F
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Loans create deposits, not savings
Investments are necessarily constrained by savings
R
E
NGINES
10 July 2019
F
RIEND
O
F
T
HE
E
CONOMY
According to our
thesis,
India’s investments, and thus, sustainable higher growth, is constrained by the sharp decline in
the gross domestic savings (GDS) led by the household sector. While related arguments are gaining traction in the
mainstream, several pseudo theories have come forward, two of which are gaining momentum. However, with some
basic analysis, these two related pseudo theories can be proved invalid.
Pseudo theory#1 – Loans create deposits, and thus boost savings:
According to this theory, low deposit growth, and thus,
lower savings can be addressed if lenders are able to lend freely. Since all loans automatically lead to deposits, more
credit will address the issue of low savings.
Pseudo theory#2 – Low savings can be addressed by pushing investments higher:
It is also argued that the key to revive
savings in the economy is by pushing investments higher. Since savings and investments move in line with each other,
higher investments will boost savings, and thus, the policymakers should focus on the former than the latter.
Both these theories start with undeniable facts – a tautology, in fact – but end up with grossly incorrect conclusions. In
this note, we prove that while loans create deposits, they don’t impact savings at all. Money creation (via
credit/deposits) must not be confused with loanable funds (savings/investments) theory.
Further, historical evidences prove that while investments and savings move together, as our
“Theory of Everything”
suggests, a pick-up in investments has always outpaced the pick-up in savings. This leads to higher current account deficit
(CAD), and thus, makes the revival in investments unsustainable. Investments, therefore, are necessarily constrained by
savings. And it is always desirable if the revival in savings precedes the investments recovery.
For the past few years, we have
argued
that India’s current model of consumption-
driven growth is highly unsustainable and must be replaced by investment-led
recovery. In order to make a successful transition from consumption to investments,
India’s savings must first rise because a revival in investments without sufficient
savings will create external imbalances. As our thesis is making inroads in the
mainstream, several other pseudo theories have appeared with arguments in total
contrast to our thesis. In this note, we discuss two such related pseudo theories,
which are highly misleading and can be easily proved incorrect after some
explanations.
Theory#1: Loans create deposits, but don’t affect savings
Although higher credit leads
to deposits, it does not
affect savings at all
The first theory argues that low deposit growth could be addressed by pushing
credit higher. After all, when lenders loan out money to a borrower, it instantly
creates deposits. Thus, loans create deposits, and since deposits are counted as
savings, higher deposits should lead to higher savings. Notwithstanding the
massively incorrect conclusion, the simplicity of the theory has definitely gained
some ground. The proponents of this theory, however, are massively confused
between the theory of money creation and the theory of loanable funds. Although
higher credit leads to deposits, it does not affect savings at all. There are only three
borrowers in an economy – household (or individual), a corporate and/or the
government. Let us consider an example and understand why higher
lending/borrowings don’t affect savings.
Nikhil Gupta – Research Analyst
(Nikhil.Gupta@MotilalOswal.com); +91 22 6129 1555
Yaswi Agarwal
– Research Analyst
(Yaswi.Agarwal@motilaloswal.com); +91 22 7193 4196
Investors are advised to refer through important disclosures made at the last page of the Research Report.
Motilal Oswal research is available on
www.motilaloswal.com/Institutional-Equities,
Bloomberg, Thomson Reuters, Factset and S&P Capital.
 Motilal Oswal Financial Services
F
UEL
Individual loans will push
household liabilities up,
along with an equivalent
rise in household gross
financial savings, keeping
household net financial
savings unchanged
R E
NGINES
Firstly,
let’s assume that an individual borrows INR100 from a bank. Then his/her
bank account will be credited with deposits worth INR100 against a liability of
INR100. Given below is the equation/formulae used to estimate household savings
in India:
Household savings = Gross financial savings – Financial liabilities + Physical savings
Thus, household liabilities will rise by INR100, along with an equivalent rise in the
household gross financial savings (GFS). Household net financial savings, therefore,
will remain unchanged. If the individual decides to buy a house using the loan
amount, household physical savings will go up, along with higher liabilities. Overall,
thus, household savings will be unchanged.
Secondly, let’s
assume that the government finances its higher fiscal deficit through
bank borrowings rather than bonds, which is especially true for state governments
rather than the central government. Like in the case of an individual, if a state
government borrows from a bank, the banks’ lending will rise, but so will the
government’s bank deposits against its liabilities towards the banks.
If the government borrows
more from banks, it means
that its fiscal deficit is
higher. The amount of dis-
savings by the government
will be higher to the extent
of higher revenue deficit
Unlike households, the government sector is a dis-saver in the economy. Trends in
the government’s dis-savings track the revenue balance very closely since capital
spending is included under the government’s investments
(Exhibit 1).
If the
government borrows more from banks, it means that its fiscal deficit is higher. The
amount of dis-savings will be higher to the extent of higher revenue deficit. Further,
if the government replaces bonds by bank borrowings, fiscal dis-savings are
unaffected because the government’s deficit remains unchanged. Government
borrowings, thus, are also unaffected by higher bank lending.
Exhibit 2:
Notwithstanding weak corporate lending,
corporate savings have risen in the past few years
Corporate savings
15
10
5
0
(% of GDP)
Corporate lending (RHS)
(% YoY)
35
25
15
5
(5)
Exhibit 1:
Fiscal dis-savings closely track government’s
revenue balance
2
0
(2)
(4)
(6)
(8)
FY98
FY02
FY06
FY10
FY14
FY18
* Combined revenue balance of center and state governments
Government savings
(% of GDP)
Revenue balance*
Corporate sector = Private/public financial/non-financial companies
Source: RBI, Central Statistics office (CSO), CEIC, MoSL
Notwithstanding weak bank
lending to the industrial
sector, corporate savings
have moved higher in the
past few years
Finally, the
corporate sector’s gross savings in India are estimated by adding
retained profits (net profits) and depreciation. It is not clear why higher bank
lending to corporates will push retained earnings and/or depreciation higher. In fact,
despite the weak bank lending to the corporate sector, corporate savings have
moved higher in the past few years
(Exhibit 2).
Corporate savings also, thus, is not
directly linked with higher bank lending.
2
10 July 2019
 Motilal Oswal Financial Services
F
UEL
While high credit/deposits
explain the money creation
theory, it has no effect on
domestic savings
R E
NGINES
Overall, despite the simplicity of the argument, little explanations prove that while
loans create deposits, domestic savings remain unaffected. We show that it doesn’t
matter who borrows – an individual, government and/or corporate – bank deposits
still increase against a rise in liabilities. While higher credit/deposits explain the
money creation theory, it has no effect on domestic savings.
Theory#2: Investments are necessarily constrained by savings
Related to the first theory, it is also argued that the key to revive savings in the
economy is by pushing investments higher. Since savings and investments move in
line with each other, all efforts to boost investments will help savings to recover.
The first part of this theory that savings and investments move together is a
tautology, as we have explained numerous times through our
“Theory of
Everything”.
All domestic investments in an economy are either financed by
domestic savings or through foreign capital. Gross domestic investments, thus, are
equal to the sum of gross domestic savings and current account deficit (CAD) –
not
foreign capital inflows.
Gross domestic investments = Gross domestic savings + current account deficit
Since domestic financing (or savings) accounts for more than 90% of domestic
investments, these two variables move in line with each other
(Exhibit 3).
What
matters is if the pick-up in investments can be financed through domestic savings
without exerting pressure on the external sector.
During both the episodes
(FY04-08 and FY09-12),
while India’s savings picked
up, the revival in
investments outpaced the
recovery in savings
India has witnessed three episodes of a revival in investments – in the 1980s, during
FY04-08 and most recently during FY09-12. Let’s look at the two recent episodes.
Unlike the recent few years, the high-growth phase during FY05-08 (average real
GDP growth of 9.1%) and FY10-12 (average real GDP growth of 8.5%) was almost
entirely led by investments revival. India’s investment rate (as % of GDP) picked up
from 26.8% of GDP in FY04 to its peak of 38.1% of GDP in FY08. Further, after
declining to 34.3% in FY09, India’s investments recovered quickly to 36.6% of GDP in
FY12. During both the episodes, while India’s savings also picked up – from 29% in
FY04 to 36.8% of GDP in FY08 and from 32% in FY09 to 32.3% of GDP in FY12, the
revival in investments outpaced the recovery in savings.
Exhibit 4:
…however, the pick-up in investments has always
outpaced savings
Change in GDS
(% of GDP)
6.9
1.8
5.1
7.8
2.3
2.0
0.3
FY09-12
Change in CAD
11.3
3.5
Change in GCF
Exhibit 3:
Savings and investments, obviously, move
together…
Gross domestic savings
40
35
30
25
20
FY98
FY02
FY06
FY10
FY14
FY18
(% of GDP)
Gross capital formation
FY85-91
FY04-08
Source: CEIC, MoSL
All data analysed is on 2004-05 basis, which is available up to FY13
10 July 2019
3
 Motilal Oswal Financial Services
F
UEL
Almost a third of higher
investments during FY04-08
and over-85% of higher
investments during FY09-12
were financed by CAD (or
foreign capital)
R E
NGINES
As a corollary, a large part of higher investments was directly financed by foreign
capital or current account deficit (CAD). India’s current account moved from a
surplus of 2.3% of GDP in FY04 to a deficit of 1.3% of GDP in FY08 and from a deficit
of 2.3% in FY09 to 4.3% of GDP in FY12. It implies that almost a third of higher
investments during FY04-08 were financed by foreign capital (or CAD), while more
than 85% of higher investments during FY09-12 was supported by CAD. It is, then,
not surprising that the high growth during FY10-12 didn’t sustain for long.
This is nothing new. Even when India’s real growth averaged 6% in the second half
of the 1980s, India’s investments picked up from 19.1% in FY85 to 26% of GDP in
FY91. Again, while domestic savings increased from 17.8% to 22.9%, more than a
quarter of the pick-up in India’s investments was financed by CAD or foreign savings,
which rose from 1.2% to 3% during the corresponding period
(Exhibit 5).
Exhibit 5:
Investment revival in India was always financed by foreign capital (or CAD)
5
4
3
2
1
0
(1)
(2)
(3)
FY82
FY85
FY88
FY91
FY94
FY97
FY00
FY03
FY06
FY09
FY12
FY15
FY18
20
10
0
Source: CEIC, MOSL
(% of GDP)
CAD
Gross investments (RHS)
(% of GDP)
50
40
30
It is highly desirable for the
economy if savings revival
precedes the investments
recovery
Therefore, whenever investments revive, domestic savings also recover.
Nevertheless, since the pick-up in investments always outpaces the pick-up in
savings; investments-led growth creates serious risks of external imbalances by
stretching CAD. We, thus, argue that it is highly desirable for the economy if savings
revival precedes the investments recovery because with CAD already at 2.1% of GDP
in FY19, there is not much scope for investments to be supported by foreign capital.
Please note we are not implying that higher savings will push investments higher.
Like in the early-2000s, there could arise a situation where savings are increasing,
but investments are continuing to lag. If so, real GDP growth will be subdued and
the current account balance will improve. This, we believe, will create the most
sustainable future for the Indian economy.
10 July 2019
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 Motilal Oswal Financial Services
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10 July 2019
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