Lower interest rates would kill household savings

Tue, 6 Nov Pre-Open

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Last week, it was matter of choice between growth and inflation again. And the Reserve Bank of India (RBI) with its focus on the latter disappointed many, including Finance Minister.

The much expected key policy rate cut did not happen. While the move is quite dispiriting for industries and Government, let us find out how it impacts a common man. The interest rates have a direct impact on two segments - those who borrow money from banks and the other one that saves money in the banks. It is important to note here that the majority of common people fall in the latter category. On the other hand, it is the Government that represents that borrowing segment.

Lower interest rates are generally associated with high inflation and high growth and vice versa. However, it is not simple as it sounds. For there are lot of other factors involved in between that decide the final outcome. For one, the issue of inflation in India is structural (due to supply side constraints). Hence, it is considered less responsive to the interest rates. That may make one favour a rate cut to promote growth since in any case we can't do anything about the inflation. However, the choice ignores the interest of common man. And here is how.

In a high inflation environment, if RBI cuts rates, it leads to lower interest incomes for saving population. A lower income along with higher price levels in the economy leads to zero or negative real returns - a perfect recipe of disaster for households. Further, the lesser money in hand stifles demand and consumption, something not in favour of growth. Hence, in a high inflation and low interest rates scenario, there is no incentive for households to keep their savings in banks. They would rather park their money in non productive assets like gold and land. This is likely to give rise to asset inflation, hit the banking sector directly and lead to currency depreciation. It was a similar situation that led to Asian financial crisis in 1997.

Coming back to the impact on the common man, the higher fuel, food and electricity costs have already left people poorer in real terms. Needless to say, the worst victims in such case are the senior citizens with their extra medical needs and little sources of income apart from fixed income returns.

As far as lower cost of deposit is concerned, it is important to note here that most of the benefits of this will flow to Government, the latter being the major borrower. That too at the cost of common people that belong to the saving segment. While we all favour growth, we can't ignore the cost that we have to pay for it. In maintaining status quo, RBI has chosen to protect the interest of the common man over the Government and industrial lobby. Hence, while corporate and Finance Minister may accuse RBI of coming in way of growth; from the perspective of a common man, it is the most sensible thing to do.