The bank balance sheets are almost back to normalcy and the banking system is flush with liquidity as evidenced by the larger than required investments in government securities (it is above 27% against the SLR requirement of 25%) and the low yielding reverse repo and T-Bill transactions. Even liquid mututal funds have been attracting bank reserve investments. The 19% year-on-year growth in deposits against the 9.7% growth in credit for the same period, is only adding to the excess liquidity. The incremental credit-deposit ratio at 38% is currently close to 2001 lows.
An indication of the rebound of demand and expectations has been the surge in commercial paper issuance by businesses and the revival of the IPOs in the equity markets. External commercial borrowings too have been on the rise. In fact, the bigger firms have been raising capital at much lower cost than the prevailing commercial bank lending rates through their Commercial Paper (CP) offerings. As I have blogged earlier, the fact that banks too have been lending to their favored clients at large discounts on the BPLR also means that the BPLR may have lost its effectiveness as an interest rate signalling mechanism.
In many respects, this ability of businesses to raise capital despite bank credit ruling at historic lows is also a measure of the increasing depth and breadth of India's hitherto bank-dependent credit markets. Further, the price signals conveyed by the debt markets - commercial paper and other medium and long term debt offerings - have been more reflective of the monetary policy signals conveyed by the Central Bank's repo rate changes.
In a banking system flush with so much liquidity and demand being comfortably met from alternative sources of credit, even if the RBI were to raise rates, we may not see any immediate rise in the lending rates. The same inertia that we saw with monetary policy transmission when repo rates were on their way down will be witnessed when the rates are now hiked.
On an optimistic note, Chetan Ahya feels that the sequential figures on credit growth and the rebound in industrial production (credit growth lags behind IIP figures) means that credit growth will start "recovering from December 2009 to reach 16% by March 2010 and further to 22% by end-2010". He writes about the expectations that,
"The WPI non-food inflation rate to rise sharply to 4.7% year-on-year by March 31, 2010, compared with –2.9% year-on year during the week ended October 17, 2009. Moreover, with rising oil prices, the working capital demand of oil companies is also likely to pick up to the extent the government refrains from increasing domestic fuel prices. Recovery in corporate capital expenditure will also support the credit demand over the next 12 months. Early signs from fund-raising activity of the corporate sector indicate that capital expenditure is about the bottom. With industrial production growth likely to remain, increased capacity utilisation will mean higher investments by the corporate sector supporting the recovery in credit growth."
See this for a summary of the reasons for low credit growth - recoveries after downturns can proceed without credit growth (firms use up inventories, have lower cost of financing etc), access to non-bank sources of finance, access to working capital through money market MFs and overnight debt issuance etc.