The Hindu Business Line : `Fiscal incentives may not go to augment total savings'

To increase savings, postal insurance can be a potent instrument, feels the author. Studies have found that whenever banks showed some degree of instability, households shifted their savings from banks to postal savings.

Chennai March 14 We hear bankers bemoan that deposits are not spiking despite hikes in interest rates.

One possible reason is that the rates are still far from enticing money that is flowing into alternative avenues.

More disquieting can be the fact that household financial asset holdings are not diversified, as an essay in Institutions & Markets in India's Development from Oxford (www.oup.com) notes.

The book, edited by A. Vaidyanathan and K.L. Krishna, revisits themes that K.N. Raj, one of India's famous economists, had pursued in his long career.

"Capital market institutions like the stock exchanges and even the mutual funds industry have come into disrepute essentially because of the vast gyrations in share prices.

"As a result, the households are increasingly clinging to bank deposits and small savings as preferred avenues for holding financial assets, and amongst them, to long-maturity deposits and saving instruments, despite reductions in interest rates on them," writes Mr S.L. Shetty, in the book, citing a 2004 research by EPW Research Foundation.

"In a poor society with limited social security facilities (which also cannot be expanded radically until the size of organised labour becomes a dominant force), image of financial institutions and banks as secure outlets becomes a prime consideration for asset holdings."

Mr Shetty calls for "a fresh look at the branch banking policies of scheduled commercial banks" because of the curious reduction of branch expansion in rural areas — from nearly 33,000 in 1996 to about 32,000 in 2004.

"The spread of bank branches in rural and semi-urban areas had stimulated household saving in bank deposits and also in other financial assets in rural areas until the 1990s," he points out.

There is an urgent need for a wide variety of rural banks — such as, commercial bank branches, regional rural banks, and cooperative institutions, says Mr Shetty.

Saving stimulus

Contrary to popular thinking, "studies have shown that any exuberant yield rates do not contribute to higher saving." So too, "excessive fiscal incentives may not go to augment total savings."

They may at best achieve some shifts between saving instruments, says Mr Shetty. He apprehends that largesse such as total exemption from taxation of company dividends in the hands of share-holding households can be counterproductive, in the long run.

To increase savings, postal insurance can be a potent instrument, feels the author. India has more than 1.5 lakh post offices, of which nearly 90 per cent are in rural areas.

"The government-run postal saving systems were the most important of the institutions created to promote savings in Japan, Korea, Malaysia, Singapore, and Taiwan."

Studies have found that whenever banks showed some degree of instability, households shifted their savings from banks to postal savings.

"Post offices have always attracted rural and semi-urban clientele.

Also, the postal insurance schemes could be expanded to provide not only social security, but also widen the scope of rural savings," suggests Mr Shetty.

Post office interest rates should not be benchmarked to their respective maturity yields on Government papers, as suggested by the Y.V. Reddy and Rakesh Mohan Expert Committees, argues the author.

For, "such a measure is likely to introduce a degree of instability in yield rates which deserves to avoided."

Instead, there should be realistic and stable interest rates, which should be adjusted ``only when the inflation rate deviates from the trend by a wide margin'', proposes Mr Shetty.

More urgently, postal savings system may require `revitalisation of the organisational and administrative structures' to make it `hassle-free and customer-friendly'.

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`Fiscal incentives may not go to augment total savings'