Why No One is Worried About Savers

Economists are like sheep. They like to move in a herd.

If one of them says that the Reserve Bank of India (RBI) and banks need to cut
interest rates in order to revive the economy, largely everyone else follows.

This basically stems from the fact that the practitioners of economics like to think of
the subject as a science, having built in all that maths into it over the decades.

In science, controlled experiments can be run and results can be arrived at. If these
experiments are run again, the same results can be arrived at again.

The economists like to think of economics along similar lines. But then economics is
not a science.

Take the case of the idea of a central bank and banks cutting interest rates when the
economy of a country is not doing well. Why do economists offer this advise? The
idea is that as banks cut interest rates, people will borrow and spend more.

At the same time corporates will borrow and expand, by setting up more factories and
offices. This will create jobs. People will earn and spend more. Businesses will
benefit. The economy will do better than it did in the past. And everyone will live
happily ever after.
Okay, the economists don’t say the last line. I just added it for effect. But they do
believe in everything else. Hence, they keep hammering the point of banks having to
cut interest rates to get the economy going, over and over again. The corporates who
pay these economists also like this point being made.

The trouble is that what the economists believe in doesn’t always turn out to be true.
Or to put in a more nuanced way, there is a flip side to what they recommend. And I
have seen very few professional economists talk about it till date. In fact, low interest
rates hurt a large section of the population especially during an economic recession
and contraction.

In India, a section of the population, is dependent on the level of interest rate on bank
deposits (especially fixed deposits). Currently, the average interest rate on a fixed
deposit is around 5.5% per year.
The inflation as measured by the consumer price index in September stood at 7.34%.
Hence, the actual return on a fixed deposit is in negative territory. It has been in
negative territory through much of this year. This doesn’t even take into account the
fact that interest earned on fixed deposits is taxable at the marginal rate. After taking
that into account the real return turns further negative.

This hurts people living off interest income, in particular senior citizens. Senior
citizens whose fixed deposits have matured in the recent past have seen their interest
income fall from around 8% per year to around 5.5% per year, in an environment
where food inflation is higher than 10%.

The only way to keep going for them is to cut monthly expenses or start using their
capital (or the money invested in fixed deposits) for regular expenses. It is worth
remembering that India has very little social security and health facilities for senior
citizens, as is common in developed nations.

Lower interest rates also impacts a large section of the population which saves for the
future through bank fixed deposits. It is worth remembering that it is this section of
the population which actually drives the private consumption in the country. When
returns on their savings fall, the logical thing is to cut consumption and save more. If
this is not done, then the future gets compromised on.

Lower interest rates hurt institutions like non-government organisations, charitable

trusts etc., which save through the fixed deposit route.

The stock market wallahs love lower interest rates because a section of the population
continues to bet on stocks despite the lack of company earnings. The price to earnings
ratio of the stocks that constitute the Nifty 50, one of India’s premier stock market
indices, is currently at more than 34.

Such high levels have never been seen before. It’s not the chances of future high
earnings which have driven up stock prices but the current low interest rates, leading
to more and more people trying to make a quick buck on the stock market. The
government likes this because it feeds into their all is well narrative.
At the same time, given that the government is cash-starved this year, the stock
market needs to continue to be at these levels for it to be able to sell its stakes in
various public sector enterprises to raise cash.

Between March 27 and October 9, the deposits of banks (savings, current, fixed,
recurring etc.) have increased by a whopping Rs 7.4 lakh crore or 5.4%. In the same
time, the total loans of banks have shrunk by Rs 38,552 crore or 0.4%. This basically
means people are repaying loans instead of taking on fresh ones, despite lower interest
rates.

In this environment, with banks unable to lend out most of their fresh deposits, it is
but natural that they will cut interest rates on their fixed deposits. You can’t hold that
against them. That is how the system is adjusting to the new reality. But what has not
helped is the fact that the RBI has been trying to drive down interest rates further by
printing money and pumping it into the financial system.

Between early February and September end, the central bank has pumped more than
Rs 11 lakh crore into the financial system.

Not all of it is freshly printed money, but a lot of it is. This has apparently been done
to encourage corporates to borrow. The bank lending to industry peaked at 22.43% of
the gross domestic product (GDP) in 2012-13. Since then it has been falling and in
2019-20, it stood at 14.28% of the GDP. Clearly, Indian industry hasn’t been in a
mood to borrow and expand for a while. Hence, the so-called high interest rates,
cannot be the only reason for it.

The real reason for the RBI pumping in money into the financial system and driving
down interest rates has been to help the government borrow money at low interest
rates. As tax collections have fallen the government needs to borrow significantly
more this year than it did last year.

All this has hurt the saver. But clearly unlike the corporates and the government, the
savers are not organised. Hence, almost no one is talking about them. In the latest
monetary policy committee meeting, there was just one mention of them.
One of the members had this to say: “With retail fixed deposit rates currently ranging
between 4.90-5.50 per cent for tenors of 1-year or more and the headline inflation
prevailing above that for some months now, there has been a negative carry for
savers.”
We already know that no economist talks about this phenomenon or more specifically
the fact that low interest rates and high inflation should have led to a cut down in
consumption. How big and significant is that cutdown? How is it hurting the Indian
economy?

Is this cutdown in consumption more than the loans given by banks because of low
interest rates?
These are questions that need answers. But the problem is that to a man with a
hammer everything appears like a nail. For economists interest rates are precisely that
hammer which they like using everywhere. This situation is no different.

The trouble is their hammer doesn’t necessarily work all the time.