Explained: What unchanged savings rates mean for banks and savers

The government’s decision to keep interest rates on small savings instruments unchanged is a setback for small investors. At a time when inflation is over 7% and bond yields have risen over 7.4%, the decision will not only result in a negative real rate of return – after adjusting for inflation – for savers and retirees , but the status quo is also likely to encourage banks to slow the rise in deposit rates.

Are the prices attractive?

Considering that retail price inflation reached 7.97% in April and 7.04% in May, prevailing rates on small savings schemes may have disappointed savers, even though they are higher than bank fixed deposit rates. The RBI expects retail price inflation to be above the upper tolerance level of 6% until the end of the year.

Under Thursday’s decision, schemes such as the Public Provident Fund (PPF) and the National Savings Certificate (NSC) will continue to bear an annual interest rate of 7.1% and 6.8%, respectively. , in the first quarter of the next fiscal year. The one-year term deposit program will continue to earn 5.5% interest in the second quarter. One to five year term deposits will earn a rate of around 5.5 to 6.7%, payable quarterly, while five year recurring deposits will earn a higher interest rate of 5.8%.

With the exception of PPF and Sukanya Samriddhi Yojana, all other small savings instruments are currently generating negative real returns in a high inflation environment. Moreover, as the RBI is expected to raise the main policy rate – the repo rate – to bring down inflation, savers expect more returns from small savings schemes and bank deposits.

What does this mean for banks and savers?

It is now unlikely that banks will opt for a significant increase in deposit rates. If the government had raised the small savings rates, it would have been forced to opt for a more pronounced increase in deposit rates to prevent the flow of money from the banks to the small savings schemes.

Additionally, when stock markets boomed in 2021 after the March-April 2020 crash, investors poured a record amount of money into stocks and mutual funds. Now that the markets are showing enormous volatility following rising rates and outflows from foreign portfolios, savers are turning to bank deposits and small savings. Much will now depend on the amount of rate hike the RBI announces in the coming months.

What have been recent interest rate trends?

Low savings rates are linked to benchmark government bond yields, but despite the upward movement in G-Sec (government securities) yields, the government has not raised interest rates . On Thursday, the benchmark 10-year bond yield rose to 7.45%, up 140 basis points over the past year. The RBI also raised the repo rate by 90 basis points to 4.90% in the April-June quarter. Interest rates on small savings were cut by 40 to 110 basis points for the first quarter of 2021-22, but the decision was later reversed, with the finance minister saying “orders issued by oversight will be withdrawn “.

What was the impact of negative returns?

While inflation is now above 7%, the one-year bank deposit rate is now 5.3% (SBI). This means that depositors lose money after adjusting for inflation. There are not many options for savers and depositors. Markets are risky and volatile. They can’t gamble with retirement money. In addition to this, the country does not have an adequate social security system, although government and semi-public employees receive a pension after retirement. Technically, negative real rates discourage savings and stimulate consumption. This, in turn, could fuel inflation further and lead to even more negative real rates. Keeping interest rates too low for too long can have negative consequences.

How have the banks reacted?

After the RBI raised the repo rate since May, banks started raising deposit rates. Earlier this month, SBI raised rates by 15-20 basis points on some national retail term deposits below Rs 2 crore. Rates for seniors are increased by 50 basis points for these tenures. Other banks have also raised their rates. The rise in the bank deposit rate will also depend on demand for credit, which has now started to show signs of growth.

The banking system has maintained excess liquidity since June 2019 due to deposit accumulation due to higher growth in bank deposits compared to loan disbursement, except for the last two fortnights. It is important to note, however, that if the small savings rate is not increased, banks will not be forced to raise rates unless they need to raise funds for credit demand. If the government had raised the small savings rates, the banks would have been forced to raise fixed deposit rates.

Buy now | Our best subscription plan now has a special price

What can investors do?

While one can strategize about investing in a good debt product that offers better returns, experts say stocks are the best option to beat inflation and generate a positive real rate of return.

While smaller savings instruments offer rates below 10-year G-Sec yields, trading at around 7.4%, financial advisers say people in the highest tax bracket can opt for highly rated debt securities and invest in mutual funds which are also more tax efficient. “Debt investors can instead opt for target maturity funds that invest in GSec/PSU bonds and government securities. If investors invest for five years, they can earn an after-tax return of around 6.5%. Even for a period of three years, investors will be able to get 5.5% after tax,” said Surya Bhatia, Founder of AM Unicorn Professional.

Vishal Dhawan, Founder and CEO of Plan Ahead Wealth Advisors, said that while people in the highest tax bracket may opt for target maturity funds for principal safety, “ideally investors should opt for products with short maturities so that at maturity they can reinvest at a higher rate interest rates are on an upward trajectory However, to hedge against inflation, one must look to equities despite the malaise because only equities can provide inflation protection”.

Comments are closed.