The monetary scene in 2015-16 has been far from satisfactory. There is some euphoria over the rate cuts invoked by the Reserve Bank of India and the new method of calculating the base rate based on the marginal cost of funds; it is believed that this will improve the transmission mechanism. However, overall conditions do not look very encouraging.

The RBI has lowered the repo rate by 75 bps in FY16. Deposit rates have been lowered with alacrity and have fallen by about 110 bps, which is higher than the change in the repo rate. The lending rate, as indicated by the base rate, is down by around 60 bps which is less than the decline in the repo rate, which has, in turn, fostered the debate over the transmission mechanism.

Lag effect However, this lag is inescapable. If banks follow suit when the RBI lowers rates, only incremental deposits get priced at the new rate while in the case of lending almost all loans have to go at the new rate. Therefore, this lag, in effect, can be explained and it is not really right to focus too much on transmission.

Other interest rates have shown a mixed picture. The 10-year G sec rate was down by 20 bps but this was more on account of tight liquidity conditions brought about largely by the sluggish growth in deposits, even though growth in credit was weak. It looked almost that the central bank was pushing interest rates down against the market forces. The forward premium on the dollar, however, was more responsive with a decline of 120 bps on the six-month contract.

The major impact of rates is on credit and deposits, and this relation needs some analysis in terms of how they have reacted to lower interest rates. The demand for credit is the main issue. Growth in credit has been quite sluggish for the second successive year. RBI data for the last year reveals an increase of 11.3 per cent as against 9 per cent. However, this is misleading as in March 2015 (one fortnight after the last reporting fortnight), there was an upsurge in the growth in credit on account of the borrowing for the spectrum purchase which, combined with the year-end phenomenon, resulted in an increase of nearly ₹3 lakh crore.

This gets counted as credit in FY16 as the financial year for the banking sector officially ended on March 20 which was the last reporting fortnight. If the same adjustment is made, then growth this year over April would be just 6.5 per cent with the comparable number for last year being 7.7 per cent. Therefore, growth in credit has been lower than that in FY15 if looked at in this manner.

Further, it appears there has been limited demand for credit which can be attributed to the slow pace of growth in industry in particular with industrial growth for the first 11 months of the year amounting to just 2.6 per cent. For the same period, RBI data for sectoral distribution of credit reveals that manufacturing and services were under-performers. Growth in credit to manufacturing was 3.3 per cent as against 3.5 per cent last year, while that to services was 5.9 per cent versus 3 per cent.

Sluggish credit growth Growth has been brought about more by retail credit which increased by 17.9 per cent (14.2 per cent) and agriculture 11.8 per cent (13.3 per cent). Therefore, quite clearly, the demand side of the story has been ignored even as there is a clamour, which goes overboard at times, for lowering of interest rates. Nobody borrows just because funds are cheaper and with RBI data on capacity utilisation for Q3-FY16 still being in the 70-72 per cent range, there is less incentive to invest more.

The higher growth in retail credit may be attributed to the relatively better responsiveness of the banks to interest rates in this area as the delinquency levels are lower. This brings to the fore the issue of willingness to lend on the supply side.

While lower demand for credit has been working towards lower growth, banks too have been withdrawing from lending especially for long-term purposes given the build-up of NPAs. This has been compounded by the challenge of capital availability for some of the public sector banks. Any which way, there are considerations on the supply side too.

A worry is the composition of credit in industry. In FY16, the highest growth rates were witnessed in steel 9.2 per cent (2.9 per cent), mining 9 per cent (1.5 per cent) and infrastructure 7.6 per cent (9 per cent). This is a concern because these three sectors have been identified by the RBI as those which are prone to becoming NPAs along with textiles and aviation. While banks have managed to lower their exposure to textiles, the other three remain vulnerable to delinquency.

Tepid deposit growth The other aspect of banking on the liabilities side are deposits, which have been impacted sharply after several years. The growth in deposits has slowed down to 9.9 per cent from 10.7 per cent last year. The deposit growth rate has been moving down which is a result of both higher consumption due to high food inflation as well as lower financials savings with deposit rates going down. With an average rate of 7.25 per cent being offered on deposits with tenure of more than one year, this avenue is extremely unattractive and compares unfavourably with small savings as well as fixed maturity plans of mutual funds which offer higher rates with the possibility of lower tax rates under certain conditions.

Hence, the basic signals emanating from developments in the banking field besides the NPA overhang and capital issues for PSBs are far from encouraging. With both credit and deposits slowing down for the second successive year, the growth story of the Indian economy, which appears to be better than that of most countries, looks less luminous. This is because both of them are representative of two crucial aspects of the economy, that is, investment and savings, which finally will also get reflected in the current account deficit once the former picks up.

The writer is the chief economist of CARE Ratings. The views are personal

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