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Chewing the bitter pill - Views on News from Equitymaster
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  • Feb 28, 2002

    Chewing the bitter pill

    The Indian investors are a puzzled lot. Their attempts to invest safely some how boomerang. The stock markets with their glorious history have managed to scare the retail investor. The so-called safer mutual funds like UTI, have shaken investor confidence time and again. And now comes the decision to cut small savings rates by 50 basis points, the only investment avenue that has proved to be safe. The government has reduced the real interest rates. A real interest rate is the compensation, over and above anticipated inflation, that a lender demands to lend his money.

    This will certainly not go down well with the middle class that have a bulk of their savings in instruments like PPF and Post Office savings. Especially the retired community will feel the pain, as these investments are the only source of income for many.

    But the government has reasons for taking this measure. The small savings deposits by the public are basically loans to the fiscal system. The interest rates that these schemes pay are the cost of capital. Fiscal system in turn lends out this money to the industry. Now for the system to operate profitably the lending rate to the industry has to be higher than borrowing rate from the public. Consequently, higher interest rate for small savings schemes, which will be the cost of capital for the industry. High cost of capital discourages investment as it raises the break-even point for industries.

    Thus, high interest rates are a structural bottleneck for the growth in the industry. The lower interest rate will provide stimulus to the industry by

    • Lowering of financing costs for hire purchase schemes
    • Cost of capital will decline and consequently, hurdle rates for investments will drop

    The impact of the rate cut ideally over a period of time should be growth in purchases of goods and better off take in housing loans. Thus improving the demand situation. Also, increased investments by the industry, which in turn will generate more employment opportunities.

    The effort on part of the government could also be to channelize public funds directly into businesses instead the saving being made available to the industry through the financial system. The financial systems has strong norms regarding lending, which prevent them from lending in certain cases. Also, with net NPAs at 6.7% of net advances, a lot needs to be improved in the evaluation processes of the banks and intuitions. With the interest rates falling people will have to look for investment opportunities outside deposits for capital to grow. This could encourage investments in businesses.

    However, the industry too has its share of problems. The rate cut in October did not improve credit off take. The institutions are prudent about disbursements. Also fearing global competition industry has not been very keen to invest.

    Thus, now the onus shifts on to the government to rapidly improve the investment environment by removing the other structural bottlenecks like lack of infrastructure.

    Whatever be the rational is behind the rate cut, the going will certainly be tough for retired senior citizens. As on every investment of Rs 100,000, their earnings would be Rs 500 lesser.



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