Illustration: Jayachandran / Mint

The Reserve Bank of India (RBI) said last week that year-on-year growth in bank credit in the fortnight ended 1 January was 13.7%, sluggish compared with the 25%-plus rates of growth we saw in the midst of the last decade’s boom years, but far better than the comparable figures in the middle of 2009, when bank credit growth had almost come to a grinding halt.

Bank lending is usually a lagging indicator of economic conditions, so the fact that the recent spurt in credit growth comes a few months after economic output growth recovered is not surprising. It now seems very likely that lending will rise further in the coming months, to perhaps 15% by the end of the fiscal year, as companies restock inventories and infrastructure projects come in the market for financing.

Complaints from business lobbies that banks are not supporting the economic recovery should hopefully die down in the coming months, though it is still not clear whether small and medium enterprises are getting ample credit from banks.

RBI will also be looking at the recent trends in bank credit as an input for the new monetary policy due to be announced at the end of January. Bank credit is now growing apace with growth in nominal gross domestic product (GDP) which measures output growth and inflation. It would be good if bank credit growth picks up by a few more percentage points, though we doubt it will anytime soon reach the levels seen during the boom when it was expanding at twice nominal GDP—a credit bubble that saw excess money inflating prices of goods and assets.

Despite the recent recovery, bank credit is still flying below recent trends. The central bank should be careful about increasing interest rates right now, a move that could squeeze lending all over again. Given that it is battling resurgent inflation, RBI will nevertheless have to signal to bankers and the financial markets that higher interest rates are almost inevitable later in the year. The best way to do this right now to is to start soaking up excess liquidity—banks currently park around Rs60,000 crore of overnight money every day with the central bank—by increasing the cash reserve ratio.

It would be prudent to let bank credit keep expanding for at least one more quarter.

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