Financial Daily from THE HINDU group of publications
Sunday, Nov 03, 2002
Money & Banking - Credit Policy
Columns - Taking count
Credit Policy: Nothing to cheer savers
THE Monetary and Credit Policy pronouncements from the RBI had nothing to cheer the savers in the country. However, it could have been much worse. Thankfully, it was not. The cut in the bank rate could have been higher than the announced cut of 25 basis points. Importantly, the RBI Governor has said it will remain unchanged till the end of the financial year. In addition, the savings bank rate was not cut. That could have led to another round of significant decline in interest rates.
However, fixed and term deposit rates look set to decline by much more than 25 basis points. Some banks, such as Bank of Baroda and Punjab National Bank, which cut rates before the Credit Policy, have already or appear to be ready to bring down rates further. Private sector banks, such as Lakshmi Vilas Bank, have also aggressively cut rates. Longer-term rates, beyond three years, seem set to decline below 8 per cent in almost all banks, with public sector banks offering around 6.75- 7 per cent.
Real rates fall
The decline in deposit rates is only to be expected. However, what was disappointing was the reliance placed in the monetary policy on the WPI and the CPI indices for gauging inflation. Several tomes have been written on how the WPI and the CPI are not reliable inflation indicators. Still, they are cited to indicate the declining trend in inflation and how the decline in interest rates is, therefore, justified. That the rate of inflation has declined sharply in the past couple of years is believable. However, present levels of inflation, as indicated by the WPI and the CPI may be suspect.
Even if the official CPI numbers are taken for granted, then it is above 4 per cent. Clearly, real rates of return (simply put - the difference between nominal rate and inflation rate) have fallen sharply. What impact this will have on the savings habit is hard to guess. Perhaps, the powers that be are themselves intent on increasing consumption to kickstart economic growth.
Unfortunately, for an individual investor, increasing consumption may prove unwise. This is because of the prospect of rising taxes. Increasing fiscal deficits are pointers of increased taxes in future.
Perhaps, increased savings in the form of allocation to stocks need to be considered. In fact, the dividend yields on bank stocks are more than the interest rates on term deposits. For example, the expected dividend yield on Bank of Baroda at 8.5 per cent is more than the rate of 6.75 per cent offered on its three-year term deposits. This was the case even a year ago. However, the difference between term deposit yields and dividend yields have now widened. This may be an indicator that bank stocks or, in general, most stocks are undervalued.
Will rates rise?
Deposit rates may rise only after lending rates have also fallen to relatively low levels. Lending rates have not fallen as much as deposit rates in the last couple of years. Banks say they have contracted high-cost fixed deposits in the past, which prevent them from lowering lending rates. So, it may take a while for lending rates to decline.
The consistent decline in lending rates may be partly helpful in improving the credit offtake in the country. Only improvement in credit offtake will create pressure on liquidity and lead to a climate in which increase in deposit rates can materialise.
Here too, if the RBI cuts the CRR aggressively or liberalises the fixing of savings bank rates, then the extent of a rise in deposit rates may be checked. Of course, the trend in government borrowings also matters. Any significant increase in government borrowings along with improvement in credit offtake may even ignite inflationary expectations. That will be far worse for the savers.
All things considered, the factors are ranged against any significant rise in interest rates or real rate of return. Essentially, the possibility of interest rates staying at present levels for a longer time indicates that the proportion of savings from income needs to be enhanced (and possibly invested in stocks) to achieve financial goals.
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