What A Trifecta Of Higher Currency, Rising Deposits And Weak Credit Signals
An impending recession, brought on by a pandemic, has led to an unusual combination of indicators being seen across the Indian economy.
Currency in circulation is rising but so are bank deposits even as credit growth is weak.
The combination, according to economists, suggests that consumers are holding on to more cash and keeping more funds in bank deposits amid a degree of uncertainty, while lenders are staying away from fresh credit.
The combination of these factors was highlighted by Reserve Bank of India Deputy Governor Michael Patra in the minutes of the last Monetary Policy Committee meet.
Currency In Circulation Is Rising
The pace at which currency in circulation is expanding continued to accelerate for the eighth straight week, rising 19% year-on-year in the week ended May 29, 2020, according to data from the Reserve Bank of India. This was the fastest rate of growth since January 2019.
Currency with the public, computed after deducting cash held in banks and currency chests from the total currency in circulation, rose 18.7 percent from a year ago during the week ended May 22, 2020.
Between mid-March and the end of May, currency in circulation rose by 9%, the RBI data shows.
This is a common response to any uncertain outcome, said Abhiman Das, RBI chair in finance and economics at IIM-Ahmedabad.
People will hold more cash, particularly from a precautionary motive, Das said. In addition, the opportunity of ownership style investments such as real estate and stocks has dried up as has use of savings as lending for opportunities, he added, explaining the sharp rise in currency in circulation.
Bank Deposits Are Also Rising
Typically when currency in circulation is rising, bank deposit growth tends to weaken as consumers are holding on to cash rather than keeping funds in bank deposits. This time around, along with currency in circulation rising, bank deposit growth has also picked up.
Aggregate deposits continued to grow at a higher pace for the fourth straight week, with growth rising to 10.65% over a year ago during the week ended May 8, 2020, shows RBI data. This was the highest since May 12, 2017.
Demand deposits, such as those held in current accounts and savings accounts, rose 11.32% year-on-year for the week ended May 8, while time deposits, or fixed deposits, rose 10.57%.
Pranjul Bhandari, chief India economist at HSBC, said it’s understandable for bank deposits and currency in circulation to rise at the same time as both as forms of financial savings. Some consumers may be holding more money in banks while others may be storing cash due to limited access to bank branches, she explained.
We may actually find financial savings rise through the Covid-19 episode, said Bhandari. “With households saturated with debt, they may not want to dip into savings further to fund discretionary consumption,” she said. Also, the lockdown norms and weak consumer confidence may come in the way of discretionary consumption such as travel, tourism, visits to restaurants, Bhandari said.
However, some economists believe the trend is transient. As the lockdowns ease people will begin spending again, said Renuka Sane, associate professor at National Institute of Public Finance and Policy. We will see an increase in borrowing by Indian households to be able to ride out the liquidity constraints that Covid-19 related lockdowns may have brought, she said.
Government Borrowing & Spending At Play?
According to Soumyajit Niyogi, associate director at India Ratings & Research, the government’s borrowing and spending patterns may have a role to play in the evolving conditions.
In the initial days, currency in circulation may have risen as a result of precautionary holding, but now it appears to be because of the government’s disbursements and cash transfer flowing to the bottom of the pyramid. “Even as the amount per individual may be low, it’s still significant on an aggregate,” Niyogi said.
The government may also be playing a role in the phenomenon of increased deposit growth.
“Deposit creation happens through lending which is endogenous,” said Niyogi. “The rise in deposits is largely on account of the credit flowing to the central and state governments by way of borrowing, and also due to short term credit provided by the RBI through enhances ways and means advances limits.”
The government is set to borrow Rs 12 lakh crore from the markets in FY21. In addition, the RBI has increased the short-term credit limit for both the central and state governments in order to help fund short-term expenses.
Meanwhile bank credit growth has remained weak with limited demand from the private sector and individuals for fresh borrowings. Credit growth rate in the banking sector for the fortnight ending May 8 stood at 6.5%, while the bank deposit growth rate was at 10.6%.
The combination of a spike in currency in circulation, along with tepid corporate credit and a rise in aggregate deposits is interesting, Niyogi added.
According to an analysis by Soumya Kanti Ghosh, group chief economic advisor at the State Bank of India, deposits increased significantly during the first phase of the lockdown as people were apprehensive about spending and turned frugal. There some decline in deposit growth in subsequent weeks but this rose again. This suggests that consumers are continuing to hold more money in bank deposits, Ghosh concluded.
However, the increase in deposits is also attributable to the pick-up in government spending with the hike in WMA (ways and means advances) limits, Ghosh said.
View Of Monetary Aggregates
When viewed from the perspective of monetary aggregates, the current patterns suggest that the RBI is ensuring strong growth in ‘reserve money’ to support the economy. Currency in circulation is the largest part of reserve money.
With currency in circulation and demand deposits rising, M1, which includes currency with public and demand deposits, is growing at 14.57%.
Broad money or M3, which includes time deposits as well, is growing at 11.5%.
The rise in money supply remains well above nominal GDP growth, which fell to 7.2% in FY20.
“While reserve money adjusted for the first round CRR effects is expanding substantially in relation to its pace a year ago, this essentially reflects the large monetary stimulus and the public’s flight to cash – currency in circulation expanded year-on-year by 18.4% up to May 22, 2020 as against 14.9% a year ago,” deputy governor Patra wrote in the MPC minutes.
This high growth in reserve money is important at a time when the money multiplier is low. The money multiplier, which measures how much money supply is created from central bank money through bank lending, is low when banks are risk-averse and unwilling to lend.
Since the money multiplier is depressed owing to risk-averse banks, the RBI is keeping reserve money high in a bid to prop up broad money, and hopefully, GDP growth, Bhandari said.
With the money multiplier remaining weak, the monetary base is largely built on credit to the government by the RBI through open market operations, repo and enhanced WMA limits, said Niyogi. “Had there been no spending by the government in the current circumstances, impact on the GDP would have been far more adverse. As such, amid the slew of high frequency indicators depicting the contraction in the economy, cash in circulation remain the bright spot.”