A Perfect Storm Has Begun Stifling India's Bank Credit Growth

Tight liquidity and higher interest rates are beginning to slow down the credit growth of India's banking sector.

The Reserve Bank of India's incremental cash-reserve-ratio requirement, its dollar sales to buttress a weakening rupee and the goods and services tax outflow are all leading to liquidity turning negative since March 2023.

Non-food bank credit rose 19.7% year-on-year to over Rs 148 lakh crore as on Aug. 11, according to the latest data by the RBI, primarily driven by the merger between Housing Development Finance Corp. and HDFC Bank Ltd.

The credit growth number would have been 14.8% without taking the $40-billion merger into account. This is below the trend of over 15% banks have been recording over the last year or so.

The RBI's move to raise CRR was targeted at sucking out the liquidity generated due to an increase in the Rs 2,000 notes into the banking system. The high cost of funds due to a cumulative 250-basis-point hike in the repo rate since May 2022 has also affected the credit offtake.

Banking system liquidity turned deficit for the first time in the current fiscal on Aug. 21 after the incremental CRR sucked out about Rs 1 lakh crore from the banking system. Currently, liquidity in the banking system is estimated to be in deficit of around Rs 23,644 crore. The last time banking system liquidity turned into deficit was on March 26.

Another repo rate hike in India would impact the loan growth outlook, reducing affordability and, therefore, demand, especially in loans for housing and micro, small and medium enterprises. It will be negative for the asset quality cycle as the higher equated monthly installments may impact serviceability of loans, according to HSBC Global Research.

Some analysts say credit growth will remain weak due to elevated interest rates and global uncertainties.

"Personal loans and services sector is driving the credit, but the issue continues to be industrial credit, where the growth in the MSME sector has come down quite significantly because of the end of (the) ECLGS," Indranil Pan, chief economist at Yes Bank, said.

The Emergency Credit Line Guarantee Scheme, launched in May 2020 as a part of the Union government's Covid-19 measures, was introduced to provide emergency loan facilities to the MSMEs, which have suffered during this pandemic.

Under the scheme, about 95% of the Rs 3.19 lakh crore guarantees issued as of March 25 attributed to the loans sanctioned to the MSMEs, according to the government data. The scheme has now been closed.

While credit to industry registered a growth of 8.1% year-on-year in June compared with 9.5% in June 2022, loans to services sector accelerated to 26.7% due to the improved credit offtake to the non-banking financial companies, according to the latest RBI data. Even personal loans grew 20.9% in June from 18.1% a year ago.

The banks' deposits have risen 13.5% year-on-year to the highest level in six years as of Aug. 11 at Rs 192 lakh crore, according to the RBI.

While the deposits have not risen as much as credit, it has certainly been propped up by the return of Rs 2,000 denomination notes.

"The higher interest rates are helping in terms of deposit growth, but it is difficult to reason out whether it is because of slowing economy going forward and people are getting cautious about spending," Pan said. "Having said that, there is some amount of resilience being seen in the economy. That, to an extent, should be helping deposit mobilisation."

Further rate hikes by the RBI are also likely to improve banks' deposits, according to Anand Dama, head of BFSI Research at Emkay Global Financial Services. "We could see some rate hikes here and there if inflation does not come in control. Looking at MPC, banks are not going to cut deposit rates going further, especially before the festive season kicks in," Dama said.

In July, India’s retail inflation skyrocketed to a 15-month high of 7.44%, marking the third instance of the CPI reading this year crossing the RBI's upper tolerance limit of 6%.

Over the past year, a steep rise in food prices amid global disruptions has compelled the central bank to raise its benchmark repo rate to 6.50% from 4.40% in May last year. At the monetary policy meeting this month, RBI Governor Shaktikanta Das said the monetary policy committee would take further actions promptly and appropriately as required to keep inflation expectations firmly anchored and to bring down inflation to the target. 

The RBI projects the headline inflation at 5.4% for current financial year.