RBI GOVERNOR NOT HITTING THE NAIL ON THE HEAD

RBI GOVERNOR NOT HITTING THE NAIL ON THE HEAD

By

Lt Gen PG Kamath (Veteran)

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Three days before the budget the RBI Governor spoke at an event organised by the Financial Express on 20 Jul 2024.? He said that the Savings are shifting from Bank FDs to MFs and that the slow deposit growth could lead to Structural Liquidity issues at the banks.? He said this has forced banks to resort to short-term borrowings and issue certificates of deposits. However, though he was advising the banks to restructure their strategies to accept the current public trend, I am afraid he did not pinpoint the reason; why the public at large is moving towards the MFs in preference to FDs.

Now let me attempt to answer this question.? The main reason is the heavy income tax on those who have invested in FDs.? If 20 to 30 percent of one’s hard-earned earnings out of FDs goes towards income tax, its higher interest gets neutralized.? Also, it further gets eroded due to the depreciation of its purchasing power due to inflation. Hence the public at large is prepared to take risks in MFs as they have a better return.? The losses of some of the MFs would be made up by higher returns in some others. ?The risks are indeed worth taking.

Let us look at the interest rates of the last five years; 2019-20, 6.10 percent, 2020 -2021, 5.30 percent, 2021-2022, 5.20 percent, 2022-2023, 5.65 percent, and 2023-2024, 6.75 percent.? It adds up to 29 percent.? Let us presume the cumulative interest adds up to 30.5 percent presuming that at least a few investors have invested for longer terms. Though there is a variation in interest rates in different banks, for uniformity in calculations let us stick to the SBI. The SBI interest rate for Fixed Deposits with a five-year lock-in period is 6.50 percent for the general public.? It amounts to ?1,38,042 at the end of five years.? Hence, the total interest gained is ?38,042/-

Taking our calculation further, the interest of ? 38042/- incurs an income tax ranging from 20 percent (Income slab of 12 to 15 lakhs) to 30 percent (Income slab of 15 Lakhs).? Deducting 20 percent and 30 percent tax, the amount that one has gained from the one lakh FD is (38042 – 7608 = ?30434) and (38042 – 11412 = ? 26630) respectively.? Hence the ? Total Amount i.e. Principal + Interest after deducting the income tax is ? 1,30,434 (A) and ?1,26,630/- (A1) respectively.

During the period there has been inflation as well that is depreciating the value of the money invested. From 2019 to 2023; inflation has risen annually by 3.73, 6.62, 5.13, 6.70, and 4.38 percentages.? It works out to 26.56 percent over the last five years.? So, the purchasing power of the rupee has gone down by 26.56 percent.? After depreciating 26.56 percent of the final purchasing power of the amount i.e. {A – (26.56 x A/100} = A – 34643 = ? 95791 (Z) and {A1 – (26.56 x A1 / 100)} = {A1 – 33633} = ? 92,997/- (Z1) respectively.

Summary:

One invests one lakh for five; the amount becomes ? 1,38,042/-

He pays an income tax of 20 or 30 percent on the interest gained; the amount decreases to A and A1 respectively.

The inflation of 26.56 percent over five years decreases the purchasing power of Amounts; A and A1 to Z and Z1 respectively.

Hence a principal of ?1 lakh invested in 2019 on an annual interest of 6.50 for five years and then paying the Income tax of 20 or 30 percent on gains, and further battered by inflation eroding its purchasing power by 26.56 percent fetches goods and services worth ? 95791 and ? 92997 respectively in 2024. Hence, why should anyone invest in FDs?

Dear RBI Governor; this is the reason why people at large are preferring MF and are abandoning the FD route in their investments.? It is not that you do not know about it but it is not diplomatic for you to say it in public.? The liquidity problems in banks are there to stay till the time you make the FDs overall attractive.? Banks will not have the funds to lend, forcing them to resort to borrowing from the RBI at the Repo rates and this will add to their rates while lending it to the public thus reducing the liquidity in markets and would ultimately dampen growth and retard economic activities.? Hence the RBI governor instead of lamenting in public should get going to make the FDs attractive enough for the people to take the FD route for their investments.

We all know the money invested in the MFs is basically in the secondary markets and rotates between the sellers and buyers. It does not get converted into active capital unless you are buying a primary share.? On the contrary, the FDs convert the idle savings of the public into active capital of banks which can be lent to traders and entrepreneurs to invest in production activities spur the market forces, and increase the GDP.? To further add to the self-inflicted woes of the government, the incentive to invest in PPF has been removed from the new tax regime. It will further reduce the money available to the government as the public would have further invested this amount into MFs and Share Markets.? It leaves no money in banks as well as with the government.

Tailpiece: The real smart people are in the Telangana Government where they have institutionalized corruption; the Income tax of the CM and other cabinet ministers is paid from the government exchequer.? How do you like it? Brilliant! It must have been the Brain Wave of a manipulative bureaucrat and accepted by the politicians with glee and applause.

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