Thank demonetisation for surplus liquidity, but loan market hit as few takers step up

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Updated: January 7, 2020 4:30:40 PM

Credit growth to the non-government non-financial sector has weakened to a record low of 6.4% on-year in Q2 FY20.

loan, credit growth, demonetisation, economy, indian economy, loan growth, notebanOne of the side-effects of demonetisation was the massive injection of liquidity into the financial system, which allowed higher credit growth.

Even as credit supply saw growth in recent years, the loan market is still struggling with the demand crisis. Demonetisation is attributed to be the main reason behind the surplus liquidity but this could not help to circulate the credit market due to weakening demand in the economy. It is expected that the growth in the loan market will not revive in the next year as well, however, if markets are allowed to operate in an uninterrupted manner, the revival of credit growth could take considerable time, said a Motilal Oswal report.

Credit growth to the non-government non-financial (NGNF) sector has weakened to a record low of 6.4 per cent on-year in the second quarter of the current fiscal year, while the incremental credit has declined by 90 per cent on-year in the first quarter.

“If the impact of demonetisation is considered, it can be concluded while credit demand has weakened further, credit supply has improved,” the report added. During FY18 and mid-FY19, credit growth picked up but interest rates declined further. The combination suggests the dominant role of abundant supply created by demonetisation.

However, one of the side-effects of demonetisation was the massive injection of liquidity into the financial system, which allowed higher credit growth. But, this movement suggests that higher credit growth was not led by better demand, instead, the low-rate higher credit supply was supported by the higher credit growth in many quarters post-demonetisation, making it difficult to comment on whether credit demand improved or worsened during the period.

Apart from it, since there is no shortage of liquidity in the system, measures such as lower cash reserve ratio (CRR) or lower reverse repo rate by widening the rate corridor will most likely be fruitless, Motilal Oswal report adds. Another major reason behind the decreasing credit growth is the lower corporate demand but even if regulators succeed in increasing the risk appetite of lenders by incentivising them to lend to the commercial sector, the reprieve is expected to be short-lived unless better economic fundamentals and higher macro expectations are restored.

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