The State Bank of India (SBI) has decided to reduce interest rates on savings deposits below Rs 1 crore by 50 basis points to 3.5% per annum. This is because it has been encouraged by a record low retail inflation and higher bank deposits.
The last time India witnessed such low interest rates on savings accounts was in 2003.
The rate cut is likely to have a cascading effect on the interest rates of other banks as well, leading to lower income for the common people from their savings accounts.
The rate of interest of fixed deposits has not been touched yet, but it is likely that they too will see a fall in the coming days.
What led to the cut?
Interest rates on savings accounts have a direct correlation with the amount they have in deposits. After demonetisation, in the months of November and December 2016, the SBI received Rs 1.5 lakh crore into its savings accounts.
Banks give higher interest rates on savings accounts to attract more funds, in order to lend them to commercial borrowers. The fact that a huge amount of money came into the banking system due to the note ban made banks lose their appetite for more deposits. Now, they can afford to give lower interest rates on savings as well as fixed deposits.
Moreover, the government has been pressurising public sector banks to reduce interest rates on commercial loans, to boost industrial investment and consumption in the country. The only way to reduce interest rates charged on loans is to reduce the interest paid on savings and fixed deposits.
Now that the SBI has reduced its interest rates on savings accounts, there is likely to be a reduction in the rates for home loans, commercial loans and auto loans.
Moreover, the government has been constantly reducing interest rates on small savings like EPF, PPF, Kisan Vikas Patra and Sukanya Samriddhi scheme. The small savings schemes directly compete with bank savings accounts to attract deposits from retail consumers.
Once the government reduces interest rates on these schemes, the banks get a free hand to reduce interest rates on their savings accounts as well.
For the April to June quarter of 2017, the government cut interest rates on these schemes by 0.1%, signalling to banks to go for a rate cut on savings accounts.
Expectation from RBI
The Reserve Bank of India is also likely to cut interest rates by 25 basis points on Wednesday, 2 August, after retail inflation hit a record low in June.
Most economists are of the view that given the low rate of inflation, there was a case for a rate cut by the RBI.
This will further put pressure on the banks to reduce their interest rates. A low interest rate regime in the country calls for lower interest rates on savings deposits as well, and the SBI has taken the decision in line with those expectations.
The people adversely affected by this rate cut will be the poor, pensioners and housewives, since they rely on interest from their savings to increase their wealth.
These people usually do not go for home or auto loans, hence the benefits of a lower interest rate on loans will not affect their lives. These are the people who do not want to invest in riskier assets like share markets, mutual funds or debt funds.
While they will not take their money out from the banks, it will impact their savings in the long term.
Stock markets, mutual funds, industries and loan takers can now expect good days ahead. A lower interest rate on savings indicates lower interest rates on loans as well.
Once the other banks follow the SBI’s lead and announce interest rate cuts on commercial loans, there will be a direct benefit for those who avail of them.
Post demonetisation, more and more people from the middle class are moving towards stock markets and mutual funds in the hope of increasing their returns on the money invested.
Investments in mutual funds rose to Rs 18.96 lakh crore in June 2017, as compared to Rs 16.28 lakh crore at the end of October 2016 . This clearly indicates that post demoentisation, people have started investing more in mutual funds, in search of higher returns compared to bank deposits.
According to the Economic Times: “The total market value of domestic money invested in the BSE-200 at the end of March 2017 was bigger than the value of foreign fund holdings for the first time in two years… It is estimated that the value of Indian non-promoter and non-government holdings was $323 billion compared with $303 billion for foreign funds. This is the first time this has happened in eight quarters.”
Given the euphoria in the Indian stock markets over the past few months, the reduction in the deposit rates is part of an overall plan to push more Indians towards riskier assets in search of returns.
As long as the market gives good returns, there will be no complaints. Those who don’t have the appetite for investing in the share market will have to settle for lower returns, hoping that inflation does not go up in the near future, because it is unlikely that banks will increase their deposit rates, even if inflation goes up.
The party has begun for the urban, young, middle class investors, and for corporates demanding lower interest rates. Those not part of this euphoria will have to live with this new reality.