Here’s a snapshot of the Indian credit crunch: During the two weeks ending 12 September, the incremental credit-deposit ratio shot up to 236%, falling to a still very high 139% in the subsequent two weeks to 26 September. The table shows the phenomenal rise in the incremental credit-deposit ratio.
Why did it happen? Credit growth accelerated in the four weeks to 26 September and was especially strong in the last two weeks. That’s not only because the traditional “busy season” has started but also because other avenues of funding, such as stock markets and international sources, have dried up and companies have no alternative than to turn to banks. Deposit growth has failed to keep pace with the growth in credit.
What’s more, the 25 basis points rise in the cash reserve ratio from 30 August worsened the liquidity squeeze, as it sucked money out of the system at a time when money was already scarce because of the outflows on account of advance tax.
Add to that the dollar outflow and vigorous efforts by the Reserve Bank of India, or RBI, to defend the rupee (forex reserves fell by $5.8 billion or some Rs28,246 crore over the two weeks to 12 September) which sucked out rupees from the system and the upshot was a crisis of liquidity.
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Another indication of the severity of the credit crunch was the widespread selling of investments by banks to fund loans. Bank investments in SLR, or statutory liquidity ratio, securities fell by Rs13,645 crore in the two weeks to 12 September and by another Rs17,553 crore in the subsequent two-week period.
SLR investments were at 28.68% of deposits as on 26 September, which means the banking system can sell some more till it reaches the SLR limit of 25%, but most banks are already below that limit and have no alternative but to scramble for deposits. Hence the series of deposit rate increases recently.
It’s a lot like 1998, when the rupee plunged and industry went through a credit crunch, only this time the scale of the disaster is much larger than during the Asian crisis.
What of the future? Data on credit and deposit growth after 26 September are not yet available but will doubtless show the same trends. Dollar outflows and RBI’s efforts to defend the rupee have resulted in forex reserves falling by $7.8 billion in the week to 3 October.
Part of that fall is due to valuation effects, but after making adjustments for that, it gives an idea of the amount of rupee liquidity sucked out in just one week.
Seen in this light, the Rs60,000 crore pumped in by RBI through cuts in cash reserve ratio, the percentage of deposits banks have to park with the central bank, merely buys some breathing space and more liquidity infusions may be needed as long as the panic continues.
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