PremiumDespite the recent spate of deposit rate hikes by banks, the real return on deposits or inflation-adjusted return is still in the negative territory, indicating how runaway price rises impact domestic savers.
Inflation as measured by the consumer price index (CPI) came in at 7.04% in May, the fifth straight month above the Reserve Bank of India’s (RBI) flexible target of 2-6%. Meanwhile, State Bank of India’s (SBI) one-two year fixed deposit -- typically used as a proxy for bank deposits -- offers a return of 5.3%, pushing the real rate or the inflation-adjusted return to -1.74%.
Going by RBI’s internal projections, CPI is expected to stay above the central bank’s target range of 2-6% for three quarters of the current financial year, which could further curtail real returns on deposits, unless banks substantially hike deposit rates. To be sure, the inflation projection of the monetary policy committee (MPC) of the central bank -- at 6.7% in FY23 – does not take into account the repo rate hike of 50 basis points (bps) on 8 June.
Lenders like State Bank of India (SBI), Bank of Baroda (BoB), IDBI Bank and HDFC Bank have recently raised deposit rates, albeit in a few maturity buckets. Experts said that had it not been for the abundance of liquidity in the system, banks would have raised deposits rates much more. In fact, whatever deposit rate increases have been done are quite marginal in nature and nowhere close to the 90-basis point hike we have seen in the repo rate.
“These rate hikes are also not across the board and just over a few maturity brackets as banks require funds in specific tenors to match assets being created," said Madan Sabnavis, chief economist, Bank of Baroda.
Historically, a 100-basis point hike in repo rate leads to a 50-bps increase in deposit rates; for lending rates it is used 75-80 basis points under marginal cost of funds-based lending rate (MCLR) regime until 2020. Since October 2020, RBI mandated banks to link all new floating rate retail loans to external benchmarks and because most lenders chose to use the repo rate, transmission of lending rate hikes is immediate.
“The rising interest rate scenario is beneficial to depositors to the extent that earlier they were getting nothing, but now they are getting something. However, unless the market dynamics change, there is a huge push for lending and the system liquidity gets eroded significantly, deposit rate hikes will not be commensurate with lending rate hikes. Thus, depositors will still get negative returns," said Sabnavis.
Surplus liquidity, as reflected in average daily absorption under the liquidity adjustment facility (LAF) stood at ₹5.5 trillion between 4 May to 31 May, lower than ₹7.4 trillion during 8 April to 3 May, RBI governor Shaktikanta Das said on 8 June.
CareEdge Ratings said on 13 June that the banking system has been sustaining a liquidity surplus since June 2019 as bank deposits were growing faster than the pace of credit disbursement, except for the last couple of fortnights. That said, flow of deposits into the banking system have not been affected by negative real returns. As on 3 June, total deposits in the system stood at ₹167.33 trillion, up 9.27% from the same period last year.
“Transmission of policy rates is typically faster in a rising interest rate cycle. The real rate will also be a function of of how inflation evolves. The assumption is that inflation has near-peaked, even though it will remain high, across the world, and in India as well," said Madhavi Arora, lead economist, Emkay Global Financial Services.
Arora said that it would remain challenging for the central bank to get back to a positive real rate territory, which has not been seen in a long time. That said, savers are always at the receiving end on that front and this imbalance would be a long-drawn process.
“While both lending and deposit rates will increase as the policy rates go up, banks would like to keep a higher margin. Therefore, lending rates would go higher than deposits," said Arora.
