Every monetary policy review is a pensioners’ nightmare as the constant call for lowering of interest rates to spur the economy is not good news for the one who has a fixed corpus of funds on which money is to be earned. According to the 2011 Census, there were around 104 million senior citizens—defined as those who are above 60 years of age. This is around 8.6% of the population. While some of them continue to work, it may be assumed that when one reaches the age of retirement, the chief source of livelihood would be the accumulated savings, as the ongoing flow would be limited and erratic. Bank deposits, in general, are the most preferred source of savings for these gentry, and while some would be diversifying their savings into mutual funds and small savings, the interest paid by banks on deposits would continue to dominate their savings portfolio. The impact of changing interest rates on this group should be understood carefully as the movement in inflation rates tends to cloud our interpretation—as the concept of real interest rate does not capture adequately true situation. Typically, money saved in a bank would earn a nominal interest payment based on the prevalent rate structure. This amount, however, is influenced by the inflation rate, which cumulates over time. Hence, even when inflation rate comes down from, say, 4.5% to 3.3%, the saver is affected cumulatively as prices are actually not coming down. Further, when interest rates are changed, the nominal return also changes and gets adjusted for cumulative inflation as prices of products consumed in, say, 2017 are already higher than they were in 2016.
The accompanying table provides the nominal returns on savings of `1 lakh kept in a bank deposit for a year, and juxtaposes stock market return, i.e. Nifty, with the same to gauge the difference in earnings between the two. The interest rate considered is for one year and it’s assumed that the same is rolled over every year at new rate. The last six years have been considered—the period coincides with the new CPI index with base of 2012. For 2018, the half yearly Nifty returns have been annualised for comparison purposes. From 2015 onwards, the returns on the deposit have actually come down quite sharply, with the fall being around 25%. In comparison, the stock market would have given uneven but higher returns on an annual basis, barring 2013 and 2016. In the latter year, the stock index fell, meaning thereby that there would have been a negative return for the saver. This is one reason as to why those who do not have a flow of income post-retirement and depend only on accumulated savings put their money in bank deposits.
Here, it is also assumed that the tax implications are the same for both the instruments, though equity has inherent advantages. Interestingly, on a cumulative basis, the stock market would have delivered 63% higher returns than bank deposits, which make them the typical high-risk, high-return investment. The second table includes additionally the impact of inflation on returns on deposits and stocks with 2012 as the base year. The inflation adjusted interest or stock return would be incremental nominal return plus inflation-adjusted real value of preceding years’ return. Hence, for 2017, the negative incremental nominal return (Rs 700) would be adjusted with `5,223 further indexed with inflation of 4.52%. In short, a retired person who had Rs 1 lakh in 2012 and was interest dependent would be able to consume goods worth `3,935 in 2017-18, even though the nominal return would be Rs 6,500. The stock market again gives a higher cumulative return with the same risk of negative fall. In such a situation, it could be tempting for savers to become aggressive in the equity market and distort their potential risk matrix.
Usually, the fallacy in thought is that real interest rates are spoken of with respect to current return and inflation. However, for those with fixed savings, cumulative inflation matters most, and hence even a decline in both interest rate and inflation does not help, but, in fact, increases pressure on living standards. In addition, it has been observed that while prices of food grains and horticulture products could actually come down after they peak due to supply shocks, those of other consumables including services or manufactured products never do. Hence, prices of dishes in restaurants or toothpaste or processed products like cheese or noodles never come down and only increase. Therefore, utmost care should be taken when interpreting the concept of real interest rates as it is a very narrow concept and obfuscates the cumulative impact, especially for those who are fully dependent on interest rates for income. Also, as mentioned earlier, unless inflation turns negative—which never happens—only then can one be happier with interest rates also declining less than proportionately.
The argument of real interest rates is an ongoing one and often comparison is made with other countries or benchmarks used to pinpoint an appropriate return on deposits. This can be 1.5-2%. While this does sound theoretically sound, this concept does not deal with cumulative impact of inflation, and while this does not matter for the working population where income is indexed with inflation, the fixed corpus holders—retired people—would get less solace from the fact that inflation is also low when interest rates are lowered by banks. Although 8.6% of the population may be quite small to guide policy decisions, as the balance could be gainers, it cannot be disputed that when interest rates are lowered, this class gets affected quite sharply. This should be kept in mind.