BRIDGING THE CREDIT GAP TO DRIVE GROWTH

Globally, debt has been a key driver of GDP growth, and India, as the world’s fastest-growing large economy, has significant potential to expand its debt relative to the size of its economy. With one of the lowest private debt-to-GDP ratios among major economies, India has ample scope to leverage debt for growth. This untapped potential could contribute an additional 200–300 basis points to annual GDP growth over the next 20–30 years, helping the country align with the current global average private debt-to-GDP levels.

India's domestic credit to the private sector, at just 55% of GDP in 2020, significantly trails the global average of 148% and lags far behind its Asian counterparts like China (182%), South Korea (165%), and Vietnam (148%), according to the World Bank. This highlights the underutilization of key private debt sources—bank credit and the corporate bond market—which hold immense potential for driving India's economic growth.

Enhanced Credit Capacity of Banks

India's credit growth slowed to a CAGR of 8.3%, primarily due to weak credit expansion in the industrial sector and high levels of non-performing assets (NPAs). These NPAs surged during the economic slowdown, driven by overcapitalization in certain sectors and stress in corporate balance sheets, which hindered banks' ability to lend and negatively impacted economic growth.

However, significant progress has been made in addressing these challenges. Improved regulatory oversight, government-led recapitalization, the introduction of the Insolvency and Bankruptcy Code (IBC), and deleveraging by stressed firms have helped reduce NPAs considerably. As of September 2022, gross NPAs have dropped to a seven-year low of 5%.

The RBI's latest stress tests reveal that Indian banks are now well-capitalized and resilient, even under extreme stress scenarios. By September 2023, the aggregate capital adequacy ratio of 46 major banks is projected to remain at 13.1%, comfortably exceeding the regulatory minimum of 11.5%. This indicates a robust banking system capable of supporting credit growth and driving economic recovery.

The mortgage market in India is poised for significant growth, with projections to double from $300 billion to $600 billion over the next five years. This growth is fueled by rising income levels, improved affordability, and fiscal support. Despite this expansion, the mortgage market will still account for only 13% of GDP, far below countries like China (18%) and the US (52%).

This upward trend is also reflected in the real estate sector, where developers have notably reduced unsold inventory levels following the pandemic, signaling a healthier and more dynamic market.

A major challenge to the growth of private debt in India has been the limited access to credit and the inability to effectively assess creditworthiness. This has constrained banks and Non-Banking Financial Corporations (NBFCs) from expanding their credit offerings to households.

However, the development of digital infrastructure, anchored by digital identity systems and a robust digital payments network, has significantly advanced financial inclusion. This transformation has enabled better credit assessment, risk underwriting, and recovery mechanisms, streamlining the credit distribution process.

Despite these advancements, a critical issue remains in the credit market—the widening gap between the demand and supply of credit for Micro, Small, and Medium Enterprises (MSMEs), which is estimated to be $250–300 billion. Addressing this gap is vital to unlocking the full potential of India’s private debt market.

The financial services sector is increasingly utilizing data from India's digital and payments infrastructure to enhance underwriting quality. This shift is evident as banks and NBFCs begin offering cash flow-based loans to individuals and MSMEs, moving away from the traditional reliance on collateral-based lending. This innovation is opening up new credit opportunities for previously underserved segments.

Building a Robust Corporate Bond Market: A Key to Meeting Long-Term Financing Needs

The Government of India’s National Infrastructure Pipeline (NIP) envisions $1.4 trillion in infrastructure investments over five years. However, with fiscal constraints limiting the scope for increased public investment, alternative financing options beyond government funding and banks must be explored.

Infrastructure projects often have long gestation periods, and domestic financial institutions currently lack the capacity to fully support such large-scale financing needs. While efforts to strengthen development financial institutions are underway, a robust corporate bond market with greater secondary market liquidity is essential for sustainable long-term financing.

In contrast to developed economies, where capital markets play a significant role in mobilizing long-term debt, India’s bond market lacks the depth and breadth needed to support such funding, as evidenced by its limited secondary market activity. Strengthening the corporate bond market is crucial to bridging this gap and meeting India’s ambitious infrastructure goals.

As of September 2021, India’s fixed income market was valued at INR 192.5 trillion ($2.4 trillion). The domestic debt market is largely dominated by government securities (G-secs) and public sector enterprise bonds, which account for approximately 92% of trading volumes in the secondary market.

Despite its potential, the corporate bond market remains underutilized, contributing just 16% of GDP in 2021. This is significantly lower compared to Asian counterparts like South Korea (87%), Malaysia (57%), and China (36%), highlighting a substantial opportunity for growth and development in this segment.

 India’s corporate bond market requires greater depth, with an emphasis on all categories of investment-grade bonds. Currently, ‘AAA’ and ‘AA’ rated bonds account for over 90% of outstanding bonds, while ‘A’ and ‘BBB’ rated bonds constitute less than 10% of the market. In contrast, these lower-rated bonds make up more than 60% of the corporate bond markets in regions like the US, EU, and Japan.

India’s corporate bonds outstanding have the potential to more than double in the next five years, increasing from 16% of GDP to 22-24%. A more liquid secondary market could independently fuel this growth. Improved market liquidity, coupled with greater macroeconomic and fiscal stability, would help narrow yield spreads caused by trading illiquidity and inflation. This would lower the cost of capital for issuers and encourage large corporations to shift more of their borrowing from banks to the bond market. Such a shift would free up bank capital, enabling increased lending to smaller borrowers.

By building on the momentum of accelerated credit growth and fostering a robust corporate bond market, India can create an optimal financial framework. This would support sustained high economic growth with a larger share of private sector debt and a reduced cost of capital for the economy.