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Bank depositors: An extinct species? - Outside View by S.S. TARAPORE
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Bank depositors: An extinct species?
Sep 30, 2015

The late Mr. L.K. Jha, Governor of the Reserve Bank of India (RBI), 45 years ago, enunciated that in a fair system, the endeavour should be to provide the highest possible rate of interest to depositors while providing the lowest possible interest rate to borrowers. How does today's Indian financial system fare in relation to the Jha Dictum? The Jha Dictum to function would need that players in the financial system should have more or less equal bargaining power and that the authorities viz. the RBI and the government be neutral referees. The ground reality is that depositors, though larger in number, are no match for borrowers who, though fewer in number, are powerful. While the RBI and government would ideally like to be fair referees, political economy considerations result in depositors being crushed.

Obsession with cheap credit

Indian economic thought has all along been strongly of the view that credit in the organised sector must be provided at relatively cheap rates. In today's overall economic milieu, lending rates of 10-14 per cent are considered outrageously high. In the unorganised sector, the rates of interest on borrowing with collateral of gold are upwards of 36 per cent while without collateral the rates are 60 per cent or more.

Intellectual reasoning for low nominal interest rates

An immutable law is that if the real rate of interest (i.e. the nominal rate of interest minus the inflation rate) is higher than the growth of the economy then the economy would slow down. While over the past decade India has had a relatively robust real growth rate ranging between 5-9 per cent, our policymakers seem to feel that 1.0-1.5 per cent real rate of interest is appropriate. Given that we are a capital scarce economy, the real rate of return for savers ought to be at least 3.0-3.5 per cent.

Appropriate indicator for inflation

The standard international gauge for assessing inflation is retail inflation. Infirmities in the Consumer Price Index (CPI), with multiplicity of indices, and the lagged availability of information led the authorities to use the Wholesale Price Index as the standard measure of inflation. It is to the credit of Governor Raghuram Rajan and Deputy Governor Urjit Patel that the Agreement on the Monetary Policy Framework signed by the RBI and the Government on February 22, 2015 uses the CPI as the indicator of inflation. The world over, official indices understate inflation but in India, even more so.

In the recent period, Dr. Arvind Subramanian, the Chief Economic Adviser Ministry of Finance, has argued that the CPI is not the appropriate indicator for inflation and that we should use other fancy indicators such as the GDP deflator which would point to deflation.

Gauging inflation over time

As Governor Rajan has aptly pointed out, monetary policy works with a lag and for effective monetary policy what is important is anticipated inflation and the changing of inflation anticipations through credibility of monetary policy. Since the objective is to contain inflation over the medium-term, it makes eminent sense to focus on a moving average inflation rate with a distributed lag (i.e. the highest weight given to the latest year and lower weights for earlier years). Again, it is important to take into account the level of inflation which, in recent years, has been particularly high in India.

Implications for depositors of appeasing borrowers

For banks to bring down lending rates, it is necessary to reduce deposit rates. In the recent period, banks have been reducing deposit rates on fixed deposits. All that seems to preoccupy the banks and the authorities is to bring down interest rates for borrowers. It is not convincing to say that as of August 2015, the CPI inflation is 3.66 per cent and therefore deposit rates should be slashed. The reduction of deposit rates by banks before the RBI's monetary policy of September 29, 2015 has put fear in the minds of depositors. The powerful agents pay scant respect for the interests of depositors. Punishing bank depositors is going to have an adverse effect on savings in financial assets.

Fight back by bank depositors

The late Mr. M.R. Pai had said that bank depositors are the real owners of banks and without depositors there would be no banks. In this context, bank depositors have to undertake a multi-pronged strategy to counter the short-sighted policies. The fight back could include the following responses.

Firstly, depositors should move from short maturities to longer maturities as the recent reduction does not seem to be the end of reduction of fixed deposit interest rates.

Secondly, bank depositors should consider a shift to non-bank deposits with companies which have an impeccable record of maintaining financial commitments such as the Triple Rated Housing Finance and other companies.

Thirdly, bank depositors should move to the small savings schemes of government before these rates fall such as the Senior Citizen Savings Scheme, Public Provident Fund and Post Office Time Deposits.

Fourthly, bank depositors should reduce Savings Bank Deposits and lock into longer -term fixed deposits with banks as also top rated non-banks. Savers often feel that precautionary balances should be held in Savings Bank Accounts but invariably savers keep very large balances in Savings Bank Accounts. These excess balances should be put into fixed deposits with banks and non-banks.

Fifthly, bank deposit holders must take a call on the proposed Gold Bond by the government. If the interest rate on these bonds is 3 per cent or higher, savers should throng to Gold Bonds which are to be subscribed in rupees.

Lastly, depositors' associations should articulate that bank depositors deserve more equitable treatment and pray that the sagacious Governor Rajan resists the powerful nexus of large borrowers and government pressing for policy rate reductions. The way things are going, bank depositors could become an extinct species.

Please Note: This article was first published in The Freepress Journal on September 21, 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.


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