Credit Expansion: Meaning, Role and India’s Credit-GDP Ratio

Credit means loan and credit expansion means that people are taking more loans. The increase in loans for the private sectors, individual, and public organisations is credit expansion. Credit to GDP ratio is seen as an indicator of credit expansion in the country.

Objective of Credit Expansion

The stated objective of Credit Expansion is to make credit abundant in the economy which in turn spurs the business activity, makes capital inexpensive,  brings down interest rates, leading to a boom in the economy.

Link between Credit Expansion and Economic Growth

During credit expansion, the consumers have more money in their hand to spend and business can borrow to fund their activities. This leads to a quick boom in the economy. However, every credit-induced economic boom comes to at an end when an important sector of economy becomes incapable of repaying the interests.  Thus, uncontrolled credit expansion will give an illusion of prosperity for short term and manifests in quick boom-bust cycle and may bust in little time.

Thus, while sustainable credit expansion is one of the policies adopted by the governments to sustain economic growth and business activity; most economies remain cautious about uncontrolled credit expansion.

Credit Expansion in India and China

In India, RBI uses a monetary policy tool called Credit Control to keep a check on unsustainable credit expansion and control the demand and supply of money (liquidity) in the economy. RBI does this by two methods viz. Quantitative control to regulates the volume of total credit and Qualitative Control to regulates the flow of credit. You may read more about it here.

We note here that sustainable credit expansion has been a policy in India. The increased financial inclusion and increased access to credit by formal financial institutions to rural poor is also a manifestation of Credit Expansion.

India’s credit GDP Ratio

India’s credit GDP ratio has been between 5-6% as evident from the below graphics from Economic Survey 2016-17.

We note here that overall credit- GDP ratio as well as the proportion of total credit accounted for by the banking sector is not out of  line for India. On the other hand, in 2009, China had launched an historic credit expansion, which has so far seen the credit-GDP ratio rise by an unprecedented about 63 percentage points of GDP, much larger than the stock of India’s credit-GDP. Its worth note that the Chinese growth has slowed from over 10 percent to 6.5 percent during this period, which echoes the perils of uncontrolled credit expansion.