Credit growth isn’t necessarily evidence of overheating.
While one had expressed disagreements with some of the macro-economic policy recommendations of the Raghuram Rajan Committee (RRC) in this paper’s last week’s debate, “Should we go slow on financial sector reforms?” (September 24), the report also contains a number of “small steps” for reforming the banking system. Some of the suggestions are welcome, if the authorities act upon them: principles-based, rather than rule-based, supervision; faster, more efficient bankruptcy proceedings; FDI in asset reconstruction companies; use of technology for greater financial inclusion, in a cost effective fashion; use of non-traditional correspondents to extend the scope of banking to rural areas where the branch model is not suitable; etc. On the other hand, one has reservations about the practicability of a statutory, single supervisory body or the utility of a Financial Sector Development Council headed by the finance minister.
But the focus of this article is somewhat different. The latest Report on Currency and Finance published by the RBI, focuses on the banking sector, its projected capital needs, etc. As the report notes, the savings rate in the economy has gone up from 23.5 per cent in 2001-02 to 34.8 per cent in 2006-07. Clearly, the domestic savings rate is approaching the Asian level. The question is to what extent the increased savings rate and the need for financial inclusion of a huge proportion of the population currently outside the banking system, should lead to, or indeed need, a fresh look at the traditional approach to M3 growth. Is the 18 per cent per annum M3 growth assumed for forecasting the capital requirements of the banking system adequate? To consider this issue, I have looked at the growth in bank credit and M3 since 2001-02. Over the period, bank credit has gone up from 28 per cent of GDP to 55 per cent of GDP at the end of the last fiscal year. On the basis of the assumptions made in the Report on Currency and Finance, bank credit would grow to Rs 51,48,000 crore, by the end of March 2012. Using the same assumptions, I estimate the nominal GDP in 2011-12 at something like Rs 72,68,700 crore, giving a bank credit-to-GDP ratio of 71 per cent. The point is that this ratio remains well below the corresponding number for 2006 for most of the Asian economies like China (137 per cent), Thailand (101 per cent) and Vietnam (75 per cent). The comparison remains unfavourable even if the variable used is bank deposits or M3. This apart, according to RRC, the average bank credit to GDP ratio for the top 10 countries in the World Bank’s Doing Business Report 2008 is 130 per cent. The point worth pondering is whether a ratio of 70 per cent by March 2012 would be sufficient to achieve 9 per cent real GDP growth. In other words, to what extent, do we need to factor the sharply higher domestic savings and the need for fast growth of the banking industry to achieve financial inclusion in the M3 and credit growth we feel comfortable with? Surely, we need a medium-term strategy to come near the Asian levels if growth is to be sustained.
| FINANCIAL INCLUSION AND GDP GROWTH | ||||
| Fiscal Year | Nominal GDP (Rs crore) | Bank Credit (Rs crore) | M3 (Rs crore) | Bank Credit/ GDP (%) |
| 2002 | 20,97,726 | 5,89,723 | 14,98,355 | 28 |
| 2003 | 22,61,415 | 7,29,215 | 17,17,960 | 32 |
| 2004 | 25,38,170 | 8,40,785 | 20,05,676 | 33 |
| 2005 | 28,77,706 | 11,00,428 | 22,51,449 | 38 |
| 2006 | 32,75,670 | 15,07,077 | 27,29,545 | 46 |
| 2007 | 37,90,063 | 19,28,913 | 33,16,093 | 51 |
| 2008 | 43,03,654 | 23,61,914 | 40,02,189 | 55 |
| 2012(Proj.) | 72,68,700 | 51,48,000 | 71 | |
| CAGR in % (2002-08) | 12 | 24 | 17 | |
One test of the central bank’s attitude towards credit growth could come sooner rather than later. As a result of the banking crisis in US, banks have become extremely cautious in lending even overnight money, as reflected in the overnight LIBOR which is ruling way above the Federal Funds rate. Clearly, Indian banks’, and Indian importers’ and exporters’ recourse to short-term credit is getting squeezed. It seems that many of such credits are not being rolled over. (There was a report last Monday that Indian banks are using buy-sell swaps to fund their overseas branches.) This means that much of short-term dollar credit in the form of PCFC, and suppliers’/buyers’ credit would shift to rupee financing. This could well be the reason why the growth in bank credit remains very high despite the sharp fall in housing loans, project finance and slow industrial growth. Would the central bank look at the credit growth in its proper perspective, and not as evidence of “overheating”?
Tailpiece: Rating agencies have retained the AAA rating of the US despite the huge increase in its liabilities and the twin deficits, citing the economy’s resilience. The agencies had also rated the “super senior” tranches of CDOs as AAA until recently.