Savers' interests must come first
It is recognised by government that if growth is to be stepped up, it is essential to step up public investment in key sectors. But ultimately, higher investments require higher savings. Once it is clearly understood that increasing savings is of paramount importance, all other policy parameters fall into place.
Recent trends in savings
Household sector savings account for 73 per cent of gross domestic savings and hence the focus has to be on how to raise such savings. Of the financial savings of the household sector, deposits are a little less a little less than 60 per cent. Hence, increasing savings in the form of bank deposits is vital. Yet, all we hear from government honchos, leading economists, fiscal experts and industry leaders is that the stimulus for growth must come from lower interest rates.
Responsible policy requires higher, and not lower interest rates. But not a day goes by without influential opinion makers pleading for lower interest rates. While the need of the hour is higher household sector savings, the harsh reality is that household sector financial savings are falling. Unless this trend is reversed we can bid good bye to our cherished hopes of a higher real rate of growth.
A fundamental malady in the Indian system is that we violate natural factor endowments. Capital is scarce, yet we have an innate desire to keep the price of capital low. On many savings instruments we do not see anything wrong with negative interest rates i.e. nominal rates of interest adjusted for inflation.
The late Dr V K R V Rao, the doyen of the Indian economic community, 70 years ago explained that savings are short in India and his clear message was ‘Work harder and save more', but today's call is ‘Part with your savings with lower interest rates'. Ignoring the sage Dr Rao is costing India dear.
Need for total policy reorientation
There is a need for a total revamp of our economic mindset. If we want more savings, we need to pay higher interest rates. Fiscal concessions are important but only to the saver segment which is subject to income tax. There is a vast segment which is not subject to income tax and as such, tax concessions for this segment are meaningless. A few illustrations would suffice.
Illustratively, an 8.5 per cent tax-free return is equivalent to a taxable rate of return of 12.7 per cent, at the maximum income tax slab rate. Moreover, the investor enjoys a Section 80 C deduction from income. The government ends up paying a massive cost for garnering such funds.
There is the social objective that all individuals should make a provision for their later years of life. Yet, for instruments on which there are no tax concessions, the authorities would not consider a nominal rate of interest of 12.7 to be appropriate. In other words, the system is biased in favour of the highest income tax bracket and against the non-income tax payer. Take a three-year fixed deposit with a bank, at say, an interest rate of nine per cent per annum. At the maximum tax slab of 33 per cent, the net of tax return is 6.0 per cent. The surprise is that savers still keep bank deposits. This is essentially because of security and liquidity considerations.
In contrast, dividends in the hands of the individual are tax-free without any limit and subject to a low dividend distribution tax of 16.5 per cent.
What will bring about higher savings?
There are two options. First, if we are targeting savings, interest on all bank deposits should be made totally free of income tax. The revenue department would baulk at such a measure on grounds of revenue loss. But hearts that talk about revenue protection do not bleed when dividends from companies are free from income tax in the hands of the recipients.
The second option would be to push up interest rates to the point that banks start paying 12 per cent on deposits. It would be recalled that at one stage, when interest rates were determined by the RBI, a rate as high as 12 per cent was fixed for deposits of one year and over (in 1991).The low interest rate brigade of today would get hot under the collar and label such views as heresy!
Life is after all about hard choices. If we want higher savings, we have to provide higher interest rates to savers. The hard reality is that if we do not wish to adequately reward savers, we just cannot obtain higher savings.
Ever since the late 1980s, we have been encouraging consumption financed by borrowing, which then entails lesser savings. Here again, any restraint to the artificial consumption boom is considered heresy.
The golden mean
To resolve the savings gridlock, an acceptable solution could be (i) Some increase (or at least no policy-induced reduction) in fixed income financial assets. (ii) Some reasonable limit up to which bank interest on bank fixed deposits is freed of income tax. (iii) Tax-free income from dividends for individuals should be subject to a ceiling and the dividend distribution tax raised from its present 16.5 per cent level to say 20 per cent. We in India need to recall the French saying, "You can't make an omelette without breaking an egg."
Please Note: This article was first published in The Freepress Journal on December 29, 2014. 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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