The twin balance sheet problems (bad bank loans and high corporate debt) are almost behind us, but robust credit growth appears to be a low percentage in the current fiscal year. The latest RBI data pegs bank lending for FY22 at around 8.6%, indicating an extremely slow recovery and miles from the 14-16% growth seen over the past decade. While the improvement in the quality of banks’ assets and the deleveraging of corporate balance sheets are encouraging, the rise in inflation could create an unpleasant surprise.
We are heading into a cycle of rising rates in an environment of weak credit growth, which has remained below the trend line for more than five years in a row. Prior to the Covid-19 pandemic, India’s economy slowed due to weakening business investment cycle, and this was accentuated by demonetization, GST implementation and NBFC crisis . In FY22, loan growth picked up, but signs of a full rebound in the investment cycle are still not visible. Interestingly, lenders seem optimistic, but heavy borrowers have not yet familiarized themselves with the so-called “capex mahotsav” theme. This means that demand uncertainty and high inflation only point to slower loan growth and increased pressure on margins.
As history shows us, borrower confidence influences the credit cycle more than the policy rates themselves. Companies take out loans even during a cycle of rising rates provided they are confident in their cash flow. Even though banks’ overall loan portfolios are better than during the pandemic years, the recovery is not uniform with at least two key segments, namely corporates and the self-employed, particularly in the service sector, which are not have yet to overcome the financial trauma caused by Covid lockdowns.
Unfortunately, we are seeing high inflation long before loan growth has started to be fully vigorous or even before it has recovered to pre-downturn levels. Liquidity is plentiful and interest rates have been generally benign, but the question is to what extent the RBI’s action to curb inflation through higher interest rates will delay the recovery of bank lending, which in turn depends on strong economic growth. Policymakers must ensure that rate hikes in response to inflation do not hurt demand.