Think Finance, Destination TAPMI
Minister of Finance & Corporate Affairs, Mrs. Nirmala Sitharaman tabled the Economic Survey 2018-19 in Parliament today. With the theme of Shifting Gears and “Blue Sky” policy-making, India aims to achieve a sustained growth rate of 8% to become a $5trillion economy by 2025.
Source: Economic Survey 2018-19, Press Information Bureau
By Abraham Mathew Valliyakalayil
The world GDP stood at nearly 74 trillion in 2015. The worth of the world bond markets was 100 trillion. Where was India at that time? This article attempts to juxtapose the Indian bond market with that of the world. Indian debt market is just 17% of its GDP as compared to the US which is worth 123%. We also lag behind with respect to other emerging markets such as Malaysia, Thailand, and China.
There can be a plethora of reasons for this trend. Firstly, India in contrast to these countries offers much higher interest on fixed deposits. These attractive interest rates discourage retail investment in corporate bonds as term deposits carry lesser risk. Thus, risk-averse retail investors prefer fixed deposits over debt and risk-seeking investors opt for equity.
Break-up of Term-Deposit & Inflation Rates of Asian Countries
| Country | Fixed deposit rate | Headline Inflation |
| India | 7.95 % | 3.4 % |
| Malaysia | 4.33 % | 1.8 % |
| China | 3.75 % | 2.1 % |
| Thailand | 2.8 % | 1.1 % |
Secondly, institutions which are the major players in the bond market shy away from investing in corporate bonds. The reason being that the secondary market is still underdeveloped, owing to the lack of demand and supply (causing market illiquidity).
Issues on the demand side:
Issues on the supply side:
The institutional restrictions, preference for higher ratings (reason for higher interest rates) and the high cost of issuing (resulting in a high cost of capital, KD) has an adverse impact on number primary issues.
Conclusion:
Analyzing the supply and demand aspects, we can say it is analogous to the chicken and egg situation. The above problems can be tackled by an effective implementation of the Insolvency and Bankruptcy Act which was passed on 5th May 2015. This can hasten the liquidation of distressed companies, thereby protecting the value of companies’ assets. It will also aid the asset reconstruction companies by attracting more participation into the NPA market. Furthermore, improved banking governance and adoption of Basel III norms mandating holding of high-quality liquid assets can also act as an elixir. Overall, these measures can improve the investors’ confidence in the corporate bond market.
By Garima Singhal & Vishnu Pillai
INTRODUCTION
Reserve Bank of India’s bimonthly report in March revealed that the deposit growth in the fiscal year 2015-16 has slipped to 9.9%, the lowest in the last five decades. India is an economy, which is considered as saving centric, and the country’s banking system provides the depositor with one of the highest interest rates ranging from 4.5%-7.5% on time and demand deposits (up to Rs. 1 Crore). Inflation has seen a downward trend and the economy is moving towards faster growth. In spite of all these reasons, Indian banks are facing liquidity crunch due to low deposit growth that has also led to an increase in the credit-to-deposit ratio to 77.6% in March 2016 from 76.5% in the previous year.
In all this debate, the question arises why deposits in banks are so important for India’s growth and if the nation is really growing at a high growth rate then why are deposits in the banking system decreasing to such a large extent?
Figure 1: Growth in bank deposits (in %), Source: RBI
NEED FOR DEPOSITS
India is a developing country rapidly moving towards better technology and efficient ways of working. Similarly is the financial market of the country, which is currently in its growing phase. A financial market is a market where direct trading takes place in equity, bonds, currency, commodities etc. Here the investors and people in need of funds meet directly without the need of intermediary like banks. As the financial market of the nation grows and become more efficient, the need for banking sector becomes less important. However, in India where financial markets cope with the problem of adverse selection and moral hazard, banks play an important role in transferring funds from investors to borrowers.
Moreover, banks work on the principle of spread, which is the difference between the interest paid on deposits and interest earned on loans. As deposit growth falls and demand for the loans increases, banks need to increase the rate of interest on their deposits resulting into less spread for banks and reduction in profitability.
Also, with the current credit-to-deposit ratio of 77.6%, banks are lending 77.6 rupees for each of Rs. 100 of deposit. As banks need to maintain other reserves under CRR and SLR, lending such a high amount can lead banks to run into a liquidity shortage, which is not a favorable situation for the banking system as a whole.
As a result of all these factors, deposits have become a crucial component in the banking system to facilitate the smooth flow of funds from investors to borrowers.
Figure 2: Prime Lending Rate in India from April 2015 – March 2016,
Source: www.tradingeconomics.com
REASONS FOR FALLING DEPOSITS
In countries like India and China people tend to save more for the future than consuming today. As a result of this saving habit of citizens, the Indian economy was hit to a lesser extent during the Financial Crisis of 2008, but what has led to the reversal of this trend in current times? Though there is no sure answer for this question, few factors explain the reversal to some extent.
In the past when the country was facing a double-digit inflation, banks were providing high-interest rates on deposits, to reduce the impact of inflation on people’s savings. But as inflation eased, interest rates on deposits have not reduced in the same proportion providing people with a higher real rate of interest. This has resulted in people earning same returns with fewer funds parked in the banks. This could have resulted in the reduction of deposits in banks.
Moreover, the behavior of present generation is changing, as people want to fulfill more of their present demands than saving for the future. The availability of various insurance schemes in the market to face future uncertainties has made this task of present consumption more attractive, preventing people from worrying about future thereby saving less.
Second of all, as the financial market in the country is growing and becoming more efficient, new and better products like Mutual Funds, Equity Traded Funds, Bonds, Real Estates etc. are becoming available to people to earn more profit with the same amount of money invested. Also, the returns provided by these investments are far above the inflation rate resulting in more returns in nominal as well as in real terms. Another reason for the growing popularity of financial products is the liquidity they provide. As a result, people who are willing to take risks to earn higher profits are moving towards these products rather than parking their funds in banks.
Another reason that can also be considered as one of the factors for falling deposits growth is an increase in the maximum limit under the Liberalized Remittance Scheme. Under this scheme, the RBI defines the maximum permissible amount that Indians can remit to other countries. The maximum amount under this scheme has been raised to $250,000. As a result of this, people have started sending more money to their parents, children or relatives in foreign countries instead of saving them in bank accounts. This can be validated from the fact that the transactions under this scheme have seen a jump from $106mn to $449mn from May 2015 to Feb 2016.
The largest factor that is contributing to this rise is the amount sent by parents to children who are studying abroad. This shows that our education system is not only incapable of retaining its talent but also is one of the major causes of money leaking out of the economy.
The points discussed above identify the fact that people presently are reluctant to put money in banks. But what if in the previous years the funds deposited by people was just higher deposit growth than normal rate and presently that trend is only getting reversed to attain its normal pace. This can be inferred from the fact that during the period of Financial Crisis, markets were facing great uncertainty and the economy was experiencing double-digit inflation. People were losing jobs and were more focused on saving to secure their future consumption as much as possible, which led to very high growth in deposits. As the economy recovered from recession over the years and inflation rates have fallen, people have reverted to their actual rate of spending bringing the deposits growth down.
The other factor that is more perplexing is that in the situation when deposit growth is at its all-time low, currency in circulation is seeing a high growth of 14.6% as compared to 11.32% growth over the previous year.
In the scenario where not only advance ways of doing banking are coming up every day resulting in improvement in efficiency of transactions but also schemes like Pradhan Mantri Jan Dhan Yojana(PMJDY) which are trying to put ideal money into circulation by opening up bank accounts, high growth in currency in circulation despite fall in bank deposits raises questions. Though this increase can be described by few factors, actual reasons remain uncertain.
Elections could be seen as one of the reasons for the rise in currency, as it is a phase where a large amount of money is spent by political parties for funding their campaigns and to lure the voters by offering them cash. The rumor of each voter in Tamil Nadu getting somewhere between Rs.3000 to Rs.6000 during the Assembly Election in April – May 2016 added fuel to this fire. Even Mr. Raghuram Rajan hinted this as a possible reason for an increase of Rs. 50,000 crores more money in the hands of the public than what was expected by the Central bank. Another interesting fact that came to light during this period was that the amount of money with the people had not only increased in the poll-bound states but also the neighboring states.
But if we were to believe the above reasoning then didn’t we have more states going for elections last year? Why didn’t the level of deposits fall in the last year or the year before it during the elections? Or is it that the states that went to polls last year (Bihar, Delhi- 2015) or in 2014 (Parliament, Maharashtra, Haryana, Andhra Pradesh, Jammu & Kashmir, Jharkhand) had a better follow-up of electoral policy than the states that had elections this year (Kerala, Tamil Nadu, Assam and West Bengal).
Another factor which gives rise to the possibility of high currency in circulation is the rise in service tax from 12.36% to 14% and with the introduction of the Swachh Bharat cess and Krishi Kalyan cess, it reaches to 15%. Because of this rise, people may be seen as reluctant to put large sums in banks due to increase in transactions costs or ATM charges. Though the cost may be lower on transaction basis but combined cost may result in keeping people away from depositing in banks. Moreover, with the rise in service tax people may be more willing to pay for services in cash instead of through bank accounts as transactions from accounts are recorded whereas cash payments cannot be traced and can be used as a means of saving tax.
All this presents one side of the picture that concludes that people are not depositing at the same rate as of before but there is a second angle to the picture. What if people are still saving at the same rate but they do not have enough income to save which is leading to the fall in deposits growth?
The data based on Quarterly Employment Survey (QES) of the number of jobs created in select eight industries shows that the number of jobs generated in 2015 is only 135,000 which are very low as compared to that of jobs created in 2014 that were 421,000. This fact puts another problem in picture that though the economy is growing at a rate of 7.4% currently it is facing difficulty in translating the growth into increased jobs to accommodate the growing workforce of the country. Moreover, in the rural area the fall in income due to crop failures caused by two successive droughts is aggravating the problem. This has resulted in farmers losing their crops and worsening the situation in both urban as well as rural areas.
Table 1: Changes in employment in selected sectors (in lakh numbers)
Source: Labour Bureau
The actual reason for such a high fall in growth of deposits is still unknown. In a scenario, where the economy is booming and with the pressure from industry to reduce the interest rates is continuously growing, banks will be required to reduce the interest rate on their deposits as well so as to maintain their Net Interest Margins (NIMs). However, as banks are already facing the problem of lower deposit growth, reducing deposit interest rate may make the situation worse forcing banks to face a highly constrained situation from both low deposits as well as high loan demands. Therefore the banks will be required to come up with schemes that can give investors attractive payoffs to deposit money in the bank and to focus on making the banking system more robust so as to not only reduce the growing NPAs but also control the increasing growth of currency and inject back the money which is currently out of the system.
Post March 2016, the deposit growth has increased in banks. So this fall in deposits growth in FY2015 may be considered as one time phenomenon but if such a trend continues to persist in the future, banks should not only focus on finding the root cause of such a high decrease but also try to find new avenues to earn its income so as to bear the brunt of its reduced NIMs.
Bibliography
Damodaran, H. (2016, May 2). The Indian express. Retrieved September 29, 2016, from http://indianexpress.com/article/explained/why-growth-in-bank-deposits-is-at-a-53-year-low-2779714/
Dugal, I. (2016, April 1). The curious case of rising currency in circulation. Retrieved September 29, 2016, from Money, http://www.livemint.com/Money/5iGPiveWOKHyZx7n0g9qLP/The-curious-case-of-rising-currency-in-circulation.html
Bhattacharya, S. (2016, April 15). India’s job growth lowest since 2009: Where are the jobs PM Modi? Business. Retrieved September 29, 2016, from http://www.firstpost.com/business/where-are-the-jobs-mr-modi-2731002.html
Das, S., & Nayak, G. (2016, April 7). Article: Banks in a fix as deposit growth hits 50-year low, loan disbursement rises – the economic times. Retrieved September 29, 2016, from http://articles.economictimes.indiatimes.com/2016-04-07/news/72132317_1_deposit-growth-saugata-bhattacharya-indian-banks
Bureau, O. (2016, April 12). “Higher spending, remittances hurting deposit growth.” Retrieved September 29, 2016, from Money & Banking, http://www.thehindubusinessline.com/money-and-banking/higher-spending-remittances-hurting-deposit-growth/article8467576.ece
By Payal Sachdeva
The concept of “Negative interest rate” was flourished after 2008 financial crisis when all other means to reinvigorate the economy had been exhausted. It is a monetary policy tool employed by central banks to combat deflation. This tool was first adopted by Sweden’s central bank in July 2009 when the overnight deposit rate was lowered to -0.25%. European Central bank did the same in 2014 followed by Bank of Japan recently which has resulted in $10 trillion worth of government debt carrying negative yield.
A common misconception with the concept is that the depositors think they need to pay interest for their deposits to the bank. However, this is not true. Usually, commercial banks are required to keep a certain amount of money as reserves at their central bank as a safeguard against bank runs and to accommodate for last minute loans. The central banks generally pay the interest rate on these deposits, however, in Japan and Eurozone, banks have to pay central banks for parking their reserves.
Since commercial banks are charged for parking their reserves with the central bank in negative interest rate regime, they prefer to park that money with other banks to manage liquidity and meet the reserve requirements at a lower rate with an intention to earn some interest. Since a lot of banks try to get rid of their excess reserves, the competition pushes the interbank rate down which enables banks to pass on the benefits to their customers in the form of lower mortgage, personal loan, education loan etc. This is the ultimate objective of lower interest rate – to encourage investment and consumption, thereby stimulating the economy. Also, it might encourage investors to seek avenues abroad for better returns, which eventually leads to the depreciation of the currency due to the currency outflow. This would in turn boost exports to revive the economy. Euro has depreciated against the dollar by 20% since ECB introduced negative deposit rate.
However, a major concern is that banks would be unwilling to increase the lending as the profit margin between lending and deposit rate squeezes when they absorb the cost of negative interest rate. Though central bankers say it’s too early to gauge the impact of interest rate, they predict that if more and more central banks use this tool, it could actually lead to a currency war of devaluations.
By Sachit Modi
On August 9, 2016, Dr. Raghuram “Rockstar” Rajan, who is set to end his 3-year term on September 4, released his last monetary policy review. The RBI Governor, who has reduced the benchmark policy rate by 1.5% since January last year, decided to keep it static in his final review, owing to the inflationary trends. He also stated that, in order to achieve the Liquidity Neutrality goal, RBI will continue to pump funds into the market, as and when the need arises. This article gives few of the major highlights from the review.
The Bi-monthly Rates:
| Repo Rate | Reverse Repo Rate | Cash Reserve Ratio | Marginal Standing Facility | Bank Rate | Inflation Target | Growth Forecast |
| 6.5 % | 6.0 % | 4.0 % | 7.0 % | 7.0 % | 5.0 % | 7.6% |
Inflation and Inflation Target
In June, the CPI-based retail inflation, driven by sharper-than-expected rise in the food prices (particularly vegetables and sugar), rose to 5.77 %, a 22-month high figure. Even though the market is expecting the food prices to increase further, the inflation target has been set by RBI at an optimist 5.0 % with an upside risk for Jan-2017. This has been kept in line with the RBI’s fixed target of bringing it down to 4.0 % in the next 5 years. The upper tolerance target of 5.0 % has been set by keeping in mind a strong expectation for a progressive monsoon and softening positions of oil and other commodities in the market. One thing to note here is that the inflationary trend is expected to be boosted by the contributions from the GST Bill and the 7th Pay Commission’s Housing Allowance. However, the governor is expecting the influence to be very minimal in the long-term.
Rate-cut Transmissions
The governor took a strong stance against the banks for passing on the rate cuts only modestly. Recently, the banks have been citing the upcoming $20 billion worth of Foreign Currency Non-Residents (FCNR) redemptions as the reason for the same. However, Dr. Rajan stated that RBI, with an efficient management plan and Open Market Operations (OMOs) to the tune of INR 80,500 crore, is well balanced to carry on the redemptions smoothly. This leaves the banks with no further reasons, ‘as of now’, to hold the cuts to themselves.
Conclusion
Overall, the RBI Governor’s valedictory policy was a hallmark of his term. This policy stands out as a unique document in terms of liquidity management, macroeconomic developments and pass-through of previous policy rate cuts to the lending rates.
By- Nayan Saraf
In December 2015, RBI introduced the guidelines in computing interest rate based on marginal cost of funds called Marginal Cost of Funds based Lending Rate (MCLR), to replace the base rate for bank lending, from 1st April, 2016.
Previously, the bank loan rate was calculated as base rate + spread. The base rate is based on average cost of fund which is the interest given on deposits, negative cash carry on account of CRR (as RBI don’t give any interest on it), operation cost, and minimum hurdle rate, and the spread represents the riskiness of the borrower. Hence, if the base rate is 9.20 and the riskiness of the borrower is 0.30, then the bank loan rate would be 9.20+0.30= 9.50%.
What’s the problem with the base rate?
More often than not, the commercial banks are reluctant to pass on the benefit of lower interest rate to their customers whenever RBI reduces Repo Rate. Hence, in the case of Repo rate cut, the cost of funds i.e. the cost of fresh borrowing goes down for banks as they usually reduce the interest rate on deposits, but they do not reduce their lending rate. This leads to asymmetry and lag in monetary transmission.
How will MCLR overcome the problem in the base rate?
Under MCLR, banks need to calculate the marginal cost of fresh borrowing. MCLR is reviewed every month that ensures that banks pass on the benefits of lower rate immediately. The rationale behind this methodology is quite simple: If banks can borrow at lower rate, they should lend at lower rate.
Policy Implication:
The immediate policy implication would be reduced EMI on home loans and term loans. But banks have already found a way to cheat MCLR, for example, by increasing the spread to maintain the rate at the existing level. Also, MCLR is a double edge sword, in the case of increased cost of fund, MCLR would also be higher, and so would the EMIs.
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