Shyam Ponappa: Bank credit - Growth and patterns

India needs continuing rapid bank credit for this phase of growth.

One issue that deserves RBI and Finance Ministry review for action is the rate of bank credit growth. A perverse outcome of the capital inflows we seek "" and have for once succeeded in getting "" is that credit is less accessible and more expensive because of the RBI's actions to curb bank credit as India enters its most promising phase of growth. While steps must be taken to contain liquidity, the point at issue is the objective of reducing bank credit growth. Perhaps this is because orthodoxy demands that when bank credit grows rapidly, it should be reduced by curtailing availability and increasing interest rates, to avoid excesses.

Let us consider the relevant facts in India's current unprecedented growth phase. While bank credit has been growing over the last few years at around 30 per cent, rising to 35 per cent in July 2006 before dropping to 22 per cent in June 2007, it is instructive to view it in a comprehensive context. The factors to be considered are GDP levels, bond markets as an alternative source of funds for growth, and levels of saving, investment, private consumption, household debt, and housing finance. Considering some of these attributes in emerging economies as well as in mature markets helps to round out the picture.

Bank credit & GDP: In 1970, bank credit to the private sector in India was at about 19 per cent of GDP. The UK was at 29 per cent, Brazil at approximately 48 per cent, and China at about 52 per cent, while the USA was already over 115 per cent. By the mid-90s, India reached 29 per cent. The UK had crossed 110 per cent while Brazil was at 60 per cent, and China over 90 per cent. By 2005, India reached 37 per cent, or twice its 1970 level. Meanwhile, emerging Asian economies were at 100 per cent or more; only Brazil's level had dropped back to about the same as India.

Figure 1 shows the average rate of growth of bank credit to the private sector from 2002 to 2005, and bank credit as a percentage of GDP. This indicates there is considerable room for expansion. However, this must be evaluated together with bond markets to make a better assessment, after considering their roles in India compared with their roles in mature economies as well as emerging economies.

Role of bank credit: The role of bank credit in India is very different from its character in mature markets. Bond markets in developed economies are deep and liquid, and have broad participation from institutions as well as individuals. Consequently, these markets have significant disintermediation, with banks being much less important as a source of funds for growth. In contrast, in India as in emerging Asia, banks are the primary source of funds. Bond markets have not yet developed sufficient depth and liquidity, and so cannot serve as an effective alternative source of growth funds as in mature markets. In this light, high bank credit growth of good quality is precisely what India needs for maintaining economic momentum.

Bond markets: Table 1 shows India's bond markets together with other Asian local currency and US dollar bond markets excluding Japan. Asian economies in general have relatively underdeveloped bond markets. The figures show that India has a relatively less developed local currency market than Korea, China, or Taiwan, and an even less developed US dollar bond market. Considered in combination with the predominant role of bank credit, it becomes evident how essential the latter is for India's economic growth. 
 

Table 1: BOND MARKETS IN ASIA Local Currency Market
Country	Currency	Market Cap  (mm)	Market Cap  USD (mm)
Korea	KRW	255,976,160	274,186
China	CNY	1,914,587	248,454
Taiwan	TWD	3,323,867	99,824
India	INR	3,316,697	80,541
Malaysia	MYR	221,977	64,582
Singapore	SGD	72,699	47,684
Thailand	THP	1,474,494	45,009
Hong Kong	HKD	150,201	19,204
Philippines	PHP	742,451	15,598
Indonesia	IDR	25,690,496	2,827

USD Bond Market
Country	Market Cap USD (mm)
Korea	24,185
Philippines	22,509
Hong Kong	22,217
Malaysia	14,861
China	11,125
Indonesia	9,978
Singapore	8,577
India	3,602
Thailand	2,750
Pakistan	1,359
Vietnam	822
Source HSBC Markets Information Provided by Zhang Zhi Ming

Savings, Investment & Private Consumption: Next are trends in saving, investment and consumption. For the period 1999-2005, domestic saving was 32 per cent of GDP and rising, household saving steady at over 22 per cent, capital formation rising at over 32 percent, and private consumption trending down below 60 per cent since 2004. This looks good ... but for the self-inflicted damage we could incur, by (a) curtailing access to credit, and (b) making credit more expensive.

Household Debt: The level of household debt in India is low compared not only to the US and Europe, but to other Asian countries as well, e.g., Thailand, Taiwan, and Malaysia (Figure 2). Average household debt in Emerging Europe was 12.1 per cent of GDP, 27.5 per cent in Emerging Asia "" well over India's 9 per cent in 2005 (perhaps 12 per cent now?), 9.2 per cent in Latin America, and 58 per cent in Mature Markets. Without advocating extravagant consumerism, household debt levels in India have room for considerable growth.

Housing Loans: The penetration of housing loans as a percentage of GDP is very low in India (7.25 per cent at the end of 2005). This compares with 10 per cent in China, and 61.3 per cent in Singapore. Figures for 2002 for the EU were 42.6 per cent, and for the US 79.6 per cent. The huge demand for housing combined with the relative safety of housing loans suggests that this area requires action to increase the availability of finance at reduced rates.

Consumer debt & productivity: Finally, an insight attributed to Jagmohan Raju of Wharton is that many Indian consumers take on debt for productivity-boosting utility products, rather than for consumption or entertainment.** This deserves serious scrutiny; if true, it is a powerful reason in itself against constraining consumer credit and/or making it more expensive.

Lending booms & financial deepening: The IMF cites examples of lending booms in developing economies without subsequent crises in Egypt, Lebanon, and Indonesia.# Driven essentially by the financing needs of a large investment and consumption expansion because of structural reforms, these countries experienced a permanent financial deepening. Other examples cited are euro-convergence countries like Ireland and Spain, and the developed economies of Australia and the UK. The IMF report also draws attention to where and what sort of corrective action is necessary: in systems and training for institutions with substandard credit evaluation procedures, and/or with unrealistic projections of repayment capacity.

Therefore, unless the data and analysis are wrong, the RBI and the government should consider:

1. Accepting that during rapid development, credit will grow faster than output, and provide for it by inducting systems and corrective measures for lax enterprises, with the emphasis on minimising misuse and asset bubbles.

2. Taking all reasonable steps to assure availability of loans at low interest rates as a sound enabler for growth, especially of infrastructure.

* 'Growth Without Sacrifice', BS August 2, 2007: https://bsmedia.business-standard.comsacrifice-ratio.blogspot.com, and ''Ideal' Inflation & Exchange Rates For India', BS July 10, 2007: http://idealinflation-exchangerates.blogspot.com

** 'Despite Growing Debt, the Indian Consumer Banks on Tomorrow', October 31, 2006: http://knowledge.wharton.upenn.edu/india/article.cfm?articleid=4105&CFID=32583999&CFTOKEN=56310536&jsessionid=
a830583bfa34026567e3

# 'Assessing and Managing Rapid Credit Growth and the Role of Supervisory and Prudential Policies', July 2005: www.imf.org/external/pubs/ft/wp/2005/wp05151.pdf

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