Where did banks deploy all the funds they received in the past one year? Perhaps this sums it up best: at the end of October 2016, just before demonetisation, the year-on-year increase in bank credit was Rs5.9 trillion and the rise in bank investments in government securities was Rs2.1 trillion. A year later, at the end of October 2017, the year-on-year increase in bank credit had fallen to Rs5.3 trillion, while bank investment in government securities soared to Rs4.6 trillion. In effect, banks dumped the excess deposits into government securities, bringing down interest rates on them and helping the government borrow at cheaper rates.
Of course, it’s impossible to untangle how much of this trend is due to demonetisation, how much to the goods and services tax (GST), how much to banks’ aversion to lending as a consequence of burgeoning bad loans and how much due to other factors affecting the economy. All we can say is that as a result of all these factors, most of the accretion to deposits went into investments in government securities, while a combination of demand constraints and excessive leverage curbed business borrowing.
The immediate effect of demonetisation was a rush to deposit the demonetized notes in banks. Did that result in a huge growth in bank deposits? It did, but only for a while. By the end of last month, the year-on-year growth rate of bank deposits was 9.24%, about the same as the growth rate of 9.25% at the end of October 2016. The growth in deposits has proved to be a purely temporary phenomenon.
As is well known, cash in circulation has decreased and with deposit growth remaining the same, the money supply (M3) growth too has come down. At end-October 2017, year-on-year M3 growth was 6.5%, compared to 10.4% at end-October 2016.
Has the lower bank credit been offset by bank investments in company bonds? Not really—bank investments in corporate bonds over the past year have grown only marginally, mainly because investments in bonds issued by public sector companies has fallen, although there has been decent increase in investments in bonds issued by the private sector. At the end of September 2017, year-on-year growth of bank investment in commercial paper too was a mere 2.3%. However, banks have poured money into company stocks.
Credit growth across all sectors has slowed—in agriculture, services, even personal loans (see chart). Year-on-year credit growth to industry at end-September 2017 was negative, compared to a small positive growth at the end of September 2016. But credit to industry was in any case scarcely growing a year ago, so the difference is minimal.
Personal loan growth has been the least affected. Of the growth in non-food credit in the year to end-September 2017, personal loans contributed 61%, loans to services another 28%, while agricultural credit contributed the rest. As mentioned earlier, industrial credit contracted slightly.
Growth in credit to the services sector too fell from 18.4% in September 2016 to 6.98% a year later. Similarly, growth in agricultural loans has gone down from 15.91% in September 2016 to 5.76% in September 2017.
Despite the talk about the difficulties of small industries, the fact is that bank credit growth to micro and small enterprises in the manufacturing sector was slightly positive at the end of September 2017 from a year ago, in contrast to loans to medium-scale enterprises, which showed a sharp contraction. But lending to small and micro units in the services sector has decelerated considerably, although growth remains in positive territory.
Also, bank lending to microfinance units has shrunk a lot, while growth in lending to weaker sections has slowed.