Status of Household Deposits in India
- November 4, 2023
- Posted by: OptimizeIAS Team
- Category: DPN Topics
Status of Household Deposits in India
Subject :Economy
Section: Monetary Policy
- Household Deposits:
- Household deposits with Scheduled Commercial Banks (SCBs) increased at a CAGR of 9.8% from ₹81 trillion in March 2019 to ₹118 trillion in March 2023, with a significant jump in March 2021.
- YoY changes fell sharply after the March 2021 peak, indicating a declining trend, especially post-pandemic.
- Factors such as low per capita income growth, unremunerative bank deposit rates, and increased investment in the stock market and mutual funds impacted deposit growth.
- Precautionary savings shifted from banks to insurers due to the growing demand for life and health insurance policies.
- Bank Loans:
- Household borrowings from SCBs increased steadily from ₹45 trillion in March 2019 to ₹76 trillion in March 2023, with a CAGR of 13.7%.
- Personal loans (PLs) dominated the non-food credit (NFC) portfolio of banks, with a CAGR of 15.4% over the five-year period.
- Housing, credit card outstanding, education loans, and vehicle loans constituted nearly 67% of the total PLs in 2022-23.
- Increased speculation motives led to premature withdrawals of term deposits for stock market investments and property price speculation, creating liquidity and credit default risks.
- Policy Implications:
- Banks should adopt a cautious approach towards loan deployment, especially in unsecured loans and PLs, to reduce society’s indebtedness.
- Emphasizing the importance of positive real interest rates, measures to reduce liquidity and asset-liability management risks are crucial.
- Mobilizing term deposits from households can improve overall gross domestic savings and reduce reliance on bulk deposits, ensuring a stable financial ecosystem.
About Nominal and real interest rates
Nominal and real interest rates are essential concepts in the field of finance and economics, representing different aspects of the cost of borrowing and lending.
- Nominal Interest Rate:
- The nominal interest rate refers to the stated interest rate on a financial product or investment. It is the rate at which money invested grows over time, not adjusted for inflation.
- It represents the absolute return on an investment or the cost of borrowing without considering the impact of inflation.
- Nominal interest rates are the rates typically quoted for loans, savings accounts, bonds, or other financial products.
- Real Interest Rate:
- The real interest rate, on the other hand, is the nominal interest rate adjusted for inflation, representing the true increase in purchasing power or the true cost of borrowing.
- It reflects the rate of return after accounting for the effects of inflation, providing a more accurate measure of the actual growth in wealth or the actual cost of borrowing.
- Real interest rates give a clearer picture of the profitability of an investment or the actual cost of a loan in terms of the purchasing power of the currency.
The relationship between the nominal and real interest rates can be expressed using the following formula:
Real Interest Rate = Nominal Interest Rate – Inflation Rate
When the inflation rate is zero, the nominal interest rate and the real interest rate are the same. However, when there is inflation, the real interest rate can differ significantly from the nominal rate.
It is important to consider both nominal and real interest rates when evaluating investment opportunities or making financial decisions to ensure a comprehensive understanding of the true costs and returns involved.
Why there is a shift in household financial savings away from traditional deposits?
The shift in household financial savings away from traditional deposits can be attributed to various factors, including changing economic conditions, evolving consumer preferences, and advancements in the financial services sector.
Some key reasons for this shift are:
- Low Real Interest Rates: With interest rates on deposits often failing to keep pace with inflation, the real returns on traditional savings have diminished. This has prompted individuals to explore alternative investment options that offer the potential for higher returns.
- Increasing Awareness and Financial Literacy: Improved financial awareness has encouraged individuals to diversify their savings and investment portfolios, seeking opportunities beyond conventional deposit accounts. People are now more open to exploring various asset classes to optimize their financial growth.
- Changing Economic Environment: With the liberalization of financial markets, individuals have gained access to a broader range of investment options, including equities, mutual funds, bonds, and other financial instruments. This has contributed to the diversification of savings away from traditional bank deposits.
- Shift in Investment Preferences: Many investors are now inclined towards equity markets and mutual funds, seeking potentially higher returns. The growth of mutual fund investments, particularly through systematic investment plans (SIPs), highlights this evolving investment preference among households.
Household Savings:
- Refers to money left after taxes and consumption expenditures.
- Components: Includes financial assets (currency, deposits, equity, etc.), physical assets, and gold and silver ornaments.
- Significance: Vital for long-term economic growth, acts as a primary source of domestic loanable funds.
Factors Influencing Household Savings:
- Income: High-income households tend to save more, while low-income households prioritize consumption.
- Interest Rate: High real interest rates make savings more attractive; inflation impacts savings decisions.
- Future Income Expectation: Economic optimism can lead to increased consumption rather than saving.
- Wealth: Increasing asset values may reduce the incentive for households to save more.
- Tax: Higher personal taxes reduce disposable income, affecting consumption and savings decisions.
Importance of Household Savings:
- Supply Source: Provides domestic funds for capital investment, increasing productive capacity.
- Profit: Savings generate returns such as interest income, dividends, and capital gains.
- Production Boost: Investments from savings contribute to increased production and growth.
- Financial Market: Savings flow into the financial market, supporting businesses and increasing productive capacity.
- Wealth Accumulation: Savings allow households to accumulate wealth, impacting consumption and stimulating real GDP growth.
- Buffer: Savings allow households to prepare for future consumption, contributing to overall well-being.
Status of Household Savings:
- Decline: Household financial savings dropped to 5.1% of GDP in FY23, a 40-year low.
- Liabilities: Financial liabilities increased by 5.8% of GDP in FY23, indicating heightened reliance on loans for consumption and real estate purchases.
- Debt: Household debt remained significantly high at 37.6% of GDP in FY23.
Implications of Fall in Household Savings:
- Capital Investment: Reduced savings could impede the Indian government’s financing of capital investments.
- Foreign Capital Dependence: Decreased household savings might lead to increased dependence on foreign capital.
- Investment Cycle Impact: Increased borrowing affects the investment cycle, with private consumption contributing to a significant portion of the GDP.
- Debt Increase: Rising borrowing leads to tied-up future income, resulting in reduced investments.
- Rising Inequality: The increase in financial liabilities alongside falling asset levels could suggest a rise in income inequality.
Chakravarty Committee (1985)
The Chakravarty Committee, formed in 1985, was constituted by the Reserve Bank of India (RBI) to examine and make recommendations on the existing structure of interest rates in India and lay down the seeds of Liberalisation in India. The committee was tasked with evaluating various aspects of interest rates, including their determination, structure, and implications for the Indian economy. The committee’s recommendations were aimed at promoting the efficient functioning of financial markets and ensuring the stability of the banking system.
Some key recommendations of the Chakravarty Committee are as follows:
- Differential Interest Rates: The committee suggested the implementation of a system of differential interest rates to better align the rates with the various sectors of the economy. This approach aimed to encourage specific sectors by offering preferential rates, thereby stimulating growth and development.
- Real Interest Rates: The committee emphasized the importance of maintaining positive real interest rates to promote savings and discourage inflationary pressures. It recommended that the real rate of interest offered on bank deposits should be kept at a positive level to ensure that depositors receive returns that exceed the inflation rate, encouraging savings and financial stability.
- Regulatory Measures: The committee recommended regulatory measures to ensure that interest rates are determined by market forces while also preventing the exploitation of consumers by financial institutions. It suggested the implementation of regulatory mechanisms to monitor and control interest rates to safeguard the interests of both depositors and borrowers.
- Interest Rate Structure: The committee proposed reforms in the interest rate structure to facilitate a more efficient allocation of financial resources. It recommended a review of the existing interest rate system, including the introduction of market-based interest rates and the removal of administrative controls, to foster a more competitive and dynamic financial market.
The recommendations emphasized the significance of offering deposit rates that exceed the inflation rate, ensuring that depositors receive positive real returns on their savings. By maintaining positive real interest rates, the committee aimed to encourage individuals to continue depositing their funds in bank accounts, fostering a stable savings environment and contributing to the overall economic growth of the country.