Saving’s not what it used to be

Let’s look at the evidence before the Governor. According to him, the annual rate of inflation remained below 4.0 per cent up to mid-January 2003 and rose thereafter to 6.2 per cent by end-March 2003. The components of the Wholesale Price Index (WPI) are (i) manufactured products; (ii) primary articles; and (iii) fuel, power, light and lubricants. They have weights of 63.7 per cent, 22.0 per cent and 14.2 per cent respectively. Of these, the sharpest increase in 2002-03 was in the ‘‘fuel, power, light and lubricants’’ group — prices increased by 10.8 per cent. In the primary articles group, there were steep increases in the prices of oilseeds, sugarcane and cotton. Manufactured products registered a price increase of only 4.8 per cent, but this must be compared with no increase in the previous year.

Further, during 2002-03, non-food credit of scheduled commercial banks recorded a growth of 26.2 per cent. Demand deposits also registered a strong growth of 10.3 per cent. According to the statement, both are indicative of the fact that a substantial part of lendable resources of banks has been deployed for productive purposes. At a disaggregated level, credit flows increased to iron and steel, metal and metal products, cotton and jute textiles, electricity, paper and paper products, fertilizers, drugs and pharmaceuticals, cement, gems & jewellery, construction, food processing, computer software, power and roads and ports. So far so good. But the other side of the story is that there is obviously a spurt in demand which has stimulated a spurt in production. What happens when demand increases? At least in the case of manufactured products, the tendency of manufacturers is to raise prices.

The statement admits that there is adequate liquidity in the market. Interest rates are soft. The call money rate, discounted rate of commercial paper and cut-off yields on Treasury Bills have converged to a narrow band of 5.5 to 6.0 per cent. The yield on Government Securities with 1-year residual maturity is 5.50 per cent and on securities with 10-year residual maturity is 6.21 per cent. Yields on non-government bonds have witnessed a sharper reduction.

Term deposit rates have also moved down. On maturities up to one year, the rate is between 4.00 and 6.00 per cent. In the case of long term deposits, the rates are in the range of 7.25 to 8.75 per cent. Consequently, lending rates have also declined. The PLRs of public sector banks have declined and are now in the range of 9.00 to 12.25 per cent.

Given this evidence, there was a strong case for a ‘‘standstill’’ on the Bank Rate. Nevertheless, the Governor has announced a reduction in the Bank Rate by 0.25 percentage point from 6.25 per cent to 6.0 per cent, and has indicated his intention to keep it unchanged until October 2003. He has also announced his intention to cut the CRR from 4.75 per cent to 4.50 per cent with effect from June 14, 2003. Together, these two measures will trigger lower interest rates and enhanced liquidity. If demand picks up — as the Governor expects it to — there will be pressure on prices. Added to this, if the monsoon is less than normal there will be an upward pressure on the prices of primary articles.

Industry usually complains of high ‘real’ interest rates. That complaint is no longer heard because of the reduction in lending rates and the rise in the rate of inflation. But there is a flip side to lower interest rates. Perhaps for the first time in recent years, depositors, that is savers, will be ‘‘rewarded’’ with a negative real interest rate. This is so because, again, perhaps for the first time in recent years, the rate of inflation is higher than the rate of return on time deposits from one year to three years.

There is some concern that this development will impact savings. There is, of course, the counter-intuitive argument that those who wish or need to save will, whatever be the consequences, save and that a negative real interest rate may not encourage them to consume rather than save. May be so, but in my view, there is something fundamentally wrong if a saver will get a negative real return on his savings. It is the savings of the household sector that keeps this country afloat. Household savings accounts for 22.5 per cent in the overall Gross Domestic Savings ratio of 24.0 per cent (2001-2002). Besides, in a country with virtually no social security for the vast majority of the people, anything that may discourage the people to save — or will harm them when they save — is not acceptable.

The Governor expects that inflation will remain benign in the range of 5.0 to 5.5 per cent. Some years ago, the policy stance was that inflation should be kept, at all costs, below 4.0 per cent. Be that as it may, an inflation rate of even 5 per cent will hurt the small depositor who will get only 4 per cent on a term deposit with maturity up to one year. If inflation goes beyond 5.5 per cent, the Governor will have little choice but to raise the Bank Rate. There was a strong case for the Governor to have taken a ‘standstill’ position and not cut the Bank Rate. High inflation and a negative return for the depositors/savers make for an explosive combination, especially when key elections are round the corner.

(Write to the author at pcexpressindia.com)