Demonetisation update 26- be careful what you wish for

This afternoon I was attending a talk by Shri. Shivshankar Menon, former National Security Advisor to Government of India on the security situation in Asia-Pacific at the Raffles Town Club in Singapore. Popped into my mailbox a report by Sajjid Chinoy of JP Morgan on the optimal policy after demonetisation. The tone of the report was not alarming.

He cautioned against a fiscal policy boost to consumption. He felt that it could only boost imports from China. Apparently, 40% of India’s trade deficit is with China alone. He argued for public investment in infrastructure.

But, he said that deposit rates could keep coming down. That is not such a good news for a country that wants to encourage its people to take to banking and deposit cash into their bank accounts and build a saving and credit history. The government was right to guarantee a minimum rate of return on deposits to senior citizens but that is a drop in the ocean. No, I am not advocating that the government provide a top-up to all savers. But, if deposit rates fell faster than lending rates, it is not necessarily good news for the Indian economy which needs to encourage savings.

Indeed, low lending rates would end up boosting personal loans including for real estate, especially now that apartment prices have come down. That is short-term good news but not good long-term. I wrote this in my Swarajya cover-story on the currency swap exercise in December:

Lower deposit rates spell negative real rates for savers. India’s official inflation rate might be closer to 4% but core inflation rate is above 5% and the public’s perception of inflation rate is closer to 10% than 4%. Negative real rates are a big disincentive for savings and, if they remain persistent, they work against the objective of ‘less cash’ in the economy. Households would have less incentive to keep their money with banks. India’s savings rate is barely above 30% and well below its investment needs. That is why India’s current account is perpetually in deficit. Hence, aggressively low deposit rates would be against what the doctor ordered for the Indian economy. Talk of the law of unintended consequences. [Link]

The more worrisome part of the JP Morgan report was on state finances. Despite the 14th Finance Commission bounty for them, their fiscal deficit is going up. This is what they wrote:

Contrary to the perception that states have been the epitome of fiscal discipline, the consolidated deficit of the states has increased from 2.2% of GDP in FY14 to 2.9% in FY15 and is on course to widen to 3.3% of GDP in FY16, despite much higher transfers from the Center under the 14th Financial Commission – an outcome that we had sadly foreseen in 2015 by examining the state budgets (see “India: making sense of fiscal policy this year”, April 29, 2015,).

So, advocates of a relaxed Fiscal Responsibility and Budget Management mandate for India should be careful. They may be opening a can of worms, undermining India macro stability. India may end up, if it is not watchful, with loose credit conditions, low deposit rates, high fiscal deficit (combined) and low fiscal credibility.

This blogger, therefore, keenly awaits the release of the FRBM framework report next month.

[postscript: There is a lot of excitement about the report of the All India Manufacturers’ Organisation on the job losses in various sectors in the first one month of the demonetisation. That report, based on a survey done in the first month of the currency swap, has suddenly been widely  publicised in the media in recent days. See here, here and here. I called them up. They said that the situation looked less dire now than it did after the first thirty days. Their more comprehensive report is due in the next few days. They have promised to send me a copy. That too is keenly awaited.]


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