How India can fill the credit gap to fuel economic growth

Banks’ ability to provide credit has improved

The Indian economy witnessed a bank credit boom during the period 2008 to 2014 with non-food credit registering a CAGR of 16.8%. However, in the subsequent years (2014 to 2021), credit growth decelerated to a CAGR of 8.3%. This was influenced by a weak industrial sector credit growth and banks being saddled with high levels of NPAs, which had skyrocketed due to the economic slowdown, overcapitalization of certain sectors, and certain other factors creating stress in corporate balance sheets, impacting the ability of banks to lend, and increasing credit gap, thereby exerting a negative drag on India’s growth.

The NPAs have since declined considerably with improved regulatory oversight, re-capitalization of banks by the government, implementation of the insolvency and bankruptcy code (IBC) and progressive deleveraging by some of the stressed firms. Despite the pandemic, gross NPAs, as of September 2022, have reached a seven-year low of 5%. Mortgage market is expected to double from US$300b to US$600b over the next five years in the backdrop of rising income levels, improved affordability and fiscal support and yet remain at 13% of GDP well below China (18%) or US (52%).

The most significant roadblock to growth in private debt was the lack of access and ability to assess creditworthiness, which therefore restricted banks and Non-Banking Financial Corporations (NBFCs) from growing their credit book to households. The digital infrastructure centered around a digital identity and a robust digital payments system has supported widespread financial inclusion. This has unleashed the potential to assess credit, underwrite risk and establish recovery mechanisms, reducing the friction in distributing credit.

Similarly, a critical issue in India’s credit market has been the burgeoning gap between the demand and supply of credit to Micro Small and Medium Enterprises (MSMEs), estimated at approximately US$250 to 300b. Outstanding bank credit to industry shows a share of medium enterprises steadily squeezed out, from 13.5% in 2007 to 4.3% in 2020. The government has recently changed the definition of MSMEs in 2020, a big move forward that has subsequently supported the flow of credit from banks to MSME.

Development of corporate bond market crucial for long-term financing requirement

The GoI’s NIP contemplates US$1.4t worth of investment in infrastructure assets over five years (discussed in detail subsequently). Given the fiscal constraints, there is limited room for expanding public investment and it is important that financing options, other than government and banks, should be explored.

Infrastructure projects often involve long gestation periods, and domestic financial institutions do not have sufficient capacity to fund such projects. While enhancement of development financial institutions is in progress, they would also be better served by a more robust corporate bond market with far greater secondary market trading liquidity. Unlike developed markets, where long-term debt is largely mobilized from capital markets, India does not presently have the capacity due to lack of depth and breadth in the bond market reflected in very thin secondary market liquidity.

The size of India’s fixed income market was estimated at US$2.4t as of September 2021. Government securities and public sector enterprise bonds dominate the domestic debt market and account for ~92% of overall trading volumes in the secondary market. 

The corporate bond market (total bonds outstanding) at 16% of GDP (2021) is an opportunity that remains sub-optimally utilized as compared to Asian peers – South Korea (87%), Malaysia (57%), and China (36%). India’s corporate bond market needs greater breadth with focus on all categories of investment grade bonds. 

Private non-bank credit in early stages of evolution with bright future

Private non-bank credit can be described as non-bank, non-NBFC lending in high-yielding and illiquid debt-like instruments. It is typically offered to mid-market firms, which are underserved by traditional sources of capital.

From the borrower’s perspective, private non-bank credit offers flexible capital solutions in terms of structure and longer loan tenures to match the cash flow profiles of the business.

From the investor’s perspective, private credits appeal lies in the higher yields and diversification benefits this asset class offers.

Formation of National Company Law Tribunals and the introduction of a creditor in control Insolvency and Bankruptcy Code, 2016, are the foundation for the growth of private non-bank credit in India. India’s high yield investment class is providing sizeable opportunities to non-traditional players to participate and create value.