The weakness at the heart of India’s economy

Waiting for demand revival.
Waiting for demand revival.
Image: REUTERS/Rupak De Chowdhuri/Files
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A weak banking system has come back to haunt India’s economy during the pandemic.

The country’s recovery has been slow and elusive in the wake of a stringent, months-long lockdown that drove it into a deeper recession than most of the world’s large economies. According to the data released by the government, India’s economy contracted by 24% and 7.5% year-on-year in the first two quarters of the current financial year.

Such a sharp downturn has pushed the authorities into action. India’s central bank has slashed the repo rate (the rate at which Reserve Bank of India lends to banks) to a record low and infused liquidity into the markets through innovative measures. In unprecedented moves, the central bank bought bonds in open market for the first time, and offered money at a cheaper rate to banks for one-to-three-year period. But this hasn’t moved the needle of credit growth.

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Indian banks’ non-food credit growth, which discounts for loans given to government agencies to buy crops and grains, was shrinking even before the spread of pandemic. It is now expected to hit a multi-decade record low for the current financial year. This shows that there is a lack of demand from retail customers as well as large corporations to borrow and spend. It’s an important indicator to watch going into 2021, as the banks dominate India’s financial system.

“On the back of low GDP growth, the credit off-take is also expected to remain muted,” says Anil Gupta, vice president for the financial sector of rating agency ICRA. Gupta expects the bank’s loan growth to remain weak, at around 2 or 3%, “despite a steep decline in lending rates and ample liquidity with banks. The slower credit demand is broad-based, with key borrower segments such as large industries, as well as retail segments, witnessing either a contraction or a lower credit demand.”

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Layoffs and drastic pay cuts, which have hurt people’s incomes, have damaged loan demand.  Companies are wary of investing given the glacial recovery. All this all points to the underlying weakness in the Indian economy and the challenges it faces in catching up to pre-Covid levels.

In short, the pandemic has exacerbated what was already a difficult situation for Indian lenders.

Demand for credit is weak, but so is the supply from financial institutions. Indian banks are still reeling from a series of large corporate defaults in the last five years, which have resulted in an uptick in bad loans, hurting the lenders’ balance sheets. Capital has eroded as banks covered up for the rise in non-performing assets.

S&P Global Ratings expects the ratio of banks non-performing assets to loans to shoot up to 13-14% this financial year. Jobs losses and bankruptcies are expected to fuel a burgeoning crisis in bad loans.

And so, despite cheap capital, banks remain leery about ramping up lending. One example is Kotak Mahindra Bank, one of the biggest lenders in India, which recently decided to shrink its loan book and sharply reduce its exposure to small businesses to shield itself against the impact of the Covid-19 slump.

“The weak bank credit growth numbers is a reflection of both the risk aversion in the banking system, with better access and lower rates mainly for higher rated companies, and lower demand,” says Sreejith Balasubramanian, an fund management economist at Mumbai-based IDFC Asset Management Company.

India’s economy desperately needs an upswing in credit growth to escape the pandemic malaise. Unfortunately there’s little demand for borrowing, and banks aren’t in any shape to lend it.