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15
June 2017
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Real Interest (The Total Investment & Insurance
Solutions)
Empirical
evidence in economic literature in India is mixed regarding the impact of real
interest on financial savings. Some economists have found savings to be
insignificantly related to real interest rates, while others have found a very
small but positive interest rate elasticity of savings. If indeed the empirical
evidence is any indication, it seems that real interest rate may have to stay
positive at much higher levels than 1.5% to have any meaningful impact on
financial savings, says a research note. The
Total Investment & Insurance Solutions
In
a report, State Bank of India (SBI), says, "The Reserve Bank of India
(RBI) has also changed the goalposts often in so far as estimation of real
interest rates are concerned. Even the RBI had admitted that the estimation of
such rate of interest is highly sensitive to underlying assumptions and hence
is a challenge for the conduct of monetary policy. The RBI had estimated this
rate at 0.6-3.1% in Q4FY2015 that in itself is different from the 1.5% as laid
in monetary policy."
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Real Interest 1 (The Total Investment & Insurance
Solutions)
Inflation
adjusted deposit rate or real interest rate for FY2017 was at a 15-year high at
3.2% due to low inflation, and will remain high as the inflation scenario for
FY18 is quite benign. Now the question arises whether these high real rates
will impact financial savings, which was average 10.4% of GNI for the last five
years, in some way or other, SBI wonders.
In
1973, economists Ronald McKinnon and Edward Shaw postulated a relationship
between high interest rates and private savings. In theory, SBI says, high real
interest rates have two opposing effects on private savings. The first is the
substitution effect, in which saving increases as consumption is postponed to
the future, and the second is the wealth effect in which savers increase
current consumption at the expense of saving. "The impact of real interest
rates on private saving is, therefore, ambiguous and can only be established
empirically. Further, McKinnon and Shaw said that under conditions of financial
repression, the substitution effect dominates the wealth effect, thus enhancing
financial intermediation," it says.
More
crucially, SBI says, in the Indian context, studies have shown the substitution
effect of real interest rate is more than the wealth effect leading to overall
negative impact of higher interest rates on savings rates. The Total Investment & Insurance Solutions
"However,
the actual coefficients are significantly small and insignificant in most of
the cases. The coefficient ranges from 0.1 to 0.3, suggesting a large change of
as much as 3% to 10% in real deposit rates will be needed to change savings
rate by 1% and small changes will hardly make any difference, if any.
Additionally, causality analysis in India between income per capita and savings
rates shows that such causality run mostly from income to savings. This implies
that high gross domestic product (GDP) growth and increase in per capita income
would significantly improve the savings rates in India," the report added.The Total Investment & Insurance Solutions
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