X

Sign up for Equitymaster's free daily newsletter, The 5 Minute WrapUp and get access to our latest Multibagger guide (2017 Edition) on picking money-making stocks.

This is an entirely free service. No payments are to be made.


Download Now Subscribe to our free daily e-letter, The 5 Minute WrapUp and get this complimentary report.
We hate spam as much as you do. Check out our Privacy Policy and Terms Of Use.
Depositors are, but poor relatives - Outside View by S.S. TARAPORE
 
 
Depositors are, but poor relatives

The reduction on January 15, 2015, in the Reserve Bank of India (RBI)policy repo rate from 8 per cent to 7.75 per cent, has triggered unprecedented joy in the stock market, industry, analysts and media circles. The popular perception is that the policy relaxation is a panacea for all the ills of the economy.

Banks' response

Anticipating the RBI policy action, a number of banks reduced deposit rates even before the policy announcement. India has a history of banks rapidly lowering bank fixed deposit rates when inflation falls, but being hesitant to raise rates when inflation rises. The Consumer Price Index (CPI) shows a year-on-year increase of five per cent for November 2014 and advocates of lower interest rates are arguing for a series of rapid policy repo rate reductions.

Medium-term inflation rate

For a meaningful assessment of inflation, it is necessary to consider the medium-term inflation rate. What is relevant is not the latest year-on-year inflation rate but the level of inflation and the increase in inflation in the medium-term. Advocates of lower interest rates argue that with the latest inflation rate of five per cent and allowing for a real rate of interest of say two per cent, the deposit rates for one year and over ought to be reduced to seven per cent. The CPI (base 2010=100) as of October 2014 was 145.2, which would approximate to a compound rate of inflation of 9.8 per cent, which would imply that the present fixed deposit rate of 8.75 per cent for one year would imply a negative real rate of interest.

Hazards of low deposit rates

The household sector accounts for about 73 per cent of gross domestic savings and bank deposits account for 60 per cent of financial savings of the household sector. To raise the real rate of growth of the economy, the present savings rate has to be increased from 30 per cent to 35 per cent of the GDP. Furthermore, if the objective is to increase financial savings, rather than physical savings, it is imperative to avoid adventurist policies of rapidly lowering bank deposit rates. It is precisely for this reason that the RBI has followed a responsible policy of not undertaking reckless reductions in policy interest rates.

Appropriate level for policy interest rates

For a stable and viable regime of interest rates, they cannot be moved around like the price of tomatoes, from Rs 80 per kilo to Rs 20 per kilo and then back to Rs 80 a kilo. Changes in interest rates have wide repercussions in the economy and hence great care is required when the RBI signals interest rate changes. For efficient transmission of the RBI's policy interest rates, the RBI policy rate should be somewhere between the one-year deposit rate of 8.75 per cent and the base lending rate of 10 per cent. As such, to be a lender of last resort, the RBI policy repo rate should be at least nine per cent.

Distortions in short and long interest rates

In a well-functioning financial system, the long-term interest rate should be the average of the future anticipated short rates, adjusted for risk and uncertainty. In India, the inversion of the term structure of interest rates is essentially because of the government's overriding concern that its huge borrowing programme is undertaken at relatively very low rates.

Cartelisation of the savings bank interest rate

Yet another adverse feature from the depositors' viewpoint is the cartelisation of the savings bank deposit rate by major banks. The few private sector banks, which have broken ranks from the cartel, have experienced a reduction in their cost of funds, as the proportion of current and savings accounts (CASA) has risen as these banks offer a rate of interest on savings bank accounts higher than the cartel, which offers only four per cent. A number of banks in the cartel, which have a low CASA would benefit; the possible reason for such banks not opting out of the cartel is the fear of retaliation by the cartel.

RBI's policy responses in ensuing period

Since the RBI has already taken policy action on January 15, 2015, it should resolutely resist the call of seductive sirens to lower the policy repo rate in the policy review on February 3, 2015, as also on Budget Day in the latter part of February 2015.

Paramount position of depositors

The veteran champion of consumer rights, the late M R Pai, would often say that depositors are the real owners of banks, as without depositors, there would be no banks. Responsible policy calls for all economic agents to stop treating depositors as poor relatives in the financial system.

Note: This article was first published in The Freepress Journal on January 26, 2015. Syndicated.

This column, Common Voice is authored by Savak Sohrab Tarapore. Mr. Tarapore, is an economist and he runs his own Multi-Language Syndicated Column. Mr. Tarapore's other column, which appears in The Hindu Business Line, is titled Maverick View.

Disclaimer:
The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

 

Equitymaster requests your view! Post a comment on "Depositors are, but poor relatives". Click here!

  
 

More Views on News

How to Ride Alongside India's Best Fund Managers (The 5 Minute Wrapup)

Jun 10, 2017

Forty Indian investing gurus, as worthy of imitation as the legendary Peter Lynch, can help you get rich in the stock market.

How To Read Your Mutual Fund Account Statement Correctly (Outside View)

Aug 17, 2017

PersonalFN simplifies the mutual fund account statement for you.

This Small Cap Can Drive Chinese Players Out of India (and Make a Fortune in the Process) (The 5 Minute Wrapup)

Aug 17, 2017

A small-cap Indian company with high-return potential and blue-chip-like stability is set to supplant the Chinese players in this niche segment.

Which Gods Will Bring Down the US Empire? (Vivek Kaul's Diary)

Aug 17, 2017

Mr Trump is in the White House and the gods are in their heavens; what's not to like?

Will They Haul Off Trump's Statue, Too? (Vivek Kaul's Diary)

Aug 16, 2017

All across the country, the old gods become devils. New, gluten-free gods take their places...

More Views on News

Most Popular

Demonetisation Barely Made Any Difference to Tax Collections(Vivek Kaul's Diary)

Aug 7, 2017

The data tells us quite a different story from the one the government is trying to project.

A 'Backdoor' to Multibaggers: It's Like Investing in Asian Paints Ten Years Ago(The 5 Minute Wrapup)

Aug 10, 2017

Don't miss these proxy bets on growing companies or in a few years you will be looking back with regret.

Should You Invest In Bharat-22 ETF? Know Here...(Outside View)

Aug 8, 2017

Bharat-22 is one of the most diverse ETFs offered so far by the Government. Know here if you should invest...

Signs of Life in the India VIX(Daily Profit Hunter)

Aug 12, 2017

The India VIX is up 36% in the last week. Fear has gone up but is still low by historical standards.

7 Financial Gifts For Your Sister This Raksha Bandhan(Outside View)

Aug 7, 2017

Raksha Bandhan signifies the brother-sister bond. Here are 7 thoughtful financial gifts for sisters...

More
 

Become A Smarter Investor In
Just 5 Minutes

Multibagger Stocks Guide 2017
Get our special report, Multibagger Stocks Guide (2017 Edition) Now!
We will never sell or rent your email id.
Please read our Terms

S&P BSE SENSEX


Aug 18, 2017 11:09 AM

MARKET STATS