The Union Budget 2016 for financial year 2016-17 to be presented next February could have an unpleasant surprise for the Indian middle-class.
Interest rates on retail deposits could be announced, affecting millions of Indians in the middle income group and who form a significant vote base for the Narendra Modi government.
The logic is simple: If lending rates have to come down, deposit interest rates have to be reduced first, for which the government would have to lower interest rates on a range of fixed-income products offered through post offices. The cascading effect would be a risk the government would be forced to take hoping the trade-off does not harm the BJP politically.
The Reserve Bank of India (RBI), since January this year, has reduced the repo rate by a cumulative 125 basis points (bps), but only half of it, about 60 bps, has been passed on by banks to borrowers, according to RBI Governor Raghuram Rajan.
A worried RBI has said it will come out with new guidelines for calculating the base rate this week.
"The median base lending rate has declined only by 60 bps since then. There is a particular way to calculate the base rate now. And our worry is it should not come in the way of banks to pass through lower lending rates to customers. That is why we took a relook at the base rate and are coming to the marginal cost pricing which we will be announced later this week," Rajan told reporters after the fifth bi-monthly monetary policy review on 1 December.
A look at interest rates on term deposits offered by Indian post offices would give some insight on the nature of the risk involved.
The total term deposits held by Indians with post offices stood at Rs 2,42,795 crore as of 31 March, 2014, in 3.62 crore accounts. The interest rate on term deposits, including the monthly income scheme, has remained unchanged at a high 8.4% from 1 April, 2014, for a tenure ranging from one year to up to three years, and 8.5% for more than three years and up to five years.
On the other hand, public-sector banks offer anywhere between 7% and 7.75% interest for a one-year term deposit.
"Any cuts in lending rates will require deposit rates to be adjusted down. This in turn needs the government to lower returns on post office deposits and other small savings schemes, which compete with banks' deposits. We expect some developments on this front on or before the February 2016 budget," said Radhika Rao, economist, group research, DBS Bank.
The earliest the Modi government can make an intervention would be in the forthcoming Budget to be announced in February next year.
Keen to ensure that any move by the government does not impact the middle class, Union Finance Minister Arun Jaitley said on Friday his government would have to "move cautiously" on reducing interest rates on retail deposits, since it has the potential to "hurt vulnerable sections like retired employees".
