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Home >Opinion >Views >Govt’s April Fool’s joke on small savings schemes would have hurt the economy

The central government just played an April Fool’s joke on a large section of India’s middle class, which invests in small savings schemes.

Late Wednesday evening, the government announced a substantial cut in interest rates on small savings schemes for the three months to June.

The interest rates on Senior Citizen Savings Scheme and National Savings Certificate were cut by 90 basis points to 6.5% and 5.9%, respectively. One basis point is 0.01 percentage point.

When it comes to the Public Provident Fund (PPF), a very popular form of investment and tax-saving among India’s middle class, the interest rate was cut by 70 basis points to 6.4%. This would have been the lowest interest rate on the PPF since July 1974, when the rate was at 5.8%.

In a tweet sent out on Thursday morning, 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."

A simple explanation for this lies in the fact that assembly elections are currently on in several states, and this would have turned voters away from the Bharatiya Janata Party.

Nevertheless, a cut in interest rates on small savings schemes would have been in line with the overall fall in interest rates across the economy, including those on bank deposits. In February 2021, the weighted average interest rates on domestic term deposits of banks stood at 5.39%. The deposit rate has seen a fall of 113 basis points since the beginning of 2020. 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 expected to help both individuals as well as corporate borrowers, leaving more cash in hand for other economic activities than just repaying a loan. Also, at lower interest rates, individuals are expected to borrow and spend more, and corporates are expected to borrow and expand, helping the economy grow in the process.

This is something that corporate leaders, economists, analysts and fund managers have pointed out time and again over the past few years.

As of February 2021, the overall lending to corporates contracted by 0.24%, telling us clearly 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%.

There is the third beneficiary of lower interest rates, and that 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. In this scenario, lower interest rates are going to help the government.

The trouble is that borrowers, who everyone seems to talk about, and who want lower interest rates, are just one side of the equation. There are savers on the other side as well, and lower interest rates are already hurting them. A cut in small savings schemes interest rates would have hurt them further.

The interest rates on offer now are very close to inflation, or the rate of price rise, which was at 5.03% in January. In fact, the rate of core inflation, which excludes food, fuel and light items, stood at close to 6% in January.

Core inflation is more relevant for the middle class. Once we take core inflation into account, the real rate of interest (interest rate minus core inflation) on deposits is in negative territory. And this is without even taking into account the income tax that needs to be paid on interest on deposits.

Clearly, there is a problem here. The irony is that none of the economists, analysts and fund managers are talking about it. While it is difficult to put numbers to it, a section of the population, in particular, 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.

Also, it needs to be remembered that 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 financial instruments. 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. This is something that neither the Reserve Bank of India (RBI) nor the government seems to take into account.

Of course, these things cannot be easily measured. But just because something can’t be measured doesn’t mean it doesn’t have an impact or is not important enough to at least be talked about.

Further, due to low interest rates, a small section of savers has moved their money into the stock market in search of higher returns. They have been successful over the past year. Nevertheless, the current valuations are high, and it is safe to say that stock prices have been in bubble territory for a while now, with too much money having chased stocks over the past year.

A cut in interest rates on small savings schemes would have pushed more investors into stocks, increasing the overall riskiness of the system. As has been the case many times in the past, when stock bubbles (or other bubbles like real estate) have burst, troubles have spilt over to the real economy.

This is not to say that interest rates should be at higher levels. Between March 27, 2020, and March 12, 2021, the banks have raised deposits worth 13.55 trillion. During the same period, they have given out loans worth just 4.27 trillion, which is less than a third of the deposits.

In an environment where banks have been unable to lend out a bulk of the deposits they have raised, 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.

In all this, the savers are getting hurt. That is hurting the economy as well. While there isn’t much that can be done about it, the least we can do is at least talk about it. Trying to project lower interest rates as a panacea for everything isn’t the right way to go about it.

Vivek Kaul is the author of Bad Money.

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