We have seen a correction of more than 10 per cent in the stock market in India in the last four months. However, overall, in the last 4-5 years, there has been a big pull factor in the stock market. There has also been a long-term pull of the debt and liquid funds that are available.
But the story does not end there. There is also a somewhat ongoing push factor from banks. It is interesting that both the pull-factor and the push factor are, in part, policy-induced. And, it all contributes to the making of a K-shaped economy; some parts of the economy grow fast while the growth rate for others comes down.
It is all not just about shifting asset preferences. The overall high returns in the stock market over the last few years are partly cyclical and overdone but there is more to the story. The economic policies have favoured the corporations and the stock market.
These policies include, inter alia, reduction in the corporate tax rate, higher tariff and non-tariff barriers that protect the domestic industry, and considerable public spending which tends to favour the corporate sector rather than the small businesses.
Stock market pull
The pull of the stock market is “naturally” strong. Consider next the push factor from banks. With more than 5 per cent inflation, the real returns on savings accounts are less than minus 1-2 per cent. The real returns on current accounts are less than minus 5 per cent in India!
The real interest rates on fixed deposits are better but only relatively so. The post-tax returns become unpalatable — more so as the tax is imposed on the entire nominal gains, and not just on the real gains.
Even after accounting for the “free” services that banks provide, the post-tax and inflation-adjusted returns are extremely low. An important reason for the low returns on money in banks is that the public sector banks (PSBs) are often inefficient. Though their non-performing assets (NPAs) seem to be under control in the last few years, the long-term record is very different.
In any case, their long-term operational costs are high. And, even though they get recapitalised now and then, they charge high interest from borrowers and pay low interest on deposits.
Given this “competition” from PSBs, and hardly any new licenses for new banks, the existing private banks are complacent but they are relatively efficient. However, the benefit of this relative efficiency is passed on mainly as sustained high profits; that benefit hardly goes to depositors of the private banks (or their borrowers)! This is true even after adjusting for the relatively better services.
So, there is a push factor for depositors even from private banks. This operates alongside the pull factor from the stock market.
Low deposit growth
Consequently, the rate of growth of new bank deposits is well below the rate of growth of fund inflows into the stock market. Given the relatively low growth of deposits, the long-term growth rate of bank credit is, in the final analysis, relatively low — in the banking sector as a whole. This does not affect big businesses much; in fact, the push factor and the pull factor makes financing easier for them.
But the micro, small and medium enterprises (MSMEs) are affected. The relatively low credit from banks to MSMEs affects their business as well as their employment. There is also an adverse effect of low credit on consumption smoothing, housing finance, student loans, farm loans, etc; all this is particularly true as the less well-off get less loans.
Ironically, the PSBs are an important part of the problem in banking — more so as they are the reason for “profits on a platter” for the private banks and even non-bank finance companies. This is not a statement on the bankers involved. But the PSBs do need to be privatised.
Of course, the privatisation needs to be at the right price, and to the right buyers. Also, the sale proceeds need to be reinvested and not consumed.
Finally, the “social regulation” (besides the prudential regulation) of banks needs to be improved. All this can reduce the push factor. The push factor from banks is also because banks need to invest at least 18 per cent of their deposits in approved (read, government) securities under the statutory liquidity “regulation” (SLR). The return on these securities is significantly less than that on bank loans.
Also, banks need to observe a 4 per cent cash reserve ratio (CRR). The return on these reserves is zero! Accordingly, returns for depositors get reduced and interest costs for borrowers get higher.
Some observers feel that the shift from bank deposits to the stock market will not last long, given the high valuations in, say, the Nifty 50 and other indices. But it is all relative. The future returns on stocks can get lower but they may still beat the returns on bank deposits in the long term and even the medium term; this is particularly true after considering taxation.
This is not defending valuations in the stock market; it is highlighting the far-reaching implications of the policy towards banking.
Overall, we need several changes in policy. The bias in, among others, taxation, trade policy, and public spending that favours of the corporate sector needs to go.
The taxes that work against bank deposits need to be amended. PSBs need to be privatised appropriately. Bank licensing needs to be liberalised gradually. Charges for services that banks provide need to be explicit.
The high CRR and SLR need to be phased out. Changes have been suggested here for some policies that have come up after a change in the central government in 2014, and for some policies that have been around for a long time. These policy changes will pave the way to reducing both the pull of the stock market and the push from banks. This will, in turn, contribute to reducing the tendency towards a K-shaped economy.
The writer is an independent economist. He taught previously at Ashoka University, ISI (Delhi) and JNU