Thoughts & Ideas

Saturday, June 13, 2015

An Aspect of Financial Repression in India

Financial repression refers to "policies that result in savers earning returns below the rate of inflation" in order to allow banks to "provide cheap loans to companies and governments, reducing the burden of repayments". The term was introduced in 1973 by Stanford economists Edward S. Shaw and Ronald I. McKinnon in order to "disparage growth-inhibiting policies in emerging markets".

This monograph tries to evaluate the extant of losses being suffered by bank depositors in India due to implicit policy of Financial Repression being carried out by Government of India along with the tacit consent of the Reserve Bank of India.

As per RBI statistics1 for the year ended March 2014, the position of Indian banking industry was:                        
                                                                  INR Billion                                                               
Total Loans & Advances                      67,352.32            A       
Total Interest / Discount Income                     6,296.97            B               

Gross (Nominal) Interest Yield on Loans        9.35% pa           C = B/A
& Advances                                                                                                                                                         
Less: Inflation Rate                                     7.00%  (say)          D          
Less: Operating Expenses                           1.90%2                  E            
Less : Gross NPAs                                     3.80% as per RBI  F                 
Real Rate of Interest                            - 3.35%      G = C - (D+E+F)

That is, the effective real rate of interest at which lending is done by the Indian banking system is negative!

Question is who pays for this negative returns?

Is it the government?  No, the Government recapitalizes PSU banks for the losses they make on nominal basis not the "real" basis.

The implications of the negative real rate of interest include:
  • It is the inflation tax that millions of depositors are collectively paying by keeping their savings as bank deposits. Banks pay low rates of interest on deposits and average nominal interest rate on deposits are hard pressed to cover the rate of inflation.  The amount of annual subsidy paid by the (mainly poor) depositors to the rich and powerful in India is Rs. 225,677 crores (INR 2,256.771billion – G*A)!
  •  It is the poor subsidizing the rich.The bigger you are and the more you borrow from the Indian banking industry, effectively the larger amount of subsidy you get from the banking system.
  •  The borrowers effectively gain through three forms. First, the negative real rate of interest. Second, only the rich and powerful are able to corner bank loans and benefit from it thereby also increasing the level of income and wealth inequality. Third, by defaulting in repayments!
  • The rich have alternative forms of savings, the poor do not - they are also not organised to have a voice. The value of their savings keeps getting eroded since the Indian banking system does not give adequate returns on deposits.
  • Increasing nominal interest rates on deposits would ensure that bankers would be harder pressed to improve efficiency of operations including reducing transaction costs, better design of loan contracts and more effective monitoring of loans.
  • One of the pernicious results of negative returns by keeping savings as bank deposits are scams of the like of Peerless, Sharada, JVG, CRB, Sahara at regular intervals as the poor desperately seek avenues for small savings which are at least inflation proof.
  • And to add insult to injury – the small Indian bank depositor is subjected to relentless, inescapable Tax Deduction at Source.  


                                                                                               INR Billion
Total Operating Expenses                                                         1,825
Total Earning Assets (Loans, Advances & Investments)          96,181
Op. Expenses / Total Earning Assets                                        1.90%