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The Dark Side of the Rate Cut

Lower rates are not good news for everyone

Raghuram Rajan has started cutting interest rates and it's simply impossible to find any comment on it that is not heavily optimistic. Certainly, I'm not about to view coming lower interest rates in a negative light, but simply point out that the impact on savings must be considered. Right now, the focus is on cheaper money for businesses and government and the prospect of higher growth. As far as the impact on investments go, all attention is on the booming equity markets which have welcomed Rajan's rate cuts with big jumps. The bond markets are also happy. Since we look set for a long period of interest rate declines, bond investors as well as fixed-income mutual fund investors are going to make handsome returns of the kind that they haven't seen for a while.

So who isn't invited to this party then? Clearly, only those who save in banks and other fixed-return deposits. A drop in interest rates will see a fall in savings bank rates and fixed deposit rates. Not just that, public provident fund (PPF) and post office deposit will also now fall, as will EPF returns. This is inevitable, and is an integral part of generally lower interest rates in the economy.

Of course some people will point out that since inflation has fallen, lower interest rates do not mean lower real rates. However, that's only partially true. The official inflation rates do not reflect the actual inflation that an individual faces. Older, more conservative investors are rarely able to gain any direct advantage from lower rates. What this means is that times of good economic growth are, on a relative basis, implicitly disadvantageous for those who keep their long-term savings in fixed income asset classes. The logic of the time points towards equity. For some, it might be better to take some risk rather than see the real value of their savings whittled away.