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Repo Rate and Bank Credit

S S Sangwan ( is SBI chair professor, Centre for Research in Rural and Industrial Development, Chandigarh.

The Government of India has, on more than one occasion, mounted pressure on the Reserve Bank of India to reduce the rate of interest to encourage investment. The RBI has, however, remained cautious, but has reduced rates gradually since early 2015. At lower rates of interest, the fixed and administrative cost acquires more weight in the banks’ cost of funds which restrict their ability to reduce rates in proportion to the repo rate reduction and the gap between the two tends to widen. Lowering repo rates has not accelerated bank credit.

In the pursuit of pushing the growth rate of gross domestic product (GDP) upwards, the Government of India has been consistently mounting pressure on Reserve Bank of India (RBI) to reduce the rate of interest to boost investment. Industrialists, in general, were also in tune with this demand, whereas banks are struggling to reduce their increasing non-performing assets (NPAs). The average annual inflation in terms of consumer price index (CPI) has come down to 4.49% in 2016–17 (2.89% up to September 2017) from 4.88% in 2015–16, 5.88% in 2014–15, and 9.34% in 2013–14. In this situation, RBI has been treading a cautious path to manage inflation and growth rates through changes in its monetary policy instruments like repo rate, marginal standing facility rate, bank rate, statutory liquidity ratio, and cash reserve ratio from time to time.

Among these, the repo rate is the most important and has a direct bearing on the liquidity of banks and hence, their lending rates. The repo rate was the highest at 8% in January 2014 and it remained at this level till December 2014. After easing inflation since January 2015, the repo rate was reduced to 7.25% by June 2015 in three tranches of 0.25% each and further reduced to 6.75% on 29 September 2015 and then to 6.50% on 5 April 2016 and to 6% in August 2017. It is now at the lowest level since September 2010. In response to the reduction in repo rate, the State Bank of India (SBI) brought down its base rate from 10% in January 2015 to 9.10% in September 2016, and 8.95% in September 2017. Most other banks have followed the SBI rates. Thus, the repo rate has been intermittently reduced by 2 percentage points, that is, 25%, over the last two years and the base rates of banks also moved downwards, though not in tandem (Figure 1)..

In fact, at lower rates of interest, the fixed and administrative cost acquires more weight in the banks’ cost of funds which restrict its reduction in proportion to the repo rate and hence the gap between the two is increasing. Whether the reduction in repo rate in the last three years has accelerated bank credit is examined in terms of rate of increase in outstanding gross bank credit (GBC) after 2013–14. The sectoral deployment of bank credit is taken from monthly releases of RBI up to October 2017.

Table 1 (p 19) shows that growth rate of the GBC has decelerated from 13.9% during 2013–14 (19 April 2013 to 18 April 2014) to 8.7% and 8.4% in 2014–15 and 2015–16 and it further crashed to 3.2% during 2016–17 (29 April 2016 to 28 April 2017). It is a downward trend that still continues as per the latest data of September 2017. The April data of different years has been taken as March figures are sometimes inflated by some banks. If the flow of bank credit is inversely related with rate of interest then the outstanding bank loans should have been subdued in April 2014 when repo rate was the highest at 8% during January–December 2014. The outstanding bank loans should have been higher in April 2015, 2016 and 2017 when repo rates have come down to 7.50%, 6.50% and 6%, respectively. Accordingly, the rate of credit growth should have accelerated during the years 2014–15, 2015–16 and 2016–17 compared to that of 2013–14. But the actual growth rates of GBC are just the contrary even up to September 2017 as given in Table 1.

Broad sector-wise, food credit is just minuscule 0.74% whereas the remaining 99.26% is the non-food-credit (NFC). The growth rate of the NFC has fallen from 14.2% during 2013–14 to 8.9% during 2014–15 and 8.4% during 2015–16 and crashed to 4.5% during 2016–17.

Among the sub-sectors of the NFC, only the “personal loans” have retained growth rates of 15.7% during 2014–15, 19.7% in 2015–16 and 14.4% during 2016–17 which are almost at par with that of 15.1% during 2013–14. Within this sector, housing, loans against shares, vehicles and other personal loans were the buzzing segments, though these have recorded a decline since last year, probably due to the impact of demonetisation. Hence, consumption has somewhat kept afloat the bank credit to some extent, but these loans are just 23% of the total NFC as on 28 April 2017. “Agriculture” is another sector whose credit growth rate was retained at 14.1% during 2014–15, 15.3% in 2015–16 compared to 14.8% during 2013–14 but it has also come down to 7.4% in 2016–17. This sector accounted for about 14% of total NFC as on 28 April 2017.

The dominant services sector in the economy accounts for 24% of the total NFC and the growth rate of its outstanding in bank credit has been 6.6%, 10.9%, 4.1% during 2014–15, 2015–16 and 2016–17 respectively which is lower than 17% during 2013–14. The most hit sub-sectors under services are hotel and tourism, shipping, commercial real estate and loans to non-banking financial companies (NBFCs). There was some silver lining in non-priority trade, computer software and personal services but the same has also vanished since last year.

“Industry” is the major sector accounting for about 38% of the NFC in April 2017, down from 41% in 2016. In terms of growth, it has been hit the hardest as its rate has decelerated to 5.9% during 2014–15, 0.1% during 2015–16 and -1.4% during 2016–17 as compared to 12.3% during 2013–14. Within the industrial sector, the micro and small units are the main sufferers with -6.7% and -1.2% credit growth during 2015–16 and 2016–17 as compared to positive growth rate of 10% in 2014–15 and 21.1% during 2013–14. Among its sub-sectors, the growth rate in outstanding bank credit is negative in 2015–16 and 2016–17 for sugar, edible oils, food processing, engineering goods, power, infrastructure and textiles compared to their positive rates during 2014–15 and 2013–14. The sub-sectors of industry which recorded revival in 2016–17 over 2015–16 are petrochemicals, rubber and plastics and telecommunications which have little share in total industry. Prima facie, it is reflected that employment-generating industries like textiles, cement and its products, food processing, sugar, infrastructure, glass and its wares, paper products, transport and its equipment and all engineering have lower offtake of bank credit. Their subdued position, in turn, may have reduced the income of the low-paid workers.

Of the GBC, the advances in “priority sector” account for 34% as on 28 April 2017 and the share has remained almost constant in the last three years. The rate of growth in outstanding credit under priority sector has decelerated from 17.1% in 2013–14 to 9.2%, 11.2% and 3.7% during 2014–15, 2015–16 and 2016–17. Among its main sub-sectors, agriculture, services, housing, loans to weaker sections have maintained positive credit growth between 2015 and 2017 but their rates decelerated from the level of 2013–14. Even the manufacturing, microcredit, export credit and education loans under priority sector have also recorded lower growth in the last three years.

Thus, credit growth in almost all the broad sectors does not indicate a positive impact of the reduced repo/hence interest rate. Some sectors like personal loans and agricultural loans have retained their growth rates in 2014–15 and 2015–16 but recorded sharp decline during 2016–17 and thereafter. Some studies have found an inverse relationship between growth rate of GDP and interest rate over a long period, though the cause and effect relation between the two is debatable (Wuhan and Khurshid 2015). Whether lower rate of interest alone can induce higher investment has not been exclusively established. A survey by the Centre for Monitoring Indian Economy (CMIE 2016) found that lack of promoters’ interest and unfavourable market conditions were main reasons accounting up to 50% in stalling the implementation of projects. Export for the last three years is continuously declining and domestic demand has shrunk due to widespread drought conditions. Even domestic demand may have subdued after demonetisation. It may be due to reduced propensity to consume from the accounted money. The proverb “easy come, easy go” may have restricted the spending of people especially in the upper income group after all money deposited in banks. The capacity utilisation of manufacturing units in the last three years was lower than 2013, as per RBI bimonthly surveys Survey of Professional Forecasters.

At an aggregate level, the capacity utilisation of Indian manufacturers was 71.2% in the April–June quarter in 2017 compared 71.7% in 2016 and 73.4% in 2013–14 in the same quarter.

Therefore, after an improvement in NPAs of banks and their recapitalisation to the extent of ₹2 lakh crore, the increase in demand especially domestic is sine qua non for revival of credit offtake. Domestic demand can surge if the income of low-income groups are increased. It may require continuous higher allocation for Mahatma Gandhi National Rural Employment Guarantee Act, roads, railways and power projects, especially those at the last stage of completion for creating employment opportunities. Besides, the housing sector has the highest income multiplier due to its linkage with 300 other sectors. It should focus on the ultimate users like teachers, military personnel, paramedical staff, and workers of the unorganised sector in the price range of ₹20 to ₹25 lakh for quick sale. This can happen if such houses adhere to only quality of construction instead of comforts and aesthetics. Some fiscal incentives have been announced by the Government of India (after the initial drafts of this article in June 2016) but more of these allocations must be targeted for those living in small towns and big villages.


CMIE (2016): “Why Projects Still Get Stalled?” 3 May,

Wuhan, Li Suyuan and Adnan Khurshid (2015): “The Effect of Interest Rate on Investment; Empirical Evidence of Jiangsu Province, China,” Journal of International Studies, Vol 8, No 1, pp 81–90.

Updated On : 16th Jan, 2018


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