Since the global financial crisis, one set of folks who seems to have acquired a lot of skill and clout in lobbying for stimulus packages from governments are borrowers, across economies. Whenever a crisis in any shape or form hits, policymakers automatically think of providing relief to borrowers by pruning interest rates, while not hesitating to throw savers under the bus.
As the Covid-19 outbreak has rudely interrupted economic activity and clouded income prospects, global central banks have been busy driving down interest rates to throw a lifeline to the indebted. Indian policymakers have faithfully followed this global playbook. The Monetary Policy Committee (MPC) recently slashed the repo rate by 75 basis points to 4.4 per cent, a level not seen for two decades, including the period after the global financial crisis. From their peak of 8 per cent in 2015, India’s benchmark rates have declined 210 basis points till date.
Interest rates on bank deposits have declined more steeply than the policy rates. The SBI — which offered 8.5 per cent on its one to three-year deposits in April 2015 — now pays 5.7 per cent. Interest rates on savings accounts are at sub-3 per cent. Even the Centre, which held out against the clamour to reduce interest rates on its small savings schemes until recently, has now caved. In its latest reset, it has reduced rates on its post office time deposits by between 110-140 basis points. Staples for regular income earners and retirees such as post office time deposits and the Monthly Income Scheme now offer rates of 5.5-6.6 per cent.
Apart from being particularly ill-timed to a period when households badly need cash flows, these rate cuts result in negative real returns for savers. The last four consumer price inflation readings in India were at 5.5-7.6 per cent, much higher than these deposit rates.
While rate reductions may give debt-heavy households and businesses relief in these difficult times, policymakers seem to forget that rate cuts are a double-edged sword. They force income sacrifices on the thrifty folk who have eschewed loans and postponed spending, to build up substantial savings in financial instruments.
If policymakers took a harder look at the numbers of savers versus borrowers in the Indian context, their stimulus packages would be devised very differently.
More savers than borrowers
One reason why governments in the developed world turn automatically to rate cuts when their economies run into hot waters is that their households thrive on leverage. In India, the loan culture is at a far more nascent stage with only a fraction of the households able to access bank finance.
Data from the Bank of International Settlements (BIS) tells us that, based on bank credit, India has among the lowest household debt to GDP ratios in the world. In Q3 2019, while India’s household debt amounted to just 12 per cent of the GDP, the ratio stood at 75 per cent for the US, 84 per cent for the UK, 59 per cent for Japan and 58 per cent for the Euro area, averaging 60 per cent for the world. Even emerging market economies had well over three times India’s household debt levels (41 per cent).
This represents bank credit alone. Once you add NBFC retail loans (about ₹5 lakh crore) and housing finance loans (about ₹10 lakh crore) to the banks’ retail loan book of ₹21 lakh crore (all numbers as of March 2019), India’s household debt-to-GDP climbs to about 19 per cent. But even this is well below global averages. Clearly, given the relatively low levels of household debt in India, rate cuts are likely to be less effective as relief in times of crisis.
RBI data on the incremental flow of household savings reiterate the fact that Indians save more than they borrow. In FY18, Indian households added ₹29.4 lakh crore in incremental savings, of which ₹18.7 lakh crore was financial savings. In the same year, households added financial liabilities of ₹7.4 lakh crore, just 40 per cent of their incremental assets.
Granular data from the RBI on the retail deposit and lending operations of Indian banks also suggest that the savers among Indian households vastly outnumber loan-takers. As of March 31, 2019, scheduled commercial banks featured 185 crore deposit accounts from individuals who held ₹71 lakh crore worth of deposits. In comparison, the same banks held just 8.4 crore retail loan accounts, with outstanding amounts of ₹21 lakh crore.
Effectively, for every ₹1 of loan that Indian households had taken from banks, they had ₹3.4 invested as bank deposits. The number of borrowers doesn’t increase too much even if you add up numbers from non-banks and housing finance firms. CIBIL TransUnion, India’s largest credit bureau, estimates the total number of active retail borrowers in India is at about 10 crore.
This suggests that rate cuts, far from helping the average Indian household in times of strife, actually does it harm by shrinking its passive income.
Yes, the extent of leverage at Indian households is likely to be understated by bank/NBFC numbers, given that less affluent households are forced to borrow mainly from informal sources such as money lenders. But then, such borrowers are hardly likely to benefit from repo rate cuts as the usurious rates they pay on their loans aren’t pegged to official benchmarks.
Giving savers their due
Once we recognise that household savers make up a far larger constituency than borrowers in the Indian context, and thus may need income support in times of crisis, what can be done to protect their interests?
One, having already slashed interest rates on small savings, the Centre must tax the interest income that savers earn from their fixed return instruments at lower rates or even announce a tax holiday for a year. Ironically today, returns on mutual and equity investments (likely to be favoured by more affluent individuals) get more favourable tax treatment than interest on deposits and small savings.
Two, the Centre needs to revisit the quantitative caps on small savings schemes such as the Post Office Monthly Income Scheme (₹4.5 lakh) and the Senior Citizens Savings Scheme (₹15 lakh) set ages ago, adjusting them for inflation. While banks are bound to kick up a fuss against these measures — claiming that they will hurt rate transmission — a bit of competition on the deposit front will be good for savers at this juncture.
Three, given that both the Centre and States will now desperately need extra-budgetary resources to fight the Covid-19 crisis, they can consider primary offers of 1- and 3-year tax-free Covid bonds exclusively targeted at retail savers. Even offering 50 basis points more than market borrowing costs can result in a reasonable return for savers.
In the medium term, as the economy seeks to climb out of its hole, it will surely need its savers to bankroll both consumption and new investments. Therefore, while devising stimulus packages from here on, it will be important for the MPC and the Centre to keep savers in mind while resorting to rate actions. In 2016, the RBI had stated its intent of ensuring a 150-200 basis-point real return for savers over and above prevailing retail inflation. We need to go back to this principle, to ensure that thrift remains a paying proposition for savers.