Impact of ‘rate cut’ on
savers’ interests
Those who have invested their savings with a long term
perspective considering the security and liquidity concerns,
should not be given a shock
The major monetary policy announcement made by Reserve
Bank of India (RBI) on 29 September 2015 is a reduction in the
policy repo rate under the liquidity adjustment facility (LAF) by
50 basis points (bps) to 6.75% from 7.25% with immediate
effect. The measure is widely welcomed by finance ministry,
banks and industrial circles, among others who include
economists of a different school who have all along been
criticising RBI Governor Dr Raghuram Rajan for his stance on
inflation.
The impact of the rate cut on economic growth and the mood
of international rating agencies and other stakeholders
including foreign institutional investors (FIIs) will be analysed
and researched by economists and media in the coming days.
This article attempts to caution savers that their interests are at
stake and perhaps, time has come when they have to be
vigilant about the drain on their resources, which get invested
in various financial instruments brought out by government,
banks and corporate.
This caution comes from a second reading of the
announcement made by finance ministry on the same day RBI
held the bi-monthly monetary policy review to the effect that
government will review the interest rates on small savings,
which ‘banks say, come in the way of lowering interest rates.’
Those who are responsible to pay interest have every right to
review the rates and bring it down to their advantage. But,
those who have invested their savings with a long term
perspective considering the security and liquidity concerns,
should not be given a shock, just because there is a temporary
change in the movement of prices (let us not get into the
controversy about wholesale and consumer price index -WPI or
CPI here).
Some analysts console savers that return on investments have
become ‘positive’ these days with inflation getting tamed. May
be true. However, I am unaware of a single household budget,
which has come down because prices have come down.
Interest rates
At present, interest paid by bigger banks on long term fixed
deposits (FDs) is less than 8% per annum, post office term
deposits earn between 8.40% (3-year term deposits) and 8.80%
(10 year National Savings Certificates-NSC) and public provident
fund (PPF) scheme fetches 8.70% per annum. A revision of
these rates downward will move savers from safe and secure
investments to other riskier avenues, which again will involve a
social cost to the nation in the long run.
Deposit insurance
Here, a word about deposit insurance. The present ceiling of
Rs1 lakh for deposit insurance coverage was fixed ages back. As
there will definitely be migration of savers to smaller banks,
there is a strong case for a review of deposit insurance to
increase the amount covered and, if possible bringing more
institutions which accept deposits from public, under the
umbrella of deposit insurance.
Government borrowings
Even at this stage, when Centre is seriously thinking in terms of
managing government borrowings (public debt) by themselves,
one doubts whether those who argue for and against are aware
that government borrowings (both central and state
governments) are dependent on a captive source? It includes,
investment by banks (statutory liquidity ratio -SLR),
organisations like Life Insurance Corp of India (LIC), Employees’
Provident Fund Organisation (EPFO) and other public sector
undertakings which are guided by several legal obligations and
‘moral suasion’.
The Centre will do well to have a look at the possibility of
leaving the interest rates on government borrowings to market
forces, by increasing the retail investment component in
government securities.
Passing on the benefits of rate cut
The present monetary policy review makes the following
observation:
“In the bi-monthly policy statement of August, the Reserve
Bank indicated that further monetary policy accommodation
will be conditioned by the abating of recent inflationary
pressures, the full monsoon outturn, possible Federal Reserve
actions and greater transmission of its front-loaded past
actions. Since then, inflation has dropped to a nine-month low,
as projected. Despite the monsoon deficiency and its uneven
spatial and temporal distribution, food inflation pressures have
been contained by resolute actions by the government to
manage supply. The disinflation has been broad-based and
inflation excluding food and fuel has also come off its recent
peak in June. The Federal Reserve has postponed policy
normalisation. Markets have transmitted the Reserve Bank’s
past policy actions via commercial paper and corporate bonds,
but banks have done so only to a limited extent. The median
base lending rates of banks have fallen by only about 30 basis
points despite extremely easy liquidity conditions. This is a
fraction of the 75 basis points of the policy rate reduction
during January-June, even after a passage of eight months since
the first rate action by the Reserve Bank. Bank deposit rates
have, however, been reduced significantly, suggesting that
further transmission is possible.”
Some banks, of course, reduced their cost on resources by
reducing deposit rates.
Let us not assume that Dr Rajan conceded a 50bps cut,
perceiving that anyway, this cut may not have much impact on
any of the economic indicators including inflation till end
FY2016. The gesture may put himself in a better position to
bargain with FM on several other issues at a better comfort
level and also silence the economists who accuse him for going
slow on ‘cuts’ for the time being.
Longer intervals for review
At least from Calendar Year 2016, RBI should consider reverting
to quarterly schedule for Monetary Policy Review. There are
enough fora for RBI to share its mind on policy issues between
such reviews and technically, monetary policy measures
including revision of base rates need not always coincide with
such reviews. Lesser frequency of reviews may reduce scope for
external pressures and lobbying also to that extent.
(The writer is a former General Manager, Reserve Bank of India
and author of the 2014 book “Banking, Reforms & Corruption:
Development Issues in 21st Century India".)