With credit offtake racing ahead of deposit flows, banks are seeking an unusual fix to their problem in the Union Budget. SBI’s economic research wing has argued that there is an immediate need to bring about parity on taxation between interest on bank deposits and gains on shares/equity mutual funds, given rising investor preference for the latter.
The view seems to be that the 15 per cent short-term capital gains tax rate and 10 per cent long-term capital gains tax rate on equity helps it trump deposits on returns. While this argument is a little tenuous, there is a genuine case for lowering the incidence of tax on interest income, not only from bank deposits but also fixed income products such as small savings schemes. These products are the go-to vehicles for less-affluent savers and the main source of income for seniors. It is true that the younger cohort of the population has been allocating a higher proportion of its incremental savings to equities. However, it is doubtful if tax policies have played a big role in this shift. Inexperienced investors always chase the asset class with the highest recent returns. With the stock indices more than trebling from Covid lows, stocks and equity mutual funds have been the beneficiaries of this returns chase in the last four years. Should stock markets correct or equity returns revert to their long-term average of 12 per cent or thereabouts, newer investors are likely to shy away. While comparing their term deposits with other products on taxation, banks also need to introspect on whether they’re offering a fair deal to savers when tax considerations are left out of the equation.
Despite ostensible competition for CASA (Current Account Savings Account), most large banks have not seen it fit to revise their sub-3 per cent rates on savings accounts for decades now. On term deposits, they have opted for snail-paced transmission in a rising rate cycle. Reserve Bank of India data as of end-June showed that the weighted-average interest on term deposit balances has risen by just 125 basis points between April 2022 and now, while the policy rate is up by 250 basis points. The weighted average interest rate of about 6.28 per cent on banks’ outstanding term deposits offers a slim real return to the depositor.
Having said this, there are macro payoffs to be had from taxing interest income on deposits and small savings schemes at a flat rate of say 10 or 15 per cent, as opposed to taxing them at the investor’s slab rate. Parity in taxation of fixed income and equity products may ensure that savers with a low risk appetite don’t allocate to equities purely for tax reasons. Lower tax on interest can also boost real returns on deposits, which are the largest component of household financial savings. Redefining “long-term” for equities from 1 year to, say 3 years, can lift tax collections while nudging equity investors towards a long-term orientation.