Look beyond near term measures to push credit growth

Amid the early signs of revival of the economy, RBI has been proactively nursing the financial ecosystem system with ample liquidity to accelerate credit growth. Manufacturing Purchasing Managers Index (PMI) has gone up to 58.9 in October 2020, the highest in more than a decade. Service sector PMI also increased from 49.8 in September to 54.1 in October or the first time in eight months. 57.4 million e-way bills generated during September are close to pre-covid level. Power consumption has grown by 13.38 percent to reach 110.94 billion units in October 2020. Toll collections have breached pre-covid level, up 116 percent. First time since February 2020, the GST collections breached Rs.1 trillion mark in October 2020 indicating that economic activity is fast heading towards pre-Covid19 levels. 

The Foreign Direct Investment (FDI) during first five months of FY21 is at a high at US $ 35.73 billion. Foreign Portfolio investments inflows are close to US $ 3.2 billion in October 2020. As a result, the forex reserves have touched a lifetime high of US $555.12 billion after it surged by $3.615 billion in the week ended October 16. These signs of buoyancy are set to increase demand for credit. 

• Near term response:

The near term response of RBI has been ahead of the curve. The significance has been the foresight of monetary policy committee to continue accommodative stance of the monetary policy throughout this fiscal and also into the next financial year 2021-22 so long as it is necessary to support growth. 

Further the spree of rate cuts, innovative liquidity measures, moratorium in the repayment of loans that ended on August 31, 2020, temporary relaxations in prudential norms, postponement of implementation of last phase of Basel – III and opening up restructuring windows to tackle covid induced stress of borrowers are some of the progressive measures ostensibly showing positive results. 

• Status of credit growth: 

The slow flow of bank credit has been a worrying factor that can be an impediment in the overall revival trajectory. Banks have sanctioned loans of Rs. 1,87,579 crores to 50.7 lakh business units under Rs. 3 Trillion Emergency Credit Line Guarantee Scheme (ECLGS) for the MSME sector. The scheme to end on October 31, 2020 has since been extended till November 30, 2020 to enable full benefits to reach the target group. A credit growth of 5.7 percent recorded during the current year up to the fortnight ending October 9, 2020 does not augur well with 8.9 percent growth recorded during the same period last year. 

The series of near term measures of RBI to spruce credit growth might be ‘work-in-progress’ but introspection into the reasons for decline in credit appetite of banks will help alter the course of intervention. Logically, going by commercial consideration, banks should be eager to lend but are not using their full potentiality to expand credit.  Some of the possible inhibiting factors could be (i) lack of demand for credit from the industry due to overhang of uncertainty in the business environment (ii) fear of rising gross Non-performing Assets (GNPAs) and (iii) receding capital to risk weighted assets ratio (CRAR) (iv) impending burden of additional provision of 10 percent on restructuring of loans based upon Kamath committee template (v) load of 5 percent provision on restructuring of MSME loans of up to Rs. 25 crores  (vi) fear of diminishing profitability of banks in prolonged slowing economy and so on. 

Some of the critical weaknesses and fears of banks can be assessed from the RBI data provided in the Financial Stability Report – June 2020. The Capital to Risk weighted assets Ratio (CRAR) of Scheduled Commercial Banks (SCBs) went down to 14.8 per cent in March 2020 from 15.0 per cent in September 2019. The GNPAs ratio is at 8.5 per cent and provision coverage ratio (PCR) at 65.4 per cent in March 2020. 

The GNPAs could potentially rise to a high of 14.7 percent by March 2021 under severe threat that seems imminent now. Though RBI postponed implementation of last leg of adding 0.625 percent of capital conservation buffer (CCB) till March 31, 2021 under Basel – III, the minimum CRAR of banks stands at 10.875 percent. Given the fragile base of CRAR any aggressive lending may further erode it. 

• Beyond near term measures: 

Going beyond the near term measures, it may be necessary to support banks with long-term supports to enable banks to push credit growth. Rs. 20000 crores of capital infusion proposed by the government may not augur well to shore up CRAR to a level where banks can expand credit. According to Moody’s investor Services, Public Sector Banks would need as much as Rs. 2 Trillion in next two years even for a credit growth of 8-10 percent and to maintain a provision coverage ratio of 70 percent in covid induced state of asset quality. RBI and government need to work out methods to provide enough capital to banks to augment credit growth, more importantly keeping in view the needs of ailing entrepreneurs at the bottom of the pyramid. 

It may also be necessary for RBI to explore possibility of reducing risk weights on all new loans extended under priority sector as is done for retail sector laying down clear exit policy from the forbearance as and when normalcy is restored. When the long-term measures are in harmony with the near term measures, the call for speedy bank credit growth could work better that can accelerate revival of the economy.