Balancing it Right

In the midst of bankers at a State Bank of India (SBI) conclave in Mumbai a little over a month ago, Reserve Bank of India (RBI) Deputy Governor S.S. Mundra expressed concern over the falling deposit growth, particularly in public sector banks (PSBs), which account for over two-third of the industry's deposits and advances. The deposit growth of PSBs crashed to an all-time low of 4 per cent in 2015/16 compared to over 14 per cent five years ago. But the situation changed dramatically when Prime Minister Narendra Modi announced the demonetisation of Rs 500 and Rs 1,000 notes, comprising 86 per cent of the currency in circulation. For bankers, there is now a problem of plenty.

With people lining up before banks to exchange old notes or deposit cash in their current accounts & savings accounts (CASA), the banking sector has got deposits of over Rs 6 lakh crore in just two weeks. Of the Rs 14.5 lakh crore demonetised currency, at least Rs 10-12 lakh crore is expected to flow back into the system. Kalpana Morparia, CEO of JP Morgan India, says: "(Demonetisation) is a step towards inculcating a habit of using the formal financial system."

The fund flow into CASA, which account for 40-50 per cent of the industry's resource mix, will help banks shift from high-cost deposits, lowering the cost of funds. SBI has already reduced its one-year term deposit rate by 15 basis points to 6.95 per cent. Similarly, banks are going slow on bulk deposits, which are relatively costly. SBI has reduced its bulk deposit rates by a massive 125-190 basis points for various maturities. The others, too, are following suit.

The rise in deposits has substantially improved the liquidity in the system. "The liquidity has turned surplus compared to the deficit prior to demonetisation," says a Kotak report. The bigger problem, though, is that there are not enough avenues to park these surplus funds. Credit growth has been down in the dumps at less than 10 per cent. Most banks are parking their surplus funds in short-term instruments like the reverse repo window of the RBI at 5.75 per cent or 91-day Treasury bills, which are offering around 6.50 per cent rate. In addition, excess liquidity is finding its way into the government securities market. The 10-year benchmark yields have fallen from 7.64 per cent before the demonetisation to 6.4 per cent levels. Lower deposit rates and falling G-Sec and bond yields have set the stage for a cut in lending rates. Come December 7, RBI Governor Urjit Patel is widely expected to cut the repo rate by 25-50 basis points in the monetary policy. Clearly, demonetisation is expected to lower demand as reduced cash in the system has shrunk people's purchasing power. In addition, consumer price index (CPI) inflation eased to 4.2 per cent in October, from 4.39 per cent in September.

The Other View

However, experts are not enthused by the inflow of money into deposits because of the withdrawal limits. The market is expecting a lot of money to flow out of the banking system once the RBI removes the cash withdrawal limit of Rs 24,000 per week for savings accounts and Rs 50,000 for current accounts. "We are yet to know whether the funds flowing in are long-term in nature or being routed through the banking system because of the demonetisation conditions," says Kalpesh Mehta, Partner at Deloitte India.

Some say demonetisation is like a black box with a lot of uncertainty till the entire process is completed. There are already reports of Jan Dhan accounts being used to park black money. An estimated Rs 21,000 crore has been deposited in these no-frills accounts. Plus, with the US set to increase rates, a fall in interest rates in India is likely to have a negative impact on the rupee-dollar exchange value, which is already at a low of 68.57. "We expect the rupee to extend its weakness from the current levels and touch 70 in the near future," says Abhishek Goenka, CEO of India Forex Advisors.

The likely softening of inflation is also being seen as a short-term development as India has many structural issues such as supply-side constraints and high fiscal deficit. Further, handing over the surplus funds to the government for funding the fiscal deficit or infrastructure building would be inflationary. Fitch Ratings has said in its report that demonetisation could also affect the ability of borrowers in sectors that rely on cash transactions to service their loans. This will have a worsening effect on banks' asset quality. In fact, the RBI has temporarily allowed banks to give small borrowers more time to repay before their loans are classified as non-performing assets.

Even as regulators like Mundra are fire-fighting currency shortages and other issues, the bankers are assessing the paybacks and the likely negatives. Many bankers say they have no option but to go with the events as there are no prior instances of any country attempting demonetisation on such a large scale.