In a bank-led financial system such as India’s, credit is expected to drive economic growth and a low-interest rate regime therefore is an important plank of monetary policy.

The RBI has been striving to keep interest rates low, often voting for growth over inflation. It’s another matter that credit has not picked up and the reasons are familiar — weak investment appetite, inadequate demand, risk aversion of banks. But some questions remain: Did low rates help, and whom? Did credit go to sectors that had strong linkages with growth?

There’s a need to look at disaggregated credit data to find the answers.

First, lending rates and credit growth. As of March 2021, the weighted average interest rate of all loans was 8.8 per cent, with almost half (48 per cent) of all loans under an average rate of 8 per cent. Of these, almost 50 per cent consisted of loans to just two sectors — personal loans and finance.

The pricing of personal home loans (average 7.6 per cent) clearly indicates that it was competition and the pressure to lend, rather than risk or tenor that went into pricing considerations. The rates to finance (NBFCs, HFCs) averaged 7.3 per cent and seemed to simply follow the logic as for banks viz. the need to boost growth.

Since these were also the only sectors where credit has been growing, it would appear that low interest rates worked. But it did not explain why industrial credit did not grow, since these loans were also not very expensive at 8.7 per cent. In fact, the pricing of loans reveals a few kinks with regard to both risk and tenor.

Riskier industries (those with large NPAs) such as metals, infrastructure and utilities had as much as 44 per cent of their loans under 8 per cent; not only do these look underpriced given their longer tenor and sector risks, but it also puts paid to the notion that NPAs were due to high interest rates.

From a tenor perspective also, the pricing appeared to be inverted — short and medium loans at 9 per cent and long-term loans at 8.7 per cent — to be sure, the pre-ponderance of lower rate home loans at 7.6 per cent may have distorted the average.

Short-term credit

In fact, if personal loans were excluded, the total credit portfolio is more suggestive of a working-capital intensive system than fixed-capital. Which makes it all the more important for short-term credit to be cheaper. While short term markets (CPs and CDs) reflected this more accurately as they responded quickly to rate cuts and liquidity infusions, banks were hampered by high intermediation costs in the form of credit risk, something that policy rate cuts or liquidity infusions cannot address.

While credit to personal loans and finance sectors grew aided by low interest rates, did that translate into GDP growth? The impact sectors viz. construction and finance add about 15 per cent and 6 per cent, respectively, to total GVA. Construction is an important sector from the point of view of employment also. But the numbers show that the construction value-add predominantly (about 80 per cent) comes from the non-residential category (roads, bridges and infrastructure), not so much from housing, whose contribution is reckoned more on an imputed basis through the implied rental value of residential property.

We have seen banks keeping away from infrastructure and construction for many years now, having burnt their fingers in the past. So much so, the government has now been forced to fund the sector through the Budget. The scenario looks unlikely to change in a hurry unless debt markets or the new specialised infrastructure financing institutions step up in a big way. This could mean that contribution to growth from bank credit may be only moderate. The GVA from financial services is also limited given the almost similar credit portfolios of NBFCs.

As for the main sectors that drive economic growth, viz. industry and services (20 per cent and 40 per cent of GVA respectively) credit offtake has either stagnated, as with industry, or has been tepid. Surprisingly, loans to agriculture, which contributes 20 per cent to GVA, bore an average rate of 9.4 per cent which looks high in the context of their requirement being overwhelmingly short-term working capital. Yet agricultural credit has grown faster than industrial credit.

It is distortions such as these that perhaps restrict the impact of interest rates. The only long-term borrowers in the system today seem to be home loan borrowers and financial intermediaries, besides of course government. Unless banks address their high intermediation costs and shift focus away from home loans and finance, bank credit can only have a marginal effect. If the status quo does not change, sectors that drive growth and need credit will have to look up to debt markets or specialised long term financing institutions rather than banks for their requirements

The writer is an independent financial consultant

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