One of the concerns about the current recovery is that credit growth continues to be very low. The latest data from the Reserve Bank of India show that credit growth was 10.1% year-on-year as on 20 November. The worry is whether such low credit growth is sufficient to fund a recovery.

The accompanying chart compares year-on-year growth in bank credit with expansion in nominal gross domestic product (GDP). Notice that the gap between the rate of growth of credit and that of nominal GDP narrowed quite a bit during the September quarter. The usual explanation is that companies have been able to tap other sources of funds, including external commercial borrowings and qualified institutional placements. Prime Database says that companies raised 25% more funds through private placement of bonds in the first half of the current year, compared with the same period last year.

Also See A Lagging Indicator (Graphics)

But the chart also shows what happened during the last recovery, in 2003-04. Notice how the gap between bank credit growth and nominal GDP growth contracted sharply in June 2003 and even became negative in the September 2003 and December 2003 quarters. This was also the period in which the stock markets anticipated the recovery by moving up sharply, with the benchmark Sensex going up 61% between July and December. Clearly, during a recovery, GDP growth starts to move up first and it takes a while for credit growth to catch up—in other words, credit growth is a lagging indicator. That’s common sense, because companies will start using up their slack, running down inventories and increasing capacity utilization before starting to borrow more. The September GDP data show that addition to inventory during the quarter, at Rs14,770 crore, was much less than the addition of Rs27,464 crore in the June quarter.

How long will it take for credit growth to get back to usual levels? During the last recovery, year-on-year credit growth was back to 19.7% at the end of the June 2004 quarter and the gap between credit growth and nominal GDP growth widened to a record high during the December 2004 quarter, as companies acquired confidence and started expanding. So there’s no need to worry about the lack of credit growth—it will happen slowly and steadily. The concern is that in mid-November 2003, at a comparable stage of the recovery, banks’ credit-deposit ratio was 54.7%. It’s 69% at present. That means banks will be forced to raise rates far sooner this time.

Graphics by Ahmed Raza Khan / Mint

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