Sharp cut in small savings rates was ill-timed:Business Line 3rd April 2020

While the effort is to improve monetary transmission, the deep cuts will hurt ordinary people at a time when retail inflation is on the rise

The decision to cut the small savings rate by 70-140 bps is not well-timed and would affect people in the lower income segments, especially in the semi-urban and rural areas. This deep cut in rates is probably the first of its kind as the approach so far has been to have a calibrated reduction in rates. The last time they were cut was in July 2019, by 10 bps.

There are probably two motivating factors here. First, the RBI has gone in for a sharp cut in the repo rate by 75 bps and second, the small savings rates have not been tinkered with significantly for some time. While there could be a strong economic rationale for the same, the timing is quite odd.

The argument is that the RBI has addressed the pandemic by lowering the repo rate, which will work if deposit rates are lowered, leading to lower lending rates. Deposit rates can come down if small savings rates are lowered. This overemphasis of transmission comes at a time when inflation is high and above the 6 per cent mark. Also, the shutdown has led to the supply of food products being affected by paucity of labour and transport facilities. Prices have gone up, and so will headline inflation. Presently, with inflation at 6 per cent and repo at 4.4 per cent, the real return is negative. One-year term deposit gives a return of 5.9-6.5 per cent, which gives negative to 0.5 per cent real return.

Small percentage

Small savings are around ₹10 lakh crore, of which around 68 per cent are in deposits. This compares with ₹133 lakh crore of bank deposits, and hence the former is just 5 per cent of the latter. Quite clearly, the argument that is normally given for banks not being in a position to lower deposit rates because of small savings rates being higher is not really strong, as just 5 per cent volume of deposits cannot be driving total deposits in the system.

The reason for low participation in small savings is that they are normally catering to people in the rural and semi-urban areas, where post offices are contact points and provide these facilities. The senior citizens’ scheme is also popular due to the higher rates offered — which has come down from 8.6 per cent to 7.4 per cent — but the outstanding volume is just ₹0.68 lakh crore.

Therefore, while theoretically the two could be competing, in practice, they have different target segments and interest rates do not really influence customers. It has been seen that deposits are always sticky and do not move from one bank to another even when there is variation in interest rates. Hence, to think that customers would en masse all go to post offices on account of higher rates being offered is quite far-fetched.

Impact on deposits

The logical fallout is that banks will lower the deposit rates for sure, and the quantum would probably be 50-100 bps on new deposits. While the immediate impact will be that the formula-based MCLR will come down, there is a possibility that growth in bank deposits will slow down. This was witnessed in FY19, when the banking system was in a state of scarcity with the RBI going in for a record OMO purchase of ₹3 lakh crore mainly due to the slowdown in growth in deposits, as households moved to mutual funds and stocks.

This time, there will be added pressure on deposits, because of the higher inflation and lower income growth due to depressed performance of companies. The fall in interest rates will affect those who depend on savings for sustenance, which can be around 20-25 per cent of the population.

Curiously, small savings are critical for the government for financing the deficit. In the last four years, the recourse sought has increased from ₹0.67 lakh crore in FY17 to ₹2.4 lakh crore in FY20, which will be retained in FY21. Hence, the size of support is 30 per cent of gross market borrowings which are to be ₹7.8 lakh crore this year. Intuitively, it can be seen that if these savings were not available, the market borrowings would have been higher at ₹10.2 lakh crore. Hence, if there is a decline in the growth in small savings, the government will be most affected as it will have to borrow more from the market which in turn will push up yields.

The rate cuts on small savings should have been calibrated and of a smaller magnitude, to eschew the shock effect of a single large cut.