Will financial savings be preferred again?

Mon, 17 Feb Pre-Open

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Investing in a fixed deposit earns one an interest rate of about 8 to 9%. But with consumer prices (CPI) rising at the pace of about 10%, one's purchasing power essentially is reduced by 1 to 2% in one year. Stretching this over longer periods and compounding the effect only worsens one's purchasing capacity over the long term.

This is where the concept of 'real interest rates' comes in.

That consumer prices have reduced over the past few months is a good sign. But with the same being largely due to lower vegetable prices - while core inflation continues to remain high - it means that a lot more work needs to go into controlling inflation.

Real interest rates continue to remain weak. And as reported by Mint, the combined effect of declining inflation coupled with higher interest rates, has reduced the unattractiveness of financial savings.

As per data displayed on the World Bank's website, real interest rates hovered in the territory of 4-7% during the four year period ending 2008. Post that, with inflation troubles starting to emerge, the real interest rates in India declined to levels of 2% towards the end of 2011.

Nevertheless, what is more important to note that real interest rates since have been in the negative territory, which means that financial saving instruments became unattractive. However, with inflation rates having declined in the past few months, the real interest rate figure as of January 2014 stood at a relatively lower figure of -0.8%.

What implication will this development have on India's central bank's stance on liquidity is something that will be evident only in next monetary policy review. But in all probability with the RBI having set firm targets to curb inflation over the next few years, the likelihood of it cutting rates seems minimal.

So with returns from financial savings like fixed deposits remaining in the negative territory (negative real rates) and stock markets remaining volatile, Indians moving their money back to financial savings in the near term is a remote possibility. This means that financial savings will continue to decline in proportion of overall household savings. Instead, physical savings - property and gold mainly - will continue to increase in proportion to overall savings. This in a scenario when savings of Indian households itself has also decreased as a percentage of the GDP over the past few years.