Resolving deposit, credit balance lies in real economy, not on Mint Street

The market’s memory can be short. The same time last year we were fretting about weak deposit growth. Today, we are fretting about weak credit growth. We believe one thing is common across both periods. While all eyes look to the Reserve Bank of India (RBI) to help, the central bank can only partly address the problem using the monetary policy levers at its disposal. Instead, the root of the problem — and the real solution — in both instances lies elsewhere: The real economy and the composition of gross domestic product (GDP) growth. Let us explain.

 

Last year’s deposit drag was a two-fold problem — concerns over tepid deposit growth and compositional shifts (too few sticky deposits, too many callable deposits). Once inflation started to fall, the RBI loosened monetary policy, pushing base money growth up. Real deposit growth started to rise in early 2025.

 

But was the entire problem solved? Perhaps not. The deposit composition problem persists — too much callable bulk corporate deposits and too few sticky retail household deposits. This, we believe, is not in the RBI’s control. Rather, it has its root in the real economy. In the few years after the pandemic, returns to capital (i.e. corporate profit growth) was higher than returns to labour (wage growth), and this showed up in savings behaviour.

 

Fast forward to today and the concern has flipped on its head. Real deposit growth has begun to rise after a period of weakness, but real credit growth has started to fall after a period of strength. There could be many reasons for this, ranging from lower GDP growth to increased risk weights in unsecured lending.

 

But why is this important? GDP growth has softened over the last few quarters (averaging 6.5 per cent year-on-year over the last four quarters, versus 8.5 per cent in the eight quarters prior). We find a two-way relationship as credit growth affects GDP growth, and vice versa. Therefore, if credit growth can be pushed up, GDP growth could arguably rise back up as well.

 

Can the RBI help? Yes, it can, and it has. The RBI has cut the repo rate as well as the cash reserve ratio by 100 basis points (bps) each since early 2025. It has also infused domestic liquidity worth ~10 trillion. The transmission of these rate cuts has been off to a good start.

 

Will it solve the entire credit slowdown problem? Likely not. Because just as the deposit composition issue had its roots in the real economy last year, the credit softness issue has links to the real economy too. Weaker growth has lowered demand for credit. And more importantly, the changing composition of growth has played a role too.

 

We find that after a few years of strong growth, the formal sector is slowing in 2025. This is being led by sluggishness in equity market returns and wage growth, following a strong run.

 

On the other hand, after a long period of weakness, the informal sector is improving, led by better weather events, improving farm incomes, and falling inflation boosting purchasing power.

 

This pivot in the growth composition from formal to informal can be a drag on credit growth. Until last year, investment demand for credit was strong as households in the formal sector were investing in real estate. Meanwhile, consumption demand for credit was strong too, with households in the informal sector doing poorly and taking loans to meet consumption needs.

 

Now, with formal sector fortunes not rising as rapidly as before, this sector may be less willing to sign up for long-term financial debt such as housing loans, thereby slowing personal loan growth. Meanwhile, the informal sector, benefiting from higher real income, may not feel the need to take personal loans to fund consumption.

 

Credit growth is being squeezed from both ends. What’s the way out? We find that the key driver of credit growth has changed over time, from the supply of credit to demand for credit.

 

In the decade ending FY18, which was characterised by the twin balance sheet problem of too much non-performing loans (NPLs) at India’s banks, supply of credit was the problem. Following a painful period of asset quality recognition, the NPLs at banks were lowered. Since FY18, the main driver of credit growth has been its demand.

 

So how does one encourage demand for credit? The RBI has played its role via rate cuts, which will likely stoke demand for credit over the next few quarters. But as discussed above, the current credit growth problem has its roots in the composition of GDP growth. Addressing that will likely provide a bigger and more long-lasting solution, than continued RBI policy easing.

 

And we believe the RBI knows this. After a period of policy easing, it is gently focusing back on normalisation and macro stability. Recent steps in issuing variable rate reverse repos to take out some of the excess liquidity and align the call money rate more closely with the policy repo rate, in our view, speaks to that. Indeed, this alignment is a cornerstone of India’s inflation targeting regime.

 

So, if the RBI can’t hand-hold credit growth beyond a point, there needs to be another way to spur the real economy. In the chicken-and-egg debate of whether credit growth or GDP growth will rise first, we, thankfully, have a new contender — reforms.

 

At a time when global supply chains are being rejigged once again, if India can do the right reforms and become a more meaningful producer and exporter of goods, that could spur investment and growth. This in turn could give a fillip to credit demand.

 

The opportunity is clear. Supply chains are rejigging mostly towards mid-tech goods. India can embrace this opportunity with its abundant labour and wage cost advantage. But to do this it needs the right reforms — lower tariff rates on intermediary inputs, more trade deals with other economies, more openness to foreign direct investment inflows, and more ease of doing business reforms across states.  

 

Higher credit growth and GDP growth will likely follow, if India pursues the right reforms, rather than waiting for RBI action to do the trick.       

 

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  The author is chief India and Indonesia economist, and managing director, global research, Hongkong and Shanghai Banking Corporation