Credit has been growing at around 30% in the past three years. Bank or investment company credit is continuing to grow highly for three reasons. Economic growth has accelerated; there has been a change in banking institutions’ asset portfolios from investments to credit;, and banks have woken up to the potential of retail credit. Retail loans have been growing at 40%. As a result, the share of retail loans altogether advances has gone up from 22%in March 2004 to 25.5% in March 2006. Within retail loans, the biggest drivers have been mortgage loans. Home loans grew at 50% in 2003-04 and 34% in 2004-05. Home loans account for nearly 50% of most retail loans.

Home loans are loans designed to purchasers of homes, as specific from loans to real estate programmers. With real estate developers, banking institutions can burn off their fingers terribly if real estate prices fall (which is quite likely given today’s prices). Mortgage loans are made against future income, not against resources. If the purchase price that a borrower has covered a home drops, the borrower will not lose his capability to service the loan: most borrowers are middle-class, salaried individuals.

Besides, banks make sure there is an acceptable margin to the loans they make: the loan to value percentage can be pegged at 70% or lower. So, if the worthiness of the house drops even, the banks have enough collateral to protect their loans should the borrower default on the loan payment.

It is these factors that make mortgage loans one of the safest types of loans for banks. Similar margin protection is on another important retail loan, loans against shares. On the low-cost side, banks are not only experiencing lower defaults, these are effecting significant recoveries against loans written off actually. NPAs have been decreasing not only as a proportion of total assets however in absolute terms.

Gross NPAs declined from Rs 59,124 crore in March 2005 to Rs 51,815 crore in March 2006. The percentage of world-wide web NPA/ total advancements of banks of just one 1.22% is respectable by international standards. In the current buoyant financial conditions, it is hard to see this changing for the worse. In a nutshell, rapid credit growth does not translate into poor loan quality and present any systemic risk. That is partially because of the particular structure of credit growth: it offers a huge retail element which is intrinsically high quality. What about credit development as drivers of inflation?

Money supply is continuing to grow at 19%, powered by large credit development. This is above the development of 15% targeted by the RBI. However, the RBI had projected GDP development for FY 2007 was for 7.5-8%. We will probably see growth closer to 8.5%. A full case could be produced out for the money source development to support higher growth.

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The RBI, nevertheless, considers that money source has still run ahead of the development rate- it sees clear indicators of ‘overheating’ throughout the market. One indication is the inflation rate, which has crossed 6%. Another is soaring asset prices. A third sign to consider is the existing accounts deficit. How worrying are these indicators?

The rise in the inflation rate to over 6% comes up partly from the base effect- there was a razor-sharp fall in the wholesale price index for this time this past year. The base effect will continue till June. The inflation rate will moderate thereafter as the bottom effect is corrected and there is certainly, quite possibly, a cut in the oil price in response to the decline in oil prices internationally. Casing prices may have peaked.