Govindraj Ethiraj: Growth is moderated, what's next?

DOUBLE EDGE

Last week, a Business Standard-organised round table discussion in Chennai dwelt in some detail on the challenges faced by the Indian banking sector in raising resources. Notably, the discussion centred around whether banks should moderate credit in response to a resource scarcity.

"At no cost must credit growth be moderated," an audience member said somewhat passionately when asked whether credit moderation was indeed a solution. And that seemed to be the presiding view, given that all present agreed on the need for strong and sustained economic growth.

But, said Canara Bank chairman MBN Rao, credit growth had already been moderated in recent months, reeling off statistics to illustrate his case. Latest Reserve Bank figures indicated, he said, that year on year, bank credit growth had already slowed to around 29.8 per cent as of last week. Compare this with a 32.5 per cent growth rate for the same period in the previous year.

The base is obviously much larger, credit numbers at Rs 424,043 crore to Rs 348,804 crore (previous year) but Rao felt the trend was noteworthy. Indeed, there is a slowdown in credit. Of course, anecdotal evidence from the borrowing side is showing the same trend. Most large banks are reporting a 25-30 per cent drop in home loan enquiries in recent months, helped, obviously by sky rocketing real estate prices as well. Existing consumers are busy grappling with the stretch in loan repayments as they dread the next letter from the bank. Real estate, incidentally, constitutes roughly 25 per cent of total credit.

There may not be a direct correlation yet but equity analysts meanwhile are predicting a slowdown in corporate profits. An HSBC analyst told this newspaper last week that earnings growth for the 30 companies that make up the BSE Sensex will drop almost 50 per cent in the coming 12 months from 30 per cent to 17 per cent.

The reasons would be potential revenue slowdown, margin reversion and rising interest costs. A Citibank analyst echoed a similar view, adding that rising employee costs and interest rates would show up in the bottom line. It might be worth noting that this newspaper called a profit slowdown, but was ahead by three or four quarters!

Whichever way you look at it, the party's taking a break. The cost of funds is rising, prices of commodities are being checked and every attempt is being made to cool a clearly overheated economy. The question now is where and importantly when should the corrective measures stop. When should we take our feet off the brakes and practise, in an aviator's parlance, appropriate throttle management?

To stay focused on the banking side of the problem, could the banks have been better prepared? At least they had sufficient warning. For the last two years, Reserve Bank governor Y V Reddy and Deputy Governor Rakesh Mohan have been actively exhorting banks to step up deposit mobilisation. Last September, Rakesh Mohan expressed surprise that deposits from rural areas were not increasing. On the contrary, the number of accounts was falling, he pointed out.

And yet it would not be fair to say banks have not tried. Bank deposits grew at 24.8 per cent this year till date, compared to 17.2 per cent as of last year. It's just that it has not been enough when contrasted with the growth numbers mentioned above. Banks have had other problems. Like, at the urban level they've faced competition from mutual funds and other asset classes, including most prominently real estate, where many have diverted their savings surplus, either as investments or equated monthly instalments.

Banks face the additional challenges of raising equity capital (which the government will not allow them to) and raising too much debt (which their balance sheets will constrain). Indeed, Canara Bank's Rao argues that the time has come to allow overseas deposits into Indian banks, apart from NRI money. In effect, full convertibility or pretty close.

Banks have yet another paradox to reckon with. Most of the big ones are listed, forcing them, as one banker at the discussion put it with a smile, to focus on profitability too, rather than only being a mobilisation race. So for all the central bank's pleas of resource mobilisation, Dalal Street cannot be ignored totally.

So it's a fait accompli that's been served. Thanks to a resource bind, at least principally, credit moderation has begun. And, independently or otherwise, it will begin to tell on various aspects of the economy. While all this could well achieve the objective of inflation control, it's also choking off supply, albeit mildly for now, at the top. And the economy does appear to be entering, to use another aviator's term, a loop of sorts.

The question is: Have we firmly entered the loop and begun the circular climb? If that is indeed the case, there is a while to go before the whole thing plays out. If, on the other hand, we figure out how to increase resources, loosen credit and of course fight inflation at the same time, we might be better off. That obviously is a dreamlike situation. Instead, we are better off figuring how to bring the aircraft back to level, as it emerges from the loop. Whether or not we actually enter it. Best that planning for this tricky maneouvre begin right now.

govindraj@business-standard.com