By Priyanka Venkat
This year has been a difficult one, especially where the economy is concerned. The rolling out of the Goods and Services Tax, the after effect of demonetisation and the credit slump because of an ailing banking sector, are only some of the issues that have kept the country on edge.
Silver linings
However, all is not lost. The economy seems to be making a turnaround and things could soon get better. For starters, Indias GDP rebounded to 6.3% in the September quarter, from the three month low of 5.7% in the June quarter. This is good news and is an indicator that the country is finally recovering from the aftermath of the GST and demonetisation.
Slowing credit growth has, however, remained a prominent concern that looms over the economy. For the year ended March 2017, credit growth fell to 5.08%, the lowest recorded in 60 years. There might be a turnaround in this story as well, with off-take in bank credit reaching a three year high in November. As per RBI data, bank loans increased to Rs. 79.6 lakh crores in November, a 9.64% rise. This is higher in comparison to the 6.6% rise during the same period in 2016, and the 9.3% rise in 2015.
The credit growth conundrum
The problem behind low credit growth is multi-faceted. There are various aspects of the issue that need to be understood. For starters, the NPA problem plays a vital role in impacting profitability and the availability of capital with banks. Public Sector Banks hold a significant portion of stressed loans, which amounts to over Rs. 10 trillion. This is particularly disturbing considering that they contribute to 70% of credit creation in the economy. To write off the bad loans, they need a large amount of capital. They often do not have an adequate amount to do so, as they have the additional burden of meeting Basel-III norms. As per the norms, Public Sector Banks are required to hold a higher amount of capital to be safe. This leaves very little capital for lending, thereby affecting credit creation. Recapitalisation of PSBs is therefore highly welcomed.
Credit growth has been impacted by low demand and supply of corporate credit as well. Where the supply of credit is concerned, banks are not willing to lend to those who have an overly debt-laden balance sheet. A large amount of debt in their balance sheet affects their cash flow, impairing their ability to make repayments.
However, the problem is not only limited to banks not wanting to lend. There is a slowdown in demand for loans by corporates. This is because of diminished demand majorly due to GST related uncertainties. The reduced market has resulted in low capacity utilisation, which is averaging at around 70%. So, in a nutshell, the reduced demand has led to companies operating below capacity, which has, in turn, led to their reduced demand for loans for investment.
Revival in loan demand could boost credit off-take
In October, corporate borrowings from overseas markets reached $4.4 billion, a three year high. Additionally, bank loans given to big corporate borrowers rose to 21.5 lakh crore, a 0.2% rise. There finally seems to be an increase in demand for bank credit, signifying a shift from previously dominating sources such as commercial papers, foreign currency borrowings and bonds. Moreover, the recent rise in fuel and commodity prices has led to an increased requirement of working capital. This, in turn, has also contributed towards the increased demand for loans. According to a survey by the central bank, demand could further increase in FY 2017-18, with the infrastructure and services sector expecting a growth in demand and business in the fourth quarter.
The slow revival in demand is an indicator that the economy is making a comeback from the impact of GST and demonetization. The Manufacturing PMI or Purchase Managers Index has also shown an increase in November. The Purchasing Manager’s Index (PMI) in November increased to 52.6 points from 50.3 in October. A Purchasing Manager’s Index indicates the level of business activity in the manufacturing and services sector. The hike in the index is reflective of a higher flow in orders, from both the domestic market and overseas. This would improve the demand for credit by manufacturers to fulfil the orders.
Improved capacity utilisation and refunds
However, for credit growth to indeed rise, there is the need for an increase in borrowing for investment. Currently, capacity utilisation stands at around 70%. It is only when capacity utilisation improves to a minimum of 80% that companies be interested in taking loans to invest in big projects. According to a report by Morgan Stanley, consumer demand is on the rise with the recovery from GST and demonetization. With a higher frequency of orders and the deleveraging of corporate balance sheets, companies are likely to operate at higher capacities and approach banks for credit.
Where exports are concerned, however, the government still needs to take measures to ensure an improved order flow. For instance, there is a dire need to ensure that refunds under GST are made on time to exporters. Exporters are yet to receive at least Rs. 50,000 crores due over the past four months, from the government in refunds. These refunds are for the taxes paid by them on goods that they purchased or manufactured. The resulting crunch in working capital is leading to exporters refusing new orders and laying off workers. This would consequently lead to a fall in orders and result in them not taking loans from banks to furnish the same.
Road to reforms
Reforms such as recapitalisation and the Insolvency and Bankruptcy Code would give the necessary assistance required to kick-start credit creation. Recapitalising the deserving PSBs would provide them with the leeway needed to start lending again. Quicker resolution of NPAs under the Bankruptcy Code would help to clean balance sheets and free up capital to give as loans or invest elsewhere. Both these measures provide a necessary boost to corporate sentiment.
The slow revival in corporate demand and confidence, coupled with improving consumer demand, is likely to increase capacity utilisation. This would further spur borrowing for investment. While the acceleration of credit growth is highly dependent on how the reforms are executed, along with a healthy demand, the recent uptick in credit growth could spell better times ahead for the economy.
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