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Economy Feb 1, 2013

Why Mr C’s finmin should not rob Grandma to boost growth

By R Jagannathan

The finance minister wants interest rates to be reduced steadily in order to push up growth and investment. The Reserve Bank of India, despite being unconvinced on inflation and the current account deficit (CAD), has obliged recently by cutting repo rates.

But the story, it seems, is going to get worse. Today's Business Standard reports that the finance ministry wants banks to cut the differential rates offered on fixed deposits (FDs) held by senior citizens. Banks currently offer senior citizens rates that are higher by 0.5-0.75 percent depending on tenure and their own need for longer term stability on funds.

But P Chidambaram's ministry is trying to rob grandpa and grandma in its quest for lower interest rates so that the investment climate gets better.

What his ministry should be asking itself is one simple question: can you push up investment without saving? He should read the latest data on GDP numbers to get his answer.

According to data released by the Central Statistics Office yesterday, India's gross domestic savings (GDS) fell dramatically from 34 percent to 30.8 percent of GDP in 2011-12.

senior citizens are probably the most stable of FD investors for the simple reason that they live on this income after retirement

Senior citizens are probably the most stable of FD investors for the simple reason that they live on this income after retirement

Reason: sharp fall in savings by all segments, from households to the public sector (government) to the corporate sector.

Guess why? The biggest relative drop is in government savings, which halved from 2.6 percent to 1.3 percent of GDP. This is largely due to misplaced subsidies, especially in the energy sector. This is where Chidambaram needs to push up his savings rate.

The biggest percentage drop has been in household savings, which fell from 10.4 percent to 8 percent - a fall of 2.4 percent.

No prizes for guessing the reasons: inflation has boosted the cost of living, which has eaten into savings. The corporate sector's drop is the lowest - from 7.9 percent to 7.2 percent of GDP.

But consider what this fall in the savings rate has wrought. The 3.2 percent diminution in the GDS led to a 1.8 percent drop in gross domestic capital formation (GCF), which fell from 36.8 percent to 35 percent in 2011-12 in current prices.

Now, cut to the finance ministry's pressure on banks to cut rates on FDs held by senior citizens. Business Standard reports that a stern finmin has sought an action-taken report from public sector banks on its directive to chop senior citizens' rates.

There are several things wrong with this directive, even assuming you think senior citizens should not be entitled to special favours from banks.

First, senior citizens are probably the most stable of FD investors for the simple reason that they live on this income after retirement. Breaking FDs - usually done only for shifting to higher deposit rates - is a planned event for seniors, and the sheer stability of these FDs makes them attractive to bank managements in matching assets and liabilities.

Second, banks are not foolish. At a time when credit is increasing faster than deposits, it makes sense for some banks to raise FD rates of the relevant tenures for all depositors, not just senior citizens. This is why Axis Bank and ICICI Bank raised their deposit rates a day ahead of the credit policy announcement on 29 January. They knew the RBI may cut rates and still went ahead with raising deposit rates. Today, government-owned Oriental Bank has raised short-term rates steeply and SBI has said thatRs 15,000 crore deposits have flown out of its kitty due to the issue of tax-free bonds.

Third, and this is most important, is it any of the finance ministry's business to tell what rates public sector banks should set for FDs? Don't banks know what is good for them?

Fourth, the government's own savings schemes are paying well, especially when they come with tax-benefits, unlike bank FDs. The Public Provident Fund pays 8.8 percent tax-free, while National Savings Certificates, which come with 80C benefits, pay 8.6 percent and Post Office Senior Citizens' FDs pay 9.3 percent. Public sector tax-free bonds are currently being issued in the range of 7.5-7.9 percent, which yield a post-tax return of over 11 percent. If banks have to compete with these rates, and that too without tax benefits, how will they ever raise deposit growth by cutting rates?

Fifth, the real consequence of insisting on a lower FD rate that does not yield real returns after inflation will be lower savings and a shift to other assets like gold. The finance ministry's obsession with lower domestic rates is increasing the country's dependence on foreign flows - as is obvious from the steady increase in foreign investment in domestic government bonds. Stamping on domestic savings and increasing one's dependence on volatile foreign savings flows can be seen as anti-national.

The simple takeout is this: the finmin should stay clear of dictating interest rates to banks. And if improving the investment climate needs the FM to stamp hard on the savings of grandpa and grandma, it is a pathetic argument.

by R Jagannathan

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