Pause rate cuts to manage inflation, unemployment concerns

The 115 basis points cut in repo rates since February this year has, according to the SBI’s research report, led to banks cutting rates on fresh loans by 72 basis points, “the fastest transmission ever recorded!” Steps to reach credit to NBFCs seem to be paying off, with a sharp increase in commercial paper issuances by the sector and improved funds access for those that do not have a high rating. However, the rate cuts have hurt savers at a time when retail inflation is rising. At present, a 5 per cent return on a three-to-five year fixed deposit in a public sector bank is one whole percentage point below the prevailing inflation rate. While supply-side shocks since the lockdowns began have pushed up prices, negative real interest rates for savers have been around since last December. A real return of over 1 per cent should be considered reasonable in a country with an elderly population of about 150 million (about half the population of the US) with no social security protection worth the name. Job losses have impacted middle-class employees in anonymous mid-sized concerns; a negative real return on savings will add to the financial fragility of such households. The rise in precarity is brought out by the fact that over ₹30,000 crore has reportedly been withdrawn from the Employees’ Provident Fund accounts since April by eight million subscribers — far above the norm.

Some distraught savers could even move out of bank deposits into physical assets such as land and gold — even as bank deposits have remained inelastic to the spate of rate cuts and financial scams so far. It should be noted that the shift from bank deposits to mutual funds no longer seems feasible, after the meltdown of IL&FS, DHFL and the like. This could lead to ‘disintermediation’ or the inability of the financial sector to channelise savings into productive investment. In such a situation, the RBI must not take the hapless retail depositor for granted, while focusing on borrowers’ interests.

India’s savings at 30.1 per cent of the GDP in 2018-19 are already at a 15-year low, largely owing to a drop in household savings from 23 per cent of the GDP in 2012 to 18 per cent today. Over half of these savings are in financial instruments. As for the overall savings rate, efforts to shore it up through macro-prudential regulation are essential to ensure sustainable long-term growth without recourse to expensive overseas borrowings. There has been a rise in external borrowings in recent years owing to the savings-investment gap, while the capacity to invest has been affected as well. In the short run, too low an interest rate differential between India and the rest of the world could impact capital flows in these uncertain times. A pause in interest rate cuts appears to be the best course of action under these circumstances.

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