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B. Venkatesh

THE Chairman of the Twelfth Finance Commission recently stated that further cut in deposit rates could affect savings and investment in the country. What is the linkage between these two variables? Suppose you have Rs 10,000 as surplus money after incurring regular monthly expenses. What would you do? You could buy more goods and services or park it in a bank deposit. How would you decide between savings and consumption?

Assume a one-year bank deposit pays 5 per cent per annum. Suppose you have to postpone buying furniture if you invest in the fixed deposit. You will be willing to deposit only if you believe that the price of that furniture will increase by less than 5 per cent next year.

Suppose the price of furniture increases 3 per cent next year. You would be better off because you postponed consumption. Why? You earned 5 per cent on your deposit but had to pay just 3 per cent more for the furniture. There is more to savings than that. Banks use the money that you and I deposit to lend to businesses. These businesses, in turn, invest to produce more goods and services. This leads to higher income levels. In certain cases, investment leads to higher employment levels too. The economy, therefore, improves.

If banks cut deposit rates, the tendency will be to save less and consume more. So, banks will have lesser money to lend.

That means businesses cannot find adequate funds to invest in additional capacity. The income levels cannot, therefore, improve.There is also impact on price levels. If the businesses are not able to supply goods to meet the increase in current consumption, prices will go up leading to inflation. The economy, hence, suffers. Of course, these effects are not immediate because it takes time for a reduction in deposit rates to actually impact savings.

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