Can credit growth recover to double-digits?

Supply of credit is further likely to be aided by assurance of supportive monetary policy—low rates amid ample liquidity—by RBI.

By Anubhuti Sahay

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The increased likelihood of a sustained reopening of the economy by Q4FY22 (quarter ending March 2022), higher inflation, lowest level of net non-performing assets (NNPA) in the banking sector since FY16 amid ample liquidity, and low rates bode well for an increase in bank credit demand. This is especially likely amid multi-decade low credit growth in FY21 due to the pandemic. However, the key questions are how much credit growth can improve and can it recover to double digits?

We think credit growth is likely to revert towards 7.5-8.5% over late FY22/H1FY23 from an average of c.6% since the outbreak of the pandemic. Our expectation on bank credit growth is closer to average recorded during FY15-21. A rise in consumption-related loan demand (comprising primarily of mortgages and other personal loans), which slowed to 14% from average growth of 17% during FY16-20, is likely to provide a fillip to overall credit demand. Such loans account for c.40% of credit demand. Higher inflation (especially WPI inflation) is likely to raise demand for working capital (accounting for 30% of credit), similar to FY19 or FY11-13. WPI inflation is likely to average 9.5% in FY22, in our view, on favourable base effects and higher input prices.

Investment-related credit demand (medium- and long-term loans except those under personal loans) is also likely to increase, especially as sectors like steel and cement plan to raise capex over the next few quarters. With banks better positioned today—lowest level of NNPAs since FY16—than a few years ago, supply of credit is likely to improve to meet increased demand. Several studies, including those by RBI, underline the salutary impact of strong balance sheets on credit growth. Supply of credit is further likely to be aided by assurance of supportive monetary policy—low rates amid ample liquidity—by RBI.

However, we caution against expectations of double-digit growth, which we believe is unlikely and, even if recorded, unsustainable. We say so for multiple reasons; most importantly, given the lack of certainty on strong demand beyond FY23 (crucial for a pick-up in private investment and related credit demand). Single-digit investment-related credit demand (accounting for almost 40% of credit demand) has weighed on credit growth since FY15 and unsurprisingly reflects slow private sector investment cycle.

Our analysis shows that private-sector capex rises when capacity utilisation (we use RBI’s aggregate measure of capacity utilisation) is closer or above 75% on a sustained basis. From FY13 to date, capacity utilisation has remained well below 75% (barring FY19), leading to slower private sector capex.

We acknowledge there is a strong possibility of capacity utilisation moving towards 75% by late FY22/FY23 as pent-up demand is released. In fact, the latest RBI survey shows that capacity utilisation is at 69%, closer to pre-pandemic levels. However, sustainability of capacity utilisation at c.75% beyond FY23 is uncertain on lack of clarity on demand resilience.

Our analysis of available employment and job surveys indicate the purchasing power of Indian consumers has improved since last year; but it remains below the pre-pandemic phase. A decline in the number of employed workers (according to CMIE data, the number of workers is down by c.6mn relative to pre-pandemic), a shift towards lesser skilled/lower-paying jobs from regular jobs, and subdued real wages on relatively higher inflation have adversely impacted purchasing power. As restoring jobs lost during the pandemic, especially secure and better paying jobs, is likely to take time, demand could plateau after the initial sugar rush on a reopening of the economy fades. The unprecedented nature of the pandemic is also likely to weigh on any substantial plans to boost capacity, in our view.

Also, loss of personal income is likely to keep banks cautious on lending to SMEs and retail segments given worries about a potential rise in NPAs (which have likely bottomed and are likely to see a rise over the next few quarters). Corporates, on the other hand, have deleveraged in FY21 and easy liquidity amid slower economic activity could contain demand for working capital loans.

In a nutshell, while the improved balance sheets of corporates and banks, along with higher inflation, are constructive developments for credit growth, it is insufficient for a capex and related loan revival. In our view, lagging demand is the biggest factor holding back capex and sustained double-digit credit growth.

The author is head, South Asia, Economics Research, Standard Chartered Bank