As India’s economy shows signs of private investment picking up, an indicator that holds out hope is our ‘credit-to-GDP gap.’ This measures the difference between the country’s credit-to-GDP ratio—which hit a plateau at around half our annual output after a steep climb in the first decade of this century—and the underlying trend of this variable (stripped of cyclical effects). A positive gap points to above-trend loan disbursals. Encouragingly, the gap turned positive in June 2023 for the first time in a decade, according to Bank for International Settlements data. In other words, demand for credit acquired relative buoyancy after a prolonged slump. While overall investment is still much below its late-2000s peak as a proportion of GDP, we have had a slight uptick on this count too. Taken together, they make for optimism over the economy’s trajectory ahead.
To be sure, the credit-to-GDP gap, formulated in the early 2000s as an early-warning indicator of a banking crisis, has been contentious and is often used along with other data. But its acceptance has risen amid evidence of it being a useful signal, especially for emerging markets. In our case, its reading is in sync with several other metrics that we track routinely. Our banks are broadly in better shape than a decade ago, with bad loans as a chunk of bank assets having fallen to low single-digit rates, while the rate of credit growth has reached mid-teen levels, even as capacity utilization in the manufacturing sector has crossed 75%, which suggests business borrowings should start regaining the share they lost to retail loans as expansion plans are dusted off for action. The post-pandemic recovery in consumer demand has been uneven, with a divergence in how the well-off and hard-up fared, but markets for many products and services have logged record sales and even the laggards have begun to look up. Although unsecured retail lending driven by a fintech fan-out has emerged as a concern for the central bank, prudential norms have been tightened and the risk of debts going bad appears to pose no systemic threat at this point.
Should manufacturers approach a level of 80% capacity utilization, we can expect the overall investment scenario to brighten. India Inc has done much to deleverage itself over the past several years and an asset-quality rescue by the government has meant that both investors and lenders face few balance-sheet constraints. This makes space for a fiscal policy pivot in 2024-25. Our post-covid economic growth has been boosted by heavy capital expenditure by the Centre, with its fiscal deficit having enlarged as a result. However, for gross capital formation to regain the verve it had during our last boom and re-gear the economy for sustainable expansion at above 7.2% per year, which is roughly the pace that doubles GDP every decade, we need private investors to chip in much more. To the extent that New Delhi’s capex thrust was designed to ‘crowd in’ such investment, 2023 data suggests it has finally begun working to that effect. It’s time, then, for a sharp fiscal pullback, sharper than outlined by India’s official glide path to 4.5% of GDP by 2025-26. The economy has emerged from its covid crater and grown faster than expected, but a big fisc for too long risks crowding out private players if growth dynamics shift in the desired direction. The Keynesian pump has served us well, but the Centre must not get addicted to its big-spender ways. It will make acceleration harder.
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