Guaranteed lending through the banking system has been an important component of the government’s economic response after the pandemic. In keeping with this trajectory, finance minister Nirmala Sitharaman asked heads of Public Sector Banks to push hard on the credit paddle. “In order to keep up the momentum of the stimulus we are giving, we have also asked the banks to go out there and give credit to people who want to borrow”, Sitharaman said on August 25. Can India lend its way out of the current economic predicament? The formalisation push, which is also an important component of this government’s policy approach, can emerge as a roadblock here. Here are four charts which can put this in perspective.
Evidence from the CMIE Prowess database captures the declining importance of bank credit for corporate India clearly (ABHIJIT BHATLEKAR/MINT)
1. Low rates might not drive lending, going forward
Evidence from the latest forward-looking surveys conducted by the RBI suggests that businesses believe that borrowing costs have already bottomed out. The Industrial Outlook Survey (IOS) and the Services and Infrastructure Outlook Survey (SIOS) ask respondents about their perception (in the current quarter) and expectations (in the next quarter) on the cost of finance. Both these surveys suggest a sharp rise in the expected cost of finance in the second quarter (July-September) of the current fiscal year.
This may seem a bit counterintuitive, given the widespread consensus that the RBI is not going to increase policy rates at least this year. They survey responses might be reflecting a view about the change in direction and not necessarily the quantum of rise in cost of finance for businesses, a senior private sector economist, who spoke on the condition of anonymity, told HT.
It could also be the case that businesses expect non-banking lending rates to rise as the central bank gradually starts pulling back the surplus liquidity in the market, which most experts agree, will happen much before interest rates are increased.
2. But low interest rates didn’t really boost credit demand
That interest rate has not been the most important determinant of credit off-take in the recent past becomes more than clear when we compare lending rates and credit growth in India. The Centre for Monitoring Indian Economy (CMIE) database has weighted average lending rates of Scheduled Commercial Banks (SCBs) from September 2014 onwards. A comparison of non-food credit growth with the lending rates shows that both have been falling together in the past two years. This underlines the importance of demand side factors in driving credit growth.
3. Bank lending does not capture the entire credit universe in the economy
To be sure, bank credit is not the only source of credit in the economy. Sitharaman herself pointed this out in her interaction with the bankers. “The Finance Minister highlighted that with the current changed times, industries now have the option of raising funds even from outside the banking sector. Banks themselves are raising funds through various avenues” a press release dated August 25 from the Press Information Bureau said.
Evidence from the CMIE Prowess database captures the declining importance of bank credit for corporate India clearly. Share of borrowing from banks in total corporate borrowing increasing almost doubled to reach 50% between 1990-91 and 2008-09. This share has been coming down steadily since then and was just around 30% for 2020-21. To be sure, part of the decline in bank credit could also be a result of what has been described as the twin-balance sheet crisis where both banks (on the asset side) and businesses (on the liability side) had bad loans on their books and reluctant to lend or borrow. However, there has also been a steady increase in share of borrowing from sources such a bond markets, which offer better interest rates than banks. To be sure, the bond market route to credit is mostly available to large borrowers. This is exactly why the finance minister underlined the importance of lending to small and retail borrowers in her meeting with banks.
4. Has govt’s formalisation push generated headwinds for small business growth and therefore loan demand?
An August 26 story by Bloomberg Quint has reported that the All-India Consumer Products Distributors Federation is protesting against the decision of consumer goods giant Hindustan Unilever Ltd. to partner with Reliance Industries owned JioMart to supply products to retail stores. The distributors association’s anxiety is understandable, as a cash-rich company like Reliance can easily capture the market by offering better terms to retailers than the traditional whole-sellers, as the distributers are popularly described in India.
This episode is yet another addition to the ongoing formalisation push – policies such as demonetisation and rollout of GST have played a major role here – in the economy. While the consumer might even gain from such developments; assuming formalisation is not a conduit for eventually developing monopolies, there is bound to be significant (creative) destruction of small businesses and incomes in the process.
A research note dated July 15 by Pranjul Bhandari from HSBC Securities and Capital Markets had shown that the ratio of unorganised and organised sector employment in the trade, hotel and restaurants sector is the largest among major non-farm sectors in the country. This also means that the costs of formalisation purging informal players out of business would be the largest in this case.
“But formalisation can be a double-edged sword. If it happens at the cost of putting small informal firms out of business, then the disruption in the informal sector can weigh on demand in subsequent periods. In previous research (and also discussed earlier in the report), we found that when urban informal workers without social security lose jobs, many move back to their rural homes. But rural wages are 2.5x lower than urban wages, leading to lower demand and growth over time”, the note says. Bhandari’s warning is worth paying attention to at a time when the government is banking on lending to small business to revive the economy, but small businesses might be facing a squeeze from big capital.
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