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By Manas R Das and Ganga Narayan Rath
Bank Fixed Deposits (FDs) are the only investment product people don’t think twice about before investing. They are considered the safest form of investment ensuring that tax-paid principal amounts are safe as many depositors are also regular tax payers. FDs are also the most popular and trusted vehicle of investment among senior citizens. Worryingly, rising consumer inflation since June of this fiscal (April and May figures not announced), combined with falling nominal interest rates on bank deposits as measured by the RBI’s Weighted Average Domestic Term Deposit Rate (WADTDR), has led to the real return on deposits turning negative or woefully low.
Between June and October 2020, considering inflation based on the Consumer Price Index-General (CPI-G), the negative real return continuously worsened from 23 bps to 195 bps, though in November 2020, it somewhat softened. If inflation based on the Consumer Food Price Index (CFPI) is considered, as a large chunk of household expenditure is on food items, the negative real return would further exacerbate, ranging between 272 bps and 534 bps up to Oct-20, but somewhat soften in Nov-20. Chart 1 depicts the movements for the period Jun-20 to Nov-20.
w.r.t. - with respect to. Based on NSO and RBI data.
Even on average basis, during Jun-Nov 2020, the negative real return worked out to 110 and 387 bps with respect to inflation rates based on the CPI-G and CFPI, respectively.
Financial Repression: Arguments
When depositors are not compensated adequately for their savings, the condition is referred to as ‘financial repression’. The Economic Survey 2014-15 had observed that during 2003-13, the average real return on deposits had almost steadily declined from a little below 6% to nearly (-)2% in 2013, plunging in between to (-)4% in 2010. During 2013-14 also, the real return remained negative. However, during 2014-15 to 2019-20, it remained positive, but on a declining trend basis.
The RBI’s Dec-20 Monetary Policy Statement observes that “inflation is likely to remain elevated, barring transient relief in the winter months from prices of perishables.” It projects CPI inflation at 6.8% for 2020-21 Q3, 5.8% for 2020-21 Q4; and 5.2% to 4.6% in 2021-22 H1. Assuming the Nov-20 WADTDR to continue, this would mean negative real return on bank deposits at 116 and 16 bps, respectively, in 2020-21 Q3 and Q4. In 2021-22 H1, the real returns would turn slightly positive in the range of 44 to 104 bps. Thus, ‘financial repression’ of depositors will linger.
Arguments in favour of negative or low real return on deposits are premised on the assumption that it would compel bank depositors to migrate to money or capital market-related instruments, which could reduce the interest burden on banks. This argument may be fine for high net worth and financially sophisticated depositors, but not for most depositors who belong to the middle class and lack the understanding or risk appetite to enter the markets. Moreover, the middle class depositors are mostly fixed income earners and vulnerable groups like pensioners who supplement their pensions with interest incomes from bank deposits.
Arguments in favour of negative or low real return on deposits are premised on the assumption that it would compel bank depositors to migrate to money or capital market-related instruments, which could reduce the interest burden on banks. This argument may be fine for high net worth and financially sophisticated depositors, but not for most depositors who belong to the middle class and lack the understanding or risk appetite to enter the markets.
In fact, bank deposits are growing on the strength of the middle class; as on Jan 1, 2021, the YoY growth in aggregate deposits of Scheduled Commercial Banks (SCBs) was 11.5% as against 9.8% in the corresponding period of the previous year. The second argument postulates that negative or low real interest rate would lead savers to save less and spend more, which can mitigate the recessionary condition prevailing at present. However, unlike many developed economies, the Indian middle class is not a big spending lot, and would rather squeeze expenditure to fit current shrinking incomes.
Thus, negative or low real returns on deposits, even in the short-run, will scar Indian households financially. Further, in order to compensate for the low return on bank deposits, households are increasingly switching to physical assets rather than financial assets. During 2015-16 to 2018-19, the share of household savings in physical assets in total savings serially increased from 53.2% to 63.3%. This has ultimately shrunk the rate of capital formation.
Furthermore, interest income from bank deposits beyond a point is taxed as interest income, whereas income on bonds and capital appreciation in stocks and MFs are taxed as capital gains. Depositors are also subjected to TDS on interest income. Besides, banks are not allowed to offer indexed deposits where the principal and interest are linked to the price level.
The Road Ahead
In order to ensure that bank depositors get a reasonable return on their deposits, it is advisable to revisit the 1985 Chakravarty Committee Report which had basically recommended that bank deposit rates (nominal)be linked to the expected rate of inflation and a positive real rate of interest, which, for instance, was recommended at ‘not less than 2%’ for 5 years and above deposits. When implemented in April 1986, although these recommendations had limited success, today with the inflation targeting framework in operation, implementation of the committee’s recommendations can be explored.
Moreover, it’s not appropriate for banks to link deposit rates to the Repo rate as the latter is intrinsically borrower-first and borrower-positive. Credit pick-up has for long been insensitive to lending rate cuts, which have been rather continuous. For instance, despite all the stimuli, the YoY growth in SCB credit was 6.7% as on Jan 1, 2021, 80 bps below that in the similar period last year.
The forthcoming budget should consider phasing out tax on interest income from bank deposits, beginning with senior citizens.
The forthcoming budget should consider phasing out tax on interest income from bank deposits, beginning with senior citizens. With no publicly available data on how much the government nets from this tax, it is befuddling. If, at all, the tax is retained, TDS on the tax should be done away with as it deprives the taxpayer of current income, which may squeeze current consumption, if not withdrawal from savings. In addition, had the NPA level in banks been low, it would have enabled them to realise more interest income leading in turn to offer higher deposit rates. Thus, depositors are also indirectly bearing the brunt of humongous NPAs for no fault of theirs. Therefore, a fast amelioration of asset quality is of paramount importance.
In a banking set-up, depositors are the largest stakeholders. In India, they contribute almost four-fifth to the SCBs’ sources of funds. Therefore, their financial and non-financial interests must be protected as enshrined in the Banking Regulation Act, 1949. The significance that the Act attaches to the interests of the depositors can prima facie be gauged from the fact that the phrase ‘interests of the depositors’ appears 15 times in 118 pages of the Act, i.e., once in every eighth page. Slicing away a portion of depositors’ maturity value by the systemic imposition of negative real rates of interest must be removed.
In a word, depositors must receive realistic interest rates.
(Manas Das is a former senior economist with State Bank of India and Ganga Rath is a former Chief General Manager of the Reserve Bank of India)(Views are personal)