In the last three to four years, many people in India have migrated from bank savings to mutual funds. This manifested itself as an increase in mutual fund assets under management (AUM), but not as a decline in the level of bank deposits. This is because deposits simply move from the bank customer’s account to the mutual fund’s bank account, and from there to other bank accounts. This process continues.
The total amount of bank deposits will be maintained. Even if demand decreases in this situation, these should not decrease. This has become a familiar story. While the above description serves as a starting point, it is not the complete story. And given its incompleteness, this story may even be misleading. It is important to complete the story.
There’s some really interesting economics and data here. In the case under consideration, the sediment level does not decrease, but the sediment level is on the sediment time path, and the time path can be relatively flat. In other words, the rate of deposit growth may decline.
Additionally, if inflation is higher than previously, inflation-adjusted deposit growth could decline further. But how could this happen?
change in taste
Changes in asset preferences have resulted in a surplus of deposits relative to demand. Second, note that bank deposits are, by definition, part of the money in circulation. This means that there is surplus money in the economy. This is what economists call excess endogenous money. It comes from within the economy. It is not issued or induced by a central bank.
However, like an increase in exogenous money, endogenously created excess money can also lead to inflation in the absence of intervention. However, it is reasonable to expect the Reserve Bank of India (RBI) to intervene.
how? In the normal course, the RBI keeps increasing its reserves (or base money) from time to time to meet the needs of an economy with rising nominal GDP. However, given the excess money circulating in the economy, the RBI can address the situation by reducing the rate of increase in external reserves.
Given the relationship between reserves issued by the RBI and currency in general circulation, a slowdown in reserve expansion by the RBI could result in a slowdown in the rate of increase in money in circulation in the economy. And since the money in circulation also includes bank deposits, the rate of increase in deposits on the supply side may also slow down.
Let’s get back to the topic here. Even if there is a preference shift away from deposits, existing bank deposits in the economy cannot decline, but additional bank deposits on the supply side will decline more than they would otherwise have. Possibly. This helps adapt to relatively low demand for bank deposits. This is the starting point for our analysis here.
If the RBI appropriately reduces the reserve growth rate and nothing else changes, the story of correction will more or less end there. However, if the RBI does not adequately reduce the rate of reserve growth, there will clearly be excess funds in circulation. And this may actually lead to an increase in inflation to some extent.
inflation rate
Rising inflation rates can tilt the time course of real deposits downward. This change in the flow of real deposits is the second part of the adjustment to the shift in preferences from banks to mutual funds. The first part of the adjustment, as we saw earlier, is the downward slope of the trajectory of nominal deposits. It helps explain in detail how higher inflation occurs. Under the circumstances considered here, there are two possibilities for an increase in inflation.
First, high food prices in the economy can cause excess money in circulation to sustain cost-push inflation.
Second, excess funds can cause higher demand-pull inflation. Consider “too much money chasing too few goods.” Over the past four years, reserve growth has fallen from more than 10% to nearly 5%.
Still, the average inflation rate over the past four to five years has been more than 1 percentage point higher than in previous years. This isn’t the complete story yet. There was yet another very important development. The share of currency in deposits decreased from 17% to 15.1% from October 2022 to September 2024.
In this context, the amount multiplier has increased from 5.2 to 5.6. Therefore, money supply and bank deposits will increase. But everything else wasn’t the same. There was a shift from banks to mutual funds – the main story here. In other words, there were two reactions: an increase in deposit channels due to a decrease in demand for money, and a decrease in deposit channels due to the shift from banks to investment trusts. The result is that overall deposits over time have not actually changed significantly and consistently.
RBI is not responsible for this. It’s just a response to economic conditions. In conclusion, although the level of bank deposits will not fall due to a change in preferences from bank deposits to mutual funds, the trajectory of bank deposits may be adjusted downward in nominal terms and perhaps a little more in real terms. There is sex. Although this adjustment mechanism has worked very well, it has actually been hampered by other changes in the economy, such as the demand for money.
The author is an independent economist and former visiting professor at Ashoka University.
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Published October 4, 2024
