Family savings in India face the threat of more interest rate cuts

• Myth 1: India’s household savings are strong enough.
• Myth 2: Indians factor in inflation while choosing investments.
• Myth 3: Further interest rate cuts will spur consumption and savings.

The biggest myth of all myths in India is that a person may decide to buy a home or a car just because the Reserve Bank of India (RBI) has cut interest rates by 25 basis points or 50 basis points. The fact is a person buys any discretionary item like a home or a car only when he or she has enough savings, borrowing capacity, and reasonable certainty about the future.

Right now, Indian households are running short of all three as visible in the slowing sales of homes, cars, and even items of daily use. Amidst rampant unemployment and slow wage growth, people are eating into their savings and this is dangerous.

Slowdown in consumption has been sharper in the last nine months despite four interest rate cuts by the RBI, though much of it has not been passed on by the banks. If monetary stimulus was enough, there would be signs of improvement in the economy or the sentiment but there aren’t any.

On the contrary, lending rates are coming down and so are deposit rates-- and that hurts households directly. Therefore, another interest rate cut may not be the answer to rev up the sluggish economy and household consumption. The calls for further interest rate cuts are based on certain myths.

Myth 1: India’s household savings are strong enough

It has been true for decades that Indian households have saved for a rainy day and it is often these savings have been a shield during dire economic crises in the past. However, that is changing for many reasons. “As investment depends crucially on a low cost of capital, reducing real interest rates need not necessarily lower savings when the demographics are favourable,” the 2019 annual economic survey argued.

However, India’s household deposits in banks have declined to their lowest level in over a decade as the interest rate offered by banks declined in recent years. Household savings as a percentage of GDP has fallen to 17.2% at the end of March 2019.


Meanwhile, in the two years ending June 2019, personal loans and credit card debts have increased by over 58%, according to RBI data analysed by Forbes. People are either borrowing money or dipping into their savings for sustenance.

So, as savings depleted and loans piled on, investments have gone down. Unsold homes have increased 7% to 1.3 million units at the end of June 2019, according to an independent real estate research firm Liases Foras.

However, gold prices hit a whopping ₹40,000 an ounce last month. And that brings us to the second myth.

Myth 2: Indians factor in inflation while choosing investments.

In theory, demand for gold should go down when inflation is low. And price rise in India has been low for over three years.


But gold is an essential part of Indian culture and tradition and even when there is a fall in demand for gold, it is relatively low.

The Narendra Modi government has tried to push people away from gold and to invest in more risky financial instruments like the share market and real estate. But as of March 2018, only 8% of household savings are in equity-- though a significant jump from 3% in FY16-- according to RBI data. While the diversification can be celebrated, the market carnage in the last one year has not only dented the confidence of the small investors, it has also made them poorer.

Nearly a quarter of all households in India prefer bank deposits, according to an RBI report in July 2017. The pecking order of preference is children, own business, and bank deposits. Only a small fraction of all Indian families save in pension funds, or mutual funds.

Very few Indians calculate adjust for inflation before investing or even while evaluating salary hikes. For example, the sentiment triggered by a 10% rise in salary is more or less the same irrespective of whether the inflation rate is 4% or 10%, even though prices have a direct impact on the savings.


A recent research by Motilal Oswal has showed that people invested less in bank deposits because the headline interest rate fell even though they may have yielded more when adjusted for inflation. "Pushing up household savings would require more efforts towards financial inclusion and possibly, incentives,” ratings agency Crisil said in a July 2019 report. As established earlier, that monetary stimulus like interest rate cuts have limited impact as an incentive.

Myth 3: Interest rate cuts will spur consumption and savings

Real investments, measured by gross fixed capital formation (GFCF), in the economy grew at an average of 9.2% in the last three years, at twice the rate compared to the preceding five, which included two of the infamous ‘policy paralysis’ period under the Congress-led United Progressive Alliance (UPA) regime when inflation was at scorchingly high level.

However, digging deeper into the data, Motilal Oswal found that in the last three years, corporate investments grew over 7% every year compared to 12% in government investment and a measly 2% growth in household investments. This, at a time when inflation was low and interest rates were falling.

The mood is sombre in most Indian homes

The reality right now in India is that people are earning less and therefore the benefits of low inflation have not reached them. Small investors have lost money in the stock market. They are either borrowing more or eating into their savings for sustenance. Any further cut in deposit rates will make consumer more cautious because for most Indian families, it’s cash--whether it is at home or in the bank-- that counts. Investments, including buying a home or a car, depends on the near-term cash savings and near-term outlook on earnings.

As most families are still reliant on bank deposits either for income or for a rainy day or retirement, any further cut in deposit rates will further affect savings and sentiment, and therefore consumption. The onus should now be on the government to revive investor sentiment via policy stimulus adding to the ones Finance Minister Nirmala Sitharaman announced in late August.

As the renowned economist and former RBI governor Raghuram Rajan wrote in his book ‘Fault Lines: How Hidden Fractures Still Threaten The World Economy’, “the more a country finances its investment through its own domestic savings, the faster it grows. Conversely, the more foreign financing it uses, the more slowly it grows.”

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