A shortage of deposits is starting to unnerve Indian bankers and policymakers. The lenders’ worry is more understandable than the authorities’.
Taking a leaf from a two-decade-old Chinese playbook, the Indian central bank is reining in money growth to tame inflation. In the process, though, it is putting up a new hurdle in the way of credit and investment. Separately, the Indian government is making the deposit crunch worse by taxing savers aggressively, but keeping the proceeds away from the financial system. Bankers are compounding the problem by not paying enough to savers.
However, it is the lenders’ behavior being put under the scanner. The Indian Ministry of Finance wants depository institutions to undertake special drives to mobilize household savings, while the Reserve Bank of India (RBI) has warned them that they are potentially skirting with “structural liquidity issues.” One of them seems to be technology. The RBI wants banks to assume that any customer account connected to a smartphone is prone to faster erosion of deposits.
From next year, banks in India would have to hold more safe assets like cash and government securities to meet the risk of runoff from Internet-enabled accounts. While this could slow systemwide credit, some individual lenders would have to do more to get out of their liquidity squeeze. HDFC Bank Ltd, the largest non-state bank in India, is planning to sell 100 billion rupees (US$1.19 billion) of its advances to lower its loan-to-deposit ratio, which has exceeded 100 percent for four straight quarters, Bloomberg data showed.
More than technology, the RBI is worried about greed. For a little bit longer than two years, credit has grown faster than deposits. Retail interest in the stock market has exploded in this period.
Households that “traditionally leaned on banks for parking or investing their savings are increasingly turning to capital markets and other financial intermediaries,” RBI Governor Shaktikanta Das said in July.
That explanation does not wash. After all, if the asset buyer’s bank balance is debited to pay for securities, the seller’s account is credited. The pie might get redistributed among lenders, and its composition might change. Still, money would not leave the system, except at ATMs, and the use of cash in transactions is slowing.
Loans create their own deposits. A new mortgage would eventually show up as a credit entry in the property seller’s account. Sure, loans for foreign education or buy-now-pay-later credit used to buy imported goods would leak from the local banking system. However, that would not cause a persistent deposit shortfall. A bigger drain is more likely taking place via taxes, which are sitting in the Indian government’s account with the central bank. That is why state-run lenders are asking New Delhi to park its cash balances with them, instead of the monetary authority.
Where the RBI might have played a role in the deposit shortage is in slowing down its printing presses. The sum total of its liabilities — currency held by the public, and reserves that banks keep in their current accounts with the monetary authority — grew 2.3 percentage points slower than the 9.7 percent expansion in nominal gross domestic product in the second quarter. Last month, the pace of money creation crashed to under 4 percent.
This is odd. The Indian central bank’s monetary base, also called high-powered money because it fuels credit, tends to run ahead of GDP growth — the two big exceptions in recent years were during the 2013 taper tantrum and in the aftermath of the sudden 2016 ban on 86 percent of the currency.
In China, a squeeze on the monetary base used to be a feature of economic management, rather than a bug. The investment boom after Beijing’s 2001 accession to the WTO could have been exhausting, turning the current account, which represents the excess of domestic savings over local investment, into deficit. However, China kept racking up higher surpluses.
In a 2007 study, former IMF chief economist Michael Mussa said the clue to the puzzle lay in the central bank’s balance sheet.
Central banks in developed countries with floating exchange rates buy government securities to print new money. Since having too much of it around is inflationary, interest rates must rise to cool demand. However, China wanted to run its economy red-hot, with an undervalued currency giving it an edge in export markets. So, instead of buying bonds, the People’s Bank of China (PBOC) scooped up incoming US dollars. Since buying US dollars from banks left them with more yuan, the PBOC then mopped up some of that liquidity.
By keeping a tight rein on the monetary base, especially from 2004 to 2006, the PBOC denied households the purchasing power that ought to have resulted from rapid economic growth, forcing them to save more at low, state-controlled deposit interest rates. By engineering a rise in national thrift, China managed to self-finance its growing hunger for investments.
Could India be pursuing a similar approach? It is no secret that Modi is aiming to put the economy on an investment-led path of growth with Chinese characteristics. Private final consumption expenditure nowadays accounts for 60 percent of India’s GDP. That number used to be almost 80 percent half a century ago. However, the investment rate is still at about 31 percent of output.
Never mind the 45 percent rate at which capital formation in China peaked in 2013. Can Modi raise the investment-to-GDP ratio to 36 percent, the high achieved by India before the 2008 global financial crisis? Even the recovery from that shock ended abruptly in 2013, as domestic savings ran out and foreigners balked from financing the country’s high current-account deficits.
Since then, the current account has been well behaved, and unlike a decade ago, banks are well capitalized. This time around, the vulnerability might be building elsewhere. It is the lenders’ deposit shortage that could put a speed limit on credit-fueled investment — unless authorities come up with some ingenious ways to keep banks lubricated while putting a lid on money creation.
Andy Mukherjee is a Bloomberg Opinion columnist covering industrial companies and financial services in Asia. Previously, he worked for Reuters, the Straits Times and Bloomberg News. This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
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