ratan Tata has brought it back to the surface. Ratan Tata separated the control of Tata Trust and Tata Sons with a few amendments perhaps targeted to stop his half brother Noel Tata from taking over on the board of Tata Trust as well as Tata Sons which has been a tradition over decades.

It is a fact that the Tata Group is currently navigating internal disputes, which it must resolve on its own. No external party can settle ownership-related conflicts within the group; the initiative must come from within. Legally, the government has no direct role or capacity to intervene in such matters, nor should it. At most, the government could exert a degree of moral suasion. Whether it concerns the Tata Group or the TVS Group, such disputes can and should be resolved internally.

Looking ahead, India cannot rely solely on a handful of major business houses like the Ambanis, Adanis, Birlas, and Tatas. Internal problems at one corporate house turn into a big problem for India. India needs hundreds of business conglomerates like Tata, Ambani, Adani, Bajaj and Birla, along with millions of companies with turnovers in the range of ₹50–100 crore. This is what will drive India’s development. India currently needs to focus squarely on pure business, an objective that can only be achieved through the collective effort of the government and the people of India. The government must put forth conducive policies for entrepreneurship in India, and citizens must promote a culture of entrepreneurship. This is how it can work and succeed.

Dr Rajeev K Upadhyay

Financing India’s Urban Future: Mumbai’s ₹9,500-Crore Municipal Bond Test

Mumbai is gearing up toissue municipal bonds worth ₹9,500 crore in one or more tranches in early 2027. If Mumbai succeeds in issuing this amount of municipal bonds, it will be the biggest local body bond issue ever in India. It is a far bigger number in comparison to the municipal bonds market in India. 26 municipalities across nine states have collectively issued bonds worth only ₹ 4540 crores till now. Outstanding municipal bonds are worth about ₹4228 crores. So, Mumbai, the richest municipal corporation in India, planning to issue municipal bonds worth ₹9500 crores is itself a historical event. However, the greater story is not Mumbai. The larger issue is how the Indian cities will finance their future over the next 10-15 years.

Mumbai can provide us with an interesting point of departure. Brihanmumbai Municipal Corporation (BMC) has an estimated budget of ₹80,953 crore for 2026-27 and capital expenditure of nearly ₹48,165 crore. This proposed bond sale of ₹ 9,500 crore is just about 12 per cent of the entire municipal budget and 32 per cent of the capital expenditure budget for a year. So the size of the issue is not very big considering the financial muscle of the BMC. But considering the state bond markets in general and the municipal bond market in particular, this isn't a small financing test. It's a major push to integrate the capital market into the infrastructure sector in cities.

 

It is important to note that borrowing from the market is not the reform. The reform is to enable the cities to become financially able to take loans from the market. This is a very significant distinction.

A bank might lend if it has a relationship with the borrower, and if the government is expected to support the project. But this dynamic does not prevail in the bonds market. The expectations of a bond investor, who is basically a lender in this case, are completely different. The investor needs to be informed regularly, receive consistent cash flows, have financial discipline, and clearly understand who will be paying back the debt.

This clarity holds the key. The fundamental tenet of public finance lies in a tight budget constraint and how financially disciplined cities are. If a city thinks it is going to be saved by someone else (government), it is not going to step up its efforts to better collect taxes or manage expenditure. A city which is aware of the future costs of borrowing will be put to a much greater test to act differently if the future performance of its finances is the basis on which the borrowing cost will be determined.

Mumbai already has a significant revenue base. According to civic data shared by BMC, it has collected approximately ₹6,200 crore in property tax for 2025-26, and projected revenue from property taxes is expected to be ₹7,000 crore in 2026-27. The estimated revenue income will be around ₹51,511 crore under its budget for 2026-27. So, the proposed ₹9,500-crore bond issue is almost equivalent to more than one year's worth of property tax revenues.

This is the point where the discipline of policy kicks in. It is important to note that Jawaharlal Nehru Port Authority (JNPA) received 8.17 million TEUs in 2025-26, which was 11.94% more than it received in 2024-25. Its container volume was also up 15.45% YOY until August 2026.

So the first step of being competitive in trade starts within the city. A container that arrives at a port but takes more time to be transported by road is not a competitive export benefit. If a manufacturing business is losing working time due to ineffective transport and/or unreliable municipal services, then they have a productivity issue. This is the idea behind agglomeration economics. The productivity of cities is the result of the concentration of firms, workers, suppliers and infrastructure. Unless a city can manage congestion and invest in high-quality infrastructure, however, it can undo those benefits over time.

That is why municipal finance must be incorporated into the trade policy of India. There will always be limits to an export strategy unless an urban infrastructure strategy is an integral part of the trade policy.

Dr Rajeev K Upadhyay

Is India Preparing Its Youth for the Future Jobs?

Today, a young engineering graduate or management postgraduate finds it hard to earn enough to live a decent life. It is difficult for most of the non-engineering/commerce graduates to even earn about ₹15,000 a month which is unfortunately less than that of the minimum wages prescribed by the central government. However, an interesting and important observation emerges in the same labour market. A person with no degree but with some specific skills, such as plumbing or an electrician’s job, is capable of earning many times more than a qualified engineer or MBA degree holder! This is not a reality in one particular market, but it is prevailing across India, be it rural or urban areas.

This may seem uncomfortable, but from the market’s point of view, the conventional education system is failing to prepare the youth for future job opportunities. At this juncture, there is a need for a serious overall review of our education system as a whole rather than just one instance in the policymaking process. We need to ask ourselves: Why is this happening, and why degrees are failing to provide livelihoods to people which were earlier capable of. Is India preparing its youth for the future job market, or is India still trapped in the past job market in which one was assessed for her/his capacity to memorise facts and figures rather than any tangible skill?

Not only is this, but also in this changing business environment where change is too quick to catch up, it is becoming almost impossible to predict where the change is coming from. So it becomes imperative for societies and economies to be more proactive rather than reactive to changes. In this environment, it's better to become the source of change than to dump on the change. So, in this critical hour of transition, India must ask: Is India preparing its youth for the future job market, or is India still trapped in the past job market?

India, at present, sits at a critical economic crossroads. It has a huge pool of young and talented citizens who are either getting ready to enter the job market in the coming years or have already entered the job market. Meanwhile, India is witnessing a large number of unemployed people of which maximum are unemployable as they simply fail to meet the industry demands and hardly possess any tangible skill useful for the industry or society. The Indian education system is still in the mode of making India literate rather than skilful. On the other hand, India has been very late in taking advantage of the demographic dividend which comes every few centuries. India started very late in manufacturing, research and development, basic sciences and artificial intelligence. When it comes to research, patents and education, India not only lags behind any developed or developing economy, but the whole system is fragmented, with no national coordination and long-term policy and framework. Not only this, the system is hardly in sync with the demands of the economy.

To address the above-cited problems, India is putting its policy parlance to modernise its workforce. Initiatives like Skill India, the PM Internship Scheme, the National Apprenticeship Promotion Scheme (NAPS), the upgrade of ITIs and targeted technology programs such as the IndiaAI Mission, AI-Ready schools, vision for Orange Economy wisely target high-growth sectors, attempting to transform India's massive youth demographic into a global talent engine. National Education Policy 2020 is a cornerstone in this effort. All this is happening in the background with no breakthrough changes in the field. The higher education system is losing its academic rigour and lagging in integrating with industry. There is no national research and development policy with identifiable and targeted objectives that are synced with demands of the economy. Even state-to-state and university-to-university education systems are so diverse that syncing them together to create a national force is almost an impossible task.

India, though known as the ‘Jugaad Factory ’, lags in innovation. Vocational education in India is the last resort for students. When nothing works in the favour of students, they are forced to opt for vocational education rather than choosing it. Students’ first choice is traditional university education. The traditional university education system is important for India, and it must remain so. However, a change is needed in the paradigm of how the vocational education system meets the traditional education system. It is important to understand that the traditional education system is alien to the vocational education system. Rather, it should be the guiding force for vocational education. But unfortunately, there is hardly any linkage between the two systems. They operate separately in India. It is important to note that the institutions of vocational education are a vital centre of innovation across the globe. The institutions of vocational studies are places where innovation is an organic product of the whole process. Not only this, but the innovations at these centres often carry immediate and greater business relevance for the economy of the day than innovations at traditional universities, which are often costly and need long-term research and support. It's important for any economy to provide enough support to both the centres of innovation and research while linking them with industry. Cooperation with industry and training should be part of the same activity rather than being two separate activities.

It is important to note that Indian states and the central government spend about 4.1% of GDP, which is more than $100 billion every year, on education. However, the economic return on these investments remains bottlenecked by structural issues. There persists a stubborn gap between basic academic degrees and the practical, AI-driven problem-solving skills the modern market demands. For India to fully capitalise on its demographic dividend and avoid rising underemployment, it must not only rapidly scale up these pilot programs but also reform public school curricula that go beyond the NEP 2020 and make education more vocational, depending on the demands of the economy, and incentivise deeper private sector investment in workplace training to quickly update the workforce with the changes.

It is important to note that the income disparity and wealth gap in India are widening faster than one’s imagination. Rising income gap and wealth gap are not uncommon, but all the developing economies have witnessed it at varying intensity. The citizens who responded promptly to the changes in the economy and enterprise gained the most, while those who waited are victims of either complacency or ignorance, bearing the brunt of rising disparity.

Dr Rajeev K Upadhyay

RBI Rate Hike: Necessary, but Not Without Risks

The RBI’s MPC faces a difficult policy trade-off. In its October meeting that would be announced on 7th of October, MPC is going to take a decision on rate hike. It has to make a very difficult decision about the economy. Basically, at this point in time, India is caught in a catch-22.

Economic growth is resilient. The GDP is growing, and the economy is getting better with every passing year. Inflation has accelerated. India’s CPI inflation rose to 4.82% in August 2026, while food inflation reached 5.95%, strengthening expectations of monetary tightening. But now the RBI has to choose between inflation and growth.

The repo rate currently stands at 5.25%. The RBI has been maintaining a neutral stance. However, considering the prevailing economic realities, a 25-basis-point hike is expected, elevating the repo rate to 5.50% at the October MPC meeting.

A rate hike is the need of the hour, but higher rates carry huge costs for the economy. Higher rates will raise borrowing costs on the one hand while weakening investment and consumption on the other hand. Credit growth in the economy will slow down and put negative pressure on the Indian rupee, making it weaker. A weaker rupee for India means higher prices. It is a spiral.

So, the key issue is therefore not simply whether rates rise, but whether the inflation shock is sufficiently persistent to justify sacrificing some growth momentum. It means the RBI will make its decision based on whether it prefers growth or price stability in its assessment.

So, now, policy calibration is more important than aggressive tightening.

Dr Rajeev K Upadhyay

Is India Using Trade Deals to its Benefit?

Data from the Department of Commerce provides important information about how India's trade with partner countries is changing. Along with this insight, the data clearly indicates that India didn't start its efforts on trade diversification, both in destination and number of goods, only after Donald Trump became President of the US for the second time; India was making efforts even before his first term.

India was already signing a number of trade deals with partner countries in the last decade as and when India could, but the data suggests that those trade deals were not converting into favourable trade numbers for India as far as the export and trade deficit numbers are concerned. Even the call for ‘Make in India’ couldn’t convert into favourable trade numbers. However, the efforts have now started converting into results post the success of the targeted PLI scheme. India has started improving its position on the account of trade deficit from $122 billion in 2021-22 to $94.6 billion in 2024-25. In 2011-12, the trade deficit was about $123 billion against a total trade of $778 billion. India’s overall trade increased significantly during the period. Total trade increased from $1.47 trillion in 2021-22 to $1.74 trillion in 2024-25.

India signed trade agreements with Australia and the UAE in 2022. India-Australia goods trade rose from an average of about $13 billion in FY2020–21 to $23 billion in FY2025–26, a 76% increase, while Indian exports doubled from $4 billion to $8 billion annually. So, with Australia, India has improved its export numbers more than the growth in total trade. India-UAE goods trade increased from $55 billion to $100 billion, an 81% rise, with Indian exports rising from $22 billion to $36 billion. In this increase, the share of oil and gas plays an important role.

The trade data with these two countries clearly indicates that the trade deals haven’t helped improve India’s external trade imbalance. The trade deficit with Australia has more than doubled to about $7 billion from $3 billion. Similarly, with the UAE, the trade deficit has also increased by more than 190% from about $33 billion to $64 billion during the period. However, what is interesting to note is that Australia’s share of India’s total trade remained around 2%, while the UAE’s increased only from roughly 7% to 8%.

In the long to medium term, if India sustains this positive development, it will release some undue pressure on the Indian Rupee, making it more competitive in the foreign exchange market. If the rupee strengthens in the future relative to other currencies, the overall impact on the domestic economy is expected to be positive. India will be less vulnerable to geopolitical disturbances. The financial market in general and the capital market in particular will become less volatile. The risk of imported inflation will go down while making imports cheaper. However, if the rupee strengthens, it will make exports less attractive.

Trade agreements are useful and important. But there remains a pertinent question: Are trade agreements sufficient to improve India's external trade imbalance? Sustained export competitiveness requires domestic reforms in land, labour, power, water, and judicial processes. Agreements create market access; structural reforms determine whether India can exploit it.

So, rather than asking how many trade deals India has entered into with partner countries in the last decade, we need to ask how these trade deals can benefit India and improve the external trade imbalance. India needs to respond at the policy and execution level internally before it enters into any trade deals to exploit the possible benefits arising from the trade deals. Prior preparation is key to success.

Dr Rajeev K Upadhyay

India's Monetary Policy Is Being Set in Three Markets, Not One

The Indian economy has become more integrated with global capital, trade and financial markets. This is directly impacting the market dynamics in India. Monetary policy is no exception. India’s monetary policy is no longer the subject of one market, but is being shaped in three markets. In reality, it never was. The money market, foreign exchange market and bond market have been shaping India’s monetary policy simultaneously.

The Money Market

Liquidity is the real policy variable. RBI's operating framework is designed in such a way that it keeps the weighted average call rate (WACR) close to the policy repo rate to avoid any liquidity mismatch. This looks good in the textbooks, but the reality is almost always different. When bank system has surplus liquidity, the repo rate alone does not tell the full story. In early September, banking-system surplus liquidity rose to about ₹11.6 lakh crore. The RBI first responded with Variable Rate Reverse Repo (VRRR) operations and then moved to outright bond sales. The message is clear. Liquidity itself has become one of the monetary policy variables.

 

 

This is not new at all. Rather, it is old economics but with new numbers. Money is never neutral in the short run. Too much of it leads to asset bubbles. Too little brings stagnation. India is now in the middle of this dilemma. Despite the RBI absorbing over ₹8 lakh crore through multiple VRRR auctions, there remains about ₹7 lakh crore of surplus liquidity. This surplus money has to be managed in such a way that it improves operations in the money market and monetary policy transmission. Basically, liquidity is a policy variable now.

The Foreign Exchange Market

The second market that directly affects monetary policy is the foreign exchange market. The special USD-INR swap facility, including $127.23 billion through FCNR(B) deposits, has mobilised $136.38 billion by August 31. These inflows have strengthened India's external position, and forex reserves have increased to about $781 billion. But these inflows through the USD-INR swap facility and FCNR (B) deposits also create rupee liquidity. The RBI received these dollars and released rupees into the banking system, overloading banking system liquidity. Here foreign exchange management enters the domain of monetary policy. Here is the irony. A weaker rupee leads to increased import costs, including oil and other inputs, resulting in worsening inflation and the trade balance. On the other hand, surplus liquidity normally softens the short-term market rates.

 

 

 

The impossible trinity, as suggested by the Mundell-Fleming model, is a real situation. The RBI is dealing with that impossible trinity, where it needs to choose between capital mobility, exchange rate stability and monetary autonomy. India has chosen capital mobility and exchange rate stability through capital inflows under the USD-INR swap facility and FCNR (B), and by defending the rupee against the US dollar. The RBI has now constrained monetary autonomy.

The Government Bond Market

The third market is the government bond market, which is subject to monetary policy. The RBI is selling government bonds worth ₹1 lakh crore in Open Market Operations (OMO) sales. The response to the first tranche of OMO sales of ₹50,000 crore on September 17 was overwhelming, with bids of ₹66,590 crore. This response by financial institutions itself tells the story of surplus liquidity in the banking system. Government securities are not another asset class on the balance sheets of banks. Rather, these government securities are the indicator of confidence and benchmark price of rupee money for the wider economy. However, OMO sales are tricky too. Through OMO sales, excess liquidity is easily absorbed, but yields also rise, impacting monetary policy transmission. The 10-year government bond yield is part of the monetary transmission story.

 
The OMO sales announcement has forced the 10-year bond yield to hit 7 per cent after three months. This will affect long-term investment decisions and the cost of capital for the government while affecting the entire yield curve. Interest rates should respond to inflation and output gaps, but exchange rates and capital inflows do have a role to play in the monetary policy transmission story. The WACR is the operating target, and OMOs and FX swaps can be used to manage durable liquidity.

The Integrated Framework: One Policy, Three Dimensions

RBI cannot treat the repo rate, the rupee and the bond yield separately. They are on the same plate and have to be dealt with together, and this is the biggest monetary policy question RBI is facing. India needs a more integrated operating framework in which capital mobility (liquidity) management, foreign exchange management and bond-market conditions are assessed together. This is necessary to keep financial conditions stable enough to protect growth, while preventing external shocks from becoming domestic inflation or financial instability. This is going to become a regular situation as India grows economically and becomes more integrated with global markets.

The trilemma is real in an open economy like India. India has chosen its position. Now India’s macroeconomic management should ensure that the surplus liquidity from forex inflows is drained without spiking bond yields, while the exchange rate remains stable without sacrificing monetary policy autonomy and credibility. Growth must be protected while keeping inflation within the threshold.

The future policy challenge for India is to successfully manage these markets together without allowing one instrument to undermine another. This is not today's inflation number or forex reserves but the next decades.

The Way Forward: Policy Coordination and Credible Communication

India is in a spiral of high food inflation. WPI in August was around 10%, and it will reflect in CPI numbers in September. It is now a tricky situation for India's aspirations. The possibility of the RBI raising policy rates in the October MPC is very high. The difference between policy rates and inflation has narrowed enough to breach the RBI’s threshold limit in the inflation numbers for September. Even a few-point rise in inflation will make real interest negative. So pressure on the RBI to increase interest rates is very high to avoid a situation of negative divergence between interest rates and inflation. At present, the Indian economy requires a low interest rate regime to sustain its growth and allowing inflation to eat that growth would prove costly for the economy.

 

At this hour, India needs to do a few things. First, the RBI must ensure that monetary policy does not chase food inflation. This job should be left to the government to use fiscal policy instruments to manage food inflation rather than to tame it. Food inflation simply cannot be tamed through interest rates. Second, India must prepare a plan for the coming decades rather than for a quarter or year. High food inflation in India is a structural problem, as it has become a regular phenomenon at intervals. This doesn’t need a tactical but a structural response.

 

 

Third, the RBI should integrate the three markets into one policy framework and publish a quarterly financial conditions index integrating liquidity, exchange rates and bond yields. This will shift the central bank’s vision from one dimension to three dimensions. Fourth, the RBI must coordinate with the government on forex management. The swap facility and FCNR (B) deposits succeeded beyond imagination but created domestic liquidity problems. The RBI must plan for the consequences before they happen, as this will now become a regular occurrence at intervals.

India's financial integration is a strength. But the monetary policy must now integrate the three dimensions along with the fiscal policy. In such times, when fiscal policy focuses on growth and demands low interest rates and monetary policy is forced to increase interest rates to stabilise prices, the chances for stand-off between fiscal policy and monetary policy increase. History is replete with such incidents. Here lies the national interest.

 

Dr Rajeev K Upadhyay

Why Zero MDR on RuPay Debit Cards?

Merchant Discount Rate (MDR) is the fee paid by merchants for accepting digital payments. This has been there in India since Visa and MasterCard entered India. Different payment networks charge at different rates across payment instruments. Credit cards generally charge higher MDR than that of debit cards. MDR on Visa and Mastercard credit cards range from 1.5% to 2.5%, while American Express credit cards charge from 2% to 3.5%. Indian payment network RuPay-issued credit cards charge zero MDR on transactions valued up to ₹2000, and for transactions above ₹2000 the charges range from 0% to 2% depending on the transaction type and value. Debit cards have relatively lower rates, with Visa and Mastercard typically between 0.4% and 0.9%. RuPay debit transactions have 0% MDR.

For UPI, there is an MDR of 0.4% on P2M transactions above ₹2000 to be paid by merchants, which is capped at ₹300. P2M transactions up to ₹2000 have zero MDR. For P2P transactions, MDR is zero. Other special provisions apply to small merchants, essential services, and capital-market transactions. Overall, the structure shows how MDR varies by payment method, transaction type and regulatory framework, with the objective of balancing digital-payment adoption, merchant costs and financial inclusion.

Post the arrival of RuPay in the scene, things have dramatically changed. RuPay has expanded exponentially as it charges the lowest rates. Despite MDR on P2M transactions above ₹2000, the MDR on UPI is still significantly lower than that of the foreign payment networks. Most importantly, MDR on RuPay debit cards is zero while Visa MasterCard and AmEx charge between 0.4-3.5% depending on the instrument. So, without doubt, India’s RuPay network is still the cheapest among all available options in India. However, zero MDR on RuPay debit cards is interesting, and it seems that the government wants to anchor some specific behavioural changes in Indian citizens. Perhaps the government is worried about the rising credit card culture, which is leading to a huge rise in the personal loans category, which has made the RBI worried. However, lower MDR on debit cards don’t reflect in the prices of goods and services. So if the government is concerned about rising personal debts, the benefit of zero MDR must pass on to consumers, which at present is limited to businesses only.

Household debt is more than 45.5% of GDP. Non-household debt has risen to 58.4% of total household debt. Non-household debt includes personal loans, credit card outstandings, consumer durable & BNPL (Buy Now, Pay Later) loans, vehicle loans and gold loans. The share of housing and business loan in household loans has fallen to 26.3% and 15.3%. This change in the nature of debt may be a cause of concern in future. So, RuPay issued debit cards can be used to change this behavior. By passing the benefits of zero MDR on Rupay debit cards to consumers might be a very small effort in this direction.

Dr Rajeev K Upadhyay

Is Human psychology a mystery?

Is Human psychology a mystery?

A person might feel satisfied standing outside an Apple Store for hours, starting at midnight, just to get a mobile phone that could otherwise be delivered to their doorstep in a matter of minutes or hours in this time of instant delivery apps. To them, this arduous wait might feel like a festival. Standing outside the store for hours might seem like an integral part of the product experience itself! They might perceive it however they please, and this very ordeal could even feel like a significant achievement! Yet, this same individual is often in a state of constant urgency in their daily life! They are always in a rush and want everything done immediately! A delay or inconvenience of even a few minutes feels so intolerable to them that they fly into a rage!

The human mind is truly beyond comprehension. People often prefer the voluntary servitude of their own desires over the prospect of unwanted freedom!

Who could stop someone from succeeding if they truly understood this aspect of human nature?

Dr Rajeev K Upadhyay