The Reserve Bank of India (RBI) recently circulated a discussion paper on deregulation of savings deposit rate. With all other deregulated deposit rates fetching much higher returns than a savings deposit due to regular upward revision by banks, a discussion on the need to deregulate savings deposit rates is very timely. The savings deposits rate remained at 3.5% since 1 March 2003 for more than eight years till early this month when RBI revised it to 4%.
Indian retail investors have long been keeping their hard-earned savings in banks. As per the RBI discussion paper, as on 31 March 2009, banks held close to Rs 9 trillion in the form of savings deposit, out of the total deposits base of Rs 37 trillion. This amounted to at least 25% of all deposits in the banking system. As such savings deposit rate has a considerable impact on the returns that small investors earn on their savings. One would recall that during 1999-2003 interest rate in India fell very sharply with 10-year government bond yield falling to below 5% from a high of 12% in 1999.
All other deposit rates in India are currently completely deregulated and banks are free to determine their own rates except the savings deposit rate. Since 2003, interest rates generally witnessed a rising trend till late 2009 when RBI cut interest rates aggressively in response to the global financial crisis, with the objective to revive economic growth. That objective having been achieved over the last one year, to moderate inflationary expectations, RBI hiked policy rates several times. In the last one year, one-year bank certificates of deposit rates have moved up by close to 4%—from 6% to 10% now. With inflation remaining close to 10% in the last one year and within that food inflation remaining still higher, savings deposit rate have resulted in negative returns to small investors.
The benefits likely to accrue to small depositors after deregulation are easy to understand. With India set to allow new private sector banks shortly, the race to capture a larger share of the lucrative small deposits is only going to intensify with the obvious benefit coming by way of more competitive (and hopefully positive real rate) returns to retail savers.
As per RBI’s discussion paper, the share of currency in household financial assets in 2008-09 was 12.5%, almost the same as that of savings deposits at 12.8%. With the Indian gross domestic product expected to grow at above 8% in the coming years, a significant amount of capital investments is required. A more attractive savings deposit rate has the potential to introduce a much larger portion of households to the banking system and gradually to transit them into the broader financial markets and thereby provide the much-needed financial resources to the banking sector.
Similarly, a market-oriented rate will reduce the pressure on government-administered small savings instruments and bring more capital to free markets. There are apprehensions that a large-scale shift to savings deposit may shorten the maturity structure of the banking system and thus restrict its ability to fund long-term requirements of various industries. Those apprehensions may prove unfounded if entry of new depositors results in accelerated growth and broadening of the banking system.
There are also apprehensions that few banks, particularly the larger ones with extensive network, may not offer the best rates to smaller investors. That can be addressed by keeping a minimum rate in place in the first phase of deregulation.
Also, differentiation can be made on the basis of the amount of deposit by introducing a dual-rate concept and thereby address the concern of the banks on the cost of servicing smaller denomination deposits. On the flip side, there are concerns that this may lead to unhealthy competition among banks in a deregulated environment. It may be noted that similar concerns were expressed even when term deposit rates were deregulated in 1997. However, experience suggests otherwise. The banking sector has grown at a tremendous pace since then and retail depositors have also benefited.
The experience has been similar in other sectors such as telecom, aviation and importing and retailing of consumer goods, where the outcome has been explosive growth for the industry and lower cost with better quality for the consumer.
Thus it can be concluded that deregulation of savings deposit rate will result in higher returns for small depositors, broadening of the banking system and higher availability of capital for industries. At the same time, this needs to be done with caution and in a gradual manner. As a first step, deregulation can start with a dual-rate system based on the amount of deposit and with a minimum stipulated rate.
Mahendra Jajoo is executive director and chief investment officer, fixed income, Pramerica Asset Managers.