The rein of cash continues as was discussed in this space earlier. More than 15.5 percent of GDP, and more than 31 percent of M3 is hard currency. A more granular review of deposits over the last fifteen years demonstrates how the composition of bank deposits has been changing, with the government and public sector entities making up an increasingly larger share of banking deposits, particularly in comparison to private sector deposits.
As arbitrary policy decisions, such as tax on cash withdrawals, increasingly onerous documentation requirements, and a clampdown on retail and wholesale businesses discouraged private sector to be a part of the formal financial system, the banking deposits that could be attributed to private sector started gradually declining on a relative basis. Considering the increasing scrutiny, private sector started keeping cash out of the system which is demonstrated by an increasing cash to GDP ratio over the last five years.
Total deposits during the last 15 years have increased by 7.7x, while government and public sector deposits have increased by 8.8x. Meanwhile, private sector deposits have increased by only 5.5x. The ratio of deposits held by the government, and public sector entities, with private sector entities was at 62 percent in January 2005. By September 2020, the same has increased to 99.6 percent, after reaching a peak of 113 percent in May 2020. It shows that as the overall economy and money supply increased, the share of sovereign and associated entities increased at a much faster rate than the private sector’s, with the latter preferring to keep its cash out of the system. In a nutshell, total sovereign deposits (including public sector entities) in the system are as much as private sector deposits.
There exists near perfect correlation between cash as percentage of GDP, and the ratio of sovereign deposits to private sector deposits. This also demonstrates that an increasing number of businesses avoided corporatization, largely due to documentation and taxation requirements. Such businesses either preferred to stay out of the system, or remain in the ‘self-employed’ category. The lack of incentives has also contributed to this trend.
The sovereign crowded out private sector credit by becoming the largest borrower, while in the case of deposits it crowded out private sector deposits through unintended consequences of myopic policy decisions which bridged a fiscal deficit, but created a structural problem for years to come. A dismal savings rate is a direct consequence of policies where the perceived benefits of keeping cash out of the system are much higher than keeping cash in the system. A string of amnesty schemes over the years has also set a precedence that one can always legitimize their cash holdings every once in a while.
Cash is a drag on the economy. It takes capital away from long-tailed productive enterprise, while avoiding the potential leverage and multiplier effect that can be generated through the financial system. The economy needs to go beyond Level-0 mobile accounts, and create an incentive structure which encourages people and businesses to participate in the formal financial system, rather than staying in the grey.
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