Bank credit has rebounded, but rising interest rates and inflation may pose new headwinds

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BBank credit growth hit a nine-year high of 15.5% (year-on-year) for the week ended August 26. Also on a month-to-month basis, credit growth accelerated. There has been a general growth in credit demand despite rising interest rates.

While personal loan growth has been strong for a few months now, the recent recovery in credit by industries – especially for large industries – bodes well for india economic outlook.

Robust credit growth is expected to continue as the holiday season begins. However, weak deposit growth and rising inflation and interest rates could slow credit growth.

Chart: Ramandreep Kaur | The footprint

Read also : Why volatile food prices will keep pressure on India’s consumer inflation level this year


Composition of bank credit

Data on the sectoral composition of bank credit are available on a monthly basis. The latest data shows that bank credit to industry accelerated to 10.5% in July. By July 2021, industrial credit had slowed to 0.41%.

Within industry, while credit to micro, small and medium industries has shown steady double-digit growth, the encouraging feature has been the recovery of credit to large industries. Credit to large industries, which languished until May, grew 5.2% in July. In July last year, credit to large industries contracted 3.8 percent.

Credit growth to the services sector improved to 16.5% in July from 3.8% a year ago. Contact-intensive services are resuming as the effect of the pandemic has faded. This likely contributed to an increase in demand for credit from the service sector. The strong growth in loans to services was contributed by loans to NBFCs and transport operators.

The personal loan segment continued to grow at a healthy pace of 18.8% in July. The segment’s strong growth was driven by loans to consumer durables (69.8%), housing (16.2%) and auto loans (19.2%).

Cycle of deleveraging and revival of credit demand

One of the fallout effects of the pandemic has been the phenomenon of deleveraging (repayment of loans) in the corporate sector. As investment activity slowed in an uncertain environment, many companies began to report a reduction in their outstanding debt.

Certainly, the deleveraging trend was not just the result of the pandemic, but a phenomenon that was propelled after the Asset Quality Review (AQR) in 2015-16. The Reserve Bank of India conducted an AQR with a view to cleaning up banks’ balance sheets. Banks have been pushed to recognize non-performing assets (NPA) on their balance sheets.

As a result, banks have come under pressure due to the surge in NPAs. Several companies have been sued in bankruptcy courts by banks for non-payment of their debt. As a result, companies have deemed it prudent to pay down debt and avoid debt-fueled growth.

Bank credit to large industries remained lukewarm until a few months ago as industries were in the midst of deleveraging. According to an analysis by the State Bank of India, 1,000 listed companies from 15 sectors reported more than Rs 1.70 lakh crore in debt relief in the pandemic year 2021. And this despite a period of rate regime low interest.

Deleveraging prevented a debt explosion at a time when demand and investment conditions were weak.

In contrast, US companies were borrowing massively at low interest rates. When the Covid-19 pandemic triggered a recession, companies did not back down. They continued to borrow at low rates. At the end of March 2021, corporate debt jumped to $11 trillion. This phenomenon has been observed in most advanced economies.

According to IMF Global Debt Database, global debt has increased by 28 percentage points to reach 256% of gross domestic product in 2020. Over-indebtedness amplifies vulnerabilities as financial conditions begin to tighten.

With the deleveraging cycle over, industries began to borrow. Bank APMs have also significantly moderated. According to the RBI Governor, capacity utilization at around 75% in the manufacturing sector is now above its long-term average. This signals the need for new investments for the creation of additional capacities.

Chart: Ramandreep Kaur |  The footprint
Chart: Ramandreep Kaur | The footprint

We are seeing the first signs of a recovery in investment activity. One way to look at the state of investment in the economy is to look at project-level data. The nominal value of new projects announced has seen a strong improvement over the last two quarters (March and June 2022) with more than Rs 12 lakh crore of new projects announced. In the last two quarters of calendar year 2021, new projects worth Rs 7 lakh crore were announced.

Chart: Ramandreep Kaur |  The footprint
Chart: Ramandreep Kaur | The footprint

Deposit growth must resume

Deposit growth has followed credit growth. The latest data posted deposit growth of 9.5%. Slow deposit growth could limit robust credit growth. Banks will need to raise deposit rates to incentivize greater deposit mobilization. Many banks have launched special deposit programs over the past month, offering more than 6% interest on term deposits.

Another challenge to sustained credit growth is the liquidity situation in the banking system. The liquidity of the banking system has slipped into deficit mode for the first time in more than three years, signaling a move to strict financial conditions. On September 20, the RBI had to inject cash worth Rs 218 billion in the banking system. Banks, which hitherto parked funds with the RBI, are now borrowing from it under the Marginal Standing Facility (MSF) window. Banks also collect funds through certificates of deposit (CDs).

The RBI will need to inject liquidity through different tools to ensure a steady flow of credit. Going forward, rising inflation and interest rates could also a threat to credit growth.

Radhika Pandey is a consultant at the National Institute of Public Finance and Policy.

Views are personal.


Read also : Why consumer confidence is on the rise in India and how this optimism can be sustained


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