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India gives little credit to the role that lending can play

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The Reserve Bank of India (RBI) seal is pictured on a gate outside the RBI headquarters in Mumbai, India, February 2, 2016. (Photo: Reuters/Danish Siddiqui).
  • Ashima Goyal

    Indira Gandhi Institute for Development Research

In Brief

A current global financial risk is the rise in emerging market corporate debt denominated in US dollars. This grew from US$1.7 trillion in 2008 to US$4.3 trillion in 2015 as quantitative easing monetary policies pumped up global liquidity. Loose talk of an Indian balance sheet problem tends to put Indian firms in the same basket.


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But contrary to this assumption, Indian private sector dollar debt is relatively low: it currently sits at US$105 billion (up from US$59 billion in 2008). Rather than excessive credit growth in this period of surplus global liquidity, India is facing the opposite problem — too low a level and growth rate of credit.

The Indian government borrows more as a percentage of GDP than other emerging economies — although it borrows much less than developed nations. But this is the only measure where India performs worse — corporations and households borrow much less than in other developing countries.

Similarly, emerging market household bank credit and market borrowings grew substantially in developing economies as a whole during the quantitative easing period — non-bank financial intermediation increased by about 14 per cent of GDP. But in India, this increase remained minuscule, and despite the slow growth of bank credit, banks remained the dominant source of credit.

Non-performing assets (NPAs) were mostly in public sector banks and large infrastructure firms, which increases concentration risk but also makes focussed resolution possible. Corporate debt grew at double digits from 2012 as high interest rates added to the repayment burden. The share of chronically stressed firms rose while gross NPAs of public sector banks doubled to 6 trillion rupees (US$9 billion) over 2012–2016. The official view is that banks were not lending because of NPAs, which encouraged a healthy growth of other market instruments. But the latter only grew in absolute numbers.

High credit growth is normally flagged as a source of risk. But in India’s case, the risk is from too low credit growth — India cannot afford to neglect any source of credit.

Also important is diversity in banks’ asset portfolios. Private banks and a growing number of public banks focus on credit to consumers, which leaves firms without an easy supply of credit. Credit and its allocation can be improved with public sector bank reform, such that they follow commercial guidelines and market instruments more closely while developing their comparative advantage in lending to firms.

Further, central banks around the world are now using macro-prudential tools in response to financial stability risks indicated by changes in credit. These tools are designed to reduce systemic risk, and include a variety of measures that restrict credit growth. But is this measurement of risk accurate?

Slow moving stock variables and ratios, such as credit-to-GDP ratios, are useful for detecting the build-up of risks. But growth of credit is better at capturing turning points in the financial cycle and at predicting systemic risk.

Research on best practices suggests there should be gradual relaxation of macro-prudential constraints when systemic risks recede — in other words, when growth of credit eases. A prompt and decisive relaxation is certainly required when macro-prudential measures constrain provision of credit to the economy, as is the case in India currently.

Moreover, macro-prudential tools can and should be coordinated with macroeconomic policy tools — one can compensate for the tightness of the other. But the Reserve Bank of India tightened both simultaneously — it enforced greater provisioning requirements as well as higher capital adequacy. At the same time, inflation targeting led to a sharp demand contraction. For its part, the Indian government did not infuse adequate capital into state-owned banks, which it had earlier pushed in unsustainable directions.

No wonder credit growth has tanked. But there is also underdevelopment of the culture, institutions and instruments surrounding credit in India. In contrast to other countries, credit in India does not lead but rather follows a cyclical boom.

Globally, growth in credit is similar to the pre-global financial crisis period, but real GDP growth is much lower, suggesting poor credit allocation and rising risks. In India, the rise in credit is much lower and has mostly gone to retail. Growth has also fallen. If India wants to revive growth, it will first have to both revive credit demand and reform credit infrastructure.

Ashima Goyal is Professor of Economics at the Indira Gandhi Institute of Development Research in Mumbai.

A version of this article was originally published here at The Hindu.

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