Opinion | What a look at the long waves of India’s credit cycle could tell us

The length of the average Indian financial cycle is 15 years, according to recent research by economists at the Reserve Bank of India (RBI). There was thus good historical reason to hope that the financial downturn that began around seven years ago would bottom out soon. However, the silver linings seem to be getting blurred again.

The recent collapse of a cooperative bank in Mumbai, the deepening crisis among non-bank financial companies (NBFCs), subterranean fears about the stability of some banks, and the unusual statement issued by the Indian central bank on 1 October that the banking system is “safe” are some indications of how the malaise in the financial sector persists.

Here are some relevant numbers. In the first six months of the current fiscal year, most of the new deposits that banks have collected since April have been parked in government securities rather than being lent to enterprises. Aggregate deposits till the week ended 27 September grew by ₹3.32 trillion. The increase in investment in government securities was of almost the same amount— ₹3.10 trillion. Food credit grew by ₹18,475 crore while non-food credit fell by ₹18,887 crore. So, there was almost no increase in bank credit to the private economy as a whole.

Bank credit growth has been weak for many years. The slack in bank lending was until recently picked up by NBFCs and, to a lesser extent, by funding from the financial markets, which is available only to large companies. However, even the NBFC lending pipe is now choked.

A table from the new Monetary Policy Report, published by the central bank earlier this month, shows that growth in total funding to the commercial sector from both bank and non-bank sources has collapsed this fiscal year till mid-September. It is not a pretty picture.

The total flow of funds has come down sharply from ₹7.36 trillion in the first six months of fiscal year 2018-19 to a mere ₹90,995 crore in the same period this fiscal year. Nearly half of that reduction is explained by the decline in lending by banks and NBFCs. My guess is that the reduction in financial support to the industrial sector is because of inventory destocking by firms that are seeing weak demand while the decline in funds flow to the services sector is a sign of stress in the real estate industry. These two micro factors are overlaid on an overall drop in nominal gross domestic product (GDP) growth to perhaps its lowest level in two decades.

The funds crunch would have been worse if it had not been for foreign capital inflows, through either foreign direct investment (FDI) or external commercial borrowings (ECBs). Needless to add, such foreign capital inflows are sensitive to global financial or geopolitical shocks. They provide relief, but are also a source of funding risk.

The growing dependence on foreign capital inflows to fund the Indian commercial sector fits well with deepening fears of a lower domestic savings rate, especially a sharp decline in the net savings rate of households, which have borrowed to maintain consumption levels during a period of weak income growth. The hidden message here is that India could face current account pressures if there is a domestic investment revival without a matching revival in domestic savings.

This column began with a long-term argument about the length of the Indian financial cycle, before going into recent credit data. Here is a final data point that switches attention back to the longer term. The Bank of International Settlements provides a very useful data series on what it calls the credit gap, which measures the extent to which the ratio of credit-to-GDP has deviated from the historical trend as calculated by the Hodrik-Prescott filter. The credit gap has been negative for 22 consecutive quarters now, or the credit-GDP ratio has been below trend. Compare this with 55 quarters of a positive credit gap from the three-month period ended December 2000.

A developing economy such as India should normally have bank credit growing faster than nominal GDP because of financial deepening. The recent negative credit gap should also be seen in the context of a broadening of the sources of finance, especially from financial markets as well as NBFCs. Yet, there is no doubt that the credit gap has been negative since the end of 2013.

Economists have for long debated whether bank credit moves in tandem with the economy, anticipates what is going to happen in it, or moves with a lag. An analysis of India’s boom in bank credit followed by a bust is profoundly dependent on the answer. It is an issue this column will soon return to. Till then, it is important that the Indian public debate focuses on not just immediate bank credit data, but also on longer waves.

Niranjan Rajadhyaksha, is a member of the academic board of the Meghnad Desai Academy of Economics