Why Is India's Financial System Less Solvent than China's?
To head off the obvious misreading: I am not saying India is insolvent. I am not saying China is solvent. I am saying that if you consolidate the banking system with the public finance system, as you should, India’s combined balance sheet is in worse shape than China’s. This cuts against the received wisdom, so it is worth walking through the arithmetic.
The popular view goes like this: India inherited a British-style banking system, regulated by a credible RBI, with private sector banks like ICICI and HDFC running alongside state-owned institutions. China has four giant state banks riddled with non-performing loans that will eventually blow up. If you stop reading there, India looks sounder.
But financial systems do not live in the banking sector alone. In every country where the state has a significant role in credit allocation, non-performing assets sit somewhere on the consolidated public balance sheet, whether the accounting labels them as bank NPLs, sovereign debt, contingent liabilities, or off-balance-sheet pension obligations. Comparing only the banking books is comparing selected pages of two different ledgers.
On the Chinese side: the Big Four (ICBC, BoC, CCB, ABC) were carrying non-performing loan ratios in the 20–25% range at the start of the decade. Recapitalizations through Central Huijin in 2003-2004 injected $45 billion from FX reserves into BoC and CCB. Asset management companies (Huarong, Great Wall, Cinda, Orient) absorbed the worst legacy loans. Reported NPL ratios at the Big Four are now around 10% and falling. Central government debt sits around 16% of GDP, with local government obligations adding another 10-15%. Total general government debt is roughly 30% of GDP on a generous count.
On the Indian side: the commercial banking system looks healthier. Reported gross NPLs at scheduled commercial banks are around 5%. But the public finance side is the mirror image of China’s. The central government fiscal deficit has been 4–5% of GDP for years; adding state governments brings the combined deficit to 7–8%. Gross public debt is roughly 80% of GDP. The RBI has been running an open market operation to sterilize capital inflows that is slowly eating into its seigniorage capacity. Priority sector lending requirements distort allocation, with agricultural loan waivers a recurring political temptation.
The direction of fiscal dominance is also revealing. In India, the banking system is partly captive to public finance through statutory liquidity ratios (banks must hold 25% of deposits in government paper), which transfers the cost of the fiscal deficit to depositors through lower yields. In China, the public finance system is partly captive to the banking system through direct subsidies and occasional recapitalizations, which transfers the cost to the state. Both are forms of financial repression; they simply put the burden in different places.
So which system is “less solvent”? Combining banking assets, bank NPLs, central and local government debt, and contingent liabilities, India’s total public-finance-plus-banking liability ratio is materially higher than China’s. If the Chinese state leveraged to Indian levels, it could write off every non-performing loan in the system three times over and still look more fiscally comfortable than Delhi. That is the empirical observation. The normative question — which is worse, a bad balance sheet with democratic accountability or a better balance sheet without it — sits beyond the scope of a bulletin article.
The broader point is that conventional banking-sector comparisons systematically mislead when the two economies have different divisions of labor between their banks and their treasuries. For readers who find this counterintuitive, our companion piece on why Latin American banking promotes less development than Asian banking makes the same general argument in a different setting. The forecast roundup for China and India speaks to the growth side of the same question, and the later piece on who actually has cheap labor finishes the sketch of why conventional China-vs-India stories fail.