Mr. PM, Your Achilles Heel Is Banking Not Bihar

India is in the midst of an economic recovery which is moving more slowly than some had expected. To dig deeper, we look at a key area of vulnerability, the banking sector, with an elevated stock of stressed loans. In previous recovery episodes, credit growth had started to pick up mid-way through the process; but not this time . It remains well below the long-term average, reminding us of the well documented “credit-less growth” phenomenon (though technically speaking India is far from being completely credit-less). 

Once considered rare, credit-less recoveries are actually more common than perceived. An IMF paper analysing 223 recovery episodes from around the world points out that one out of five recoveries are in fact credit-less; and they have some special characteristics. Output growth during such recoveries is about a third lower than in normal ones. And indeed, for India, output growth has so far been a quarter lower than in a previous ‘normal’ recovery episode. Further, the financially dependent investment sector has a disproportionately lower contribution to growth. Lower investment has indeed been a stand out characteristic in India this time while consumption has fared relatively better. In fact a substantial portion of incremental bank credit is funding personal loans 

But there are some differences as well. Globally, younger firms which tend to display higher productivity growth, find it hard to raise credit, and this explains the slower total factor productivity (TFP) growth during these recoveries. In India, start-ups have seen a big spurt in funding . And whether or not they prove to be more productive could determine India’s growth profile for the next several years.   

Global experience suggests that due to impaired financial intermediation, industries more reliant on self-funding do relatively better. To assess India’s exposure to this trend, we create an ‘external dependence index’ for the Nifty 50 companies and find that while the IT and consumer goods sectors are more self-reliant, industrials and utilities are not 

To sum up, going by global experience, India’s low-credit recovery was never meant to be rapid. Thankfully the country has some additional support – lower oil prices and growing non-bank funding sources (table 3). Also, specific policies on bank recapitalization and debt restructuring have been in the right direction. But more is needed. Fast tracking the Bankruptcy Code for resolving financial stress would be a good start …