Is Credit Growth Really That Low In India? No, Says Nomura

Adjusted for bond market borrowings and conversion of state electricity board loans to bonds, credit growth is closer to 7 percent, says Nomura.

Indian five hundred rupee banknotes are arranged for a photograph in Mumbai. (Photographer: Dhiraj Singh/Bloomberg)
Indian five hundred rupee banknotes are arranged for a photograph in Mumbai. (Photographer: Dhiraj Singh/Bloomberg)

One of the big mysteries (and there are many) in the Indian economy currently is the persistently low credit growth, which fell further after the government’s demonetisation drive in November.

After struggling along at just under 10 percent for almost a year, credit growth fell to under 5 percent starting November, according to fortnightly data released by the Reserve Bank of India (RBI). It has stayed at those levels. For the fortnight ended February 17, non-food bank credit rose a meagre 4.7 percent.

Bankers blame low demand from industry and now from the mortgage sector. Economists have cited this low credit growth as one data point that makes the strong 7 percent GDP growth in the third quarter less believable.

What the headline number hides is the slow shift in sources from where credit is being raised. A shift towards the bond markets which started in 2014 has persisted, meaning that overall credit demand may be stronger that what bank credit suggests.

Nomura has put a number to this.

In a report dated March 2, Nomura said true credit growth is closer to 7 percent. That’s not to say that it isn’t weak. Just not as weak as what the bank credit data suggests.

RBI credit data (3.7 percent year-on-year growth in January ’17) does not capture the impact of bond substitution and State Electricity Board (SEB) loan conversions. The corporate bond book has been growing at 16-18 percent year-on-year for the past 12 months, and Rs 1.7 lakh crore of SEB loans have been converted into bonds under UDAY scheme over the past 6-7 months. Adding this up, we estimate that overall credit growth is 6.7 percent year on year and industry and services credit growth is 5.6 percent year on year (1 percent contraction as per RBI).  
Nomura Global Market Research

While saying that growth in bank loans may be understating the actual demand for credit in the economy, Nomura goes on to say that there are fundamental reasons for subdued credit demand. This includes the deleveraging of corporate balance sheets.

Three sectors – infrastructure, metals and textiles – contributed 30-25 percent of total incremental credit in the financial year (FY) 2007-08 to FY14 period, when bank credit was growing at 17 percent year on year. Adjusting for these sectors, credit growth was closer to 12-13 percent. Credit demand from these sectors (excluding SEBs) is now down to zero, which is bound to impact overall demand for loans.

From an effective 6-7 percent rate of growth now, we forecast growth to pick up to 9 percent over FY17-19 (including bonds/ECBs) reflecting the deleveraging cycle. With this industry growth, PSU banks should grow at 5-6 percent year on year, representing 17 percent year on year CAGR (compounded annual growth rate) for private banks.
Nomura Global Market Research

Shift Away From Banks

Demand for credit typically shifts towards bonds when market rates are far lower than bank lending rates. This has certainly been the case since the start of 2015 when markets transmitted the RBI’s rate cuts far quicker than banks. In a January 2016 report, Ambit Capital had pointed out that banks have lost nearly 5 percent points in market share to bond markets over the past two years. This was partly because of the rate advantage in the markets.

In a speech on September 30 2016, RBI Deputy Governor SS Mundra had highlighted this and also pointed to the fact that banks have also lost share to non-banking financial companies (NBFCs).

Data presented by Mundra (below) showed that the share of bank credit in total credit reduced from 64.7 percent in the year ended March 2014 to 61.4 percent in the year ended March 2016.

Is Credit Growth Really That Low In India? No, Says Nomura
While credit from banking system has gone up by 19.22 percent between March 14 and March 16, the credit from the non-bank system during the same period has gone up by 37.4 percent.
SS Mundra, Deputy Governor, RBI (Speech On September 30, 2016)

This shift could intensify starting next fiscal.

The RBI had put in place a new framework under which banks will have to set aside more provisions and assign a higher risk weight to ‘specified borrowers’ who have more than Rs 25,000 crore in loans outstanding. This could make bank loans more expensive and push these firms towards the bond market – which was the idea behind the new framework. This limit will reduce to Rs 15,000 crore in FY19 and Rs 10,000 crore from the start of FY20.