Low payout on savings will bring down interest rates

Low payout on savings will bring down interest rates

By SHAILENDRA TYAGI | NEW DELHI | 26 March, 2016
The Finance Minister supported the slashing of interest rates on small saving schemes because ‘we cannot have a situation where lending rates are going down but deposit rates remain high’.
Lower interest offered on small savings schemes would allow banks to lower their deposit rates and hence, their lending rates.
The government’s decision to offer lower interest on various small savings schemes has being hailed as a pragmatic step, one that would bring down the interest rates in the economy. The move, however, pushes small savers to take attendant risks in the market to earn commensurate returns from it. Till now the government has been incentivising small savers by offering 2% more interest thereby, sucking the bulk of the nation’s savings towards financing its own market borrowings. This had greatly distorted the rate of interest that one generally earns or pays.  “The move would stop such subsidy to make interest rates (both earned and paid) market-driven,” says Phani Sekhar fund manager with Karvy Capital. From April 2016, the government would be paying up to 1.5% less interest on various small savings schemes.
Although giving less return to savers would reduce the savings pool in the country, yet it is a win-win situation for other stakeholders. Besides reducing the government’s borrowing cost, lower interest offered on small savings schemes would allow banks to lower their deposit rates and hence, their lending rates. “Banks would now be able to take more aggressive decisions on the lending side,” says Sekhar. This would also facilitate the growth of a vibrant bond market in India.  People having greater propensity to save would benefit from such a bond market where private investors queue-up to take loans by offering competitive rates of return. Globally, the bond market is (generally) four times the equity market but in India it is not even 10% of the equity market.
As per Nomura, the interest rate gap (small saving rate minus bank’s deposit rate) had been an important driver of collections under small savings schemes. “With small saving schemes offering higher rate of interest (relative to bank deposit), the total collection under such schemes had grown to 10 year high to over Rs. 0.8 trillion in FY 2016.” Such a saving pool is set to fall in coming years thus, increasing the government’s reliance on other sources of financing, especially market borrowings to fund its fiscal deficit.”
Sekhar adds that it is a policy driven move to push people more towards consumption. Companies have been complaining about sluggish demand conditions and the higher cost of capital as the biggest drag on their investment decisions. The government has been fighting tooth and nail to generate demand in the economy, a pre-condition to revive investment and the consequent creation of jobs. 
 

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