The decline in bank credit so far, this fiscal, is the largest in several years. As the table shows, bank credit has fallen by Rs35,297 crore in the current fiscal year to 8 June.
During the corresponding period last year, bank credit had remained more or less flat, rising by a negligible Rs29 crore. Credit growth is usually muted at the beginning of the fiscal year, partly because of window-dressing by banks at the end of March to show higher lending and partially because this has traditionally been the slack season, although that seasonality is fast eroding.
But a look at the tableshows that while there have been periods of negative growth during the first two months of the fiscal year, the contraction in credit has never been so severe, at least since the beginning of this century. As a matter of fact, if we consider not just bank loans to corporates, but also bank investment in corporate bonds and in equities, the reduction in bank accommodation to the corporate sector this fiscal to 8 June has been Rs37,805 crore, compared with an increase of Rs1,867 crore over the same period last year.
Does it mean that the Reserve Bank of India’s (RBI) policy of monetary tightening is working? It does, but there’s a twist in the tale. While there’s little doubt that higher interest rates have taken their toll on credit, the impact is being felt mainly on consumption demand, while investment demand isn’t affected, as corporates can tap the bond and American depository receipts markets abroad or the equity markets at home. The stock market knows this very well, which is why the Bombay Stock Exchange’s (BSE) Capital Goods index has gone up by 72% in the last 12 months, while the BSE Auto index has risen by 2% over the same period.
But with credit declining, inflation coming down and the economy continuing to do well on the back of investment demand, isn’t this the best of all possible worlds for RBI? Chetan Ahya, executive director and economist at Morgan Stanley, says it is.
“The difference between investment demand and consumption demand is that the former creates capacity, which increases supply and, therefore, brings down inflation,” he says. Ahya feels that if the growth in gross domestic product falls to 7.5-8%, RBI will have succeeded in engineering a soft landing.
But won’t the forex inflows be a headache for RBI? Money supply continues to grow at a year-on-year rate of 21% and as long as forex inflows continue, the choice for RBI will be to either let the rupee appreciate or allow more liquidity, which in turn could fuel inflation.
Kotak Mahindra Bank’s chief economist Indranil Pan points out that some comfort is provided by the strengthening dollar, which takes some of the heat off the rupee. Abheek Barua, chief economist at ABN Amro Bank India, says that while he feels RBI may not raise interest rates at its next monetary policy meeting in July, the limit for MSS (market stabilization scheme) securities, used to suck out liquidity, may be raised.
There’s little doubt that short-term liquidity is abundant, seen in the very low rates for overnight money. Banks are flush with funds, evident from their falling credit-deposit ratios. Credit deposit ratios of scheduled commercial banks improved to 71.57% on 8 June, a percentage point down from a month earlier and sharply lower than the 73.3% levels seen in early April.
Ahya believes that the central bank may have to raise the cash reserve ratio (CRR) to drain out liquidity. “Look at how HDFC has cut interest rates on new housing loans,” he says. “If RBI wants to keep interest rates high, it may need to raise CRR.”
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