Healthy growth of bank credit is considered the strongest proof of India’s solid economic recovery. So far though, the story on the financing side was limited by incomplete information. It was largely confined to bank credit because of insufficient or firm evidence on the strength of non-bank fund flows such as NBFCs, financing institutions like Nabard, NHB, Sidbi, etc.; housing finance companies, and from abroad. And while volumes of equity, bonds, and commercial paper issuances as well as different foreign capital flows were individually known, aggregation and adjustments for bank-to-nonbank credit flows were not. Reading the real economy through the financial prism was incomplete.
The total flow of financial resources to the commercial sector, which provides a good grip on the strength of the real economy, is compiled by the central bank. Since 2021-22, this is published annually with a 6-month lag in September. Before that, until 2019-20, the RBI shared this bi-annually—in the monetary policy reports and in the banking trends and progress report in December—and last did so in 2020. Now that the data for 2022-23 is published, what does the aggregate picture look like?
First, a few stylised facts going back to 2007-08 enable observation of trends instead of single data points, which economists are diffident about reacting to even in normal times. With the pandemic-caused trough and rebound against the 2019-20 deceleration in GDP growth to 3.9%, a longer and normalised profile is even more appropriate. The accompanying graphic shows the flow of resources to the commercial sector in absolute magnitudes and ratios to nominal GDP.
Three features are apparent. One, the total fund flows-to-GDP ratio shows steady improvement from 7.6% in FY20. Two, at 10.8% of GDP in FY23, the financing shortfall persists relative to trend 11.6% in FY12-FY19, matching the FY15-FY16 levels. It is notable the Rs 29.6 trillion funds flow last year was a quarter percent higher than FY19 (Rs 23.5 trillion) when retail inflation averaged 3.4% against 6.7% while corresponding WPI inflation of 4.3% compares with 9.4% in FY23 following 13% in FY22!
Three, compared to pre-2011 trend of 17.4%, there’s a sizeable decline of 6.6 points. This gap reflects the economy has significant catch-up to do from the financing side to complement the real one. It prompts concern if financial resources are adequate to sustain medium-term real GDP growth of 6%.
Let us examine the three main sub-components—banks, non-banks, and foreign inflows. The accompanying graphic shows that overall funding was singularly led by bank credit, with an unprecedented rise of Rs 8 trillion over FY22, when it increased Rs 5.8 trillion from FY21 level. At Rs 18 trillion last year, bank credit volumes were thrice that in FY20 when wholesale inflation averaged 1.7%!
Other domestic non-bank sources, viz., NBFCs (adjusted for bank credit) and national refinancing institutions lagged at 12-13% of bank credit flow despite a respective quadrupling and doubling over FY22 levels. Funds by housing finance companies doubled too, but the Rs 1.08 trillion in FY23 was half the Rs 2.2 trillion in FY18 and -35% lower than FY19, in which the ILF&S collapse followed by some large NBFCs caused a steep funding squeeze and confidence decline.
The feeble funding flows from nonbank intermediaries, which mainly finance vehicle and housing loans, are not indicative of substantial demand strengthening in FY23. If housing, symbolising private residential activity, used meaningfully lesser amounts in successive years of exceptionally high inflation, the proof of weakness in consumption and investment demand is significant. While bank credit to NBFCs plateaued from January 2023, industry’s credit demand in this financial year (end-July) is flat in correspondence with one year ago (~0.8%).
The third major source, foreign flows, plunged to their lowest since FY08 to 12% of the total funds in FY23 (see graphic). This reflects tightening financial conditions abroad with rising interest rates, normalising balance sheets of advanced countries’ central banks, and rupee depreciation pressures that continue. Commercial borrowings haven’t recovered since FY20, with net outflow last year. FDI inflows failed to offset, including the drop in short-term credit to a third of FY22’s.
What do these developments tell us? One, the non-bank sources of financing are not recovering as robustly as believed or understood. The excitement about strong digital lending is overdone—in the macroeconomic funding profile, its role is insignificant. Two, foreign financing has slipped with the adverse turn in the global macro environment. FDI, the sole component that isn’t entirely governed by such factors, has fallen, indicating a role for policies, regulations, etc. Three, and most importantly, if bank credit does not sustain in the post-pandemic recovery in the medium-term or is unable to fill the deficit from nonbank and foreign sources, that could constitute a financial shock and hold back economic growth.
These signs should worry policymakers who have been looking at bank credit alone. The obvious question is: Which component can offset the aggregate financing deficit? The recent decision for including India in a global bond index is one pointer. This, however, comes with heightened volatility, greater scrutiny, and policy discipline.