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Indian government's April Fool shocker for small savings schemes
Read more on - Polity | Economy | Schemes | S&T | Environment
- A shock announcement: For the second time in one year, the govt. announced it was cutting interest rates on Senior Citizen Savings Scheme and National Savings Certificate by 90 basis points to 6.5% and 5.9%, respectively. For the Public Provident Fund (PPF), a popular investment and tax-saving avenue, the rate was cut by 70 basis points to 6.4%. (lowest rate since July 1974, at 5.8%)
- Reversal of decision: In a tweet on 01-April, 2021, the finance minister Nirmala Sitharaman reversed this decision and said: “Interest rates of small savings schemes… shall continue to be at the rates which existed in the last quarter of 2020-2021." She attributed it to an 'oversight'. But it's clear that the fact that assembly elections were currently on in several states, forced her to cancel the rate revision.
- General trend: In February 2021, the weighted average interest rates on domestic term deposits of banks was just 5.39%, having dropped by 1.13 % since the beginning of 2020. In parallel, the weighted-average lending rate of banks has gone down by 85 basis points to 9.29% during the same period.
- Lower interest rates are supposed to help both individuals and corporate borrowers, leaving more cash in hand for other economic activities than just repaying a loan.
- At lower interest rates, individuals may borrow and spend more, and corporates borrow and expand, helping the economy grow in the process.
- This is the standard logic given by experts, always.
- But by February 2021, the overall lending to corporates had contracted by 0.24%, showing that borrowing isn’t just about lower interest rates. When it comes to retail lending, the growth was rather subdued in the single digits at 9.55%. (retail lending and personal loans are the most attractive segment for Indian banks now)
- Government's self-interest: The other beneficiary of lower interest rates is the government. In 2020-21, the government had plans to borrow a total of ?12.8 trillion. In 2021-22, it plans to borrow a further ?12.06 trillion. It would love lower interest rates. But are borrowers the only part of this story? No, there are savers on the other side as well, and lower interest rates hit them hard.
- Savers: The interest rates on offer now are very close to the inflation rate, which was at 5.03% in January. Core inflation (excludes food, fuel and light items) was around 6% in January 2021.
- The real rate of interest (interest rate minus core inflation) on deposits is now in negative territory. And this is without even taking into account the income tax that needs to be paid on interest on deposits.
- A significant section of Indians, e.g. senior citizens, are dependent on interest income to meet their regular expenditure. They have already been hurt by low interest rates, and a cut in interest rates on small savings schemes would have further hurt them.
- When interest rates fall as much as they have since the beginning of 2020, and inflation doesn’t, the senior citizens end up in trouble. The only way out being to cut down on their expenditure. This impacts consumption and, in turn, economic growth.
- Indians don't prefer stocks: Most Indians save by investing in fixed deposits, small savings schemes, provident and pension funds and life insurance. In 2019-20, 84.24% of the household financial savings were made in these. Investment in shares and debentures (which includes mutual funds), despite all the hype, formed a minuscule 3.39% of the overall savings. A fall in interest rates negatively impacts a bulk of India’s savers, with the return on their investments coming down. This obviously has an impact on consumption.
- Desperate for returns: Due to low interest rates, some savers have moved their money into the stock market in search of higher returns. They have been successful over 2020, but current valuations are high, and if the bubble bursts, they may lose a lot. A fresh cut in interest rates on small savings schemes would have pushed more investors into stocks, increasing the overall riskiness.
- So what is an ideal level: The Indian banking system is facing a serious problem. Between March 27, 2020, and March 12, 2021, the banks have raised deposits worth ?13.55 trillion, and given out loans worth just ?4.27 trillion (less than a third of the deposits). So banks are unable to lend out a bulk of the deposits raised, so it is natural for the interest rates to fall. The RBI has printed and pumped money into the financial system, driving down interest rates further in order to help the government borrow money at lower rates. So anyone who claims that "lower interest rates are good for the economy", clearly is focused on the borrowers, and not the savers (who are many times more numerous than the borrowers).
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