Lower Interest Rates – The Hitavada
By Dr Bharat Jhunjhunwala:
Interest rates must move in line with the rate of inflation. For example, the interest rate on the NSC in 2020-2021 was 7.9% while the inflation rate was 4.9%. The “real” interest rate obtained by the depositor was only 3.0%.
THE Government had announced a drop in the small savings rate on March 31 but withdrew it within hours. For example, the interest rate on the 5-year National Savings Certificate (NSC) has been reduced from 7.9 percent to 6.8 percent. Interest rates on Kisan Vikas Patra, Savings Plan for the Elderly and Provident Fund have been reduced and restored in tandem. There is, however, no serious reason for depositors to cry foul. Interest rates must move in line with the rate of inflation. For example, the interest rate on the NSC in 2020-2021 was 7.9% while the inflation rate was 4.9%.
The “real” interest rate obtained by the depositor was only 3.0%. The real interest rate is lower because the value of the principal decreases as the rate of inflation decreases. Let’s say you deposited Rs 100 in a fixed deposit with a bank last year with an interest rate of 4.9%. You would have had a kilo of high quality basmati rice last year. Now you have received Rs 104.90 from the bank this year with interest of Rs 4.90 added. However, the price of basmati rice has increased to Rs 104.90 per kilo in the meantime. Therefore, you would get the same 1000 grams of rice from Rs 104.90 this year. The “real” gain for the depositor is the difference between the interest rate and inflation. The inflation rate has gone from 4.9% to 3.7% now. However, the NSC interest rate remains unchanged.
The depositor will get Rs 107.9 on a deposit of Rs 100 in an NSC made last year. Thus, the real interest rate obtained by him would be 4.2 percent (7.9 interest rate minus 3.7 inflation rate). The real interest rate was 3.0 percent last year (7.9 interest rate minus 4.9 inflation rate). That percentage rose to 4.2 percent this year because the interest rate remained unchanged while inflation fell. The reduction in the interest rate on NSCs from 7.9% to 6.8% carried out by the government, had it been implemented, would have led the depositor to still obtain a real interest rate of 3.1. % (6.8% interest rate minus 3.7 inflation rate) – which would be almost the same as the 3.0% real interest rate it got last year. The second rationale for lowering interest rates is that the money deposited into these savings plans is actually a loan taken out by the government. About 95 percent of this money is used for government consumer spending and only 5 percent is used for public investment. Banks, on the other hand, lend more for investment. I think about 50 percent of the money deposited in banks goes to loans made for investments such as buying taxis or building factories. The problem is that the interest earned by the depositor at NSC is 7.9% while a 5 year fixed deposit with the State Bank of India would only earn him 5.4%.
Therefore, depositors are reluctant to deposit with banks. As a result, the ability of banks to donate banks for investment is less, just as the ability of the housewife to invest in an online course for the child is less if she has less income. It was necessary to reduce interest rates on NSCs so that it became attractive for depositors to deposit with banks. The third rationale for lowering the interest rate is that the government can borrow as much money as it wants through the sale of government securities at an interest rate of 6.2 percent. By comparison, the government has to pay interest of 7.9 percent on NSC. Thus, the government must bear an additional charge of 1.7 percent on funds borrowed from the NSC. Let’s say the government pays an additional Rs 1 crore as interest on NSC. The government has to collect taxes from the people from another method to make this payment of 1 crore.
Therefore, the high interest rates on NSC only mean that the government will collect taxes from the population and provide additional benefits to NSC depositors. It would be as if the head of the industrial establishment were lowering the wages of the workers and increasing the wages of the foremen. The reduction in the interest rate on small savings such as the NSC was justified for the three aforementioned reasons, namely the fall in inflation, the encouragement of deposits in banks and the burden on the state. The withdrawal of the reduction was not justified. I am convinced that the government will be forced to make this reduction again soon. More importantly, our rate of economic growth has declined over the past six years. The COVID pandemic has made the situation worse. The second wave of COVID presents an additional danger. A trader told me only yesterday that his sales are still down 25% from pre-COVID levels. As a result, his profits were less, the goods he bought in the market for his consumption were less, and the total demand for goods in the market was also less. Businessmen do not find it profitable to take out loans for investment in this condition. They would take a loan from the bank and set up a new factory if there was demand in the market.
They will not build a new factory or take out a bank loan when there is less demand for paper in the market. I think they wouldn’t take a loan even if the interest rate were brought down to zero, as seen in countries like Japan where there is no borrowing from banks and where the growth is lagging despite zero interest rates. The government has focused on making it possible for businessmen to take out loans to boost the economy. However, this does not happen due to lack of demand. The government must therefore change course. Instead of focusing only on lowering interest rates, the government must at the same time make money transfers to the common man as has been done in the United States and other countries to save money. purchasing power in the hands of the population, create market demand and revive the economy. .