By Andy Mukherjee
Among the many theories being advanced to explain a shortage of currency in parts of India, a rotten-to-the-core banking system is the one hypothesis nobody wants to talk about.
ATMs have run out of cash in a number of Indian states. Yes, farmers need to be paid for harvests; and next month's elections in Karnataka state will have to be fought by spending banknotes. The central bank has spoken about some areas "witnessing unusually large" withdrawals. And as always happens in these situations, news that there's a deficit somewhere could be prompting people even in unaffected areas to take more money out of their accounts than they need to.
It's speculated that Rs 2,000 notes — the highest denomination — are being hoarded. Banks, meanwhile, have been slow to calibrate cash machines to handle the new Rs 200 bill.
Then there's a possible demonetization effect.
Even as late as September, banknotes in circulation amounted to Rs 16 trillion ($242 billion), or about Rs 3 trillion less than what the economy would have needed if an abrupt ban on most of the currency circulating in November 2016 hadn't interrupted the trend growth of cash use, according to Nomura Research.
Since September, though, that gap has halved, suggesting that the shift in people's preferences to digital payments may have been temporary. By believing in their own "less-cash society" propaganda, the authorities may have supplied smaller amounts of currency than people actually wanted. Now they're scrambling to keep up.
Whatever the reason, there's something unusual going on. Typically, no more than 12 to 13 percent of banknotes in circulation leave the system via ATMs in February. This year, 14.1 percent was withdrawn. And even this could be understating true demand for cash if many ATMs stop working altogether, according to an analysis by Roshan Kishore in Hindustan Times. What if, on top of other reasons, Indians are turning to cash because of "overblown fears about the stability of the banking system," as an editorial in Livemint speculated?
This is a disturbing possibility. Already, the banking system is crippled by $210 billion in bad loans. A $2 billion fraud at Punjab National Bank, a truncated tenure — at the regulator's insistence — for Shikha Sharma, the CEO of Axis Bank Ltd., and a preliminary inquiry by government sleuths into the spouse of ICICI Bank Ltd.'s boss Chanda Kochhar could also be sapping confidence.
Economists, including those at Goldman Sachs Group Inc., are pruning their GDP growth forecasts for India, acknowledging that the banking mess runs deeper than they previously thought, according to a Bloomberg News report by Anirban Nag on Monday. Fearing that their lending decisions could get them into trouble, bankers are shunning corporate credit: Small-ticket loans to individuals may have accounted for 96 percent of all the increase in India's non-farm credit in the fiscal year that ended in March.
That being the case, it's not unreasonable to assume that depositors' trust may also have taken a knock.
Problems in a banking system usually begin on the asset side of the books; they only snowball when the liability side is affected. All Indian banks have the cushion of implicit state support. Without that, though, they're vulnerable: 18 out of 35 have seen their default risk worsen since the start of the year, according to a proprietary Bloomberg monitor.
Even if depositors' concerns are overstated, they need to be addressed. Lubricating dry ATMs with newly printed cash is a Band-Aid. Boosting the integrity of a system riven with fraud and malpractice and laden with bad loans will require deeper surgery.
(This column does not necessarily reflect the opinion of economictimes.com, Bloomberg LP and its owners)