The direction of causality between income growth and credit growth has been debated for decades. While there is a strong argument for the case that growth in the gross domestic product facilitates development of the financial system and credit markets, it is also posited that evolved credit facilities enable greater economic growth through the channels of investment and private consumption.
Irrespective of the causality, when credit growth substantially outpaces the GDP growth, overstretched credit markets and excessive leverage leave the economy susceptible to financial crises. Is there a cause for concern for the fastest growing emerging economy, India?
The GDP-Credit Nexus In India
According to the IMF, India’s real GDP growth is projected to be 6.8% in 2024 and 6.5% in 2025, against a global growth rate of only 3.2%. Over the last two years, the real GDP grew 7% and 7.7%, while bank credit grew 13.1% and 14.6%. Among other emerging market and developing economies, China and Russia witnessed credit growth at around 10%, while Brazil faced a slowdown owing to high inflation and interest rates. This raises the question about whether India’s robust GDP growth warrants an even higher credit growth rate.