[Editorial Analysis] Negative returns for savers may hold back RBI from repo rate cut

Mains Paper 3: Economy
Prelims level: Repo rate cut
Mains level: Indian Economy and issues relating to planning, mobilization of resources, growth, development and employment

Context:

• The RBI decision to frontload repo rate cuts (115 basis points since February) to 4 percent has partly led to negative returns for depositors. (File)

REAL interest rates:

• WITH REAL interest rates (interest rate minus inflation rate) turning negative, and erosion in the returns of savers, a large section of bankers say the Monetary Policy Committee (MPC) of the RBI— scheduled to meet August 4-6 — may adopt a status quo on policy rates in the near future.

• Technically, bank deposits are fetching negative real returns of nearly one percent (-0.99 percent) as one-year fixed deposit rate has come down to 5.10 percent (State Bank of India rate) whereas inflation in June was 6.09 percent.

• The positive real interest rate logic weighs against an immediate further rate cut based on the current inflation trajectory.

• There is a significant likelihood of MPC members voting for a pause during the forthcoming review.

Frontload repo rate cuts:

• However, despite the fall in deposit rates, there has been a 10.8 percent rise in bank deposits. SBI’s 2.70 percent rate on savings deposit accounts effectively means a negative real return of -3.39 percent after adjusting for inflation.

• The Reserve Bank of India (RBI) decision to frontload repo rate cuts (115 basis points since February) to 4 percent has partly led to negative returns for depositors.

• The uncertainty about inflation trajectory for next couple of months may weigh the rate decision.

• The upside inflation surprise suggests that headline inflation is likely to remain near the upper end of the RBI’s inflation mandate of 4 percent plus or minus two till September.

• The real returns for savers have turned negative for some months now.

• The CPI inflation-adjusted deposit rate (real interest rate) had turned negative -0.8 percent in December 2019, when inflation touched 7.4 percent and deposits rate 6.6 percent.

• It continued in the negative zone due to the uptick in inflation and downward interest rate scenario. “We expect that inflation will remain at elevated levels for the next few months so the real interest rate will continue to be in the negative zone,” SBI report says.

Conclusion:

• If we take a look at the income effect, it is a possibility that people might increase their savings in a low-interest rate regime to compensate for the loss in income and especially if there is a excessive economic uncertainty regarding the future and there is absence of social security nets.

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Prelims Questions:

Q.1) With reference to the stressed companies, consider the following statements:

1. A company would be eligible to be called stressed if it has defaulted on its payment obligations for more than 90 days or if the credit rating agencies have downgraded its securities to ‘D’.

2. An entity, which has an inter-creditor agreement in terms of Reserve Bank of India (Prudential Framework for Resolution of Stressed Assets) Directions 2019, will also be identified as stressed.

Which of the statements given above is/are correct?
(a) 1 only
(b) 2 only
(c) Both 1 and 2
(d) Neither 1 nor 2

Answer: C

Mains Questions:

Q.1) How the quantitative and qualitative tools opted by RBI for maintaining the liquidity in the market and changes brought by RBI to stabilise financial market like cut in Repo Rate? What are the recent outcomes of various steps taken by RBI in this regard?

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