Savers earn a negative real rate of return. If low policy rates are here to stay, the Budget should step in with tax breaks
For nearly the last two years, deposit accretion at banks in India has gathered pace even as overall credit growth has been sluggish, quite evidently because of the lower level of economic activity in the wake of the Covid pandemic.
The systemic liquidity overhang has also given rise to a disconnect between the real economy and the boom in the stock market, notably led by the large flows into mutual funds; loose monetary policies the world over have notably added to this effect.
Meanwhile, domestically, there are indications that the deposit growth is more in the urban and semi-urban centres while in rural areas it has been lagging. Presumably, consumption/spending has not happened among the salaried class/fixed income group and the surplus has stayed with the banking system. There cannot be any other explanation for growth in deposits even as the overall economy shrank during 2019-20; even the rebound this year has not led to overall economic output reaching per-pandemic levels. So, the savings are not the result of additional earnings/increase in output.
Yet, one of the fallouts of the low-rate regime has been the low returns for savers and those holding bank deposits. The interest rate on savings accounts is about 3 per cent in most banks now except a few private lenders. Term (fixed) deposits also fetch around 5 per cent for the one-to three-year periods in most banks.
If one were to take into account even inflation based on consumer prices at 5-5.5 per cent, savers in the country are thus earning a net negative return. This is an anomaly. Also, it hurts people who are dependent on interest on bank deposits either as the only or a major source of income. These savers do not constitute a lobby and, therefore, their woes are not heard. But for policymakers, it is a dilemma to keep rates low for borrowers (to boost growth) and ensure decent returns to depositors, even as inflation remains close to the upper band of the tolerance level of 6 per cent.
Monetary policy cannot do much here. Neither can banks offer higher rates of interest because their margins are going to be hit. At least, as far as public sector banks (PSBs) are concerned, the net earnings boost their capital, furthering their ability to lend more in future/yield higher dividends to the government.
If margins were to be foregone, the exchequer will have to bear the load of providing additional capital. In fact, it is estimated that if banks have to support a $5-trillion economy, banks would need to lend more, requiring further capital cushion. Savers would therefore have to be supported by some fiscal “sops” so that their real rate of return is positive. Here, what comes to mind is the exemptions/deductions allowed for interest income on bank deposits for income-tax purposes.
As of now, there are two exemptions allowed for interest income under the I-T Act. One is the exemption up to ₹10,000 on interest income from savings deposits under Section 88. While this may be seen as a sizeable limit because at current rates of interest only if someone keeps on average about ₹3 lakh in savings accounts will he/she hit or cross this threshold of ₹10,000.
But on all other interest income from bank deposits, tax is to be paid as per the slab under which the individual is liable except that for senior citizens there is an exemption of ₹50,000 available on interest income which is reported under “Other Income”.
There are at least three reasons why the government should examine a standard exemption across the board for all taxpayers (not merely senior citizens) on the interest income on bank deposits in the upcoming Budget, at least for the next financial year.
These savers contribute to the lendable resources of banks and thus contribute to economic growth by keeping money in banks. They also end up financing government borrowings indirectly.
Given the current prognosis for inflation as put out by the RBI, the real rate of return on deposits this financial year is going to be negative.
Net savings of the domestic sector have been a historical strength of our economy and the proposed fiscal incentive will fortify the trend of banking of their surpluses by the common people.
There will of course be a “fiscal giveaway”, but we owe it to the savers who fund the banks for supporting our economy through savings.
The writer is a top public sector bank executive. The views are personal