Merely having the surplus liquid funds to support additional investments is not enough. More important is for governments to induce additional real investments which will also use up the surplus savings into productive activities
Data published by the Bank of Mauritius (BoM) show that at the end of June 2016, the public had placed rupee deposits amounting to Rs335.6 billion with commercial banks. The banks had employed money raised from the deposits to lend up to Rs 283.8 billion to the private sector. This gives a healthy rupee credit/deposit ratio of above 84%. However, five years earlier, end-June 2012, the credit/deposit ratio was much higher at over 96%, i.e., there was a higher rate of utilisation of deposits for bank lending.
The drop from 96% in 2012 to 84% in 2016 in the credit/deposit ratio reflects a slowdown of the rate of credit pickup by the private sector. Thus, while bank credit to the private sector increased by 12.7% pa on average in the five years up to 2011, the rate of increase was only 5.6% on average the last five years to end-June 2016. The situation reflects economic slowdown and under-utilisation of available liquidity to advance the economy.
As a result of this slower pace of credit growth in the economy, banks have kept accumulating on their balance sheets ever larger surplus rupee funds from the deposits they collect. They have to employ this surplus in other financial instruments such as securities of the government. Since the periodic offer of government securities is much less than the amount banks (and others) would wish to invest in them, competitive bidding for the securities tends to bring down the overall yield to investors.
It is not only banks but also other investors of surplus funds, such as pension funds, which earn less by way of interest income on their investments due to this process of continuously falling interest rates on government securities. That includes the National Pensions Fund (NPF), putting at risk its capability to meet pension commitments as the demographic structure undergoes further change. Obviously, an institution like the NPF cannot recklessly invest in higher-yielding dubious investment instruments to compensate itself for the prevailing low interest rates on the local market.
Thus, while corporates which borrow will be advantaged by falling interest rates for having lower debt servicing, the saving public and institutions like the NPF which provide pension benefits lose out their ability to meet future pension commitments in the prevailing situation. It is important to consider this dimension of social management.
The best thing would have been to curtail the amount of surplus funds available for investment in securities. This would have avoided a situation in which there is always a larger supply of surplus liquid funds bidding to buy up the government securities on offer, thereby continuously depressing the yield on those securities over time. How could this have been done?
In an economy where real investments – both public and private sector — are sustained, lending institutions like commercial banks will employ a good part of deposits and funds mobilized from the public to either give working capital to enterprises or to contribute even to the financing of such investments or both. The stronger the pace of growth of such investments, the less the money available for competitive bidding on available government and other securities. In such a case, interest rates would not have a tendency to keep declining. In the process, surplus funds will come to be used up to support productive activity.
The slower pace of growth of private sector credit at commercial banks in the more recent years (2013-14: +3.6%; 2014-15: +2.7%; 2015-16: +3.1%) as compared with its pace of growth in earlier years (2012-13: +8.0%; 2011-12: +10.7%; 2010-11: +8.3%), reflects a situation of slow pace of growth of real investment in the economy. This is why falling key interest rates in the country in past years have kept reducing returns on savings of the public, by fostering an ever present increasing pool of surplus liquidity in the system.
The higher rate of real investment – which has been eluding us for quite some time — will come if we produce goods and services for which there is sustained demand both internally and from external markets. As a result, surplus funds will get employed to support such activities. In the event, the interest rate will not keep falling as it has been the case. Falling interest rates show that we have not been up to the task to bring up newer activities and an adequate amount of real investments in the economy, to use up available surplus funds from our savings.
It is the reason why central bankers have long been giving wake-up calls to fiscal authorities to do the needful. It is for the latter to create the additional scope needed to increase domestic economic activity and to induce the accompanying absorption of available surplus funds into newer real investments. It is they who have the power to create an environment in which productive investments can be triggered. Merely having the surplus liquid funds to support additional investments is not enough. More important is for governments to induce additional real investments which will also use up the surplus savings into productive activities.