A few months back, when Federal Reserve announced cutting interest rate to a near-zero percent, there were supporters and adversaries to the decision. On the one hand, it was seen as a measure to support the slowing economy. On the other hand, the low rates were seen as a punishment to the savers in the US economy.
The scenario is similar in India also, though our repo rate is not near to zero percent. The economic slowdown and Covid-19 induced crisis forced the RBI to cut the rates consecutively. To ensure liquidity in the market, the Central Bank has not only cut the repo rate to provide cheap credit, but also resorted to other measures including Long-Term Repo Operations (LTRO). By lowering the interest rate and increasing liquidity in the market, it is expected that there will be increased consumption, investment and employment generation. It is likely that RBI will continue with the rate cut cycle considering the Covid-19 induced damage on the economy. However, in this whole process, savers are the worst hit.
In the midst of an economic slowdown, risk aversion is dominant in the banking sector. This, in turn results in lower lending by the banks. To retain its net interest income (NII), banks have been cutting the deposit rates significantly. NII is the difference between the revenue generated by interest bearing assets (loans) and cost of servicing the liabilities (deposits). Since, the income generated from loans are on a decline, banks are trying to bring down their cost of servicing the liabilities.
Indian households contribute around 60 percent of the gross savings in the Indian economy. If we analyse the composition of gross financial assets of Indian households, currency and deposits with banks account for the highest share at 66 percent, followed by insurance funds and mutual funds. So, cut in deposit rates have sizeable impact on savers. More rate cuts are in the pipeline, making it more difficult for savers.
The gross financial assets of households as a percent of GDP declined from 12 percent in FY18 to 10.6 percent in FY20. Considering the present scenario, in uncertain economic outlook with job losses and pay cuts, it is expected that people would save more and spend less. Yet, it doesn’t necessarily translate to higher financial assets for the Indian households in FY21. As pointed out in a recent RBI publication,” a spike in net financial assets of households is likely in the first quarter of FY21 on account of a sharp drop in lockdown induced consumption.” However, it is feared that lags in the economic activity to pick up would taper off the financial surpluses of households in the subsequent quarters.
Since bank deposits are not lucrative, Indian households should look for other alternatives where they will be able to earn higher returns. The savers should not be in a position where they would be saving more but earning less. Households should look at investing in asset classes which can give higher returns like good quality debt mutual funds, NCDs of sound NBFCs, special schemes for senior citizens, government bonds or retail investors etc.