The COVID-19 pandemic was a global shock that upended lives, businesses, and economies, and India faced particularly tough challenges. Before the pandemic, India’s economy was already slowing, with GDP growth dipping to 3.7% in 2019-20. When the pandemic struck, it triggered a severe economic contraction of 6.6% in 2020-21, coupled with a sharp decline in bank lending, which hit a low of 6.5% growth in March 2020. This study dives into how this credit crunch affected Indian firms and what they did with the bank loans they managed to secure during and after the crisis. It addresses two key questions: Did the pandemic reduce bank lending uniformly across all firms, or did certain types of firms face bigger hurdles? And how did firms that received extra credit use those funds in such uncertain times?
To answer these questions, we analyzed a detailed dataset of 13,449 non-financial firms in India over a five-year period (2017-18 to 2021-22), using information from the Prowess Database by the Center for Monitoring Indian Economy (CMIE). This data included financial details like bank loans, firm size, age, and sector (industrial or services), allowing us to compare lending patterns before and after the pandemic. We used a method called difference-in-differences to isolate the pandemic’s impact and examine how firm characteristics influenced lending outcomes.
Our findings reveal that the pandemic caused a significant drop in bank lending across the board, reflecting the economic uncertainty and disruptions from lockdowns. However, the impact wasn’t the same for all firms. Smaller firms (those in the bottom 25% by asset size) and younger firms (recently established) faced much steeper declines in bank loans compared to larger, more established companies. Similarly, firms in the service sector—like tourism, hospitality, or retail—saw sharper drops in credit than industrial firms, such as those in manufacturing or construction. This makes sense, as service-oriented businesses, especially those requiring in-person interaction, were hit harder by lockdowns and restrictions.
Surprisingly, financially vulnerable firms—those struggling to cover debt payments or reporting losses—experienced a relatively smaller decline in bank lending compared to healthier firms. This wasn’t a case of banks making risky loans to failing companies. Instead, our analysis shows that the extra credit often went to firms facing temporary financial stress due to the pandemic, rather than those chronically unviable. This suggests that policies by the Reserve Bank of India (RBI) and the government, such as loan moratoriums, lower interest rates, and the Emergency Credit Line Guarantee Scheme (ECLGS) for small businesses, played a crucial role in directing credit to firms that needed temporary support to survive.
The RBI and government took several steps to ease the credit crunch. For example, the RBI cut the policy repo rate by 250 basis points, reduced cash reserve requirements for banks, and introduced measures like Targeted Long-Term Repo Operations (TLTROs) to inject roughly ₹3.7 lakh crore of liquidity into the financial system. These efforts lowered borrowing costs and encouraged banks to lend, especially to small and medium enterprises (MSMEs). As a result, while overall lending fell, some firms—particularly those temporarily struggling—benefited from these targeted interventions.
Next, we explored how firms used the additional credit they received. Under normal circumstances, businesses might use loans to invest in new machinery, expand operations, or hire more workers. However, during the pandemic, firms took a more cautious approach. Our findings show that firms with access to extra credit didn’t significantly increase their capital spending (e.g., buying new equipment) or employee wages. Instead, they primarily used the funds to pay off existing short-term debts, such as money owed to suppliers or creditors. This behavior likely reflects the uncertainty of the time—firms prioritized reducing their debt burden over taking risks on new investments or hiring, especially since lower interest rates made borrowing cheaper.
This study sheds light on the complex dynamics of India’s credit market during the COVID-19 crisis. The uneven impact on firms—based on size, age, sector, and financial health—highlights the challenges faced by smaller, younger, and service-oriented businesses. At the same time, it shows how targeted policies helped prevent the collapse of viable firms facing temporary difficulties. The preference for debt repayment over growth-oriented spending underscores the caution firms exercised in an uncertain environment. These insights are valuable for policymakers, businesses, and researchers looking to understand how economies can better support firms during crises, ensuring credit flows to those who need it most while fostering recovery and stability.
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To answer these questions, we analyzed a detailed dataset of 13,449 non-financial firms in India over a five-year period (2017-18 to 2021-22), using information from the Prowess Database by the Center for Monitoring Indian Economy (CMIE). This data included financial details like bank loans, firm size, age, and sector (industrial or services), allowing us to compare lending patterns before and after the pandemic. We used a method called difference-in-differences to isolate the pandemic’s impact and examine how firm characteristics influenced lending outcomes.
Our findings reveal that the pandemic caused a significant drop in bank lending across the board, reflecting the economic uncertainty and disruptions from lockdowns. However, the impact wasn’t the same for all firms. Smaller firms (those in the bottom 25% by asset size) and younger firms (recently established) faced much steeper declines in bank loans compared to larger, more established companies. Similarly, firms in the service sector—like tourism, hospitality, or retail—saw sharper drops in credit than industrial firms, such as those in manufacturing or construction. This makes sense, as service-oriented businesses, especially those requiring in-person interaction, were hit harder by lockdowns and restrictions.
Surprisingly, financially vulnerable firms—those struggling to cover debt payments or reporting losses—experienced a relatively smaller decline in bank lending compared to healthier firms. This wasn’t a case of banks making risky loans to failing companies. Instead, our analysis shows that the extra credit often went to firms facing temporary financial stress due to the pandemic, rather than those chronically unviable. This suggests that policies by the Reserve Bank of India (RBI) and the government, such as loan moratoriums, lower interest rates, and the Emergency Credit Line Guarantee Scheme (ECLGS) for small businesses, played a crucial role in directing credit to firms that needed temporary support to survive.
The RBI and government took several steps to ease the credit crunch. For example, the RBI cut the policy repo rate by 250 basis points, reduced cash reserve requirements for banks, and introduced measures like Targeted Long-Term Repo Operations (TLTROs) to inject roughly ₹3.7 lakh crore of liquidity into the financial system. These efforts lowered borrowing costs and encouraged banks to lend, especially to small and medium enterprises (MSMEs). As a result, while overall lending fell, some firms—particularly those temporarily struggling—benefited from these targeted interventions.
Next, we explored how firms used the additional credit they received. Under normal circumstances, businesses might use loans to invest in new machinery, expand operations, or hire more workers. However, during the pandemic, firms took a more cautious approach. Our findings show that firms with access to extra credit didn’t significantly increase their capital spending (e.g., buying new equipment) or employee wages. Instead, they primarily used the funds to pay off existing short-term debts, such as money owed to suppliers or creditors. This behavior likely reflects the uncertainty of the time—firms prioritized reducing their debt burden over taking risks on new investments or hiring, especially since lower interest rates made borrowing cheaper.
This study sheds light on the complex dynamics of India’s credit market during the COVID-19 crisis. The uneven impact on firms—based on size, age, sector, and financial health—highlights the challenges faced by smaller, younger, and service-oriented businesses. At the same time, it shows how targeted policies helped prevent the collapse of viable firms facing temporary difficulties. The preference for debt repayment over growth-oriented spending underscores the caution firms exercised in an uncertain environment. These insights are valuable for policymakers, businesses, and researchers looking to understand how economies can better support firms during crises, ensuring credit flows to those who need it most while fostering recovery and stability.
Views are personal.
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