Holy cow: Narrow money growth of 1.9% yoy in Nov lower than even during the depth of the Lehman crisis

Consumption spending in India has now slowed to a trickle.

RBS noted:

Both 'currency held by the public' and non-interest bearing demand deposits, the two main components of M1, underlie this slowdown.

This is an important development as it tells a lot about the state of the economy and household behaviour. Currency held by the public is a robust measure of transactions activity in cash based economies like India and corroborates well with other variables like auto sales.

What explains this? Two things - the first is that real deposit rates had been steeply negative until recently encouraging households to front load consumption as well as in accumulation of assets like gold and real estate. Cash tends to play a big role in transaction these types of assets in India. Second, income growth has also slowed thereby restraining household spending.

The most important implication is that consumption spending in India has now slowed to a trickle. In the national accounts, consumption spending had already been slowing but nonetheless, was still the main support to growth. It would also imply that the massive surge in gold purchases has come to an end and therefore, the trade deficit will ease to more manageable levels in the coming months.

Closely associated with this development is a steep fall in demand deposits. Typically, demand deposit growth is coincidental with economic activity and investment in risk assets like equities. The fall in demand deposits has been accompanied by a commensurate rise in time deposits, again an outcome of steeply higher deposit rates.

This rise in time deposits will have a bearing on the transmission of monetary policy and funding costs of banks. As time deposits are by definition locked in for a period of time, lower policy rates will become effective only in the mid to late stages of the tightening cycle. The RBI will therefore, need to ease monetary conditions aggressively and those hoping that rate cuts will an immediate effect on growth are likely to be disappointed.

The easing cycle should start from this month (January 24). It however, needs to be borne in mind that the first point of attack should be a reduction in the cash reserve ratio. Inflation, though on a steady decline, is unlikely to be in the comfort zone of the RBI by then.

Reserve requirement reductions will also reduce the systemic liquidity deficit in the banking system. Banks have been running a daily deficit of over INR1trn per day for sometime now. This reduction will also augment the intervention capacity of the RBI. FX intervention tends to worsens domestic liquidity.