Bank deposit interest rates may stay steady for now

When it comes to your investments, one of your favorite investment avenues could be bank deposits. The RBI’s decision to cut rates can directly affect your bank deposit’s interest. Therefore affecting what you get at the end of the deposit term.

One of the major factors that influences the RBI to either cut or raise rates is inflation. Given the scenario today it could be that your bank deposits might continue to float on the current wave of interest rates; based on RBI’s expectations of inflation levels in the coming years.

Policy makers and political commentators have been continuously saying inflation will come down. This demand (for lower inflation) is particularly strong from the industrialists lobby that benefit from negative real interest rates as they are big borrowers from the financial system.

However, the 36th RBI quarterly ( April- June) inflation expectation survey done on 4,931 household covering 16 cities conveys an inflation expectation of 14 % in three month period and 15 % over a one year period (source: RBI Inflation expectation survey of household report). This trend of higher inflation expectations from household have been the standard feature over the last two years. The reasons for these discrepancies may be because of the higher weightage which the consumers are spending on education, medical, vegetables and fruits. The total weightage for these items are 3.35 %, 5.69 %, 5.44 %, 1.89 % respectively. Unsurprisingly, the highest inflation expectations are felt by the pensioners and daily wage earners, who spend a higher percentage in food items, medicines and on education.

The CPI (Consumer Price Index) inflation data has been captured from January 2011 and fruits and vegetables which do not have any Minimum support prices have shown the highest increase apart from milk products. The compounded year on year increase in fruits and vegetables are in the range of 15 % and medical and education is in the range of 8% to 10 % levels over a 3 year period. Fruits and vegetables prices have therefore shown a permanent increase over a period of time;contrary to the expectation that prices of fruits and vegetables would correct over a period of time since they are not controlled by the government.

RBI wants to bring inflation down to 8 % levels by 2015 and to 6 % levels by 2016 (source: Urjit Patel report). In my view the 8 % levels look achievable by January 2015 as crude oil prices are lower and the rupee is expected to be stable in the range of 60 to 62 against the dollar. This could mitigate the effect of high vegetables and fruit prices. Housing prices and rentals are also expected to stabilize in the current financial year as record inventory of 7,64,000 units remained unsold in the system.

However, for the CPI inflation to come down to 6 % levels by January 2016 looks difficult as there is continuous increase in minimum support prices on rice and wheat. The food basket which constitutes 59.31% of CPI inflation has experienced compounded inflation of around 10 % in the last two years. The other items of expenditure like education and medicals are also expected to increase at a rate of more than 6 % in the coming years due to higher income levels and the propensity of the population to consume these items.

The RBI governor has on record stated the target of 6 % in CPI looks difficult and the scope for RBI to cut rates would depend on the expected trajectory of inflation by January 2016 (source: monetary policy statement, Aug 2nd). RBI would like to keep the monetary policy relatively tight and give some positive returns to the investors to anchor inflation expectations. The next target on inflation which RBI wants is 4 % +/- 2 % levels by January 2017. For achieving these inflation targets, there is a need to keep real interest rates positive for the investors. The expectation is government to stimulate production of food grains would be increasing MSP on a yearly basis. This would mean the CPI inflation to sustain below 6 % levels on a continuous basis looks difficult.

This could keep RBI from reducing repo rates aggressively. I am of the view that while banks could still independently decide to lower the rates they offer to customers, it most likely looks like the interest rate of your deposits might not dip significantly from the current levels, since the idea from the RBI seems to be that if inflation is raising prices of goods, then the interest one earns should at least be maintained at a level where food items remain affordable. I am of the view; if inflation is on the rise, then interest rates could continue to remain at their current levels.

Source: RBI

Above article is authored by Quantum.

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