Credit flow to the commercial sector is like the pulse of the economy. The relationship between the duo can be traced back to the writings of Schumpeter (1911) who argued that the financial sector can stimulate technological innovation and economic growth.

Credit & GDP

Greater the percentage of Credit to GDP more the contribution of financial sector to the economic activity of a country. The data published by the Bank of International Settlement and World Bank point that a high credit GDP ratio has direct relationship with the income level of an economy. Countries with higher GDP per Capita (eg. Euro Area) does not have less than 100% credit to GDP percentage and thus manifesting greater financial depth. Further, there are countries like Sweden, which have even higher per capita income and a higher level of Credit to GDP percentage. In the matrix of credit to GDP ratio and income per capita, India occupies a position at lower band – implying potential of further deepening the financial sector.

The above table shows that for 1bps rise in nominal GDP a more than proportionate increase in credit offtake is warranted. A lower ratio of credit growth to nominal GDP growth (below 1) is succeeded by a softer real GDP number.

Marked structural change in the credit flow to commercial sector has taken place in the recent past as adjusted bank credit growth has overtaken the traditional credit growth – denoting pick up in alternative sources of financing. Average credit to GDP percentage from 2013 through 2019 moved up to 51% from the 43 % average of the preceding 8 years.

Here, Bank credit is traditional credit flow from commercial banks and adjusted bank credit includes non-traditional credit flow like commercial paper, bonds and debentures etc apart from traditional credit.

Long term Credit Growth – India ?

Using the Hodrick-Prescott data smoothening techniques, it has been seen that over the last decade bank credit growth had a declining trend. However, the actual credit growth moving above its long term trend line lately is a green shoot.

During the past half-decade, alternative source of financing picked up. In the current industrial backdrop banks need to play a greater role in financing economic activity. Despite the declining trend the recent breakout of actual credit growth above the trend line is a positive phenomenon.

The urgent need is to sustain the same through structural change, capitalization or lowering borrowing cost, or all of them together.

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