Mr Jaitley’s prescription for ‘Tan Aur Mann Ki Shanti’

Ever since coming to power Mr Jaitley has made no secret of his conviction that lower interest rate is the answer to India’s economic problems. Listening to him one would be convinced that in the last three years all or most of the economic ills have been addressed and the Government has made India the ‘shining star’ of global economy.

It is a different matter that neither the growth rate nor the FDI show improvement by more than a few basis points, manufacturing sector continues to be sluggish, and the growth rate still falls short of the prophesied goal of 9%.

And, therefore, the interest rate obviously needs to be further lowered, preferably to 5% to match Mr Greenspan’s record in the US.

The economic arguments for low interest rates are quite simple. If the interest rates are lowered,

• People will have less incentive to save, and hence spend more
• If consumption goes up, industrialists will invest to expand their capacities
• Larger capacities will create more employment and hence the wage component of National Income will increase
• The economy will then move forward on the twin wheels of larger production and higher wage spend, each propelling the other forward.

This does not always work though, and hence the additional policy prescription of lowering tax rates on corporations and their owners (shareholders) to incentivise larger investments. To bind the whole thing together, deficit financing must be stopped or reduced drastically to avoid any upward pressure on interest rates.

This whole edifice is based on two assumptions.

Lowering of interest rate will automatically lead to lower savings and perhaps higher borrowing.

The first is that a lowering of interest rate will automatically lead to lower savings and perhaps higher borrowing. At the lowest point of interest rate before the melt down of 2008, American domestic saving rate had come down to minus 5%. In a developed economy with a well-developed social security system, this is indeed a likely outcome.

But in India, with virtually no social security, it is not inevitable. Say, a person is due to retire in five years. His retirement target is say, a modest income of ₹30,000 per month post-retirement. Assuming an interest rate of 8% ie inflation plus 3%, he needs a corpus of ₹43 lakhs. Now the rate comes down to 7%, and to earn the same amount, he would require a corpus of ₹50 lakhs.

What is his likely course of action? To give up his plans altogether and splurge as Mr Jaitley and Shaktikanta Das would have us believe? Or try to save an additional ₹7 lakhs? A country without a social security system is not the same as one with it. Lowering of domestic savings in any case is not a very desirable outcome in a developing economy.

The second assumption is that larger capacities automatically create larger employment.

But in these days of automation and robotics, it is no longer a valid assumption; the phenomenon of jobless growth is a universal one and India is no exception. Some additional employment may be created in the tertiary sector but the wage level will hardly be able to push up the demand significantly.

Today in India, almost all business associations and industrialists have publicly indicated that that till the existing capacities are fully utilised, no fresh investment can be expected. Most experts feel that at present only 70% capacity is utilised. Thus fresh investments, disappointing as it may turn out to be eventually, is also unlikely to take place in the near future.

In a situation like this perhaps Mr Jaitley and Mr Das should have turned to Keynes rather than Friedman.

Right from the beginning Mr Jaitley has been thwarted, at least partially, by the Reserve Bank of India. The RBI has been more pliant after Mr Raghuram Rajan’s departure, orchestrated or otherwise, but perhaps after the fiasco of demonetisation the RBI is no longer such a willing tool. The latest round of reduction in small savings rate (on March 31) is possibly a prod to the RBI to further lower the rates.

RBI, both during and after Mr Rajan’s tenure have been complaining that banks have not passed on the entire cut in the deposit rates to the borrowers. It is safe to assume that it will not happen. Public sector banks are increasing their income by any which way with the Government’s blessings. Because the larger profits will come in handy when the inevitable hair cut takes place while squaring the NPAs.

The argument given is that unless the interest rates on Small Savings are reduced, banks are finding it difficult to mobilise funds. It is too specious to be taken seriously.

Almost all small savings schemes have a ceiling on investments.

• Thus under MIS a maximum of ₹9 lakhs can be invested. The interest thereon was 8.3% till a year-and-a-half back. Now it is 7.6%.
• For Senior Citizens Savings Scheme, the ceiling is ₹15 lakhs, and the rates have come down from 9.3% to 8.6% during the same period.

Obviously no one will prefer banks to small savings for investment up to these ceilings. Moreover these schemes always enjoyed similar higher interest rates over banks, which never stood in the way of banks’ mobilisation of funds.

These small savings schemes have always been thought of as social welfare schemes, hence the ceilings and higher interest rates. Most of the holders of such accounts are retired people whose expenses go up even when the inflation rates come down, but do not become negative.

The total corpus under these schemes is also small as compared to total savings, as they come mostly from retired people. Why should PPF, a scheme primarily for people who do not enjoy PF, earn a lower rate of interest than PF is not intelligible.

In the meanwhile the retired people, the workers in the unorganised sector will suffer losses.

But it has its advantages. Now they should visit the nearest temple and take part in the evening rituals (thus save electricity at home), take a chapatti or two with onion or chilli, (less eating is good for health), reflect on Mann Ki Baat and then go to sleep.

They will achieve both Tan ki shanti and Mann ki shanti.

Gautam Sengupta is a retired chief executive.

This is an opinion piece and the views expressed above are the author’s own.