In the crucial financial time, where the cash flow in the economy seems to decrease and poor performance of the stock market and the Indian economy as a whole, with a mere GDP growth of 5-6%, the relevance of the country’s Central Bank have degraded largely. These days too much is being made of the Central bank’s failure to cut policy rates, on the contrary it is being accused of being dogmatic on inflation, of not seeing the parlous state of growth.

People and Corporates these days wonder if the RBI’s policy rates matter in the same ways as the policy decision of the central bank action mattered in the US or the European economy. RBI seems to become largely irrelevant to large swathes of the economy.

India’s Credit Requirement

If we look at the Indian economy’s key results or the numbers, Bank lending, which is defined to include credit and investment in bonds is:

• Some 67% of the total value of economic output or GDP in India
• The same number is reported at 145% China
• Above 200% in Europe and the US
• Whooping 340% of GDP in Japan

Does the number say that Indian economy which is currently in the growing phase can do away without credit? Or is it that the Indian economy doesn’t need any credit for the operation? The answer to both the questions is unfortunately NO. India is an economy where the credit policy has a hoary history and an elaborate institutional structure. The structure involves hundis and the caste system whose sole occupation was usury.

India is a market economy where the actual extent of credit must be as high as US and European levels. We see that the levels in US and European nation is way too high at 200% and is regarded as over leveraged which is not acceptable for the Indian economy. Having said that India is currently a growing economy and is young, newly independent with less risk bearing capacity as compared to developed nation such as the United States. So our credit level must be lower. If we compare with our neighbor and competitor in population and economic growth, China, we see that the Chinese economy have large informal credit network but this is somewhat smaller than what prevails in Indian economy. Thus India’s credit requirement could be very well estimated between the level of China and US, Europe. This can be set at the levels of 150% of GDP. Now when the requirement for the economy is decided and we take a sneak peek at what the Indian banks lend the government we find the numbers quite shocking at about 50% of GDP. Thus it can be said that the Indian banks account for only one-third of the economy’s credit requirements where as the majority part of two-third (66%) remains with the informal network.

Rate of Interest

It is needless to say that the rate of interest in the informal market are sky high as compared to the formal market where banks and other financial institutions are a part. The rates in the informal market for the unorganized sector is manifold as compared the rate in formal market. Whereas the informal rate in organized sector is somewhere at a premium of 25-60% than the formal market. For example if we talk about a vegetable vendor who is operating in the unorganized retail sector, he needs to repay Rs. 1,000 for very Rs. 900 borrowed for a day. The rate of interest in such cases is recorded as high as 400% almost 25 times of what prevails in the formal market of the economy. This leads to irregularities, corruption and is also a reason of high price and poverty if we sit back and think logically.

Factors on which Indian Interest Rates depend and vary from sector to sector

Also in India, there is a culture of creating differential rates for different borrowers where borrowers are differentiated based on their credit rating, operation, business size, etc. Informal market chit funds also called committee have existence in many parts of the country, which lend the pool of savings available to a closed group of savers-cum-potential borrowers. Intensity of credit requirement and the timing within the group determines the interest rate applicable to the borrower within the chit fund. Also decades ago, stock markets had badla where the interest rate on the financing needed to carry the trade forward varied from stock to stock, from trade to trade.

India’s interest rates vary from Sector to sector:

i) India is home to huge retail shops operating in unorganized retail sector where the shopkeepers have their own system of credit and rates of interest.

ii) Property dealers and real estate players having access to huge amounts mainly from corrupt but powerful politicians have their own credit framework.

iii) India being agrarian economy with huge population working in the agriculture sector, we see that the farmers have option to borrow directly from the banks or from the powerful coterie of buyers licensed by the Agricultural Produce Marketing Committee who have their own interest prevailing in the market and again vary from farmers to farmers.

iv) The SME sector also obtains credit from banking system or informal sources where again the rate of interest is sky high.

India’s credit market can be very well described as something which is both stunted and fragmented. As already seen two-thirds of economic activity is based mainly on informal credit where a quarter of a percentage point reduction in the RBI’s repo rate means next to nothing. If we see credit options existing in departments such as consumer finance and home loans, such pity rate cuts do matter a lot but as a whole these are nothing for maximum. If we talk about the Indian capital market, the rate cut from the central bank only helps in signalling the monetary policy which will be prevailing in the economy and thus affecting the capital market and foreign institutional investors at large.

The biggest impact of the rate cut or rate appreciation happens to the biggest borrower of central bank which is none other than the Central Government of India.

Time for RBI to take necessary Actions

So let us stop making fuss of the credit policy or its supposed failings. It’s time now that RBI needs to improve on making the formal source of credit available to common people easily. The Reserve bank should now make the most of the opportunity offered by Aadhaar-based cash transfers so as to enable a full-fledged mobile banking across the country. Also they need to implement new licenses between the banks and the phone companies so that the method of formal finance reaches any and every body across the Indian Territory.

Not only this, RBI should take steps so as to make policy rates more relevant to more people. It is needless to say that to implement such facility pan India is not a matter of a day rather would take years for successful implementation. In such a case the Government should focus on stepping up investment rather than stalling the project under the issue of official project clearance action which involves nothing but the premium requirement paid to the civil servants in order to get the tender passed.

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