Do lower rates hurt savers? Not quite, says RBI research

Barclays Capital, MPC, Abheek Barua, bank of india, reserve bank of india, interest rates, RBI, Saggar, India, Deep shock

Savers looking for higher interest incomes must wait longer with economists embracing models that suggest only a section of them lose out in a lowerrate regime, but a large chunk of savers gain due to higher economic activity.

Reserve Bank of India (RBI) executive director Mridul Saggar says the argument that lower rates hurt savers across the board doesn’t hold water. “The frontier of the macroeconomics, especially in terms of Heterogeneous Agents New Keynesian (HANK) models, provides a good reason to think that not all savers may necessarily be worse off when central banks push down the interest rates,” said Saggar in the monetary policy committee’s (MPC) June meeting.

Such models capture diverse effects of a central bank’s rate action. The conventional understanding is that the falling returns on account of lower interest rates work as a disincentive for a saver. But that may not hold on all occasions.

“As demand increases with monetary expansion, firms ramp up production. This improves their survival rate amid a deep shock like the pandemic. It also protects job losses and pushes more wages and salaries in the hands of households, most of whom may get more than compensated for a drop in their interest incomes on savings,” explains Saggar.

Put simply, soft interest rates provide an opportunity for more output and job generation making up for the loss in interest income, the theories suggest. “Savers by definition are worse off if their savings are in fixed income instruments like FDs. However, in the middle of a shock, there is a strong case to keep rates low because of the expansionary effects it has on incomes,” said Abheek Barua, chief India economist at HDFC Bank. “This is particularly true of individuals and firms that are liquidity constrained. Public debt created through fiscal expansion becomes more sustainable if interest rates are low. These second-round benefits are likely to outweigh the erosion of savers’ incomes when the economy faces a deep shock.”

These multiplier effects justify rate cuts and monetary and liquidity accommodation, according to Saggar.

The RBI lowered the policy repo rate by 115 bps (one bps in 0.01%) between September 2019 and September 2020 prompting banks to lower deposit rates as well, though not proportionately. But household financial savings rose to 10.4% of GDP in September 2020 from 9.8% a year ago.

“Also, reduction in interest rates may benefit those with savings in equities through higher asset prices,” said Rahul Bajoria, India economist at Barclays Capital. “At the same time, capacity creation may also act as a positive offsetting factor, but the time it takes for demand revival may be critical to gauge whether the savings impact is large or small, cumulatively.”

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