Will the reduced repo rate accelerate bank credit?

In pursuit of the Prime Minister's “Make-in-India” mission, there has been consistent pressure from the Centre for reduction in rate of interest to boost investment. Industrialists harp on lowering  interest rates and implementation of tax reforms promised by the government in the budget. Bankers are concerned about increasing non-performing assets. In view of the level of inflation and concern for growth, Reserve Bank of India (RBI) has been changing its monetary policy instruments like repo rate, marginal standing facility rate, bank rate, statutory liquidity ratio, credit reserve ratio and cash reserve ratio from time to time. Among these, the repo rate is  important and has a direct bearing on the liquidity of banks and their lending rates. The repo rate recorded a steep increase in three stages from 7.25 per cent in September 2013 to 8 per cent in January 2014. It remained at this level till December 2014. Since January 2015, it has been reduced in three tranches of 0.25 each, to 7.25 per cent on June 2,  2015 and  the latest upfront reduction of 0.50 per cent on September 29, brought it to 6.75 per cent at the level of March 2011. The base rates of banks also moved in the same direction, though not in tandem. After the repo reduction of 0.75 per cent during January to June 2015, the rate of interest was reduced by only 0.30 per cent. The latest reduction of 0.50 per cent in the repo rate may further reduce the rate of interest by about 0.25. At a lower rate of interest, the fixed and administrative cost acquire more weight in the banks' cost of funds. RBI has mainly been  targeting the management of inflation  in its bi-monthly monetary policy reviews, while the Centre has been concerned about the slowdown in the growth rate of GDP due to higher rates of interest.  Studies have found a positive association between the growth rate of Gross Domestic Product and bank credit over a long period, though the cause-and -effect relationship between the two is  debatable. Whether lower rates of interest alone will induce higher investment has not been exclusively established. The impact of changes in repo rate/hence rate of interest on the flow of bank credit has been  examined  on the basis of rate of growth of the outstanding bank credit (O/S) during 2013 -14 and 2014-15, on the basis the data by RBI on September 2, 2015 for the Scheduled Commercial Banks. As per RBI data, the overall O/S bank credit during the year 2014-15 has decelerated to 8.2 per cent, as compared to 12.6 per cent during the corresponding previous year. If the flow of bank credit is positively associated with rate of interest then the O/S bank loans should have been subdued in July 2014, when repo rate was the highest at 8 per cent during January-July 2014. The O/s bank loan should have increased in July 2015, when repo rate was brought down to 7.25 during January to June 2015. Accordingly, the rate of credit growth should have been lower during the year 2013-14, compared to the same during 2014-15. However, actual growth rates of bank credit are just the contrary.  Sector wise, non-food credit increased by 8.4 per cent during 2014-15, as against 12.6 per cent in the previous year. The food credit, (just 2 per cent  of the total), shows negative growth. The variations among the sub-sectors of non-food credit reveals that only personal loans have a slightly higher growth rate of 16.8 per cent during 2014-15, as against 15.1 per cent during 2013-14. Within this sector, housing and loans against shares and credit cards were the buzzing segments. However, personal loans are just 20 per cent of the total bank credit. With the roaring services sector accounting for 23 per cent of the total bank credit, the growth rate of O/S in bank credit decelerated to 6.4 per cent during 2014-15, compared to 11.8 per cent in the previous year. The most hit sub-sectors under services are transport, commercial real estate and loans to NBFC, while there is some silver lining in non-priority trade. Even in agriculture and allied sectors, the growth in bank credit came down to 13.2 per cent during 2014-15, against 19.5 during 2013-14. This sector accounted for 13 per cent of total bank credit. Industry, the major sector accounting for 43 per cent of total bank credit, has been hit the hardest and its credit growth was just 4.8 per cent during 2014-15, as compared to 10.2 per cent during 2013-14. Within the industrial sector, the growth in O/S bank credit is negative in mining, beverage, petroleum and coal products, fertilisers, textiles, construction and foodgrain processing. It has decelerated in leather, wood, paper, rubber  and plastic products, all engineering, vehicle and transport and construction. Prima facie, it is reflected that employment-generating industries like construction, wood, rubber, plastic, paper product, transport and mining have decelerated or recorded negative growth in the bank credit. Their subdued position, in turn, may have reduced the income of the low-paid workers. The sub-sector wise growth in bank credit too does not indicate a positive association with the lower repo/ interest rate. 

The deceleration in bank credit to industry inspite of a decreasing repo rate and slogans of “Make in India, Skill India, Start-up India” suggests that other boosters are required to increase investment and enhance the growth rate of GDP.  Demand for goods and services are to be increased for higher capacity utilisation, additional capital investment and to attract foreign direct investment. The falling or stagnant prices of rice, sugarcane, housing, steel, cement, automobiles and durable consumer goods indicate lack of domestic demand. Our declining exports hint at a subdued demand in the international market. Domestic demand can emerge if the income of low-income groups is increased. The recent increase in number of the minimum employment days from 100 to 150, under MGNREGA, in drought-hit areas is a step in the right direction. Job creation through completion of uncompleted projects at the last stage, especially in the power sector, may be another priority. The housing sector is the highest income multiplier due to its linkage with 300 other sectors required to be rejuvenated through construction of affordable houses in the range of Rs 20 to Rs 25 lakh. This can happen if the approach to housing is restructured by keeping the construction quality at necessity level and encouraging housing in small towns with appropriate fiscal incentives. There was a boom in bank credit for housing during 2000-2012, due to rebate in income tax on the interest, along with lower interest rates on bank loans at any place. 

The writer is  Professor, SBI Chair, CRRID, Chandigarh.