Will RBI, banks follow govts cut on small saving rates?

Individual savers will regret the fact that rates have come down, but this is only correcting an aberration, says Ananth Narayan of Standard Chartered Bank
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Mar 19, 2016, 05.02 PM | Source: CNBC-TV18

Will RBI, banks follow govt's cut on small saving rates?

Individual savers will regret the fact that rates have come down, but this is only correcting an aberration, says Ananth Narayan of Standard Chartered Bank

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Will RBI, banks follow govts cut on small saving rates?

Individual savers will regret the fact that rates have come down, but this is only correcting an aberration, says Ananth Narayan of Standard Chartered Bank

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Ananth Narayan (more)

Co-Head of Wholesale Banking- South Asia, Standard Chartered Bank |

Small savings are nothing but the money parked in instruments such as the Public Provident Fund (PPF), National Savings Certificates (NSC), Kisan Vikas Patras or Post Office Deposits. But what will these look like after the sharp interest rate cuts that were announced on Friday evening?

The move is not unexpected as the government has been wanting to make these rates market-linked for a while now. Economists and bankers, too, tend to agree. The idea is banks now will not have an excuse to keep rates high. The Reserve Bank of India in the past year has lowered the policy rates by 125 basis points, but banks have failed to pass them on. Yields on tradable G-secs, too, have only fallen from a peak of 7.9 percent to 7.5 percent currently.

Earlier banks would argue that the high rate of interest offered by small savings instruments would make them uncompetitive if they were to lower rates.

But the big question now is: will banks lower deposit rates now and will the RBI decrease the rates further or will the millions of investors in these small savings be the only ones earning lower returns?

Ananth Narayan, Regional Head, Financial Markets, South Asia, Standard Chartered Bank, says individual savers will regret the fact that rates have come down, but this is only correcting an aberration. "I wouldn't be surprised if we see a 25-50 bps rate cut in the next credit policy on April 5. At any rate, the overall rates in the system including government bond yields which are between 7.5 percent and 7.75 percent right now, should come down dramatically over the next few months by about 50-70 bps," he told CNBC-TV18.

Bhaskar Panda, HDFC Bank , too, believes the RBI will be under pressure after the government's action.

Kuldip Kumar, partner tax, PwC India and Gaurav Mashruwala, financial planning expert, too, gave their views.

Below is the verbatim transcript of Ananth Narayan, Bhaskar Panda, Kuldip Kumar & Gaurav Mashruwala's interview with Surabhi Upadhyay on CNBC-TV18.

Q: The whole premise of this move was on the fact that the Reserve Bank of India (RBI) wanted better transmission of its policy rates. The government seems to have delivered and delivered beyond what was expected. What impact do you think will this have on bank lending rates?

Narayan: As individual savers, we will regret the fact that rates have come down on small savings. This only is correcting an aberration.

The fact is RBI has slashed interest rates by 125 bps so far and looks like it might do even more in the coming days. Interest rates have come down in the economy over the last 18 months or so and looking to come down further. So it was necessary to remove this aberration of having extremely high interest rates on small savings because that was impacting transmission as you mentioned, it was impacting the deposit rates that banks could get away with. Now the leeway for banks to reduce deposit rates, the RBI to cut rates even further increases and you are absolutely right, the government has now delivered on almost on every single count; fiscal deficit has been kept at promised 3.5 percent, food inflation despite two successive bad monsoons have been kept under reasonable amount of check and now small saving rates have been brought down dramatically, so courageous step on the political front.

All this indicates that RBI should now follow suit, the ball is firmly in RBI's court. I wouldn't be surprised if we see 25-50 bps rate cut in the next credit policy on April 5. At any rate the overall rates in the system including government bond yields which are between 7.5 percent and 7.75 percent right now, should come down dramatically over the next few months maybe down by about 50-70 bps.

Q: How aggressive a rate cut would you expect from the RBI given the move that we saw on Friday evening from the government?

Panda: Yes, RBI will be under pressure as Ananth said now, after the government's action. On all front government has delivered including fiscal deficit target, including small savings rates for the transmission of the rate cut, etc. In fact if you see RBI's projections, they have taken smaller projection this year as against Rs 53,418 crore for FY16 and it was a revised estimate. They have taken Rs 22,108 crore as accrual in the small savings. So they have already done their homework well. Therefore, they have moved decisively and homework has been done and a promise that they have given and now it's time for Governor Rajan to deliver.

However, I expect 25 bps cut in April policy and post that depending on how the CPI shapes up; our estimate is that it will remain between 5.3 and 5.4 percent, maybe above 5.4 for the coming year.

Q: It is fine to expect more rate cuts from Governor Rajan, he might deliver on that hope as well. But the more important question is to you bankers, will banks start now cutting rates? I am guessing deposit rates, people will rush to cut. In fact, unfortunately, Ms Bhattacharya of State Bank of India could not join us on this conversation today; she was travelling. But, the question to bankers. Do you expect very quick deposit rate cuts? They may come anyway. The more important question, do you expect lending rates to come in as well?

Narayan: I am going to give you a very biased banker's view, but the reality is that if you look at the net interest margin of banks, ever since the rate cut cycle started — before the rate cut cycle started, it was over 4 percent for the banking community as a whole. Today it is less than 3.5 percent. Of course, a lot of things go into that. The fact that we have large loan impairments and the fact that transmission has been deeply impacted by what we think is a problem on the liquidity side, a sentiment which is not necessarily shared by the RBI. So, we think that there are structural and frictional issues which impact transmission, it is not just banks being recalcitrant to bring down rates.

But I complete take your point that rates need to come down. In fact, all the stars are aligning — not just what the government has done, not just what the RBI seems to be in the mood to do, including the fact that externally, the Fed has given a very dovish message, you have every central bank in the world seemingly worried about growth, negative interest rates in Bank of Japan (BoJ) and other parts of Europe, 75 percent of global sovereign yields are below 2 percent. All the stars are aligning including the Consumer Price Index (CPI) projections — I agree with Mr Panda there. All stars are aligning for bringing down rates dramatically, whether it is by actual rate cuts or by removing the frictional element.

Q: It is fine to expect more rate cuts from Governor Rajan, he might deliver on that hope as well. But the more important question is to you bankers, will banks start now cutting rates? I am guessing deposit rates, people will rush to cut. In fact, unfortunately, Ms Bhattacharya of State Bank of India could not join us on this conversation today; she was travelling. But, the question to bankers. Do you expect very quick deposit rate cuts? They may come anyway. The more important question, do you expect lending rates to come in as well?

Narayan: I am going to give you a very biased banker’s view, but the reality is that if you look at the net interest margin of banks, ever since the rate cut cycle started – before the rate cut cycle started, it was over 4 percent for the banking community as a whole. Today it is less than 3.5 percent. Of course, a lot of things go into that. The fact that we have large loan impairments and the fact that transmission has been deeply impacted by what we think is a problem on the liquidity side, a sentiment which is not necessarily shared by the RBI. So, we think that there are structural and frictional issues which impact transmission, it is not just banks being recalcitrant to bring down rates.

But I complete take your point that rates need to come down. In fact, all the stars are aligning — not just what the government has done, not just what the RBI seems to be in the mood to do, including the fact that externally, the Fed has given a very dovish message, you have every central bank in the world seemingly worried about growth, negative interest rates in Bank of Japan (BoJ) and other parts of Europe, 75 percent of global sovereign yields are below 2 percent. All the stars are aligning including the Consumer Price Index (CPI) projections — I agree with Mr Panda there. All stars are aligning for bringing down rates dramatically, whether it is by actual rate cuts or by removing the frictional element.

Q: Give me a numerical sense in terms of basis points, how much should we expect by way of lending rate cuts over the next two quarters or if you want to give one year projection?

Narayan: If we have for instance, the issue on the liquidity side addressed the fact is at the moment, more than Rs 2 trillion worth of liquidity support is being provided by the Reserve Bank of India (RBI) against the collateralised window. This we say is not conducive to bringing down interest rates.

If in April, once the government spending comes through, if liquidity has got even a slight surplus, even without a rate cut, 50-75 bps of reduction in lending rates can happen surely by removing the fictional element.

So, overall everybody agrees that from the current age, whether it is government bond yields, whether it is base rates, whether it is lending rates, the system is desperately crying out loud for lower rates. So that the stress in the bank balance sheet and in the corporate balance sheet can be eased and more importantly, funds can be channelled into productive investments particularly infrastructure.

At the current IRR, it is very difficult to justify investment cycle starting again and the capacity isn’t there. We desperately need lower rates to spur the next investment cycle. So 75-100 bps, absolutely, I think we are all on the same page on that one.

Q: Give us a quick word on how you are expecting the benchmark yield to react on Monday and it has a bunch of cues to react to, borrowing programme which continues to be slightly moved front, that was announced and of course this announcement on the savings rate cut, so what are you expecting on the benchmark yield Monday morning?

Narayan: From a sentiment perspective, I think it is very positive. The fact that these are steep cuts, obviously it hurts each of us as savers but for the bond markets, it should be very positive. We will obviously still have to wait for what the RBI's final response is on the monetary front, which I think we will have to probably wait till April 5. As optimistic traders, we continue to hope that something happens even before that but more realistically it looks like April 5. There, depending upon what they articulate on the rate cut front and the liquidity front, I think the yields will head down.

As I said, my own expectation over the next six months or so is that yields will head down by between 50 and 75 bps. We should see deep cuts. Thereafter, of course there are lots of imponderables. How the monsoon shapes up, how commodity prices shape up, what happens globally, what new part of the world goes up, a lot of that will determine how things pan out beyond that but at least for the next six months, I expect anything between 50 and 75 bps reduction in rates.

Q: What reaction do you expect on bond yields on Monday morning how much of softening and in terms of a quantum of rate cuts, you mentioned your expectations from the RBI, what should we as depositors and borrowers expect in terms of the actual lowering of rates from banks?

Panda: Banks cannot cut borrowing rates immediately just because RBI has cut rates. The formula on which we have taken savings deposits, we have taken deposits at a pre-determined rates, which cannot be recalibrated at any point of time.

Given debt inflexibility, banks have to wait for their assets and liability. They have to see what is the number that it is throwing and after that they can definitely transmit the rate cut that is happening from the Central Bank. It is going to happen but it will not happen like when RBI cuts rate, banks have to cut their lending rates. It is not possible.

Therefore, what will happen is that it will gradually ease the banks to cut rates in the future. I also agree with 50-75 bps cut is possible if the deposit rates remain low and also the inflation remains low.

Q: How big an issue is this really? A lot of people are also anyway putting their money in bank fix deposits along with the small saving schemes. So, come in with initial thoughts on this. How do you take in this really drastic cut? We must also keep in mind, without getting sensational, this is a quarterly revision. The government is saying we are going to make these rates market linked. So, tomorrow, if benchmark bond yields start going up, if the benchmark rates start going up in the system, then I will also get the benefit of higher rates at that point. But, right now it is a pretty ugly hit.

Kumar: Absolutely, you rightly said that. I think I would like to add another important point. You would have seen that earlier the rate announced for the employee provident fund, the rate has gone up by Rs 0.5 or 8.8 percent. But on the Public Provident Fund (PPF), the rate has come down to 8.1 percent. Now, those who are actually in the working class, at least saving in the provident fund would become a more attractive option and they will really earn a good interest, but the self employed are actually those who park their savings and particularly the senior citizens actually who are having their funds in the PPF, they are likely to get it with that. And then, of course, another point which is, if you are keeping your money in PPF and the rates are decided on quarter-to-quarter basis, but actually you are locked in for 15 years. Whether you should also have an option to exit in between, for example, if you find another instrument where you can actually get a higher rate. So, only the time will tell that how this would actually move forward, but economic survey also pointed out that. I mean this was something that was about to happen, this advocacy was already going on.

And the second thing is that even the Kisan Patra or the other small saving rate which has come down and see that the middle income group actually saves money in that. It is not always a tax payer or the higher middle income group probably saving in PPF, but what about those who are living in rural or the small shopkeeper for example. So, they do not get actually attracted to the dubious scheme or to the ponzi scheme. In a way again, they start burning their finger in the race or trying to earn a higher rate of interest.

Q: That is a very valid concern. Will people start going to some dubious collective investment schemes that anyway the government and the courts of the country have been trying to come down on? Where does this leave me? Till now, I have felt that okay, if I am in PPF, I am still okay. The whole controversy over Employee Provident Fund (EPF) itself, we have seen that play out just earlier, so I do not know till when I will get those tax breaks and that kind of security with EPF. Now, PPF rates are coming down. Where do I go?

Mashruwala: One is yes, interest rates are going down, so you need to go back to the drawing board. Look at your overall requirement, how much money you have sparked in that instruments, why were they parked, when were they needed, all those things needs to be looked at, reviewed. You may want to look at some other debt instruments, in terms of fixed deposits, maybe offered by corporate, not that safe, debt mutual funds, but yes, you will have to go back to drawing board, review the entire situation and take a call based on a couple of things.

One is rate of return. B] the tax rate that you get, C] when do you need the liquidity and four the safety of your funds, because it is not just that because rate of returns have gone down and somebody else is offering higher returns, you straightaway jump. So, these are the four parameters that needs to be looked into and based on that review your overall situation.

Q: What is your understanding? How will these new rates be applicable? In all of these schemes, if I have an existing national savings certificate, from April, 1 I will start earning a lower rate.

Mashruwala: I am not too sure. We need to understand and while a clarification probably is needed, there are two things. One is account. This is a fundamental thing. Wherever there is an account, PPF is an account and savings bank is an account. Whenever there is an account that comes in, the rate if interest on the existing fund deposited and all new funds, all the balance inside will attract newer rate of interest. The deposit, we have time deposit, national savings certificate where tenure is fixed.

Q: If I had a three year post-office deposit or a five year deposit.

Mashruwala: So, the newer ones will attract lower rate and the existing one, it will not change. It cannot change it is kind of a bond.

Q: But that is only in terms of time deposits, you might be safe on your existing deposits that you have with the post-office.

Mashruwala: So, when you go for renewal or when you start a new one. Time deposit, national savings certificate, Kisan Vikas Patra, I do not think rates will change on the existing ones. It is a fresh or the newer one or the renewal that you will do, that is where you will get a lower rate.

Q: But PPF is a direct hit?

Mashruwala: PPF is an account, savings bank is an account, so there it will straightaway apply.

Q: What is best? From a tax point of view, as an investor I will keep not everything in equity, I will want a lot of my money in fixed income instruments as well which give me the assurity or at least were giving the assurity of a certain rate of return. What is that best instrument, do debt mutual funds now start looking more attractive because they have indexation benefits, where to put money from a tax efficiency point of view?

Kumar: As I said earlier that those who are salaried class probably the contributing voluntarily to the provident fund contribution still would get them a good handsome return, 8.8 percent.

Even on a PPF accounts since the interest is fully exempt from tax, that still will continue to be attractive in my view as compared to the other scheme. What is there in the debt and on the return on that and with indexation, we pay tax for 20 percent of the value etc, I think the holding period is three years. The disadvantage is that you cannot withdraw this money after three years and after three years again you have to think we have to park the money. So, I think that while they return from those debt mutual funds, maybe debentures maybe the company deposits etc, it will depend on a year-to-year basis but the purpose of this small saving is long-term and this is with a different socio-objective as well. We should not forget that. Putting them directly at par with the money market instrument, perhaps may not be the right way to look at that.

Q: You mentioned corporate deposits but given the environment we know the risks that are now involved with certain corporate deposits in fact mutual funds have been investing into these corporate debt instruments and we have seen several blowouts there also. So where to put money, what is the best fixed income investment?

Mashruwala: If it is one single product, it is not fair, I would look at tax brackets and then take a call. So if you are in a higher tax bracket, obviously PPF probably is making sense still or any other instrument which is giving you tax benefit.

Q: Because it is exempt-exempt-exempt so there is no question of taxation at any point?

Mashruwala: That is the only reason.

Q: How will you compare it with EPF because at least as of now, even the EPF is exempt-exempt-exempt?

Mashruwala: So the majority of country or majority of people have an option of looking at EPF so consider that. There will be certain amount of money beyond, which there is a restriction in terms of liquidity. So your withdrawals, you cannot do it upto the age of 58 while PPF is a 15 year product. So you have an option there.

So now, look at the liquidity component as well. When do you require that money? Do you require money after three years, five years, seven years, safety and tax? These are the three things that has to be looked into and after that take a call. It cannot be blind that this is one single product which can be used by anybody. It never used to be possible earlier but moreso now.

I am just little sad with Senior Citizen Saving Scheme rates coming down because I don’t have the data upfront right now. I don’t know how many of them apply but for senior citizens, they probably could have left it as it is because they do their calculation, they want regular income, finance minister was saying that they are looking at annuity, Senior Citizen Saving Scheme is some kind of annuity coming down rates on that, government could have been little softer. That is one thing and probably Sukanya Samriddhi -- these one-two schemes they could have left.

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