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Who Speaks for the Savers?

The Reserve Bank’s stance on rates has provoked a noisy growth-vs-inflation debate, but what about the interests of fixed-income savers?

In the inflation versus growth argument that surrounds the Reserve Bank’s actions last week, the interest of savers is hardly being talked about. This is unfortunate. Last week, when the central bank refused to lower interest rates, industry as well as the finance minister lost no time in expressing their displeasure. The cut and thrust of the argument is widely known—the central bank thinks as long as inflation is high, interest rates cannot be lowered. The opposite camp thinks that lower interest rates will improve the prospects of growth.

For the moment, let’s put aside the supposed by-products of higher or lower interest rates (lower inflation and high growth respectively). Let us instead focus on the direct result of the rates themselves—lower income for depositors and lower cost for borrowers. Who is the biggest borrower? The Government of India, of course. And who is the biggest depositor? Why, the people of India, especially ordinary people who use no other financial instruments for their savings except simple deposits.

A huge chunk of the Indian financial system basically boils down to government borrowing from households through a variety of routes. This ranges from direct borrowing (post office deposits, for instance) to banks buying treasuries out of the SLR. The immediate and certain effect of lower interest rates will be that effectively, the government will pay households less for these borrowings. Secondary effects like those on growth and inflation may or may not happen (and who knows at what pace), but this direct effect certainly will.

One of the criticisms that are often levelled against the Reserve Bank is that Indian inflation is largely structural and doesn’t respond to high interest rates. The logic is that high rates won’t easily control inflation so you might as well lower them and look after growth. I’m not an economist and don’t pretend to understand the underlying issues. However, from the point of view of a fixed income saver, the response to this argument is a strong ‘So what?’ I don’t care if inflation doesn’t respond to low rates.

If inflation doesn’t respond to interest rates then it’s absolutely poisonous to have lower rates. The fixed income investor will then be left with the lethal combination high inflation coupled with low deposit rates. His real, inflation-adjusted returns will be zero or negative. In the interest (no pun intended) of savers, the Reserve Bank has a responsibility to ensure that real returns from deposits are maintained at some minimum level. Therefore it must not drop rates until after inflation starts falling. It’s great that the government has a plan to control the fiscal deficit, and we all hope it succeeds. But surely, the RBI is right to wait until after the plan starts getting implemented.

It may not look like at first sight, but in my mind, this issue is deeply tied with the sad state of retirement benefits in India. A lot of senior citizens depend on nothing but fixed income returns to fund their cost of living after retirement. Post-retirement financial management is getting more and more difficult for people who don’t have an inherently inflation-linked income stream like rent.

The real inflation rate that people face is far higher than the official rate. For example, the inflation in medical costs that we have seen in the last decade is, all by itself, enough to convert a formerly middle-class retiree into a pauper. And it does so, for a distressingly large number of people. Add to this the sharply higher cost of fuel and electricity, as well as those of services that older people depend on disproportionately. Ensuring a decent fixed income return is an important function of the system. In different ways, both the poor and the rich have a voice, but the senior citizens of middle India don’t.

If the government tries to hustle the RBI into lowering rates while inflation remains high, it will amount to taking money out of these people’s pocket and putting it into the government’s.