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Wednesday, Dec 04, 2002

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Are low interest rates anti-saving?

S. Balakrishnan

NOWADAYS, it is not uncommon to see articles, columns and letters in newspapers dwelling on the impact of low interest rates on those dependent on interest income from savings (bank deposits, etc).

Some go further and argue that they encourage consumption and discourage saving, which is an essential ingredient for more investment and higher growth in a developing country.

To take the second point first, it is true that stepping up savings has long been considered a key prerequisite for low-income economies to accelerate their growth rate. It has even been said that, in such situations, rising inequalities should be tolerated because it is the rich who have the greatest propensity to save and finance development. In a poor country, there is a limit even to this — little surprise that we had to resort to considerable deficit financing to fund our five-year plans in the first 25 years after Independence.

Whether high savings is always a good thing is a matter of debate in economic theory. Keynes pointed out that it had a negative effect when there is a recession. In modern times, the US stands out as a model for its extraordinary low savings. Yet it is the profligacy of consumption and business investment in America, which has kept the rest of the world humming and continues to do so. When the US economy falters, there is a disproportionate fallout on Asia. Even an extremely affluent country like Singapore is, in the ultimate analysis, almost completely hostage to America's fortunes.

To return to the interest rate theme, Japan's zero-rate policy has not had any positive effect on consumption. Deflation has superseded interest rates and postponed spending that would otherwise take place now.

Thus, the behaviour of inflation may have an overriding effect on savings and spending behaviour. As our inflation rate has been declining sharply — many segments of the economy are actually in deflation — there is less incentive to spend, even though interest rates on savings are low. Also, financial uncertainty may prompt people to save more than what they would normally.

The main reason for falling interest rates in India is the falling rate of profit in industry and business, which started with the liberalisation of investment laws and regulations and imports. Competition has destroyed monopolies and monopoly profits with consequential effects on expected returns, which have correspondingly come down.

The Western countries and Japan have pensions and social security to take care of their aged. India lacks these and it is true that the sharp drop in interest rates has led to an almost halving of interest income for those subsisting on them.

They must understand that the system can no longer afford to pay them high interest rates. Low interest rates for savers are not Government or RBI-driven but an outcome of the momentous changes in the economy in recent times.

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