Inflation ruins India's
Financial Inclusion
India is home to 135 million financially excluded households. Financial Inclusion initiated in 2005, required every household to have access to financial savings and risk services. Although this was one of the objectives for the first and second rounds of the bank and insurance sector nationalizations initiated in 1969 and in 1980, success was limited in view of the prevalence of an unregulated money lending and deposit collection sectors. The redefined aim of financial inclusions was to mitigate rural indebtedness, increase the Credit to GDP (Gross Domestic Product) ratio in the country and bring the figure close to the Asian average
In the initial stages the
Financial Inclusion project showed some elements of success. Banks and
financial institutions reported full inclusion in all the command areas
earmarked to them. This success though was mainly in account opening. Almost
all the Public sector banks opened no frill accounts for citizens in the
regions assigned them.
The inclusion project was
also largely supported by the government's rural welfare programmes National
Rural Employment Guarantee Scheme, where all the wages were disbursed through
bank accounts. Even states were asked to route their payments for social welfare schemes
through banks. The success of the project partly manifested in an
increase the savings to GDP ratio to 37 per cent in 2007-08. House hold savings
alone contributed to about 23 per cent.
The inclusion also supported the government borrowing borrowings. Inclusion pulled down the costs of government borrowings. In 2006, the average yield on the 10 year
yield ranged between 6.9 per cent and 7.42. This was because with accretion in
deposits, banks took to investing in government securities under the mandated
preemption of 25 per cent. With incremental costs of funds from inclusion accounts
at 3 per cent investing in sovereigns was highly profitable for the banking
sector.
Financial Inclusion:
Objectives and Reality
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| The Financially Excluded |
Yet progress achieved in the
financial inclusion project is at best dubious. Credit to GDP ratio in India
was barely 50 per cent in March end 2011. In 2005 it was 40.37 per cent. ( see
Chart 1). If the food credit (Credit provided to state owned agencies for
buffer stock food grain procurement) is included, then it is one per cent
lower. So much for the financial inclusion hype.
Most Indians like to compare
with the Western nations or with China. Credit to
GDP ratios in these regions are far higher, over 100 per cent. Even during peak of the
credit crisis in 2008, when across the world, monetary and fiscal stimulus was
the rule India's credit to GDP ratio remained low at 61 per cent.
The purpose of Financial
Inclusion, despite the lofty aims, were however actually more than increasing the
savings to GDP ratios or just bringing in rural India into the banking network.
Financial inclusion also aimed to bring widen the coverage of savings into
other sectors, capital markets, mutual funds and government securities and ostensibly to improve the returns of rural savers.
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| Chart 1 |
The purpose was partly to sustain the upward momentum in the equity markets and create a floor against foreign outflows. This was expected to be done through creation of domestic institutional investors as a counter weight against foreign institutional investors and insulate domestic financial markets from external shocks. Since banks seldom directly invest into equity markets, most of the funds were routed through mutual funds. Indian banks outstanding investments in mutual funds was a huge Rs 470 billion (US $ 11 billion).
Another hidden agenda in the pursuit of financial inclusion was to suppress borrowing costs for India's private corporate sectors. As rural savings in the banking sector improved, costs of working funds remained low. This was because most funds under the NREG or any welfare programme was in the savings account rather than term accounts. The jargon used by government
and public sector banks is CASA (Current and savings account)accounts. Savings deposits are seen as a long term funds by the bankings and cheap since the effective
interest payout is 3.5 per cent. Inclusion led deposit accretions in turn was helped keep the price of
credit low, after factoring in a net interest margin of 3 per cent.
The objectives also included
creating safety net for India's powerful Information Technology companies who
are completely reliant on western markets for sustenance. A TCS document on
Financial Inclusion said, "Achieving
sustainable financial inclusion
will require a
systemic effort which
leverages technology, regulatory framework and appropriate business
models cohesively!"
Inflation strikes
Financial Inclusion
However, Inflation in 2010
has driven the financial inclusion objectives haywire. Food price inflation in
2010 averaged 13 per cent as measured by the Wholesale price index. If the
consumer price index is factored, inflation impact is far higher abount 4 per
cent more, particularly for rural folk. In some of the wealthy states like
Andhra Pradesh, Karnataka, Punjab and Haryana, the average per capita income is
Rs 140 per day ($3.1). Given the current pace of the food price inflation, the
food and primary articles budget in an average house hold translated into a
little over 60 per cent of the daily income. In 2005 inflation, the food basket
expenditure was less than 40 per cent.
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| Chart 2 |
Per capita income though is
misleading in view of the wide income disparities prevalent. In reality the
actual wages of the majority is about $ 2 a day. That essentially implied high
food price inflation impact was on lesser privileged classes leaving no surpluses
after meeting the basic essentials. Obviously, savings cannot happen at the
cost of meeting more pressing expenditure.
Financial inclusion also
implied credit support to farmers and rural labour. But according to the RBI's
own admission, agriculture growth has actually slowed down to 5.3 per cent since the
beginning of the fiscal 2010-11. In other sectors credit expansion including
real estate remained in double digits for the same period.
For tenant farmers that have never benefited from
the government fiscal largesse of debt forgiveness, reliance remains on the
non-banking lending sector, with no escape from indebtedness. This class of
farmers and rural folk were expected to benefit from cheap credit availability
through financial inclusion.
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| The Financially Included |
The reality however is
damning, particularly for rural landless labour with no access to subsidized lending. The fiscal largesse of the
government did not include the small farmers, instead stayed focused at only
land owning farmers. Small farmers therefore continue to borrow at rates of over 20 per
cent from informal lending institutions, some of whom have morphed into
usurious Self Help Groups/micro finance institutions. Risk averse banks prefer routing funds to
farmers through MFIs, under the guise of priority sector lending.
Quite obviously indebted farmers cannot afford to save. As a result shot gun
accounts opened remain unutilized.
The fallout
With accretions to low cost
deposits substantially decelerating, Indian banks reliance on volatile high
cost funds have increased. In 2006 high cost Certificate of Deposits (CD) contributed
to barely 11 per cent of the incremental working funds. In 2011 March the
figure was 64 per cent.
Chart 3
The obvious impact was on the weighted average cost of
working funds. The cost of working funds for the Banks' have increased upwards
to 8.8 per cent or by 350 basis points since the inception of financial inclusion.
Obviously other financial
sectors have not remained unaffected. Borrowing costs during the period have
increased. Borrowing costs by the government increased 200 basis points
during the period.
As if that was not enough, institutional preference shifted
to shorter tenure securities. This is partly because of the volatile nature of
the CD liabilities. Borrowing costs by private corporates increased by 300
basis points during the period.
Chart 4
The rising costs indicate that credit
availability is beginning to be squeezed. A credit squeeze environment translates
into loss of employment, as investments get deferred. This in turn shows up in
deceleration in savings rates. Gross domestic savings is already down to 32 per
cent.
The option normally would be
to compensate reduced private sector investments with stepped up government
expenditure. Fiscal obsessions any exercise of this option. Without government
expenditure neither rural incomes nor financial inclusion are likely to move
forward. That essentially implies that India's expectations of playing catch China
or with the rest of the world will remain a distant dream for the foreseeable future
if fiscal conservatism is the means.
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References :
2.K C Chakrabarty,
Dy Governor, Reserve Bank of India, Pushing
financial Inclusion issues, SKOCH Summit, 2009
3. Rajdeep Sahrawat, Senior Genl Manager, Tata
Consultancy Services, From Obligation
to Opportunity
