Inflation | Savings disincentivised: Real interest rates slide into negative territory
Mumbai: A sharp fall in deposit rates due to aggressive rate cuts by banks in response to the Reserve Bank of India’s (RBI) reduction in the benchmark rates coupled with a rise in consumer prices have pulled real interest rates into negative territory, disincentivising savings.
The RBI has reduced its benchmark repo rate by 115 basis points between March and May to support the economy in light of the coronavirus induced slowdown. As a result, banks have had to reduce their lending and deposit rates to adjust to the new interest rate scenario. One basis point is 0.01 percentage point.
Meanwhile, consumer prices have risen to 6.09% in June due to the supply side constraints induced by the lockdown enforced to check the spread of the pandemic. As a result, savers who would want to keep their money in the one-year term deposit of State Bank of India (SBI), the country’s largest bank, currently risk earning almost a percentage point lower than the current inflation rate. SBI’s one-year term deposit rate is at 5.10%.
“Savers will now start asking how much to save and also where to put their money. The economic uncertainties at present would mean that returns would not be at top of savers mind but it could have an impact on domestic savings,” said Saugata Bhattacharya, chief economist, Axis Bank.
CPI may Ease to 4% by Year-end
The benchmark consumer price index (CPI) had eased to 5.91% in March from a peak of 7.52% in January. But the supply side constraints due to the lockdown have again led to a spike in June even as deposit rates have fallen sharply.
The real returns for savers have hence fallen as the one-year SBI deposit used to earn 6.50% as recently as September 2019 when inflation was at just 3.92%, thus giving a real return of as high as 250 basis points.
However, economists say real returns should be judged over a period of time and cannot be gauged from a month’s data.
“Interest rates have been lowered because there is an expectation that demand will be much lower due to a contraction in growth That would also mean lower inflation. Expectations of inflation are also lower for the next one year so we should expect real rates for savers to adjust accordingly,” said Gaurav Kapur, chief economist at IndusInd Bank.
Economists expect the CPI index to come down towards 4% by the end of the calendar year. However there are also chances of more interest rate cuts by RBI which may force banks to reduce deposit rates further.
The govt has refrained from reducing its small savings rates this quarter after sharply cutting these by 70-140 basis points for the June quarter, in sync with the fall in bond yields and interest rates on bank deposits. The small savings rates are revised quarterly.
The govt has budgeted to finance as much as 30% of its deficit through small savings and any reduction in rates could threaten that target.
( Originally published on Jul 16, 2020 )