By Meet Mehta
The State Bank of India reduced the interest rate offered on the savings account by 50 bps to 3.5% in August last year. On December 27th 2017, the government slashed the interest rate on savings schemes, including NSC and PPF, by 20 bps. As per the notification, PPF and NSC will fetch a lower annual rate of 7.6 percent while KVP will yield 7.3 percent and mature in 11 months. The girl child savings scheme, Sukanya Samriddhi Account, will offer an interest rate of 8.1 percent from the existing 8.3 percent annually. These rates kept on reducing since 2 quarters continuously. Even many banks reduced the interest rates they offered on fixed deposits substantially in the last two years. Why such a decline?
Linking the savings rate with G-Sec rates
The interest rates offered by the small savings scheme of government is much higher than the deposit rate offered by the banks. As a result, most customers choose the former to invest their savings. This, however, also means that banks face a high cost of deposits. As a consequence, the banks were unable to make smooth transmission of monetary policy rate cuts into lowering the lending rate. The RBI had cut the policy rate by 125 bps in 2015, but the lending rates were lowered only by 70 bps. RBI had expressed concern over this issue many times and as a result, the Finance Ministry took the decision in April 2016 to link the rates of these small savings scheme to the Government Securities rates and decrease the spread between savings rate and government securities rate. It planned to bring down this spread by quarterly adjustments. That’s why we noticed 10 bps reduction in the savings rate in the first two quarters of FY 2017-18 and 20 bps reduction this quarter.
Provisioning for bad loans
The banks which over-lent during the period of irrational exuberance of 2007-08 faced the problem of rising NPAs in their balance sheets. The amount of NPAs reached over sseven trillion rupees in 2016. As per the instructions of the RBI, the banks were required to make provisions for these NPAs so that they can spread the loss evenly and minimize the sudden panic of public when banks’ profit decline suddenly. As a result of this provisioning, banks registered a decline in profits and some of them registered quarterly losses. To compensate for such a loss, they tried to reduce their cost by bringing down the deposit rates.
The decline in the inflation rate was one of the significant events that the Indian economy witnessed during the past few years. The average inflation during 2006 and 2013 was more than nine percent in India which came down to 5.5 percent in the 2014-16 period. As known in the macroeconomic sense, nominal interest rate is the sum of real interest rate and inflation. The higher policy rates during 2014-15 kept nominal interest rates high and brought inflation to a lower level. This ensured the improvement of real interest rates in the economy. Keeping that in perspective, banks and the government took the decision to lower the interest rate offered on the deposits.
The decline in the inflation rate is perhaps the result of RBI’s stance to bring inflation down to a sustainable level which can help in fostering growth by ensuring certainty about future prices. RBI became much more of an inflation-focused institution when Raghuram Rajan took the leadership. During the initial period, he took many steps like shifting focus from WPI to CPI, introducing monetary policy committee, keeping policy rates high, etc. to ensure that inflation comes down. This stance of RBI remained in public debate questioning whether bringing down inflation was being achieved at the cost of India’s growth. The former governor was criticised during his tenure by many experts because of this stance–they argued that high-interest rates discourage investment in the economy. However, it seems that RBI remained successful in their strategy and it didn’t have any negative impacts on the economic growth.
The improved real interest rates because of declined inflation actually proved to be beneficial for the Indian economy. A few days ago, SBI announced to lower the base rate (minimum interest rate that a bank charges) on home loans by 30 bps. If such steps are also followed by other banks as well, they will bring down the nominal interest and help in boosting the investment—contrary to what was being worried about by the critics.
Hence, the lowering down of savings rate is a cumulative effect of government’s action, RBI’s fight against inflation and the NPA problem which cropped up in the last five years. However, since lending rates have fallen along with savings rate, it will boost the investments and have a positive impact on the GDP.
The question, however, remains: How much impact will the change in interest rates have on the GDP?
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