Demonetisation failed even to create bank savings culture

Opinion: Demonetisation failed even to create bank savings culture

It turns out that net financial savings for the fiscal year that ended March 31 were 7.1% of overall disposable income — less than the average for the five years prior


  • It turns out that net financial savings for the fiscal year that ended March 31 were 7.1% of overall disposable income — less than the average for the five years prior to hare on

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Discontinued Indian currency notes of 1,000 denomination are seen after they were deposited by people at a bank in Bengaluru.(AP File Photo)

Updated: Sep 02, 2018 12:15 IST

By Mihir Sharma, Bloomberg

The Indian central bank’s final tally of Prime Minister Narendra Modi’s2016 demonetisation drive, intended to take money derived from tax evasion out of circulation, showed that 99.3% of outlawed high-value banknotes had beenreturned. That’s a severe loss of face for officials, who had argued that holders of the cashwould rather destroy it than return it to banks, providing a windfall for the government.

The authorities managed to produce several other defences of the initiative, however.One in particular was appealing to financial markets: The notion that, in finance minister Arun Jaitley’s words, “demonetisation appears to have led to an acceleration in the financialization of savings.” Households that traditionally kept their savings in cash would now prefer toput the money into other instruments, perhaps even the stock market. This would increase the amount of capital available for companies to deploy andbanks to lend, spurring economic growth.

There certainly were some indicators to support the idea. For one, Life Insurance Corp.of India saw a 142% increasein premium collection in the monthdemonetisation was carried out. And Indian stocks have been on a record-breaking run, even though foreign investors werenet sellers so far this year.

Unfortunately, the Reserve Bank of India punched a hole in that hypothesis, too. Its annual report, as well as tallying the result of demonetisation, provideda breakdown of savings by households, acategory that includes small andunregistered enterprises. It turns out that net financial savings for the fiscal year that ended March 31 were 7.1% of overall disposable income — less than the average for the five years prior to demonetisation.

Worse yet, perhaps, households are keepingfar more of their net savings incash, not less. And their net savings going to banks are almost 50% lower than the five-year average before demonetisation. In other words, the idea that the crackdown would leave banks flush with household savings that they could lend to productive parts of the economy has been comprehensively debunked.

What’sgoing on? Some have argued that lowerinterest rates are the problem. That’s not an easy sell: Over the past year, India was one of the few countries with strongly positive real rates — and savings in bank deposits were a higher fraction of disposable income back in 2012-14, when Indians were dealing with negative real interest rates.

Perhaps, instead, a change inbehaviouris responsible. For most Indians, the defining experience of demonetisation was losing access to their bank accounts: We had to stand in long linesatATMs, and our withdrawals were strictly rationed. In contrast, those who had piles of old banknotes appeared to be able to change them (at a black-market-determined discount)with ease.

What would you learn from this? Would you trust a banking system that can be closed down on a prime minister’s whim? For many Indians, demonetisation provided their first experience of banksor digital payments. I just hope the insanity of the process didn’t put them off formal finance forever.

Still, you might say, at least the markets are doing well. That reflects households’ greater willingness to put their savings in stocks, right? And yes, the RBI data doindeed suggest that.

But look a little closerand things aren’t so bright. One of the reasons domestic institutional investors — who pumped $10 billion into Indian markets so far this year, while foreigners took$280 billion out — are bullish is because they believe a structural change is under way in how Indians save. They think we’re moving permanently away from cash (and gold, and real estate). A turn toward financialization means ever-higher equity prices.

Read: Has demonetisation worsened India’s ‘change’ problem?

The central bank data, however, suggestwe shouldn’t be so sure about that.Theheights being scaled by Indian markets might prove brittle.

Whatever the impact on savings behaviour of demonetisation, it’s clear the initiative was a policy failure, even on the administration’s own terms. I’d like to think a lesson was learned.

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