Bank credit and economic development: an empirical analysis of Indian states

Abstract

The introduction of economic reforms in India, particularly reforms in the banking sector, although boosted and edged up the profits and improved efficiency of the banks, an unwarranted consequence was the decline in credit to the less developed states and regions. The emphasis on efficient allocation of resources overlooked the developmental needs of these regions and states. This study examines the role of banks in the different states of India in the post-reform period and explores multi-dimensional role of credit in terms of, what it calls, the G-GUIDE indicators. Bank credit in the present study is examined in terms of growth, globalization, urbanization, inequality, reduction in poverty (development) and the empowerment of women.

Keywords:

• bank credit
• India
• economic development
• growth
• poverty

Acknowledgements

This paper was prepared when I was a postdoctoral research fellow at the Centre for Asia Pacific Social Transformation Studies (CAPSTRANS), University of Wollongong, Australia. I gratefully acknowledge tremendous support received from Associate Professor Tim Scrase, Acting Director, CAPSTRANS. I thank Associate Professor Kenneth E. Jackson, Dr Christine Woods and Professor Jim Hagan for their comments and support received in the preparation of this project. I also thank anonymous referee for many useful comments on the paper. Finally, the views expressed in this paper are solely mine and not that of the organization to which I belong.

Notes

1. Haggard and Kaufman (1992) point out that though international factors have been ascribed as one of the reasons for economic reforms in countries, they doubt whether this can be assigned as a major reason. They argue that the reforms were more likely to take place if favourable conditions of political support and private interests of business exist. According to them, though the reforms commonly are attributed to the ideas of senior officials and economists representing the international organizations, this is however a narrow view of the situation, as a major reason lay within the domestic economy itself.

2. This study notes that while the secondary data on bank credit are comprehensive, according to economic activity and spatially, they lack a human perspective. They lack coverage of the human population, particularly the disadvantaged groups such as lower castes (considering their predominance in UP), women and the disabled population of the state.

3. The word ‘classical’ refers to the economic thought of the period from mid-eighteenth century to the mid-nineteenth century.

4. Information can be explained as factual knowledge and it can be exchanged among individuals (Lapavitsas 2003).

5. The term has been popularly associated with Raj Krishna, a noted Indian economist, though it was actually used by B.P.R. Vithal, a noted economist and administrator (Virmani 2004). It could refer to the contentedness and belief in fate associated with Hinduism. The term also contrasts, though cautiously, the slow growth rate of the Indian economy with the high growth rate achieved by East Asian countries during the similar period.

6. The East Asian financial crisis occurred in 1997. During the year 1997–1998, the annual real growth rate of India was lower at 4.8% and in 1998–1999 rose to 6.5%. The lower growth in 1997–1998 was a consequence of negative growth in agriculture rather than a consequence of the crisis. The immediate impact of the East Asian crisis on India was limited due to the capital controls such as restrictions on short-term debt and other controls. The overall long-term impacts on India were positive in nature and crucial. These were the following: (i) the crisis underscored the importance of effective bank supervision and regulatory policies; (ii) the crisis highlighted the importance of transparency and (iii) the crisis led to the fine-tuning and smoothing of macro-policies through the adoption of multiple indicators approach which included interest rates, credit and other indicators such as output, exchange rate and inflation.

7. The Millennium Development Goals were set at the United Nations Millennium Summit held in September 2000 when 189 countries took oath to fight against poverty, hunger, illiteracy, gender inequality, diseases and environmental degradation. The first goal is to eradicate extreme poverty and hunger and two targets have been set to achieve this goal. Target 1 is to halve between 1990 and 2015 the proportion of people whose income is less than US$1 a day. Target 2 is to halve during the same period the proportion of people who suffer from hunger measured by (i) prevalence of underweight in children under 5 years of age and (ii) proportion of population consuming less than minimum level of dietary energy consumption as percentage of total population. The rationale for considering underweight children under 5 years as the proportion of population suffering from hunger is that chronic hunger is reflected early in life and underweight children subsequently grow up to be unhealthy and sick. The measure of extreme poverty is US$1 a day (UN 2003).

8. The 55th round of NSSO survey was the large sample survey conducted after 5 years by the National Sample Survey Organization (NSSO 2005). The debate arose essentially due to differences in the estimates of poverty between NSSO and National Accounts, and the change in the survey methodology from the usual recall period of 7 days used in earlier household surveys to 30 days recall period used in the 55th round. The 55th round of survey was the first full sample survey after the introduction of reforms. The increased interest was therefore due to need to judge the effectiveness of economic reforms in terms of reduction in poverty; interest not only within the country but also internationally, as this coincided with the increased emphasis on the reduction of poverty by the multilateral organizations; and spread of globalization.

9. It refers to the feudal landowners called zamindars who paid government a fixed revenue during the British rule.

10. The banks not only provide credit but also invest in the state government securities (consisting of securities floated by state governments, bonds of state-level bodies guaranteed by the state governments, share capital of regional rural banks and debentures of cooperative institutions). As part of the statutory liquidity ratio requirements, banks are required to invest 25% of their net demand and time liabilities in central and state government securities and other approved securities. This ratio was reduced from 38.5% in February 1992 to the statutory minimum of 25% in October 1997. The banks are usually holding securities much over and above the required level and this moved up to as much as 42.7% of the net demand and time liabilities in April 2004. The factors that influence banks' decisions to invest in state government securities include health of the state government finances; transparency of state budgets; policy announcements of the state governments; and credibility of their policy actions. Moral suasion from the central bank also plays a part in banks' investing in the state securities and bonds of less developed states.

11. In the Census of the Government of India, the towns are divided into six groups based on the population. These groups are Class I towns with population of 1 million and above; Class II with population of 50,000–99,999; Class III as towns with population of 20,000–49,999; Class IV with population of 10,000–19,999; Class V with population of 5000–9999 and Class VI towns with population of less than 5000 (Government of India 2004). From the perspective of banks, the semi-urban areas are defined as those with population of more than 10,000 to less than 1 million and urban areas as those with population of 1 million and above (RBI 2004).

12. Throughout the study, construction is included as part of the services sector in the data series on state output and credit. The issue of classification of construction as industrial or services sector activity has been much discussed in the Indian literature due to its implications for assessment of structural shifts in the economy. While in the India National Accounts construction is included as an industrial activity, the Reserve Bank includes it under services sector. In other countries too, there is no uniform practice (RBI 2003). The dilemma was first posed by Clark (1940), who pointed out that construction should be a part of the services sector, as besides new buildings, it also involves repairs and maintenance.