India's little engines of growth key to economic success
India’s robust economic growth has been fuelled by investment. Future growth can be supported by credit growth facilitated by NBFCs catering to underserved segments.
India has experienced strong growth over the past few years, standing out even amongst its high-growth emerging Asia neighbours. However, so far credit to households and non-financial corporations has played a limited role in economic development, as highlighted by India’s moderate credit-to-GDP ratio for each sector. As the economy matures and financial sector access is broadened, growth in private sector credit has the potential to add significantly and sustainably to growth. Just as critical as the rate of credit growth however is its equitable distribution across the population, and how the capital is invested.
Investment has been a key pillar of India’s economic success in recent years. On the government side, economic reform and generous budget allocations for capex have led to robust infrastructure development, particularly through the ‘National Infrastructure Pipeline’. While government debt-to-GDP has been relatively stable in recent years, investment’s share of GDP is trending up, eclipsing other emerging markets across Asia. Private investment is also contributing. Across Asia, only Singapore and Taiwan have seen stronger growth in total investment relative to trend. For India, total investment was 6.5% above where it would have been had it grown at the pace experienced between 2010 and 2019, while Singapore and Taiwan were 10.4% and 11.4% above trend respectively.
This investment has been funded by both domestic and international parties. India’s primary income deficit has been widening post-pandemic driven by increased foreign investment in government debt and equities. A comparatively low credit-to-GDP ratio for the private sector however highlights the opportunity for growth hence, and also that, thanks to its growing capacity, the economy is well positioned to fund further investment.
Credit growth has been fastest in the personal loan and services sectors. Growth in personal loans reflects a burgeoning middle class, rising real incomes and much-improved access to functional and reliable banking infrastructure in the major cities. These loans have mostly helped people purchase dwellings and durable goods. Housing makes up the largest share of personal loans, providing for an urbanising and increasingly aspirational population.
Growth in loans to the services sector meanwhile has largely been driven by the Non-Banking Financial Companies (NBFCs), 9% of total bank credit in February 2024. In short, NBFCs act as a conduit or bridge for commercial banks, borrowing from them to on-lend to individuals yet to gain access to credit from commercial banks. In doing so, they help banks meet their ‘priority sector targets’, that is the minimum proportion of total credit which needs to be lent to priority sectors to aid development, as determined by the Reserve Bank of India.
This dual structure for personal credit is seen in many emerging markets. However, at a certain stage of development, often there is a drive to rein in non-bank lending and instead rely on banks and market issuance for credit. China has been on such a journey over the past five or so years. At this stage though, the Reserve Bank of India (RBI) are still proponents of expanding NBFC credit supply, with the Deputy Governor recently saying NBFCs “will play a significant role in achieving the dream of a $5 trillion economy going forward.” Why continue with this complex structure?
Put simply, NBFCs can go where commercial banks cannot. These less-stringently regulated institutions can provide credit to those living outside urban settings and operating in the informal economy which still makes up around 80% of India’s economy. As many of these companies operate locally, they are also more accessible, traversing the country’s many linguistic and cultural divides – a tall task for a multi-region or national commercial bank.
This allows these providers to better reach micro and small businesses, the agents in the economy with the highest potential to scale and employ rapidly, improving productivity and lifting labour force participation, particularly amongst women. The recent growth in NBFC credit signals growing opportunity for these pockets of the economy.
There is a risk however that the heterogeneity and lighter regulation of NBFCs could build up both cyclical and structural risks. To rectify this, the RBI drafted a framework in February 2024 to improve compliance standards and risk management, while still maintaining necessary flexibility. As is often the case in emerging markets, only time will tell if this regulation proves effective. It is pivotal it does, not only for the safety of borrowers, but also to allow for the development of a savings and investment structure for households and small businesses with surplus funds.
Targeted credit growth on equitable terms paired with gains in real income has the potential to provide significant and enduring support for India’s next phase of development. And, if they can continue to provide credit to fund investment in areas where it will have the most impact with limited delay, NBFCs will prove they have an enduring role to play in India’s economy.
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