Credit Where It’s Due – “on credit growth”

Synopsis: Lack of Credit growth has lagged economic recovery. Here’s why that’s about to change.

Introduction

April-June GDP estimates show that there is strong evidence of a sharp recovery in the economy after second-wave lockdowns. Although broad-based indicators of real economic activity like mobility, energy demand, and GST e-way bill generation are now substantially higher than pre-Covid levels, the credit to GDP ratio is still lagging behind. Lack of credit growth is a drag on economic growth.

Why India’s Credit to GDP ratio is lower?

Firstly, an important reason is the inability of the financial system to profitably extend credit to smaller enterprises. The cost of loan evaluation could not be reduced below a certain level if processes were manual. For the loan to be profitable to the bank, the loan size had to be large. That meant borrowers who only needed smaller loans could not be serviced.

Secondly, the reasons for weak loan growth suggest that large businesses have been reducing their short-term loans. This has two main reasons:

• One, the fear of further restrictions due to a possible third wave has meant every business is trying to keep its inventories low.
• Two, in an economic contraction larger firms squeeze smaller suppliers and customers, reducing advances paid to suppliers and goods sold on credit to customers.

Thirdly, it has to be understood that credit growth is not weak because of the weak balance sheets of either borrowers or lenders. Corporate leverage levels are at decade lows. Among lenders, banks as well as non-banking finance companies (NBFCs), leverage is at all-time lows.

Why credit growth is going to increase in the future?

With the “account aggregator” model now underway. It will allow users to share digital data about their financial and economic transactions with potential lenders, penetration should rise further. That means an increase in the Credit to GDP ratio.

Source: This post is based on the article “Credit Where It’s Due” published in ToI on 3^rd September 2021.