Fixed Deposits

Why Mis-selling By Banks ‘May’ Have Gone Up Post-Covid

The basic idea for almost everything I write emanates from some data point that tells me something. But this piece is slightly different and comes from the experiences of people around me and what I have been seeing on the social media.

I think with this limited anecdotal evidence and some data that I shall share later in the piece, it might be safe to say that mis-selling by banks post-covid may have gone up. Mis-selling can be defined as a situation where an individual goes to a bank wanting to do one thing, and ends up doing something else, thanks to the relationship/wealth manager’s advice.

The simplest and the most common example of this phenomenon is an individual going to a bank with the intention of putting his money in a fixed deposit and ends up buying some sort of an insurance policy or a pension plan.

Let me offer some evidence in favour of why I think the tendency to mis-sell post covid may have gone up.

1) Between March 27, around the time when the seriousness of the covid pandemic was first recognized in India, and October 9, the latest data available, the deposits of Indian banks have gone up by Rs 7.36 lakh crore or 5.4%.

Clearly, there has been a huge jump in bank deposits this year. To give a sense of proportion, the deposits between October 2016 and December 2016, when demonetisation happened, went up by Rs 6.37 lakh crore or 6.4%.

The increase in deposits post covid has been similar to the increase post demonetisation. Of course, the post-covid time frame has been longer.

What does this tell us? It tells us that people haven’t been spending. This is due to multiple reasons.

The spread of covid has prevented people from stepping out and there is only so much money that can be spent sitting at home (even with all the ecommerce). This has led to an accumulation of deposits. Further, people have lost jobs and seen their incomes crash. This has prevented spending or led to a cutdown. And most importantly, many people have seen their friends and family lose jobs. This has automatically led them to curtail their spending. All this has led to an increase in bank deposits.

2) Why do banks raise deposits? They raise deposits in order to be able to give them out as loans. Between March 27 and October 9, the total non-food credit given by banks contracted by Rs 38,552 crore or 0.4%. Banks give loans to the Food Corporation of India and other state procurement agencies to help them primarily buy rice and wheat directly from farmers. Once this lending is subtracted from the overall lending of banks what remains is the non-food credit.

What does this contraction in lending mean? It means that people and firms have been repaying their loans and not taking on fresh loans. On the whole, between March end and early October, banks haven’t given a single rupee of a new loan. This explains why interest rates on deposits have come down dramatically. Interest rates have also come down because of the Reserve Bank of India printing and pumping money into the financial system to drive down interest rates.

3) Using these data points, we can come to the conclusion that banks currently have an incentive to mis-sell more than in the past. Why? Banks currently have enough deposits. They don’t need more deposits, simply because on the whole, people and firms are not in the mood to borrow.

All this money that is not lent ends up getting invested primarily in government securities, where the returns aren’t very high. As of October 9, around 31.2% of total deposits were invested in government securities. This is the highest since July 2018.

The trouble is that banks cannot stop taking deposits even though they are unable to currently lend them. They can only disincentivise people through lower interest rates.

Or they can set the targets of relationship managers/wealth managers in a way where they need to channelise savings into products other than fixed deposits.

While banks have to pay an interest on fixed deposits, irrespective of whether they are able to lend them or not, they earn a commission on the sale of products like unit linked insurance plans, pension plans, mutual funds, portfolio management services, etc. This commission directly adds to the other income of the banks.

Basically, the way this incentive plays out explains why mis-seling by banks may have gone up post covid. Also, the risk of repaying a fixed deposit lies with the bank. The same is not true about the other products where the bank is just a seller and the risk is passed on.

What to do?

So, what should individuals do in a situation like this, is a question well worth asking? Let’s say you go to a bank to invest your money in a fixed deposit. As explained above, the bank really does not want your money in fixed deposit form.

The wealth managers/relationship managers will resort to the contrast effect while trying to persuade you to not put your money in fixed deposits. The interest rates on fixed deposits are very low currently. An average fixed deposit pays an interest of 5-5.5%. Clearly, once we take inflation and taxes on the interest on these deposits into account, the returns are in negative territory.

The relationship/wealth manager will contrast these low/negative returns with the possible returns from other products. His or her pitch will be that the returns will be higher in other cases. In the pitch, he or she will tell you that the returns from the other products are as good as guaranteed. A tax saving angle might also be sneaked in (for insurance products). (Of course, he or she will not present this in such a dull way. Typically, relationship/wealth managers tend to be MBAs, who can phaff at the speed of thought and leave you totally impressed despite their lack of understanding of things).

What’s the trouble with this? The returns in these other products are not fixed. In case of a fixed deposit the interest rate is fixed (which is why the word fixed is used in the first place). Now you might end up with a higher return on other products, but there is no guarantee to that. Also, sometimes the aim of investment is different. If you are putting your money in a fixed deposit, the aim might simply be return of capital than return on capital.

Further, the investment in these other products might be locked in for a long period of time, while you can break a fixed deposit at any point of time (of course you end up with lower returns). This is especially true for a tax saving investment.

To conclude, the next time you go to a bank, stick to what you want to do with your money and don’t fall prey to what the wealth/relationship manager wants you to do. Clearly, his and your incentives are not aligned. Also, if you can use internet banking to manage your money, that is do fixed deposits online, that’s the best way to go about it.

Why No One is Worried About Savers

Economists are like sheep. They like to move in a herd.

If one of them says that the Reserve Bank of India (RBI) and banks need to cut interest rates in order to revive the economy, largely everyone else follows.

This basically stems from the fact that the practitioners of economics like to think of the subject as a science, having built in all that maths into it over the decades.

In science, controlled experiments can be run and results can be arrived at. If these experiments are run again, the same results can be arrived at again.

The economists like to think of economics along similar lines. But then economics is not a science.

Take the case of the idea of a central bank and banks cutting interest rates when the economy of a country is not doing well. Why do economists offer this advise? The idea is that as banks cut interest rates, people will borrow and spend more.

At the same time corporates will borrow and expand, by setting up more factories and offices. This will create jobs. People will earn and spend more. Businesses will benefit. The economy will do better than it did in the past. And everyone will live happily ever after.

Okay, the economists don’t say the last line. I just added it for effect. But they do believe in everything else. Hence, they keep hammering the point of banks having to cut interest rates to get the economy going, over and over again. The corporates who pay these economists also like this point being made.

The trouble is that what the economists believe in doesn’t always turn out to be true. Or to put in a more nuanced way, there is a flip side to what they recommend. And I have seen very few professional economists talk about it till date. In fact, low interest rates hurt a large section of the population especially during an economic recession and contraction.

In India, a section of the population, is dependent on the level of interest rate on bank deposits (especially fixed deposits). Currently, the average interest rate on a fixed deposit is around 5.5% per year.

The inflation as measured by the consumer price index in September stood at 7.34%. Hence, the actual return on a fixed deposit is in negative territory. It has been in negative territory through much of this year. This doesn’t even take into account the fact that interest earned on fixed deposits is taxable at the marginal rate. After taking that into account the real return turns further negative.

This hurts people living off interest income, in particular senior citizens. Senior citizens whose fixed deposits have matured in the recent past have seen their interest income fall from around 8% per year to around 5.5% per year, in an environment where food inflation is higher than 10%.

The only way to keep going for them is to cut monthly expenses or start using their capital (or the money invested in fixed deposits) for regular expenses. It is worth remembering that India has very little social security and health facilities for senior citizens, as is common in developed nations.

Lower interest rates also impacts a large section of the population which saves for the future through bank fixed deposits. It is worth remembering that it is this section of the population which actually drives the private consumption in the country. When returns on their savings fall, the logical thing is to cut consumption and save more. If this is not done, then the future gets compromised on.

Lower interest rates hurt institutions like non-government organisations, charitable trusts etc., which save through the fixed deposit route.

The stock market wallahs love lower interest rates because a section of the population continues to bet on stocks despite the lack of company earnings. The price to earnings ratio of the stocks that constitute the Nifty 50, one of India’s premier stock market indices, is currently at more than 34.

Such high levels have never been seen before. It’s not the chances of future high earnings which have driven up stock prices but the current low interest rates, leading to more and more people trying to make a quick buck on the stock market. The government likes this because it feeds into their all is well narrative.

At the same time, given that the government is cash-starved this year, the stock market needs to continue to be at these levels for it to be able to sell its stakes in various public sector enterprises to raise cash.

Between March 27 and October 9, the deposits of banks (savings, current, fixed, recurring etc.) have increased by a whopping Rs 7.4 lakh crore or 5.4%. In the same time, the total loans of banks have shrunk by Rs 38,552 crore or 0.4%. This basically means people are repaying loans instead of taking on fresh ones, despite lower interest rates.

In this environment, with banks unable to lend out most of their fresh deposits, it is but natural that they will cut interest rates on their fixed deposits. You can’t hold that against them. That is how the system is adjusting to the new reality. But what has not helped is the fact that the RBI has been trying to drive down interest rates further by printing money and pumping it into the financial system.

Between early February and September end, the central bank has pumped more than Rs 11 lakh crore into the financial system.

Not all of it is freshly printed money, but a lot of it is. This has apparently been done to encourage corporates to borrow. The bank lending to industry peaked at 22.43% of the gross domestic product (GDP) in 2012-13. Since then it has been falling and in 2019-20, it stood at 14.28% of the GDP. Clearly, Indian industry hasn’t been in a mood to borrow and expand for a while. Hence, the so-called high interest rates, cannot be the only reason for it.

The real reason for the RBI pumping in money into the financial system and driving down interest rates has been to help the government borrow money at low interest rates. As tax collections have fallen the government needs to borrow significantly more this year than it did last year.

All this has hurt the saver. But clearly unlike the corporates and the government, the savers are not organised. Hence, almost no one is talking about them. In the latest monetary policy committee meeting, there was just one mention of them.

One of the members had this to say: “With retail fixed deposit rates currently ranging between 4.90-5.50 per cent for tenors of 1-year or more and the headline inflation prevailing above that for some months now, there has been a negative carry for savers.”

We already know that no economist talks about this phenomenon or more specifically the fact that low interest rates and high inflation should have led to a cut down in consumption. How big and significant is that cutdown? How is it hurting the Indian economy?

Is this cutdown in consumption more than the loans given by banks because of low interest rates?

These are questions that need answers. But the problem is that to a man with a hammer everything appears like a nail. For economists interest rates are precisely that hammer which they like using everywhere. This situation is no different.

The trouble is their hammer doesn’t necessarily work all the time.

A shorter version of this column appeared in the Deccan Chronicle on October 25, 2020.

Lower Interest Rates Good for Govt, Banks and Corporates, Not for Average Indian

The new monetary policy committee which met for the first time over the last two days has decided to keep the repo rate unmoved at 4%. Monetary policy committee is a committee which decides on the repo rate of the Reserve Bank of India (RBI). Repo rate is the interest rate at which RBI lends to banks and is expected to set the broad direction for interest rates in the overall economy.

The RBI has been trying to drive down the interest rates in the economy since January 2019. In January 2019, the repo rate was at 6.5%. Since then it has been cut by 250 basis points and is now at 4%. One basis point is one hundredth of a percentage.
This has had some impact in driving down fixed deposit interest rates of banks. Take a look at the following chart.

The Crash


Source: ICICI Securities, October 3, 2020.

From the peak they achieved between March and June 2019, fixed deposit interest rates have fallen by 170 to 220 basis points.
This in an environment where the inflation has been going up. In March 2019, inflation as measured by the consumer price index was at 2.9%. It had jumped slightly to 3.2% by June 2019. In August 2020, the latest data available for inflation as measured by the consumer price index, had jumped to 6.6%. Meanwhile, fixed deposit rates which were around 7-8%, are largely in the range of 4-6% now (of course, there are outliers to this).

Hence, inflation is greater than interest rates on fixed deposits, meaning the purchasing power of the money invested in fixed deposits is actually coming down.

In fact, interest rate on savings bank accounts, which in some cases was as high as 6-7%, has also come down. Take a look at the following chart.

Another crash


Source: ICICI Securities, October 3, 2020.

Savings bank accounts now offer anywhere between 2.5-3%.

The fall in interest rates is not just because of the RBI cutting the repo rate. A bulk of this fall has happened post the covid breakout. Banks haven’t lent money post covid.

Between March 27 and September 25, the outstanding non-food credit of banks has fallen by 1.1% or Rs 1.1 lakh crore to Rs 102 lakh crore. This means that people and firms have been repaying their loans and net-net in the first six months of this financial year, banks haven’t given a single rupee of a fresh loan.

Banks give loans to Food Corporation of India and other state procurement agencies to buy rice and wheat directly from the farmers. Once these loans are subtracted from overall lending by banks, what remains is non-food credit.

During the same period, the deposits of banks have risen by 5.1% or Rs 6.97 lakh crore to Rs 142.6 lakh crore. With people saving more, it clearly shows that the psychology of a recession is in place.

Banks have not been lending while their deposit base has been expanding at a rapid pace. The point being that banks are able to pay an interest on their deposits because they give out loans and charge a higher rate of interest on the loans than they pay on their deposits.

When this mechanism breaks down to some extent, as it has currently, banks need to cut interest rates on their deposits, given that they are not earning much on the newer deposits. This is bound to happen and accordingly, interest rates on fixed deposits have fallen.

While the supply of deposits has gone up, the demand for them in the form of loans, hasn’t. This has led to the price of deposits, which is the interest paid on them, falling.

But there is one more reason why interest rates have fallen. There is excess money floating around in the financial system. The RBI has printed money and pumped it into the financial system by buying bonds from financial institutions.

This excess money has also helped in driving down interest rates. While banks haven’t been able to lend at all in the first six months of the year, the government borrowing has gone through the roof. As the debt manager of the government, the RBI has printed and pumped money into the financial system to drive down the returns on government bond, in the process allowing the government to borrow at lower interest rates. Take a look at the following chart, which plots the returns (or yields) on 10-year bonds of the Indian government.

Going down

Source: Investing.com

The yield on a government bond is the return an investor can earn if he continues to own the bond until maturity. The above chart clearly shows that as the government has borrowed more and more through the year, the interest rate at which it has been able to borrow money has come down, thanks to the RBI and its money printing.

Of course, with banks not lending on the whole, they are happy lending to the government. In fact, in his speech today, the RBI governor Shaktikanta Das said that the central bank planned to print and pump another Rs 1 lakh crore into the financial system in the days to come.

With more money expected to enter the financial system the 10-year government bond yield fell from 6.02% yesterday (October 8) to 5.94% today (October 9), a fall of 8 basis points during the course of the day.

The monetary policy committee also decided to keep the “accommodative stance as long as necessary”, with only one member opposing it. In simple English this means that the RBI will keep driving down interest rates as long as necessary “at least during the current financial year and into the next financial year – to revive growth on a durable basis and mitigate the impact of COVID-19 on the economy.”

The assumption here is that as interest rates fall people will borrow and spend more and corporations will borrow and expand more. This will help the economy grow, jobs will be created and incomes will grow. While, this sounds good in theory, it doesn’t really play out exactly like that, at least not in an Indian context.

Let’s take a look at this pointwise.

1) A bulk of deposits in Indian banks are deposited by individuals. In 2017-18, the latest data for which a breakdown is available, individuals held around 55% of deposits in banks by value. This had stood at 45% in 2009-10 and has been constantly rising. Hence, it is safe to say that in 2020-21, the proportion of bank deposits held by individuals will clearly be more than 55%.

When interest rates on deposits (both savings and fixed deposits) go down individuals get hurt the most. There are senior citizens whose regular expenditure is met through interest on these deposits. When a deposit paying 8% matures and has to be reinvested at 5.5%, it creates a problem. Either the family has to cut down on consumption or start spending some of their capital (the money invested in the fixed deposit).

This also disturbs many people who use fixed deposits as a form of long-term saving. The vagaries of the stock market are not meant for everyone. Also, in the last decade returns from investing in stocks haven’t really been great.

2) When interest rates go down, the families referred to above cut down on consumption and do not increase it, as is expected with lower interest rates. This may not sound right to many people who are just used to economists, analysts, bureaucrats, corporates and fund managers, mouthing, lower interest rates leading to an increase in consumption all the time. But there is a significant section of people whose consumption does get hurt by lower interest rates.

3) It’s not just about bank interest rates going down. Returns on provident fund/pension funds which hold government bonds for long time periods until maturity and post office schemes (despite being higher than banks), also come down in the process.

4) Also, no corporate is going to invest just because interest rates are low right now. Corporates invest and expand when they see a future consumption potential. This is currently missing. Also, banks lending to industry peaked at 22.43% of the GDP in 2012-13. It fell to 14.28% of the GDP in 2019-20. During the period, interest rates have gone up and down, but corporate lending as a proportion of the GDP has continued to fall. So clearly increased borrowing by corporates is not just about interest rates.

But corporates love to constantly talk about high interest rates as a reason not to invest. This is just a way of driving down interest on their current debt.

As former RBI governor Urjit Patel writes in Overdraft:

“Sowing disorder by confusing issues is a tried-and-trusted, distressingly often successful routine by which stakeholders, official and private, plant the seeds of policy/regulation reversal in India.”

One can understand interest rates going down in an environment like the current one, but there is a flip side to it as well, which one doesn’t hear the experts talk about at all. Also, anyone has barely mentioned the excess liquidity in the financial system, which currently stands at Rs 3.9 lakh crore. Why is that? Let’s look at this pointwise.

1)  The equity fund managers love it because with interest rates going down further, many investors will end up investing money in stocks despite very high price to earnings ratio that currently prevails. The price to earnings ratio of the Nifty 50 index currently is at 34.7. This is a kind of level that has never been seen before.

But with post tax real returns from fixed deposits (after adjusting for inflation) in negative territory, many investors continue to bet on stocks, despite the lack of earnings growth.

2) The debt fund managers love it because interest rates and bond prices are negatively related. When interest rates come down, bond yields come down and this leads to bond prices going up. This means that the debt funds managed by these fund managers see capital gains and their overall returns go up. Hence, debt fund managers love lower interest rates.

3) Banks invest a large proportion of the deposits they gather into government bonds. When bond yields fall, bond prices go up. This leads to a higher profit for banks. This in an environment where banks aren’t lending. Hence, bankers love lower interest rates.

4) Corporates love lower interest rates at all points of time, irrespective of whether they want to borrow or not. I don’t think this needs to be explained.

5) The government loves low interest rates because it can borrow at lower rates. Second, with the stock market going up, it can sell a positive narrative. If the economy is doing so badly, why is the stock market doing well?

6) This leaves economists. Economists love lower interest rates because the textbooks they read, said so.

The question is do lower interest rates or interest rates make a difference when it comes to borrowing by an average Indian? Let’s take a look at non-housing retail borrowing from banks over the years. In 2007-08 it stood at 5.34% of the gross domestic product (GDP). In 2019-2020, it stood at an all-time high of 5.97% of GDP.

In a period of 12 years, non-housing retail borrowing from banks, has barely moved. What it tells us to some extent is that the idea of taking on a loan to buy something (other than a house), is still alien to many Indians.

So, the idea that interest rates falling leading to increased retail borrowing is a little shaky in the Indian context.

To conclude, today the RBI governor Shaktikanta Das gave a speech which was more than 4,000 words long. In this speech, the phrase fixed deposit interest rate did not appear even once.

A whole generation of savers is getting screwed (for the lack of a better word) and the RBI Governor doesn’t even bother mentioning it in his speech. The RBI seems to be constantly worried about the interest rate at which the government borrows.

A central bank which only bats for the government, corporates and bond market investors, is always and anywhere a bad idea.

Shaktikanta Das’ RBI is at the top of this bad idea.

 

The ‘GULZAR’ Principle of Investing for Regular Income and Safe Returns

Summary: There is no real way of earning a regular and a safe income that is enough to meet the monthly expenses.

The headline was a clickbait. But now that I have your attention, let me explain the logic behind it.

The title song of the 1979 Hindi film Gol Maal was written by the lyricist Gulzar (Honestly, calling him just a lyricist is doing his talent a great disservice. Other than being a lyricist, he has written screenplays and dialogues for a huge number of Hindi films. He is a poet and a short story writer. He is also a translator of repute. Oh, and he has also directed a whole host of Hindi movies as well as a few TV serials along the way. Also, for the millennials, Hrishikesh Mukherjee made Gol Maal, much before Rohit Shetty started using the title for everything he could possibly think of).

Now getting back to the point I was trying to make. In the title song of Gol Maal there is a line which goes: “paisa kamane ke liye bhi paisa chahiye,” essentially meaning, in order to earn money, you first need money. And that is what I am going to write about today.

In the twenty months, as the economy has gone downhill, people have been getting in touch with me on email and the social media, with a very basic financial query. The numbers were small first but post-covid this has turned into a deluge. The question being asked is how a reasonable monthly income can be generated from savings, without taking any risk, in a safe way.

The answer to this question has become very important as people have lost their jobs or seen their salaries being slashed and incomes falling. What does not help is the fact that the post-tax return from bank fixed deposits are now largely in the range of 4-5%. The inflation as measured by the consumer price index is close to 7%.

Before I try answering this question, it is important to understand why interest rates on bank fixed deposits have fallen. The simple answer to this lies in the fact that there is too much money floating around in the financial system, with the banks not knowing possibly what to do with it.

Between March 27 and July 31, a period of little over four months, the non-food credit given by banks has contracted by Rs 1.32 lakh crore or around 1.3%. The banks give loans to the Food Corporation of India (FCI) and other state procurement agencies to primarily buy rice and wheat directly from the farmers at the minimum support price declared by the government. Once these loans are deducted from the overall loans given by banks, what remains is non-food credit.

What does non-food credit contracting tells us? It tells us on the whole borrowers have been repaying loans and at the same time not taking on enough new loans. It also tells us that banks are reluctant to lend. Further, as we shall see, there has been a huge surge in fixed deposits with banks, as people have increased their savings in the aftermath of the spread of the covid-19 pandemic. Banks will take time to lend all this money out.

Between March 27 and July 31, the total deposits of banks have gone up by Rs 5.95 lakh crore or 4.4%. In an environment, where the non-food credit of banks has contracted whereas deposits have jumped big-time, it is but natural that interest rates on fixed deposits have fallen. In fact, the weighted average term deposit interest rate or simply put average fixed deposit interest rate has fallen from 6.45% in February to 6% in June, the latest data available. Now that we are in August, the interest rates may have possibly fallen even more.

In fact, there is nothing new about interest rates on fixed deposits falling, this has been going on for close to eight years now. Having said that, interest rates shouldn’t be looked at in isolation, it is important to compare them with the prevailing rate of inflation. Take a look at the following chart. It plots the average interest rate on fixed deposits during the course of a year, along with inflation as measured by the consumer price index. The difference between the two is referred to as the real rate of return on fixed deposits.

Interest v/s Inflation


Source: Reserve Bank of India.

What does the above chart tell us? Between 2014-15 and 2018-19, there was a healthy difference between the average interest paid on fixed deposits and inflation. (Of course, this is without taking tax on fixed deposit interest into account, else, the difference would have been lower).

These were the years when first Dr Raghuram Rajan and then Dr Urjit Patel were at the helm at the Reserve Bank of India. In 2019-20, the real return on fixed deposits narrowed to 1.6%. Shaktikanta Das took over as RBI Governor in December 2018.

Let’s take a look at the real return on fixed deposits month wise since December 2018, the month when Das took over as RBI Governor. The real return on fixed deposits as explained earlier is the average interest rate on fixed deposits minus the prevailing rate of inflation.

Crash in real returns


Source: Author calculations on data from the Reserve Bank of India.

This chart is as clear as anything can get. The real rate of return on fixed deposits has simply collapsed since end of 2018. This has happened as the interest rate on fixed deposits has fallen and inflation has gone up.

The interest rate on fixed deposits has fallen primarily because the rate of loan growth for banks has crashed over this period. This we can see from the following chart.

Loan growth crash


Source: Reserve Bank of India.

The above chart clearly tells us that the loan growth of banks has crashed since December 2018. In fact, for the week ended July 31, it stood at just 5.4%. Given this, the Indian economy was slowing down even before covid-19 pandemic struck.

Hence, as economic growth has slowed down, the loan growth of banks has slowed down and this has led to fixed deposit interest rates coming down as well. The point being that in economics everything is linked.

Of course, there is more to this than just the economy slowing down. Since February,  like the rest of the central banks, the RBI has printed and pumped money into the financial system to drive down interest rates, in the hope of getting businesses and people to borrow more.

Also, with collapse in tax revenues, the government will have to borrow more this year, in order to keep its expenditure going. Hence, it likes the idea of borrowing more at lower interest rates. The RBI goes along with this because among other things it also acts as the debt manager of the government.

The problem is that India’s economic crisis has grown worse since the covid pandemic hit the world, leading to a lot of individuals losing their jobs or facing salary cuts. Small businesses have been majorly hit and incomes have come down dramatically.

In this environment, people are now looking to generate some sort of a regular income from their savings. Of course, most them want to do this in a risk free way. As one gentleman recently asked me: “I am currently not employed after having worked in the corporate sector for 10 years. My request to you is to honestly guide me on how and where to invest to earn steady income especially when the fixed deposit interest rates have fallen so low.”

The first thing I can clearly say is that the gentleman believes that there is a solution to his problem. He believes that it is possible to generate a good steady income despite fixed deposit interest rates having fallen.

I see this belief among many people. My guess is, it stems from the fact that way too many personal finance publications believe in offering solutions to everything. I mean, why will a reader read you, if at the end of it you say something like there aren’t really any solutions to this problem that you might have. At least, that’s how their thinking operates. Also, they need advertisers. And advertisers love solutions to everything, even when none really exist.

In June 2020, the average rate of interest on a fixed deposit was 6%. Once we take income tax into account, the rate of return would be much lower. Of course, there are banks out there which are offering a rate of interest of 7% or more. Nevertheless, these banks are perceived to be among the riskier ones. So, the question is are you willing to take on more risk, for a 1-1.5% higher return? If yes, then these investments are for you.

While, we live in an era where no bank is going to go bust, they can and have been put under a moratorium or periods under which only a limited amount of money can be withdrawn from them. And money that can’t be spent when it is needed, is essentially useless. Hence, if you do end up putting money in a bank which offers a 1-1.5% higher return, do remember not to put all your money into it.

There are corporate fixed deposits which offer a slightly higher return but again they don’t have the same safety as a bank does.

If you are senior citizen, you can look at the Senior Citizens Savings Scheme. But that comes with the pain of dealing with the post office.

Debt mutual funds as many people have found out over the last one year, come with their own share of risks. They were marketed to be as safe as fixed deposits, but they weren’t anywhere close. Also, irrespective of what financial planners and wealth managers might say, debt mutual funds are fairly complicated products, which I am sure most people selling them don’t understand. And that’s why they are able to sell them in the first place.

A lot of individuals in the last few months have turned towards investing in stocks. The logic is that the stock market has rallied from its March low. On March 23, the BSE Sensex, India’s premier stock market index was at 25,981 points. Yesterday, August 26, it closed at 39,074 points, a jump of over 50% in a period of a little over five months. This rally has been driven by a few stocks and if you had invested in the right stocks, you would have ended up with good gains by now.

While, one can’t question this logic, but what one needs to remember is that on January 12, the Sensex was at 41,965 points. From there to March 23, it fell by 38% in a little over two months. The point being the stock market can fall as fast or even faster than it can rise. Also, do remember this basic point that a 50% fall can wipe off a 100% gain. (A 38% fall would have written off a 61% gain).

Hence, the larger point here as I mentioned in this piece I wrote a few days back is, just because an investor takes a higher risk by investing in stocks, it doesn’t mean he will always end up with higher returns, precisely the reason the word ‘risk’ is used in the first place. And by the way, the 10-year return on stocks (including dividends) is less than 9% per year.

So, the question is what should a person looking for a regular and safe income, actually do? As helpless as it might sound, there aren’t many options going around beyond the humble fixed deposit, especially for people who aren’t senior citizens. The trouble is the fixed deposit interest rates are at very low levels.

If you need to generate a monthly income of Rs 20,000 at 6% per year, this needs an investment of Rs 40 lakh.

The moral of the story here being that if you want to generate a regular safe income which is enough to meet your monthly needs, you need to invest more money. Or as Gulzar wrote in Gol Maal: “paisa kamane ke liye bhi paisa chahiye.” I would like to call this the Gulzar principle of investing for a regular income and safe returns.

Also, there are corollaries to this. These are very difficult times. Hence, there is a good chance of individuals ending up in a situation where they might have to spend their savings (rather than just the return on savings) to keep meeting expenditure.

Let’s take the example of a middle-class household with monthly expenses of Rs 50,000. In order to generate this income through a fixed deposit, an investment of Rs 1 crore is needed. Of course, the chances of a middle-class household with expenses of Rs 50,000 per month having savings of a crore, are rather minimal. In this scenario, they will have to resort to spending their savings. Given this, as I keep saying, the return of capital is much more important now than the return on capital.

In the short run, the only way to generate a good regular and safe income is find a job or any other source of income by selling the skills that one has (Like I write. I can do that for a media house or do it individually). In the long run, the next time you see interest rates of 8-9% available on fixed deposits or any other safe investment, invest in these assets and lock in the high returns for as long as possible.

While, this might not sound much like a solution but that is the long and the short of it.

What do higher household financial savings tell us about the economy?

The household financial savings, which form a bulk of the overall savings in the Indian economy, went up in 2019-20. This after they had fallen in 2018-19. The question is how did this happen and what does this mean for the Indian economy in the post-covid world? Mint takes a look.

What was household financial savings rate in 2019-20?

Household financial savings essentially refers to the savings of households in the form of currency, bank deposits, debt securities, mutual funds, insurance, pension funds and investments in small savings schemes. The total of these savings is referred to as gross household financial savings. Once the financial liabilities, that is, loans from banks, non-banking finance companies and housing finance companies, are subtracted from the gross savings, what remains is referred to as net household financial savings. The net household financial savings in 2019-20 rose to 7.7% of the GDP from 7.2% in 2018-19. This primarily happened because the liabilities fell from 3.9% of the GDP in 2018-19 to 2.9% in 2019-20.

What explains this uptick in household financial savings?

The gross financial savings of households in 2019-20 stood at Rs 21.63 lakh crore, marginally better than the gross savings in 2018-19 which was at Rs 21.23 lakh crore. Nevertheless, the net financial savings jumped to Rs 15.62 lakh crore in 2019-20 from Rs 13.73 lakh crore, a year earlier. This was primarily because the financial liabilities reduced from Rs 7.5 lakh crore to Rs 6.01 lakh crore. This pushed up net financial savings. Why did this happen? This happened primarily because the Indian economy has been slowing down from start of 2019. The per capita income in 2019-20 grew by just 6.1% (nominal terms, not adjusted for inflation), the slowest since 2002-03, when it had grown by 6.03%.

How did slow growth in per capita income impact savings?

A double digit growth in per capita income has happened only once since 2013-2014. In 2016-17, the per-capita income grew by 10.39%. Over the last few years, income growth has slowed down, and in 2019-20, it slowed down dramatically to 6.1%. This has led to a slowdown in lending growth. The non-food credit growth of banks in 2019-20 was at 6.7%, the slowest in more than a decade.

What does this tell about the overall state of the economy?

A slowdown in income growth has led to a slowdown in consumption as well as a slowdown in loan growth. What hasn’t helped is the weak financial state of non-banking finance companies, which has added to the lending slowdown. Also, this means that people were looking at their economic future bleakly, even before covid-19 had struck. At an individual level, the good part for them is that they tried to go slow on their borrowing in comparison to the past. But at the societal level, this hurt the economy because it led to a consumption slowdown.

Where will the household financial savings settle in 2020-21?

The period between April and June will lead to higher savings. As a recent RBI research paper states, a spike in household financial savings “is likely in the first quarter of 2020-21 on account of a sharp drop in lockdown induced consumption.” In fact, this explains why bank deposit rates have fallen in the recent past. The money deposited with banks has gone up, while the banks are unable to lend. But this spike in savings is likely to taper in the months to come simply because of “lags in the pickup of economic activity”.

A slightly different version of the piece appeared in the Mint on June 15, 2020.