A Credit-Deposit Mismatch Is Holding Back India

Throughout the summer, India’s growth has been hindered by a credit-deposit growth mismatch, which has anchored down India’s banks’ earnings. At its core, credit growth represents the demand for loans. When credit growth accelerates faster than deposits, the economy faces (1) higher borrowing costs as banks need to borrow just to lend, which reduces margins across the economy, and (2) increased risk as loan growth becomes excessively reliant on more loans rather than real deposits.

Several factors contribute to this trend. The RBI does not mandate a specific credit-deposit ratio, only recommending a target of 70-80 percent. Additionally, the gap between credit and deposit growth could be due to the currency in circulation and RBI intervention in the FX market, with the central bank buying rupees to maintain competitiveness. The budget’s emphasis on infrastructure spending, alongside financial boosts for small states and farmers, has further fueled loan demand.

Why aren’t deposits growing as fast? One issue is the government’s aggressive taxation of savers, with the proceeds kept out of the financial system. Lenders are under pressure from the finance ministry to conduct "special drives" to raise deposits, while also being constrained by the 2024 Budget’s requirements to hold more cash and government securities. Banks, like HDFC, have even resorted to limiting credit growth by selling billions in advances, such as HDFC’s recent sale of $1.2 billion to manage loan ratios.

Beyond government policies, the RBI has also contributed to the slowdown by restricting money supply growth. RBI liabilities show that the money supply grew by 7.4 percent year-over-year in June, compared to a 9.7 percent increase in GNP. Last month, money growth slowed further to 4 percent.

The stock market is also vacuuming money away from banks. Blue-collar workers, who would typically deposit excess cash in banks, are now investing in the market instead. Deposits provide low-cost funding, but the millions of Indians moving their money into the stock market could hinder efforts to meet the 7+ percent growth target.

Why the shift to the stock market? Savings accounts offer an average return of 2.5 percent, while CDs provide up to 6.5 percent with long-term commitments. Meanwhile, the stock market has risen 26 percent in the past year. There are now 198 million mutual fund accounts, with retail investors owning 60 percent of all fund assets. Economists see further growth potential here, as Indian household savings in non-banks remain lower than in other Asian countries like Korea and Taiwan, which could sustain slow deposit growth.

To address this, Finance Minister Sitharaman and RBI Governor Das have called on banks to find ways to boost deposits, particularly to manage liquidity concerns.