People's Democracy

Economics & Politics of Interest Rate Hikes

K V George

INTEREST on bank deposits is once again in the limelight. Not a day passes without a multicolour, deceptive advertisement on interest rate hike by one bank or another. A mania has deliberately been created with seemingly varying rates of interests (RoI). The rates look prima facie different, but the real variation is microscopic: the maturity periods differ, or the conditions for premature closing differ. Ultimately the customer is confused. He is unable to make out which bank offers the highest return or which rate is more lucrative. There is a mad rush to the banks. Some terminate the existing deposits before maturity. A fresh deposit is opened with the same bank or another. The end result is negative. The net increase is negligible. Workload at bank counter turns heavier in the absence of a conversion package. 

What is all this about? What is the essence? Is it a short-term gimmick to step up deposit figures as on March 31? Or is it really a measure to absorb the excess liquidity from the economy and release the aggregate demand pull in a desperate move at holding the price line? 

SOFT RATES FOR CORPORATES

In fact everybody knows that any hike in the RoI is not to the liking of the ‘reform’ pundits because softening of the RoI is the sacred mantra of financial sector ‘reforms.’ A low interest regime is what they preach and practise. It is also a fact that the Narasimham committee (NC) recommended a deregulated, market driven, interest rate structure, detached from the ‘clutches’ of Reserve Bank of India (RBI). The NC--1 recommended “the deregulation of RoI in a phased manner in line with the macro economic conditions.”

According to the ‘reform’ advocates, a low interest regime can step up the growth momentum. The corporates would avail bank credit if the RoI is lower. If corporates shy away, the GDP growth will be slow. That is exactly why the Indian corporates and the media lords decry a hike in the cash reserve ratio (CRR) to 6 percent with effect from March 3, 2007 by the RBI. Still the government of India (GoI) and the RBI have no option but to allow a hike in the RoI, because inflation had touched the 6.73 percent mark in February. At the same time the union finance minister repeatedly consoled the corporates that it is a temporary phenomenon and would last up to, say, March end, when the rates would be reviewed. (Offers of higher RoI by banks were open only up to March 30, 2007.)

When the financial sector ‘reforms’ were set in motion in the year 1992, the RoI on deposits was in the range 12 to 15 percent. For depositors it was highly rewarding. The principal amount of a deposit used to be doubled in every 5 years. Workers benefitted because their provident funds (PF) earned up to 12 percent per annum. But as the NC report was implemented, CRR was phased down from 15 to 5 percent. The RoI was artificially scaled down. Only the pious household depositors, averse to taking a risk, remained with the banks. They were not inclined to move to the stock markets or to the real estate. These timid souls, comprising primarily of the pensioners and other senior citizens, were really taken for a ride. But credit delivery was liberal at a much lower price. A buyers’ market prevailed for bank credit wherein borrowers, particularly the corporates, dictated terms to the bankers. Farmers, small industrialists, retail traders, transport operators, students and teachers were charged higher than the corporates. Corporates bargained and secured huge loans at rates lower than even housing loans. This was precisely the scheme of things which the NC and the GoI aspired for: achieving GDP growth through the corporates, with the GoI as the facilitator. 

Nevertheless, the fruits of low-priced credit were seldom passed on to the countrymen. Prices of products were never reduced. Workers were not paid adequate wages. Consumers hardly benefitted. Even taxes owed by corporates to the GoI were not promptly remitted. Corporate families and their shareholders mostly appropriated the excess profit derived on account of a low RoI. 

BANKS FACE CRUNCH

As the matter stands, a situation has emerged wherein banks are starved of funds. They are forced to borrow funds daily at an RoI of 11 percent or more to honour the commitments arising out of demand and time liabilities. The reasons are many. Of course, huge credit growth reaching up to 32 percent is one. But lack of customer care at rural and semi-urban branches has significantly contributed to the poor increment in deposits. Then, the reduced staff strength at the counter certainly added to the cup of woes. Another major factor is the aggressive marketing of insurance products by banks in a bid to enhance the non-interest revenue. Tempted by hefty kickbacks and payoffs, many bank executives at different tiers have been shutting their eyes to the diversions of bank deposits, especially low cost deposits, towards insurance. In the short run, the balance sheets glittered. But in four to five years, the very cornerstones of banks were shaken. 

Theoretically, interest is defined as the price paid by a borrower to a lender for the use of his saving funds. The classical economists believed that interest is determined by the savings and investment. But the neo-classical school led by Wicksel and Robertson considered the interplay of monetary and non-monetary forces as the determinants of the RoI. According to J M Kaynes, RoI is determined by the demand for money, which he called “liquidity preference.” It was Nasau Senior who emphasised the element of sacrifice or abstinence involved in parting with money. Karl Marx observed that savings by the rich people do not involve any sacrifice because they have nothing more to consume. Alfred Marshal later substituted the word “waiting” for abstinence. 

Whatever it may be, interest rate has to be remunerative. It is all the more necessary in an inflationary economy wherein the value of money is diminishing each day. When money is transferred to another hand, there is a sacrifice or abstinence or waiting. When the money is back after maturity, the depositor must feel that he has been compensated for the loss of real value apart from earning something extra. Instead, it operates as a disincentive for saving if he loses in real terms. But that precisely is what the GoI too wanted. Instead of stressing on raising the domestic savings, it hankered for funds from abroad. Foreign institutional investment and foreign direct investment were rate more valuable than the domestic savings. Rural branches were shut down. Manpower was downsized. It was a cruel joke to expect that the flow of deposits would still continue. 

BORROWERS’ CONCERN

A higher RoI amounts to a high price for credit. This was the situation up to 1991. At that time public sector banks disbursed loans to farmers and other priority sector borrowers at subsidised rates. DIR loans were granted to those below the poverty line at 4 percent RoI. But the NC recommended that priority sector advances must be phased out. This proposal was, however, not fully accepted by the GoI. Alternatively, the definition of priority sector was diluted. Concessions in the RoI were also done away with. When subsidies for the poor were phased out, subsidies for the corporates surfaced with a bang. 

Indeed, a high interest regime is deeply worrying for small borrowers. Their concerns require to be addressed as a pressing necessity and priority. Priority sector advances and credit towards productive segments must enjoy concessional rates. But that does not suit the government’s scheme, as it would hit the global prescriptions for financial sector ‘reforms.’ So the GoI and the RBI, in all probability, would go back to a softening exercises, at the earliest. 

To conclude, the current hardening of the RoIs on bank deposits, declared on the eve of annual closing of bank accounts, is insincere on the one side and deceptive on the other. It inflicts a setback, albeit temporarily, to the philosophy of globalisation and global integration of the financial sector. It militates against their theory of market driven RoI. Both the GoI and the RBI are under substantial compulsion to accord approval for the reverse trend. The compulsion was created by the steep rise in prices, much more than what the official statistics reveal. The Left and democratic forces of the country and the trade union movement can be proud of the eternal vigilance displayed, for running a steady campaign run and launching relentless struggles during the last one year or more. That vigilance needs to be maintained all the more during the coming months.