Is the retail credit boom likely to fizzle out? There is certainly reason to examine these questions in the light of recent forecasts about a mild slowdown in economic growth in India.
Bank credit has exploded since 2004, growing at over 30% a year. Retail credit has steamed ahead at 40%. Indian banks have gone on a retail credit binge due to a booming economy, low interest rates and burgeoning consumer confidence. Auto loans and unsecured lending products such as personal loans and credit cards have surged. Home loans, that comprise half of all retail loans, grew by 50% in 2005 and 33% in 2006—to touch Rs180,000 crore. The momentum has continued through this year.
Despite record housing loans, India remains an under penetrated market. As per the Edelweiss Mortgage Finance Report of February, mortgage as a percentage of GDP is 8.5%, up from 6% one-and-a-half years ago. This ratio is minuscule when compared with the US (51%) and the UK (54%), and small in comparison with even other Asian countries (10-30%). Mortgage loans make up around 11% of total lending at the State Bank of India and 30% at ICICI Bank, India’s top two banks in terms of assets, which is low by international standards. The potential for mortgages in India is, therefore, huge.
Interest rates have spiked sharply in recent months on the back of the Reserve Bank of India’s tight monetary policy. Assets are being repriced faster than liabilities. Mortgage fixed and floating rates have touched steep levels of 14% and 12%, respectively. Auto-financing has become expensive, with one bank hiking by as much as 2.5% over three months. Lending rates on other consumer loans are set to rise.
While this will most certainly cool the scorching credit growth, it raises the bugbear of a painful slowdown in the economy. This is akin to fears about the US subprime mortgage woes spilling over to the mainstream financial markets, with adverse consequences.
The immediate fallout of rising interest rates is the spectre of non-performing assets (NPAs). During the heady growth phase, banks trawled deep in the market for a rapid build-up in retail assets in a bid to increase the total pie. Lenders increased mortgage tenors, making it affordable for borrowers to pay their equated monthly instalments. Average tenors rose from 150 months in 2001 to 173 months in 2006. There is a strong possibility that lending norms were eased and riskier borrowers mopped up. There is no panic yet, but these customers with less-than-favourable credit history could be the earliest ones to fall behind on their monthly payments. “As lenders penetrate deeper in the market, NPAs are likely to rise,” said D. Thyagarajan, director-structured finance ratings of Crisil, a rating agency.
The International Monetary Fund expects the Indian juggernaut to slow to 8.1% in 2007. A Goldman Sachs report estimates credit growth to dip to 20%. Higher lending rates may prompt consumers to defer their purchases. “Credit growth rate may dip in the short term, but will make up over the medium to long term. Lending in the next few months will depend on how the spreads pan out for financiers. How lenders price the risk and factor in expected increases in NPAs is important,” feels Thyagarajan.
A credit contraction would certainly cause banks to pause to evaluate credit quality, defaults and recoveries. The big question is whether the brakes applied would temper the sprinting economy or derail it like in the late 1990s.
Uma Anand Iyer is a writer based in Mumbai. Comment at email@example.com