The monetary policy focus on flow of bank credit has two dimensions. First, is ensuring adequate flow of credit to productive sectors of the economy, which captures the growth objective. Second, is directing the flow of credit to what is considered as the priority sector (PS).

Over the years, and in particular after the banking reforms of the 1990s, the way in which priority sector is defined has undergone a series of changes, generally enlarging the scope of priority sector.

This led to the criticism that targeting priority sector was losing its thrust, after which the Reserve Bank constituted a working group headed by Mr. C.S. Murthy (MWG). The MWG made a whole set of new recommendations redefining the coverage of PS as also the base for computation of targets set.

PRIORITY SECTOR COVERAGE

As regards the coverage of PS, the MWG recommended for inclusion the sectors which (i) affect large sections of society; (ii) are of considerable importance to the national economy; (iii) benefit small borrowers and involve small loans; (iv) relate to those sectors which face difficulty in getting bank credit; and (v) lead to substantial employment generation. The MWG recommended on this basis, re-fixing targets and sub-targets under PS.

The Reserve Bank implemented recommendations of MWG with effect from April 2007. In terms of flow, the emphasis has shifted to micro and small enterprises, particularly under services sector, educational loans and weaker sections, besides the continued emphasis on agriculture and allied activities. These changes seem to have had the desired impact.

The credit flow to re-defined sectors has been satisfactory, with the exception of export credit . The flow under micro-credit, educational loans and weaker sections showed increases of more than about 25 per cent during the years ending March 2009 and 2010.

Agriculture and allied activities and micro and small enterprises also witnessed increases of more than 20 per cent. For March 2010, the annual increase to micro and small enterprises was as high as 44 per cent and in particular under services sector the growth was unprecedented at as high as 84 per cent.

These results are no doubt encouraging.

MEASURING PERFORMANCE

Historically, while there were many changes in the scope and coverage of PS, the base for computation of performance in terms of overall target of 40 per cent and various sub-targets was related to what was called the ‘net bank credit (NBC)', and there was absolutely no change in that base.

NBC was arrived at after deducting the FCNR and NRNR deposits presumably on the ground that these liabilities do not support domestic credit on an enduring basis. But this base has been drastically modified with effect from April 2007.

The MWG is of the view that the computation of PS lending performance of domestic banks should be linked to the total disbursements made by banks during the previous year. For foreign banks, the MWG recommended that the target may be set on the basis of NBC or credit equivalent amount of the off-balance sheet exposures, whichever was higher. The Reserve Bank did not follow these recommendations and adopted completely a different approach. First, instead of treating performance on a contemporaneous base of NBC, performance was linked to the base of the previous year.

Second, the concept of NBC was substituted by what is called the ‘adjusted net bank credit (ANBC)'. The ANBC did not make deductions for FCNR and NRNR deposits. But, it included, strangely, the holdings of non-SLR bonds under the ‘held to maturity' category. If the credit equivalent of off-balance sheet exposures was higher than the ANBC, that will form the base for assessing performance under PS targets.

This change in base seems to have not only made the assessments of PS performance of banks much more complicated, but also resulted in overestimation of achievement of targets.

THE ACTUAL PICTURE

We attempted to compute the base on the basis of old definition, that is NBC and the new definition, namely, the ANBC. It is seen that the size of the base with reference to ANBC is much larger during the entire period March 2002 to March 2010. But, since the computation of targets is related to the base of the previous year, the percentage of PS achievement on the basis of ANBC compared with the old definition of NBC, gets overestimated in the range of 2.3 percentage points in March 2010 and as high as 5.7 percentage points in March 2006.

The overestimation during the period since March 2008 ranged between 2.3 percentage points and 3.7 percentage points. Therefore, any claim with regard to achievement of PS targets by the banking system has to be viewed with circumspection.

While the changes in coverage and scope of PS since 2007 seem well intended and apparently served the purpose, the change in base for computation from NBC to ANBC has resulted in overestimation of performance of banks under PS. It would, therefore, be preferable to change the base to the historically well tested NBC. If ANBC is to be retained, then at least the target assessment should be on a contemporaneous base. Otherwise, the targets and sub-targets should be sufficiently scaled up to reflect the performance in a fair way.

(The author is Director, EPW Research Foundation. The views are personal. >blfeedback@thehindu.co.in )

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