Mumbai: Money supply in the Indian banking system is expanding at its slowest pace in 10 years as growth in Asia’s third largest economy is slowing and bank credit and deposit growth has slackened.
The broadest definition of money supply, or the so-called M3, grew at 12.5% in the fortnight ended 30 November, the lowest since the 12.03% growth recorded on 23 November, 2003.
Although it has recovered slightly to 12.9% in the fortnight ended 14 December, the figure is still near a decade’s low, indicating the tightness of liquidity in the banking system.
M3 includes currency with the common public (essentially notes and coins in circulation), and savings and fixed deposits in banks.
The Reserve Bank of India, or RBI, had reduced the M3 growth target to 14% in the second quarter monetary policy review on 29 October from 15% set in the first quarter review in July. However, the rate of growth in money supply has fallen below the central bank’s target.
A fall in deposits is the main reason for the fall in M3, said Saugata Bhattacharya, chief economist at Axis Bank Ltd, a private lender. “About 85% of the components in M3 are made up of deposits and a slower deposit growth is one of the main reasons for the fall in M3,” he said.
Deposit growth has been lagging as bank customers preferred alternative investments like gold and real estates since post-tax returns from deposits are unable to beat inflation for the most part of the past few years. Fixed deposits, which were growing at a strong 20% rate in December 2011, have since fallen to 13.6% in December 2012, according to the weekly statistical supplement of RBI.
The Indian banking system had Rs.70.21 trillion in deposits in the fortnight ended 14 December, according to RBI data. Banks added Rs.7.42 trillion worth of time deposits in 2012. In percentage terms, such deposits have grown 13.6%. Banks have cut fixed deposit rates by 50 basis points (bps) and more since September as they are not looking for high growth in deposits when credit growth has been weak. One bps is 0.01%.
In 2011, time deposits grew 20%, Rs.9.24 trillion.
Credit growth this year so far has been 16%, lower than 17% in the same period last year.
Lacklustre credit and deposit growth is an indication of the muted economic activities, according to Rupa Rege Nitsure, chief economist at Bank of Baroda. a state-owned bank.
“The M3 deceleration just reflects the benign economic activity at the ground level,” Nitsure said. “We have even seen zero growth in manufacturing in one of the months this year which also reflects the economic activity.”
A depletion in India’s foreign exchange assets is also one reason why the money supply has fallen, said Shubhada Rao, chief economist at private-sector Yes Bank Ltd.
“Net forex assets in the banking sector have grown just 1.8% in 2012 because the RBI has had to intervene in the foreign exchange market to prevent the rupee from falling sharply,” Rao said. It had grown 17% in the same period in 2011.
The rupee has weakened 7.87% against the dollar in fiscal 2013.
Rao said high government cash balances with RBI is also another reason for the liquidity tightness and, hence, lower M3. The government has Rs.90,000 crore of cash with RBI.
She expects M3 growth to dip further by the end of December, the data for which is not available yet. “The government spending is only just beginning to happen and as the cash balances with the RBI peak, M3 will also come down before it improves when spending resumes,” Rao said.
The central bank has also been infusing liquidity in the banking system through regular purchases of government securities. So far in the current fiscal year, RBI has bought at least Rs.1.1 trillion worth of government bonds through so-called open market operations (OMOs).
RBI has cut the cash reserve ratio (CRR), or the amount of deposits banks have to keep with it, by 50 bps in fiscal year 2013 to 4.75%. But for the OMOs and cut in CRR, the M3 growth would have been more anaemic.
Economists are now expecting RBI to cut its policy rate by 25 bps to 7.75% from 8% when the central bank meets to announce its third quarter monetary policy review on 29 January.
“My credit analysis shows that a lot of small and medium enterprises are on the brink because of high interest rates and a rate cut by RBI could save them at this point of time,” Nitsure said. She pointed out that the closely watched core inflation has eased in November giving the central bank enough room to cut rates.
The so-called core inflation, or non-food, non-fuel, manufacturing inflation, eased to 4.5% in November, a 32-month low, official data showed in December.
Bhattacharya of Axis Bank, too, expects a 25 bps cut in policy rate as RBI attempts to lower the cost of funds to prop up economic growth.