scorecardresearch

How will credit behave now?

Credit growth may not be affected much by the rate hikes if economic growth remains robust. A buoyant economy is a more important pre-condition than rates

How will credit behave now?
The repo hike to 5.40% takes it to just above the pre-Covid level of 5.15%. After being very accommodative, the regime has reverted to normal.

With the repo rate going up by 50 bps, there is speculation on what the terminal repo rate will be by March. The corollary: How will other interest rates play out for depositers, borrowers and markets? The repo hike to 5.40% takes it to just above the pre-Covid level of 5.15%. After being very accommodative, the regime has reverted to normal.

It is hard to guess how other interest rates will behave during the year. But there have been some signals from the movement in rates since RBI increased the repo rate from 4% to 4.4%, and later to 4.90%. This increase of 90 bps can be linked with the movement in other rates.

The base rate for banks rose from an average of 8.02% to 8.275%, around 25 bps. The overnight MCLR was up from 6.75% to 7.10% (35 bps). The basic lending benchmarks of banks increased by just 25-35 bps in response to the 90-bps repo hike. One of the key components of these benchmarks is the cost of deposits. The 1-year deposit rate of leading banks averaged 5.3% when the repo rate was 4% and went up to 5.52%, an increase of 22 bps. This has hence aligned the lending benchmarks by a similar increase.

Also Read| PLI wind beneath renewables wings

The market rates at the shorter end have been driven more by liquidity considerations, which is interesting. RBI has spoken of withdrawal of liquidity. From around Rs 6-7 lakh crore a day, it is down to ~Rs 3 lakh crore. Therefore market rates have been very responsive, though the cause is liquidity, not the repo hike. Call rates moved in consonance with the repo rate because the latter serves as a cap. But the 91-days T-Bill moved from 3.98% to 5.04%, while the 182-days T-Bill was up by ~160 bps and the 364-days T-Bill by 152 bps (4.81% to 6.33%).

The story however takes a twist when it comes to the longer end of the maturity spectrum. The 10-year bond yield was up from 7.15% to 7.32%. Such variation is more due to the linkage with other nations’ bond yields that had also come down in this period. Besides, notwithstanding the inflation spectre and a large borrowing programme, the economy’s buoyancy assures us of no additional fund raising by the government. Global inflation has eased, and this should also reflect domestically in the next few months. Hence, the 10-year yield has come down, after crossing 7.6% post the June policy.

In this situation, another relevant question is how will credit behave? Will higher interest rates militate against borrowing? One can look at how lending has behaved in both the historical and current context. Historically, when the economy is doing well and investment is increasing, there is higher borrowing even though interest rates are high. This is led by manufacturing, within which the large companies drive credit. In 2009-14, when the weighted average lending rate was in double-digits, credit grew by 14% per annum. From 2015 to 2020, growth slowed down to 9% even as the WALR slid from 10.72% to 9.28% (7.86% in FY22).

The share of large industry in credit was ~35% in the first phase and came down to 30% in the second, indicating slowing overall investment, and the NPA overhang too affected lending to this segment. Manufacturing’s share declined from 44% to 37%, while retail’s rose to 24%. Therefore, a buoyant economy is a must for investment and credit growth, and interest rates may not matter much.

Even in the current context, after the May hike of 40 bps, the incremental credit-deposit ratio rose from 65% to 113% by the eve of the August policy. The credit-deposit ratio has also improved from 71.9% to 73.1%.

Therefore, once the economy is in the growth phase—looking likely now, based on the high frequency indicators—repo-rate rise won’t impede credit growth. Besides, as seen in the movement so far, the 90-bps hike has led to less than commensurate increase, of just 25-35 bps, for non-repo-based borrowing. For repo-based borrowing, SMEs would be a question mark, as they get affected, but may have to continue paying higher costs. For retail borrowers, interest rate cycles are part of the story, and hence a 15-20 year mortgage will witness these phases. Owning a house is more important than the financing costs which will traverse both the phases in equal measure during these tenures.

The author is Chief economist, Bank of Baroda
Views are personal

Get live Share Market updates and latest India News and business news on Financial Express. Download Financial Express App for latest business news.