A professionally administered National Sovereign Fund may prove to be a socialist mechanism for redistributing in favour of those lower down
According to the 20thSeptember 2017 ‘Financial Stability Report’ published by the Bank of Mauritius (BoM), the Bank and Government had mopped up excess rupee liquidity from financial institutions amounting to Rs 64.5 billion as of 28th April 2017. This means that these were surplus unemployed rupee funds lying with commercial banks and other financial institutions.
The BoM itself picked up Rs 46 billion of the surplus funds by issuing its own securities and taking Special Deposits from the private institutions while Government contributed by mopping up excess liquidity on the market to the tune of Rs 18.5 billion by issuing Treasury Bills. The amount raised by both has to be remunerated at appropriate interest rates. This mechanism implies that excess surplus liquidity arising in the financial system commands a price to be paid for by the public sector.
How the surplus liquidity arises
Deposit-taking financial institutions employ the deposits they collect from customers to grant credit to the private sector and to keep the balance after this into cash for meeting day-to-day transactions and/or for investing any surplus still remaining in their hands into available Government securities.
The bulk of deposits collected by financial institutions (mostly commercial banks) is employed to grant credit to the private sector. In 2006, commercial banks had raised total deposits amounting to Rs 135.2 billion and had used them to the extent of Rs 119.5 billion to make loans to the private sector (also called credit). Thus, banks had employed 88.4% of deposits in that year to grant credit to the private sector. In 2011, this ratio had gone up to 97.1%, indicating an intense use of deposits raised by banks for supplying credit to the private sector. But by 2017, bank loans granted to the private sector (Rs 290.1 billion), albeit higher, accounted for only 80.7% of the deposits raised (Rs 359.5 billion) by them from the public.
This indicates that there has been a decelerating trend of use of deposits for providing credit to the private sector as from 2013.The effect of this deceleration in the rate of growth of private sector borrowing from financial institutions has brought about an increasing level of surplus rupee liquidity on the domestic market. But surplus excess liquidity in the system was here even as from 2006 on a small scale; the fact is that in past years, its pace increased, explains the surplus liquidity of Rs 64.5 billion that the BoM and Government have had to mop up from the system by April 2017.
Surplus rupee liquidity also comes into the system from foreign exchange inflows, such as from inflows of Foreign Direct Investment (FDI) going into real estate purchases. As we know, ever increasing amounts of such inflows have come in to support an otherwise structurally weak external Balance of Payments of the country over a number of years. Part of the amount of FDI converted into rupees does the same thing: it goes into the domestic financial system to swell up deposits or as repayment of existing credit from financial institutions, or both. Deposits at banks increase; credit goes down.
Slow pace of growth of private sector credit
We must therefore ask the question as to why growth of credit to the private sector has not kept pace with the rate of growth of deposits, with the result that financial institutions have accumulated such large amounts of excess liquidity, which shows no signs abating? With the consequence that the BoM and Government may have to take up more of it from financial institutions in days to come.
There have been financial consequences due to this for both the BoM and Government. The interest paid on the securities issued to mop up excess liquidity has resulted in the BoM having to pay Rs 1.4 billion by way of interest on excess liquidity mopped up from the market in 2016. The Government acquired a little more than a third of the excess liquidity on the market, so it would have paid less by way of interest but that would still represent a significant charge against tax paid by the public.
Data show that the economy which was growing at a rate of around 5% pa until 2010 saw its pace of growth slow down subsequently to not more than 4% pa until 2017. Normally, a high rate of economic growth is accompanied by a fast-paced demand for credit. Thus, bank credit to the private sector increased by 18.6% in 2008 when the economy grew by 5.3%. In 2016, by contrast, bank credit increased by only 3.1% and GDP by 3.6%.
The slower pace of growth of the economy may not explain fully the accumulation of excess liquidity in financial institutions of the country over past years. Where deals are done on a cash basis, such as in most FDI-supported real estate activity, there is less need to obtain credit from banks. Also, when businesses which have to borrow in order to support their stocks-in-trade for exports phase down, the demand for credit slows down concurrently. This is what has been happening. Many big corporations have been “deleveraging” from financial institutions, i.e., paying back existing borrowings.
Banks are faced otherwise with debt default on an increasing scale. From 4.9% of total advances in December 2014, banks’ non-performing advances (with a high risk of not being repaid) have shot up to 7.8% in December 2016 with Rs 46 billion of such advances at the latter date. Prudence guides them therefore not to lend in excess of borrowers’ perceived capacity to repay or not to have to hit their P&L bottom line by persisting and ending up having to make additional provisions for bad debts.
In December 2016, banks’ credit to the private sector showed a contraction by -0.2% over the level a year earlier. One would have wished an expansion of bank credit to bring down the excess liquidity they already have. But this is not happening.
This should help establish that, given the amount of deposits being generated in the economy, there was and still is a need to diversify the economy into sectors of activity which have a greater demand for credit. This has not been forthcoming. Policy makers and market operators may have to bring into place more activities in the economy which have a sustained safe demand for credit. Directed fiscal stimulus based on international market research and more proactive lending by financial operators could turn the situation around, not interest rate reductions which haven’t evoked a positive response since long.
Other than firefighting by going on mopping up excess liquidity, there could be good reasons for the authorities to shift gear. They might think of employing the surplus funds by investing them into guided and safe high yielding international professionally managed portfolios of investments. In turn, such an approach could result in shifting the burden of adjustment from depositors, by offering them ever lower deposit rates, to passing on surplus funds generated by the system into a National Sovereign Fund investing wisely in foreign assets with the aim of redistributing eventual gains in favour of savers.
A professionally administered National Sovereign Fund may prove to be a socialist mechanism for redistributing in favour of those lower down, if it also earmarks specific additional revenue collections for international investment in it. Taxing unequal wealth distribution, for example, proportionately but fairly, without breaking the mainsprings of investor confidence, may also increase the value of such a sovereign fund and painlessly correct an imbalance that has been tilted for far too long against the lower and middle classes.
* Published in print edition on 6 October 2017