In the first five-and-a-half months of fiscal 2010, until mid-August, the growth in bank credit was just 1%, or Rs26,421 crore. In the past one year until mid-August, the year-on-year (y-o-y) credit growth was 14.9%.

Bankers are saying companies are not coming forth to lift credit and some lenders are even planning to extract a commitment fee from the borrowers for not drawing their loan limit. Indian firms—particularly small and medium ones—are, in turn, blaming the banking industry for not disbursing funds.

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What is the real story? Are the banks choosy about giving loans because they are scared of piling up stressed assets? Or are companies postponing their investment decisions because they are not confident yet about economic recovery?

Indeed, the credit offtake has been low, but it isn’t that gloomy as yet. In the recent past, there have been instances when the Indian banking industry has recorded even lower credit growth in the first half of a fiscal year than what we are seeing now. For instance, in the first five-and-a-half months of fiscal 2008, when the Indian economy was growing 9%, credit growth had been 0.4% (Rs7,042 crore).

In the comparable period of fiscal 2003, loan growth had been even lower—0.1% (Rs550 crore). The y-o-y credit growth until mid-August 2003 was 11.7%, some 3.2 percentage points lower than the current pace of growth.

Not too many bankers are ready to attach too much importance to the tardy credit growth and they say it is a common “slack season" phenomenon. Traditionally, the Indian banking industry divides the year into the “slack season" (between April and October) and “busy season" (November to March).

Post-harvest, rural consumer demand picks up in November; industrial and construction activities too perk up between November and March with rising demand for goods and services and this gets reflected in bank credit growth.

This argument would have been valid in the past when the economy’s dependence on agriculture was far higher than it is now. Industrial and construction activities now persist throughout the year and the relation between the harvest season and consumer demand is also getting thinner.

Crude fact

A key reason for lower growth in non-food credit this year is a sharp decline in credit to petroleum and fertilizer companies—a decline of Rs18,800 crore in the first three months of the fiscal year, compared with an increase of Rs6,500 crore last year. In fiscal 2009, oil prices rose sharply because of tight supply-demand conditions, geopolitical tensions, weakening of the dollar against major currencies and increased interest among investors and financial market participants.

Oil prices peaked in July 2008, with the average cost of crude oil for India touching $142.04 (around Rs6,946 now) a barrel on 3 July 2008. Subsequently, prices declined and fell to a low of $35.83 a barrel on 24 December. On 2 September, the price of the Indian basket of crude was $67.69 a barrel.

The average price of crude in 2009 was $83.57 per barrel, up from $79.25 in 2008.

Crude prices rose, but the prices at which Indian oil marketing companies sold petrol and diesel are regulated. This led to huge under-recoveries and weak cash flows for oil marketing firms.

As the liquidity dried up, the oil marketing firms borrowed heavily last year to meet their working capital requirements. The trend has reversed in fiscal 2010, with substantial improvement in the cash flow of these firms, and they are no long knocking at the doors of banks for money.

Working capital

Another reason behind the low credit offtake is a sharp drop in the working capital needs of manufacturing firms. “Commodity prices by and large have gone down by half. What does it do to your inventories? Your inventory valuation has gone down by half," says K.V. Kamath, chairman of India’s largest private sector lender, ICICI Bank Ltd.

In most cases, firms have scaled down inventories not because of lower production, but because of efficient inventory management. “As a result of this, the working capital need has gone down by about 40%. That brings down the bank borrowing. I am surprised how bank credit has increased by 1%," says Kamath.

According to him, “it had to happen" and otherwise the price correction that has taken place over the past year “would have been wasted".

Banks will have to live with this for quite some time as companies will not draw down their working capital limits— even if banks start charging commitment fees—unless they are able to double their capacity or input cost rises by 100% to last year’s level.

Equity, QIPs

Interestingly, other sources of money are also gradually opening up for Indian firms and they no longer solely depend on banks for funding. Since April, there have been 23 qualified institutional placements (QIPs) and firms have raised Rs17,086 crore through this route, according to Prime Database, a Delhi-based firm that tracks investments in markets.

The comparable figure for the entire last year was Rs188 crore, raised through a couple of QIPs. The primary market for equities is also looking up and half a dozen firms have raised at least Rs9,500 crore since April. In fiscal 2009, 25 firms raised about Rs2,570 crore from the primary market. After a long gap, Indian firms have also started raising debt from retail investors.

Former finance secretary Arun Ramanathan had told Mint that between October 2008 and March 2009, when the world witnessed the worst ever credit crunch following the collapse of Wall Street investment bank Lehman Brothers Holdings Inc., public sector banks sanctioned fresh loans worth Rs6.18 trillion, 50% higher than what they had sanctioned in the corresponding period of the previous year.

Many bankers say firms will start lifting the money in the next few months. According to M.V. Nair, chairman of Indian Banks’ Association, a bankers’ lobby, loans to companies by public sector banks have risen by 50% between October 2008 and May 2009, compared with the corresponding period a year earlier and the momentum will continue.

Demand for mortgages and auto loans is rising and they may soon gather the pace of early 2008, but the vacuum in unsecured personal credit will remain till banks rewrite the rules and change the financing model. Many Indian banks have accumulated stressed assets in this segment as consumers defaulted on payments. Such loans account for about one-fourth of the consumer credit market, but many bankers say this will be more than compensated by the flow of bank credit to the infrastructure sector.

Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as Mint’s deputy managing editor in Mumbai. Comment at

Graphics by Sandeep Bhatnagar / Mint