safety-is-the-key-as-interest-rates-continue-to-fall

Context: The Indian Economy is witnessing rate cuts after the covid pandemic due to which securities have become less attractive for the masses.

More on News:

  • The Vanilla economic theory suggests that lower interest rates spur growth as producers get funds at lower cost, which aids the production of cheaper goods.
  • However this ignores the needs of depositors whose returns are reduced in such a scenario.

Analysis:

  • Complex impact:The government has announced stimulus packages and rate cuts primarily to reignite the slowing economy, but the same scenario also increases money supply in the economy.
  • Impact on Depositors: People have more money in their hands which will decrease their purchasing power as production will not rise suddenly at a similar pace and their cost of living will go up.
    • As a result more people will approach the bank for depositing money in order to earn more but this will reduce the returns on their deposits.
    • This reduced return would make them disinterested and they might start withdrawing the deposits.
  • Impact on Banking Business: It will come under severe stress as lower rates will reduce the deposits inflow into banks which can create significant problems. 
    • If banks are unable to get deposits, they will be unable to lend as much to infra projects, which are crucial for development.
    • Further Savings are essential for Capital Formation in the country.

Way Ahead:

  • The depositors do have an option to switch to riskier assets like equity and mutual funds but considering the uncertainty, it is advisable to stick to less riskier assets like government securities as safety is the key in difficult times.
  • Young people (Below 45 years) can take some risks but older people should choose to invest money only in government-guaranteed schemes and bonds though they offer lower rates of returns.
  • The government also might need to cut the rates offered on Fixed term securities but that is the need of the hour if long term stability is desired.

Source:

https://www.livemint.com/news/india/safety-is-the-key-as-interest-rates-continue-to-fall-11594132558715.html

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