Winds for credit growth in the banking system in the short term; but headwinds are emerging in the medium term
Banking system credit growth recorded a significant recovery at the start of FY23, with credit growth of 11.2% year-on-year as of April 8, 2022, compared to 5.3% year-on-year during FY23. same period in April 2021, and the highest since July 2019. India Ratings and Research (Ind-Ra) estimates that while the second wave of covid had a significant impact on the credit outlook in 2021, the credit outlook has reasonably normalized at the start of 2022. The tailwinds are driven by a recovery in credit growth in the manufacturing and services segments (baseline February 2022), even if growth in the agricultural segment remains stable and sluggish in the trade segment Retail. In the medium term, inflationary pressures, supply chain disruptions and weak consumer demand could disrupt the current recovery in credit growth.
In addition, the reversal of the interest rate cycle, as indicated by the Reserve Bank of India’s 40 bp increase in the repo rate, would weigh on credit growth as borrowing becomes more expensive.
Ind-Ra, based on feedback from its rated issuers, understands that the investment revival could be delayed as many have postponed their investment plans pending further clarity on the macroeconomic front. In addition, the ongoing conflict has raised concerns about the continued pace of exports. Sectors likely to continue to perform well include energy, metals, cement, chemicals and textiles, while sectors likely to come under pressure include telecommunications, pharmaceuticals and commercial real estate. In its Banking Outlook report released in February 2022, the agency estimated banking system credit growth at 10.0% year-on-year for FY23 based on a bottom-up estimate across all sectors.
In the near term, continued corporate demand for working capital, driven by high commodity prices and the beginning of a return to the banking system of bond markets amid rising interest rates, that would keep the engines of credit growth in place. The industrial segment grew by 6.5% year-on-year in February 2022, compared to 0.4% year-on-year in March 2021. The resumption of growth is visible in all three segments – micro and small, medium and big. The agency estimates that from the perspective of incremental contributions, the medium segment was the largest contributor and was driven by disbursements under the emergency line of credit guarantee program. The micro and small business segment is the second largest contributor, largely driven by inflationary pressures on working capital requirements. The large industrial segment, which accounts for nearly 77% of the industrial segment, also began to experience credit growth relative to deleveraging in 2021.
The services segment also showed dynamic credit growth at 5.6% YoY growth in February 2022, compared to 1.4% YoY in March 2021. services contributed 18.7% to overall credit growth in February 2022, the same was only 7.9% in March 2021. The main contributors to the differential year-on-year growth reported in the services sector come mainly from two segments: non-bank financial corporations and trade.
With the impact of COVID-19 subsiding, banks are increasingly willing to lend to these segments and this is also a function of a recovery in demand as seen in these final segments. Within non-banks, housing finance companies held about 50% of the incremental year-over-year contribution in February 2022.
Retail loans continue to be the main contributor to incremental year-over-year growth, although their proportion fell from 57.7% in March 2021 to 42.7% in February 2022. Retail loans increased by 12 .3% year-on-year in February 2022 compared to 10.2% in March 2021 The proportion of real estate loans, which constitute about 47.7% of the total loans to individuals in the banking system, experienced a decline in growth rate to 6 .7% year-on-year in February 2022, compared to 9.0% year-on-year in March 2021. The agency estimates that if demand for residential real estate remains buoyant and banks continue to maintain high competitive intensity, companies home financing rebounded strongly, partly causing the slowdown of banks in the segment.
In terms of incremental contribution share, Ind-Ra observed that unsecured lending accounts for more than 50% of incremental retail lending growth since July 2021, meaning banks are looking to grow this business in search of higher margins. However, they are cautiously doing the same with stricter credit filters, posting their experience with the segment during COVID-19.