The Hindu Business Line : Reality check on interest rates

THE ANNOUNCEMENT OF a sharply higher inflation rate last Friday — 7.52 per cent for the week ended July 24 against 6.52 per cent for the previous week — has inevitably revived the debate over the real interest rate — that is, the nominal rate adjusted for inflation. The need to protect investors in bank deposits and other fixed-income securities from the vagaries of inflation has been felt for long. The issue has come into sharp focus with the wholesale price index (WPI) flaring up recently. Since the effects of the rising global oil prices have not been captured by the WPI index, the inflation news can only get gloomier. All this should prompt policy measures to ameliorate the concerns of the savers but, unfortunately, the focus has been almost exclusively from the point of view of the bank borrowers. At a time when official statistics convincingly establish that a wide segment of savers, especially those who have put money in bank fixed deposits, is getting a negative return, there should be concern from the point of view of the macroeconomy as a well. Sooner than is realised, the deleterious consequences of such a serious disincentive to the savings class will be felt. A tendency towards taking unacceptable risks in personal investment decisions might emerge.

It is an indisputable fact that banks continue to attract deposits despite offering historically low rates of interest. As in reinforcement of this point, thecountry's largest bank, State Bank of India lowered its short-term deposit rates just the day after the Government announced the spike in the inflation rate. If savers continue to flock to banks despite getting niggardly (or even negative return), it is due almost entirely to the absence of other investment avenues.

Having denied depositors the full freedom to place their savings, the Government cannot escape the moral responsibility of ensuring a fair real return for them. Needed are financial sector reformmeasures that serve to broaden the choice of avenues for savers to park their money. The reasoning that banks are flush with money and, therefore, taking a purely business decision to cut deposit rates reveals but their continuing inability to perform their most traditional function — lend. Here again, another serious flaw in the macro economy, the poor state of credit delivery (credit availability is not the issue) comes to the fore. Viewed anyway, bank depositors continue to get a raw detail due to factors not in their control. As the former RBI Governor, Dr C. Rangarajan, said recently, real interest rates should at the very minimum be positive and for a country that hopes to grow at 7-8 per cent, it ought to be higher than for countries that target 2.5-3 per cent growth.

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