Photo: IStock
Photo: IStock

Opinion | Small savings rates need to be managed for better rate cut transmission

Interest rates on small savings schemes are much higher than what it is supposed to be

We all have top of the mind recall that the tepid growth of the economy requires interest rates to be eased so that money is available relatively easily and pumps up the pace of growth. Most of us are also aware that the Reserve Bank of India has reduced interest rates, i.e., the overnight repo rate that is the signal for interest rates in the economy, by 1.35% since February this year. This quantum of reduction is significant. However, the RBI is bothered that the banks are not passing on the lower interest rate signals to lending rates, which would complete the cycle. This brings us to a conundrum.

In the latest policy review on 4 October 2019, the RBI observed that over the period from February to September 2019, against the reduction of 110 basis points of signal repo rate (till September, before the reduction of 25 bps on 4 October), weighted average deposit rate eased by 4 bps only. Weighted average lending rate on fresh rupee loans eased by 29 bps only and weighted average lending rate on outstanding rupee loans actually went up by 7 bps. Surprised? Earlier, banks had one excuse for not passing on lower interest rates. A gauge called system liquidity, which measures how much on a daily basis banks are surplus or deficient in liquidity, showed that banks are in deficit. That was rectified through an RBI action called open market operations, wherein the RBI purchased significant amount of government securities from banks and imparted liquidity. The RBI having reduced the signal repo rate and imparted liquidity to banks, what now?

We said conundrum a while ago. On one part, the conundrum may get solved automatically to an extent. The pace of credit off-take from the banking system is growing at a pace slower than earlier. There is a gauge called credit-deposit ratio, which measures how much of incremental deposits in the banking system is leading to incremental loans. The pace of credit off-take has slowed than earlier due to less of investments being done in the economy, and the CD ratio is lower now. A lower CD ratio is the reason for banks to lower interest rates. The other aspect is the cost of funds of banks. As per RBI diktat, from 1 October, floating rate loans from banks are based on an external benchmark not in the control of the bank. Fixed rate loans, which form the bulk of loans disbursed by banks, are still benchmarked to the bank’s cost of funds. This is measured through marginal cost of funds based lending rate (MCLR). When MCLR comes down, banks would reduce interest rates on fixed rate loans.

The delicate challenge we mentioned in the headline, comes in this context. Banks face challenge from small savings schemes for mobilization of deposits, particularly in rural areas. Interest rates on small savings schemes are on the higher side given the context of benign inflation and the RBI having reduced the signal repo rate by 1.35%. Higher interest rates are good for depositors, but has to be seen in the light of the overall objective of the economy. Rates on small savings are supposedly fixed as per a formula. These are market-linked, with government security yield movement of corresponding maturity. Rates are reviewed every quarter. However, the rates given are much higher than what it is supposed to be as per the formula. During the policy review, the RBI disclosed the formula-based interest rate and government-announced rates.

For the quarter October to December 2019, for Kisan Vikas Patra, the rate as per formula is 6.81% and the rate announced by the government is 7.60%, higher by 79 bps. For National Savings Certificate VIII Issue, the formula rate is 6.91% and the rate given is 7.90, higher by 99 bps. For Senior Citizens Saving Scheme, it is higher by 110 bps. For the spectrum of Post Office schemes, the differential over the G-Sec yield based formula is 70-110 bps. In the Union Budget, small savings has increased in importance. In 2012-13, it was 1.5% of total capital receipts. In the Budget of 2019-20, it is 16.8% of total capital receipts.

If the RBI measure has to be transmitted to the broad system, the mark-up spread of small savings stands in stark contrast. However, reduction of small savings rates is a sensitive issue. It will impact the masses adversely and is a political hot potato. Going forward, if and when interest rates come down, the impact on you will depend upon which side you are: if you are a borrower, it will be beneficial for you and if you are a saver, rates would be lower.

Joydeep Sen is founder, wiseinvestor.in

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