Q3 GDP: Why flood of bank deposits post demonetisation never aided growth

Going by available estimates, at least Rs 12.4 lakh crore came to banks till 10 December either in the form of exchange or deposits post demonetisation of Rs 500, Rs 1,000 notes on 8 November. What did our banks do with such huge chunk of cash deposits? Did they use this to lend to companies and individuals to create assets and thus turned the demonetisation-deposit bonanza into a productive affair? An Ambit Capital report offers interesting insights to prove that this was probably not the case.

Banks, in fact, dumped most of this money into government securities raising their bond holdings way above what is mandated by the rules, it says.



Banks need to invest about 29 percent of their deposits in government securities but currently the ratio is way above for most state-run banks, some at 30 per cent-34 percent. “Following the demonetisation event, the banking system received a record inflow of deposits. Whilst the surge in deposits is real, the same is not being lent out but is being used by banks to buy government securities,” said analysts at Ambit in a report titled, ‘3Q FY17 GDP data-CSO’s flight of fantasy continues’.

What does this means for economic growth? By definition, GDP is the product of the ‘amount of currency in circulation’ and ‘the velocity of currency’, Ambit says. “Hence, the RBI can control the amount of currency in circulation but cannot control GDP growth if the velocity is collapsing,” Ambit report said.

The report finds that demonetisation-resulted surge in bank deposits has not contributed to higher flow of bank credit and higher economic growth. “Thus, it is amply clear that the low levels off business activity are translating into low levels of velocity of money, i.e, each currency note that is in circulation, is being used less intensively than was the case pre-November 8, 2016,” Ambit said.

Deposit, credit and G-sec investment chart - Mar 3, 2017


Now read this finding along with the third quarter GDP numbers published by the CSO. According to the government agency, GDP grew 7 percent in the third quarter buoyed by private consumption at multi-year high levels and overall economic activity, especially in manufacturing sector. The CSO numbers tell us that the private consumption has picked up sharply in the third quarter by 10.1 percent almost doubling from the preceding quarter growth of 5.1 percent. This is the highest in last few years.

But if that has to happen, there needs to be a corresponding increase in bank credit growth and consumer spending activity, which has not happened as we saw in the deposit deployment trend. Now look at the bank lending data in December and January. According to RBI data, credit to industry contracted by 5.1 percent in January 2017 in contrast with an increase of 5.6 percent in January 2016. In the December, it contracted by 4.3 percent in December 2016 in contrast with an increase of 4.9 percent in December 2015.

Evidently, things haven’t improved on the economy if the high frequency macroeconomic indicators offer any clue. Credit growth to major sub-sectors such as ‘infrastructure’, ‘food processing’, ‘basic metal and metal products’ and ‘textiles’ witnessed deceleration/contraction. However, credit growth to ‘petroleum, coal products and nuclear fuels’, ‘vehicles’ and ‘construction’ accelerated.

It isn’t hard to explain why the two wheeler sales and performance figures of FMCG numbers also did not add up to this higher consumer spending theory depicted by GDP figure. The Ambit report raises doubts of the claim by finance minister Arun Jaitley that surplus liquidity in the banking system post-demonetisation will lower lending rates, thus increase lending activity contributing to higher growth. Of course, borrowing costs have come down significantly post-demonetisation with banks sharply lowering their lending rates. But, this hasn’t resulted in higher lending so far, particularly to industries, since there is no revival in economic activity on the ground yet. Till the time demand revives, banks have no option but to park the excess cash in G-Secs for minimal returns. That’s what has happened so far.

(Data contribution by Kishor Kadam)

Updated Date: Mar 03, 2017 12:41 PM

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