Despite all media hype and excitement over RBI's repo rate cut, the common man is in for a rude shock, as interest rates on all savings schemes are also being reduced to the detriment of savers, who have no say in these matters
Kudos to Reserve Bank of India (RBI) for its Diwali gift to India Inc. Late last month, the RBI surprised the market with 50 basis point (bps) cut in the repo rate. This cheered the industry and the central government, who hailed the rate cut as a move that will propel the economy to a higher growth trajectory. Finance Minister said that the rate cut will help the recovery process. Whether it will indeed achieve the desired result is anybody’s guess. There are too many imponderables and the real beneficiaries of RBI action are few and far between, for a variety of reasons.
Will industries benefit?
The leaders of trade, commerce and industry were excited because they expected that the rate cut would lead to an equivalent reduction in lending rates of banks. But banks are reluctant to pass on the entire interest rate reduction, since it adversely affects their profit, which is already under stress due to bourgeoning non-performing assets (NPAs).
While the RBI has reduced repo rate by 125 basis points (i.e. 1.25%), since January 2015, banks have passed on only 60 to 70 basis points to their borrowers so far.
While RBI has been nudging banks for transmission to the maximum extent, banks have their own reasons not to pass on the entire reduction, causing a bit of unhappiness among the corporates. Nevertheless, government hopes that the reduction in repo rate will improve the investment climate in India and provide impetus to the projects that are suffering due to the high cost of funding, thereby helping banks to bring down their NPAs also.
The rate cut is certainly a sentiment booster for industry, and will help reduce their borrowing cost to an extent and improve their cash flow giving them a ray of hope during these uncertain times due to turmoil in Europe and China.
Home loan beneficiaries to benefit:
Home loan borrowers too will benefit, as banks are willing to reduce lending rates to homebuyers for several reasons. Firstly, with lower borrowing costs, they will increase their lending to this sector. As this is the safest way to increase their retail loan portfolio, since the delinquency is lowest in housing loans. Secondly, RBI has since rationalised the risk weight and loan to value ratios, which gives them better leverage and return on equity will improve to some extent. Thirdly, reduction in interest rate will help debt-ridden builders to reduce their borrowing cost and some of them may pass on a part of such savings to consumers.
Home loan borrowers, though not very large in number, are expected to benefit by this to the extent of cut in interest rate as well as reduction in the price of houses. It is certainly good news for homebuyers, who will benefit by lower equated monthly instalments (EMIs) if they borrow from banks or housing finance companies.
But what does the common man get from the rate reduction?
According to government statistics, inflation measured by consumer price index (CPI) is slowly going down, which should benefit the common man. But in reality, the prices of food items of everyday use are continuously rising, though in small doses, leave alone coming down. As per the monetary policy statement of RBI, “inflation expectations of households remained elevated in double digits likely in response to recent month-on-month increase in the prices of vegetables and pulses.”
In fact, CPI for the month of September 2015 came in at 4.41%, much higher than the 3.66% recorded in the month of August 2015 as just announced last week. Obviously, this reduction in repo rate may further fuel inflation, unless rain gods come to our rescue.
Besides, ratings agency India Ratings’ says that the interest rate cuts and hikes have been utilised by banks “to absorb the upside and pass on the downside to customers”.
RBI has cut repo rate by 125 bps since January 2015, and banks have cut one year deposit rates by an average 130 bps but the lending rates have fallen by a meagre 50 to 60 bps, including the base rate cuts announced by banks recently. Banks are using the policy cycle to their advantage, says the rating agency.
From a study of the last 10 years, it appears that in most cases when policy rates have reduced, deposit rates have come down faster and the quantum has also been higher compared to lending rates, the note says.
So what has the large majority of common people who do not borrow from banks got from this repo rate reduction? There are no tangible benefits to the common people by this rate reduction. On the contrary, despite all the media hype and the excitement over repo rate reduction, the common man is in for a rude shock, as interest rates on all savings schemes of the govt. are also being reduced to the detriment of the large majority of savers, who have no say in these matters.
Interest rates on small savings schemes to fall:
The deposit rates offered by banks have already come down and as if to add insult to injury, interest rates on savings schemes of the government are likely to be reduced to match the deposit rates of banks. If the interest rates on senior citizens savings schemes and the post office savings schemes are also reduced, ordinary citizens, who make their living from the interest derived from bank deposits and other small savings schemes, will suffer the most. By reducing the interest rates on all savings schemes, innocent, semi-literate people will fall a pray to the Ponzi schemes promoted by the fraudsters who will cheat them making life miserable for the hapless victims.
Middle class and the lower middle class, who form more than 50% of our population, are at the receiving end of the price rise without commensurate increase in their earnings. For instance, two years back when the oil price was much higher, most of the public transport companies raised their fares according to the oil price existing then. But since then, oil price has come down by nearly 50%, but none of these transport companies have reduced fares, and the public are still paying the same old fares. Same is the case with railways, power, telephone and many other utilities that have not reduced their tariffs even though the oil, diesel and gas used by them cost much less now.
Even today, when the domestic gas price has been reduced, the biggest beneficiary of the fall in gas prices is the government, whose subsidy burden has steeply come down and the common man continues to pay the same price paid two years back. It is, therefore, a myth to say that the fall in inflation directly benefits common people, as the principle of ‘what goes up must come down’ does not apply mostly to prices of essential articles of daily use.
What can RBI do to mitigate the sufferings of the growing middle class?
Though RBI is right in bringing down repo rate to prop up the economy, they certainly have a duty to take care of the common people, who find it difficult to make both ends meet due to reasons beyond their control. Occasionally, we see RBI Governors sympathising with common people and refuse to act under pressure unless they are thoroughly satisfied that their actions are in the best interest of common people.
With a view to improve the life of common people of our country, RBI should walk the talk by taking some positive steps to offset the fall in interest rates, which will severely hurt the savers who depend on bank interest for their livelihood. Here are three concrete suggestions for RBI to urge the government to implement them for the benefit of all stake holders.
1. There is a need to exempt a part of bank interest from personal income tax to encourage savings through bank deposits. As the entire interest earned on bank deposits is now subject to income tax beyond the basic exemption, the government should exempt at least an amount up to Rs2 lakh from the basic exemption, which will help in improving the yield on bank deposits.
2. At present, interest earned on savings accounts in excess of Rs10,000 is taxable, which is out of sync with banking operations. This is because every bank is anxious to improve their savings deposits and exempting the entire interest on savings bank accounts will give a boost to achieve this objective. Besides, to develop savings habit among the young and the new generations of savers, government should exempt from I-T the entire interest earned on recurring deposits as well. This will not only benefit savers but also help in developing customer loyalty to banks, as these are long-term deposits generating value to savers.
3. The tax deduction at source (TDS) on bank deposits is the most obnoxious regulation, which causes considerable irritation and displeasure, provoking people to shun banks for investing their surplus funds. There is also a dichotomy in the present regulations where senior citizens are not required to pay advance tax on other than business income, but are still subject to TDS on their bank interest. With the help of technology, banks today report to I-T department all interest earned by depositors, so much so, nobody can evade tax on interest, if applicable. Therefore, to make life simpler for individual savers and encourage them to patronise banks, the government should completely abolish TDS on bank deposits.
These initiatives will be of immense help to not only small savers but also the banks to improve deposit inflows, which otherwise are likely to be diverted to unproductive assets and risky investments in search of higher returns.
RBI can do yeoman service to the common people of this country and to the banking industry by persuading the government to radically transform the income tax regulations applicable to bank depositors on the above lines, which can create a new paradigm of customer satisfaction and banking excellence, not experienced so far in our country. If these ideas are implemented in the ensuing central government budget, it will be a New Year gift to the common people of this country, closely following the Diwali gift to India Inc.
(The author is a financial analyst, writing for Moneylife under the pen-name ‘Gurpur’.)