Are negative real interest rates the reason why households in India are investing less in financial instruments—the proportion being held in financial instruments fell from 12% of GDP in FY10 to 8% in FY12? And, stretching the argument a bit further, as banks vie to get households back to financial savings by raising interest rates—Punjab National Bank raised interest rates by 125 bps last week on deposits of maturities of between 180 days and a year—how can banks possibly pass on any rate cuts by RBI? But, given that overall household savings also fell, from 25.2% of GDP in FY10 to 22.3% in FY12, the reason for financial savings falling may likely have more to do with households simply having that much less to save due to slowing incomes and higher inflation. A recent note by Bank of America Merrill Lynch (BofAML) makes much the same point when it says that were households breaking FDs to invest in gold, then time deposits wouldn’t be rising at a reasonable 14.6% as compared to a mere 2-2.5% for CASA deposits—households have less to keep in terms of demand deposits and, with squeezed bottomlines, corporates have a lot less to leave in the bank in terms of current accounts.
This is why, along with repo cuts, RBI also needs to infuse liquidity back into the system. Going by the multiplier, BofAML estimates every one rupee injection by RBI, by say buying gilts, leads to a five-fold hike in deposits through credit creation. Between November-January 2012, RBI’s $20 bn intervention in the forex market sucked out liquidity and brought down deposits growth from 17% in December 2011 to 13.4% in March 2012. The 125 bps cut in CRR along with open market operations (OMO) saw deposits growth go back to 14.1% by August and, as RBI stopped OMOs, deposits growth once again fell to 11.1% by December 2012.The finance minister has done his bit, it’s up to RBI now.