It’s been the third year running that deposit growth in India has lagged in credit growth. As of July, deposit growth has been 10.5%, while credit growth is over 13%. Deposit pricing has remained stickily high for banks but not high enough on a tax-adjusted basis for some depositors, while variable loan pricing has gone down (in view of banks) but not enough (for many borrowers, especially SMEs). A host of red herrings are floating around:
Deposits fund credit: Quite to the contrary, under fractional reserve banking, the primary route of deposit creation is more credit creation. When a bank gives out a loan, it credits the borrower’s account with the loaned money, thereby creating fresh deposits. In short, the new loan, at a systemic level, is self-funded.
Investments in stocks & MFs taking savings flows away from deposits: Again, inaccurate. When investor A buys a stock from investor B, money flows from A’s bank account to B’s. When investor A buys an MF, cash flows from his bank account to the MF’s. No money ever leaves the banking system.
Also, the seemingly chronic deposit-credit growth gap is puzzling. There are four sources of overall money supply growth and drags:
Money supply is determined by CRR and SLR on bank deposits. Practically, SLR is nothing but loans to GoI, which, in turn, is creating deposits. But CRR and bank capital requirements act as binding constraints – higher they are, lower the growth of money supply. CRR today, at 4.5%, is 50 bps above pre-pandemic levels.
That is the first leakage to deposit creation. But it has a very small impact, as banks can convert excess g-sec holdings to meet CRR requirements via RBI’s repo window.
If currency in circulation (CIC), or currency notes held by households, grows faster than deposits (or nominal GDP), there will be a gap in deposit creation. However, over the last five years, all three have grown 60-65%.
When GoI balances with RBI go up (usually when taxes remain unspent), that’s a drag. This, too, isn’t causal today, as most data suggest a decline in government balances with RBI over the last year. When GoI balances with RBI rise, say, because the inflow of taxes temporarily exceeds government spending, this money briefly goes out of circulation from the banking system.
RBI intervention in the money market is done either via currency markets or buying-selling g-secs in open market operations (OMOs).
Given the first three factors don’t seem to be responsible, we are left with the fourth as the most probable cause for the chronic deposit-growth gap. Numbers bear it out. Over the last year, CIC has increased by 1.9 tn, while deposits and loans have risen by 20 tn. However, only about 80% of all deposits can be deployed for loans, with the balance being earmarked for CRR and SLR.
Ergo, OMOs, which are expected to fund the ‘money supply gap’, has been at a lower level than needed by the banking system. From the numbers, it’s likely at a run rate lower than pre-pandemic levels (3-4 tn annually).
In simple terms, the cause for the crunch in deposits is monetary tightening. RBI is focused on inflation fighting – benchmark CPI has only recently gotten below the 4% target – and, hence, hasn’t loosened monetary taps. While bond prices react to a variety of demand-supply factors like FPI flows and projected new supply of bonds, etc, at a systemic level, deposit growth is tight because RBI has progressively drained liquidity out at the margin.
Some of it is Covid-era excesses being readjusted, in line with global tightening. Income velocity of money – GDP/broad money supply (M3) – which averages around 1.2-1.25 for India, went down to 1.05 during Covid as RBI sought to support a weakening economy. Since then, it has come back to 1.2, representing the margin declining incremental broad money supply for incremental income generated.
Monetary policy is globally coordinated. RBI embarked upon its version of QT along with, and in response to, the same in developed markets. India’s QT has also lasted quite a while, even as some of the underlying growth impulses have lost their post-pandemic bumps. That has been a policy choice – GoI and RBI have privileged macro stability with inflation control over higher growth.
Which is fine. But it’s better to recognise that and deal with it instead of going on a wild goose chase.
The writer is chief investment officer,ASK Wealth Advisors
