Apocalypse in the waiting for small savers

The policy repo rate (i.e. the rate at which banks access funds from RBI against the collateral of government securities) was left unchanged at 6.75 per cent in Governor Rajan’s Monetary Policy Review of December 1, 2015. This should be of some relief to savers who are constantly under threat of lower interest rates on term deposits. To get a better understanding of policy intent, it is necessary draw some inferences of relevance to depositors.

What the Policy portends  for the ensuing period

The policy statement clearly says that the accommodative stance of policy will continue and that policy changes would be data determined. Given the political economy realities and the predilections towards a higher real growth rate, the depositor should interpret this to mean that, in the immediate ensuing period, policy interest rates would remain unchanged or under certain evolving developments be lower. A rise in policy rates in the next few months can be ruled out.

Link between the repo rate, the base lending rate and deposit rate

The RBI has expressed its concern over the slow transmission process between the RBI’s signaling repo rate and the banks’ base lending rate. The RBI’s preference is clearly that banks should move to a marginal costing of funds rather than an average costing. Marginal costing of funds would provide for a faster transmission of policy signals. If banks lower rates for increased credit or for new borrowers, there would be considerable heartburn for existing borrowers. How would all this impinge on depositors? With pressure from RBI to step up the transmission process, the banks could conceivably undertake drastic reductions in term deposit rates. Savers have very little collective bargaining power and would be at the mercy of banks.

How should depositors protect themselves?

Depositors should go in for the highest maturities say up to 3 years (locking in for longer periods, at this stage, is not desirable). This should be the approach for renewals of term deposits as also for fresh deposits. Furthermore, almost all depositors keep savings bank balances, well in excess of their precautionary requirements. Depositors should be vigilant and cut down on excess balances in savings bank accounts.

Government small savings rates

At the present time the government’s small savings rates are higher at 8.7-9.3 per cent, while banks offer 7.5-8.0 per cent. Banks have been clamouring for a reduction in small savings rates as bank deposits are becoming uncompetitive. If past trends provide guidance, the government would not reduce these rates before the February 2016 Budget. Hence, savers should quickly lock themselves in these schemes before the rates are reduced. In particular, senior citizens should lock into the Senior Citizens Savings Scheme.

The provident funds are of a different genre. These funds provide the only social security that the bulk of savers have and it is necessary to ensure that the longer term interest rates of long-term savers is not bartered away  at the altar of the present frenzy of trying to appease borrowers with lower and lower lending rates. Besides, the ground realities are that the Ministry of Finance and the Ministry of Labour will be locked in battle with the Ministry of Labour claiming that the Employees Provident Fund Organisation (EPFO) has sufficient funds to pay a higher rate this year. While this tussle goes on, savers should maximise their contribution to the various provident fund schemes.

Real rates of interest and  the appropriate price indices

It is recognised the world over that savings have to be rewarded in real terms. It is often argued that this real rate should be around 1.5 -2.0 per cent. The intriguing question is which nominal rate of interest and which index should be used and what should be the time period for evaluation i.e. average of one year, 3 years or 5 years. Those arguing for low nominal rates of interest argue that the RBI has erred in using the Consumer Price Index (CPI) saying that food has a weight of around 50 per cent and monetary policy is not the appropriate instrument for tackling food inflation. The standard international index used the world over has been the CPI and now that the RBI has veered round, to using the CPI index, the argumentative Indian would like to say that this is the wrong index! The RBI would do well to persevere with the CPI as the indicator. It is not as if the Wholesale Price Index (WPI) is not monitored. In earlier years, the  emphasise was on the WPI while the CPI was considered a secondary indicator. In the present situation, the RBI would do well to continue to emphasise the CPI and as it already does also look at the WPI (see C.Rangarajan and R.Kannan, Understanding the CPI-WPI Divergence, Hindu Business Line, November 28, 2015).

Warning to savers

It needs to be stressed that savers are going to face an apocalypse in the foreseeable future. They will have to proactively decide how to allocate their meagre savings between different instruments. Increasingly, they will have to move away from fixed return deposits and similar instruments and move to mutual funds and even equity. These instruments are, admittedly, risky but the common person can no longer be completely risk averse. The policies relating to savings have been unfavourable to savers for many years and this could do damage to the fabric of India society. It is worth recalling that many years ago when the authorities went on an insensate interest rates spree, it was Mr. Rajnath Singh who, in 2003,  strongly opposed the reduction  of interest rates for savers and  brought back sanity to the system. (Syndicated)

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