India’s growth prospects anything but bright

After crashing 7.3% in FY21, India’s GDP is expected to grow 9.5% in FY22, according to the Reserve Bank of India’s (RBI’s) projections. This would translate into GDP growth of only 1.6% in FY22 over FY20. Now that credit outflow and capital expenditure (capex) data for the first half of FY22 is available, there are indications that India’s growth prospects seem anything but bright.

Personal Loans Drive Credit Growth

RBI’s credit outflow data for the first half of FY22 shows a disturbing trend. Growth in credit is being driven primarily by low-productive and low-income agriculture and non-productive personal loans (consumption) rather than high-productive and high-income industry and services. In September 2021, personal loans surpassed credit outflows to both industry and services. While outstanding to industry and services stood at ₹28.3 lakh crore and ₹25.7 lakh crore, respectively, for personal loans, the number was ₹29.2 lakh crore.

Personal loans (consumption) do drive growth but is not sustainable in the long run or sufficient if industry and services lose momentum. Agriculture, which constitutes 14-16% of GDP, can’t be expected to do the heavy-lifting. The following graph maps growth in credit outflows for all four segments of the non-food sector in the first half (H1) of FY22 to demonstrate how it is stacked against high economic growth.

The dip in credit to services in September 2021 reflects the impact of the second wave of the pandemic. Although credit to industry improved, it is far below the credit to agriculture and personal loans, dragged down primarily by large industry (which accounts for 80% of credit to industry), which recorded negative growth for all months in January-September 2021.

More worryingly, this trend in credit outflow matches the long-term trend. Since FY15, credit growth to industry and services has been in single digits. Credit growth to agriculture has been in single digits for four out of seven fiscals (FY15-FY21). All this while, credit growth to the personal loan segment continued in double digits, contributing the most.

Another interesting trend is revealed if long-term credit growth is mapped in absolute numbers. The following graph shows how personal loans have risen sharply to eclipse large industry, services and agriculture segments – which should worry policy makers.

Why is large industry of particular interest? It is because India is now relying on large industry to bail out its economy through (a) large-scale privatisation of public sector entities which is being fast-tracked and (b) provide ₹6 lakh crore via the National Monetisation Pipeline by managing brown-field (existing) infrastructure across the board, even though their ownership would remain with the government.

For those who argue that the decline in credit to industry or large industry could be due to various other factors like deleveraging, shift to debt market where cheaper money is available or classification of large borrowers as NPAs, here is another sobering news: private corporate investment has been on a decline since FY19.

Declining Private Investment and Slow Central Capex

RBI’s bulletin of September 2021 says: “In 2020-21, reflecting the impact of Covid, there was a noticeable drop in number of new projects sanctioned and also slower progress on projects already in the pipeline. Data on phasing plans for 2021-22 relating to projects in the pipeline point to persisting near-term risks to the investment outlook.”

It maps the fall in private corporate sector’s new investments (projects from less than ₹100 crore to more than ₹5,000 crore) and project completions. Both have been falling since FY19, indicating lower future growth prospects.

There is another cause for concern The central government’s capital expenditure (capex), too, remains sluggish in spite of the urgency to fast-track it for economic growth. The following graph maps data provided by the Controller General of Accounts. It shows that in H1 of FY22, only 41% of the budgeted capex has been spent (although the budgeted capex for FY22 is 26% higher than the budgeted capex for FY21).The monthly capex in FY22 is yet to reach even the level of December 2020.

Taken together, the growth impetus from private corporate sector investment and central government’s capex is not very inspiring.

Gold Loan Soars

Coming back to personal loans, they are driven largely by housing and gold loans. Growth in gold loans (raised by pledging gold) has been phenomenal in the January-September 2021 period, surpassing all segments. The following graph maps the growth in gold loans vis-à-vis credit to industry during January-September 2021 to prove the skewed nature of credit growth in the economy.

A sharp rise in growth of gold loans is indicative of deep distress in household finances. Weak financial status of households is bound to further weaken growth prospects by leading to lower consumption, which in turn will lead to lower production of goods and services and lower fresh investments.

The above developments beg the question: Why is India persisting with a cheap credit regime and for whose benefit?

Risks of Excess Liquidity

That India is in a liquidity trap since April 2020 is no secret. Lending rates were lowered as India went into the pandemic lockdown. But excess liquidity continues to be parked in RBI’s reverse repo account – where it does no good to the economy – instead of being funnelled to the economy. The following graph shows reverse repo deposits from January 2, 2020, to September 8, 2021, using RBI data to reflect this trap.

In its earlier reports, RBI was warning against continued cheap credit regime when demand was weak. For example, its Financial Stability Report (FSR) of January 2021 said easy credit and excess liquidity posed “macro-financial risks” to the economy and that this was the “unintended consequence” of monetary and fiscal measures being pursued to push economic recovery. It warned that this path could lead to economic impairment and delay recovery. Its monetary policy statement of February 5, 2021 said: “Systemic liquidity remained in large surplus in December 2020 and January 2021, engendering easy financial conditions.”

Of late, RBI has stopped talking about it altogether and continues its cheap credit regime.

Ironically, it is SBI which warned against the dangers of a prolonged low interest regime in an October 2021 research paper. It said banks were facing “significant margin pressure” as return on assets was 6%, while the reverse repo rate was 3.35%. Additionally, if cost of provisions to the core funding cost was added, the total cost came to about 12%.

The link between cheap credit and stock market boom needs no elaboration. RBI had clearly warned about prolonged low interest regime in the very same FSR of January 2021, pointing at the “growing disconnect” between the real sector and stock markets, which, it said, “got further accentuated” with “abundant liquidity” during the pandemic lockdown and later. This is not unique to India but a global phenomenon.

RBI Governor Shaktikanta Das had, in fact, spelt out this disconnect and the threat to the economy because of stock market booms (fuelled by cheap interest regime) more clearly when the economy was sinking and people lost jobs and businesses en masse. In an interview in August 2020, he said: “There is so much liquidity in the system, in the global economy, that’s why the stock market is very buoyant. It is definitely disconnected with the real economy. It will certainly witness correction in the future. But when the correction will take place, it is hard to predict.”

Now that stock markets have touched even higher highs, no more such warnings are sounded. The BSE Sensex crossed even the 62,000-mark on October 19, 2021 – from a low of 26,674 on March 24, 2020 (the day before the national pandemic lockdown) amid economic ruins of a large population.

A recent analysis shows India’s top listed firms are the most expensive globally with a price-to-earnings (PE) multiple nearly 50% higher than the global average and 1.5 times more than China’s top firms. Such over-valuation should be a cause of worry because what happens when stock markets crash is no secret. Though no such warnings are being issued, it must be kept in mind that there were no such warnings before 2008 or earlier crashes. In fact, stock market crashes typically follow high euphoria about its boom.

It is no secret that a prolonged cheap bank interest rate regime translates into negligible and even negative return from bank savings and fixed deposits, and thus, incentivises higher flow of savings and personal loans into a booming stock market. History tells us that this is a dangerous situation to be in.