The current tightening cycle, which began almost two years ago in Sep 2021 is showing no sign of abatement, considering the steadfastness of inflation (indicated by higher monthly core inflation number), reappearance of deficit in the current account, and, most importantly, a fresh round of pressure on the exchange rate. And with the IMF consistently of the view that the real rate must remain in the positive territory on forward looking basis, an increase in the policy rate appears likely in the upcoming MPC meeting. But with private sector borrowing rate already averaging close to 25 percent per annum, has the credit tightening already not gone too far?

The headline numbers might be deceiving. Although monthly private sector credit offtake has finally turned red, is the decline significant enough to indicate that the monetary transmission is taking place successfully? The intuitive answer might be yes, as the slowdown in credit offtake comes on top of a 32 percent annual inflation during the previous year, which points towards a substantive slowdown in real terms. However, it may help to dig a little deeper.

As recent as in January 2023, private sector credit growth averaged at 20 percent on 12MMA (twelve month moving average) basis, up from 11 percent a year earlier (12MMA in Jan-22). This could mean that while private sector credit may not be increasing in real terms, the rate of change hadn’t exactly begin to slowdown as recently as in six months ago (or the beginning of calendar year 2023), even though the policy rate was already close to peak level of 17 percent by then.

The 12MMA for credit growth had finally slowed down to 12 percent by June 2023, with the month-on-month figure showing red four out of past six months. But is it enough? Although monthlygrowth rate may have turned red, the 12MMA of private sector credit outstanding is still at its peak in nominal terms, suggesting that the inflection may not be here yet. At least not still.

To understand whether the appetite credit in private sector firms is still breathing its last breaths, BR Research turned to granular data and found the following nugget for its readers. Long term trends in industry-wise credit offtake (based on monthly data going 17 years) indicate that credit growth has turned negative across all segments of private sector business during previous tightening cycles (on annual basis, or 12-month average)

Industry and sector wise data shows that private sector credit growth did NOT turn negative during fiscal year 2022-23 (on annual basis or 12-month average) across any of the private sector business, indicating the monetary tightening had not gone far enough, at least not until June 2023. In fact, among top 10 major consumers of private sector credit, industries such as construction have witnessed five consecutive years of credit contraction in nominal terms (between FY10 and FY14), or non-metallic mineral products (e.g. cement and glass etc), which witnessed four consecutive years of credit contraction between FY12 and FY14.

Meanwhile, during the last fiscal year, most private sector consumers of banking credit witnessed double-digit growth in borrowing. It is pertinent to note that this period coincided with the lending window when the tap on concessional finance scheme had been turned off and the tightening cycle was in full swing. This may indicate that banks began to deploy their own capital for private sector credit once the flow of refinance from the central bank had been stemmed, which in turn allowed demand-side pressures on inflation endure longer than necessary.

At 25 percent, mark-up rates on private sector borrowing are truly abnormal, especially for working capital; and may push many businesses to the verge of bankruptcy. However, unlike previous tightening cycles – especially 2009-10 - it is still very much unclear whether the slowdown in credit offtake so far has been sufficient. The central bank has been truly behind the curve in raising rates to stem the tide of demand for credit rendering policy transmission virtually ineffective. And now, everyone must pay the price.