RBI's Lost Decade: How Unnecessarily Expensive Capital Dwarfed Indian Growth

A colleague, who is a professor at one of the premier engineering institutions of Mumbai, recently returned from visiting manufacturing clusters in China. His observations were unsettling. Chinese MSMEs, he noted, were immaculate, with spotless facilities, cutting-edge equipment, and highly trained workers. "Why can't India do this?" he asked. The answer, I told him, was very expensive capital.

This crystallized a deeper truth: the RBI's obsession with high interest rates has not only slowed economic growth, but it has also fundamentally deformed the architecture of Indian manufacturing, creating structural dwarfism.

The Numbers Tell the Story

Consider the stark contrast: 76.8% of Indian factories have fewer than 50 employees, while in China only 25% of manufacturing firms fall into this smallest size category. This substantial gap represents an entirely different conception of industrial organization. In India, most firms remain stuck in subsistence operations.

The cause is evident: while Chinese MSMEs access capital at 3 to 4 percent, often lower with strategic state support, their Indian counterparts face borrowing rates of 11 to 16 percent.

Indian manufacturers find it impossible to invest adequately in modern equipment, employee training, or facility upgrades when every rupee is consumed by immediate survival. They cannot scale due to prohibitively expensive growth capital, leading entrepreneurial energy into fragmented, sub-optimal enterprises.

This is not limited to MSMEs. When COVID forced the RBI to slash rates to a historic low of 4%, India witnessed a startup boom. In 2021, with the lowest interest rates, India added over 40 unicorns, its highest ever.

The monetary easing in response to COVID-19 briefly aligned India’s capital cost with the global norm. The result was an explosion of entrepreneurial activity and capital formation.

But then again, RBI pivoted back aggressively with rate hikes post-COVID, even though India's inflation spike was comparatively mild and core inflation stabilized rapidly. This stifled entrepreneurial momentum, drastically reducing new unicorn formation to just two in 2023, seven in 2024, and two thus far in 2025.

India now has 119 unicorns. China has over 300, and the US has over 700, both powered by a decade of near-zero interest rates and government-backed liquidity. India, by contrast, has consistently been an island of expensive capital in a sea of monetary largesse.

When the rest of the world was lending at or near zero and, in some cases, even subsidising capital through negative real rates, India maintained a 6 to 8 per cent interest rate policy for most of the decade.

The Infrastructure Paradox

This monetary conservatism extends to infrastructure, revealing an even deeper policy contradiction. The Indian government needed Japan for a zero-percent loan to finance its bullet train project. Japan extended this facility, recognizing the long-term value of quality infrastructure.

Why did India, with its sovereign currency and central bank, need concessional financing from Japan? The RBI could have provided similar support domestically through special infrastructure bonds or direct financing mechanisms. China routinely does this, funding its infrastructure through policy banks prioritizing strategic value over short-term commercial returns.

When Japan can afford to lend to India at zero percent, but India cannot lend to itself at comparable rates, something is fundamentally flawed with the monetary framework.

Addressing Potential Concerns

Some argue that cheaper capital might fuel speculative bubbles or financial instability. However, historical experience from Japan, South Korea, and China shows that strategic, targeted, low-cost capital, combined with prudent regulation, has consistently driven industrial transformation without triggering economic overheating. These nations succeeded by directing affordable capital toward productive sectors and infrastructure.

It is important to note that a decade of ultra-low interest rates in the West did not result in inflation. In fact, for most part, they had ultra-low inflation. The global spike in 2021–2022 was directly linked to large fiscal stimulus programs. In some advanced economies, these fiscal stimuluses exceeded 20 percent of GDP, far more than anything India attempted.

It is increasingly clear that inflation is driven more by fiscal policy than by monetary conditions. Central banks can suppress inflation caused by fiscal excess by slowing the economy itself with high rates (i.e., no bamboo no flute analogy). But they do not cause inflation themselves. That originates in large government deficits.

If inflation is fundamentally a fiscal phenomenon, and India's fiscal policy has been sound, then what exactly was the RBI defending against?

The Fiscal Foundation Exists

Despite this strong foundation, the RBI maintained its high-rate orthodoxy even when inflation was supply-driven and core inflation clearly stabilized. The result was a damaging mismatch: a fiscally responsible government aimed at economic growth, while the monetary arm constrained it through punitive capital costs.

Indeed, despite RBI’s persistently high interest rates, India has emerged as one of the fastest-growing major economies globally. This impressive growth trajectory is occurring despite the RBI’s monetary conservatism, not because of it.

Had the central bank aligned its policies more closely with India’s progressive reforms and strong fiscal management - offering lower-cost capital to industries, infrastructure, and startups - India could plausibly have achieved sustained double-digit growth.

The Real Cost of Orthodoxy

The human and economic cost of India's structural dwarfism extends beyond statistics. Businesses unable to scale fail to achieve efficiencies crucial for global competitiveness.

Most critically, expensive capital prevents the natural consolidation necessary for creating industrial champions. Rather than developing fewer but larger and more efficient manufacturing units, India remains trapped with millions of tiny workshops incapable of competing internationally or providing substantial quality employment.

How can Indian firms compete when their capital costs are nearly 10% higher? That is the entire margin in many industries. In fact, Chinese companies often access capital at zero or negative rates through government schemes.

The obstacle here is not entrepreneurial skill or technical capacity. RBI’s persistent high-interest regime places Indian firms at a severe disadvantage in a world dominated by low-cost capital. The difference gives Chinese businesses the financial breathing room for long-term growth, while Indian enterprises are forced into survival mode.

This points to a fundamental philosophical misunderstanding. Capital is not a natural resource or inherently scarce. It is essentially a policy instrument whose cost should reflect economic objectives and evolving conditions.

Yet Indian monetary policy has historically approached capital as if it were a precious and limited commodity, rigidly protecting its scarcity and keeping its price high even during periods of controlled inflation and fiscal discipline.

A Belated Recognition

Under Governor Sanjay Malhotra, the RBI has executed three consecutive rate cuts in 2025, including a bold 50 basis point move in June, bringing the rate to 5.5 percent. This shift is philosophical, signalling a move from reflexive hawkishness to growth-oriented policy.

Yet this pivot, while encouraging, may be insufficient and overdue in reversing a decade of structural damage. The delayed easing means manufacturing consolidation, infrastructure modernization, and startup ecosystem development have lost crucial momentum.

Recovery demands sustained commitment, ideally pushing the repo rate to between 4 and 5 percent, a level consistent with India's inflation and fiscal profile and aligned with global capital flows.

The Path Forward

The evidence overwhelmingly supports that the cost of capital is not a natural constraint but a policy choice. Countries choosing affordable capital, such as China, Japan, and South Korea during their growth phases, constructed industrial ecosystems dominating global markets. Nations treating capital as scarce and expensive remain trapped in low-productivity cycles.

This monetary conservatism stems from institutional legacy. Since the inflation-targeting regime began in 2016, the RBI has erred heavily on the side of caution, prizing inflation control over growth. But this conservatism has exacted a cost through lost investment cycles, weakened private capex, and a constrained startup ecosystem.

What the manufacturing sector lacks is not entrepreneurial energy but the financial architecture enabling enterprises to scale from small to medium to large to global leaders.

In a world where capital availability is policy-driven, maintaining artificially expensive capital while competitors thrive with affordable funding is indefensible.

With its fiscal house in order, inflation tamed, and robust foreign exchange reserve, India must decisively embrace cheaper capital, unlocking the full potential of its entrepreneurs and industries to secure its rightful position as a global economic and manufacturing powerhouse.