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Of inflation, real returns and senior citizens

LiveMint logoLiveMint 05-09-2017 Joydeep Sen

In a scenario of falling interest rates, it is a common refrain, and a valid one, that senior citizens who draw their sustenance from a kitty parked in bank or post office deposits see their regular interest income dropping.

To be fair (and practical), if overall interest rates in the economy are coming down, bank and post office deposit rates would come down as well.

There is usually an enhanced rate offered to senior citizens, of about 0.5%. To look at the reason why rates come down at all, while there are multiple reasons in a dynamic world, but the one factor that stands out is inflation. To put it simply, when inflation is low or falling, the central bank of the country would reduce interest rates, and increase rates when inflation is high or rising.

When inflation is high or rising, the ‘real’ interest rate for savers is impacted to that extent. To offer protection from high inflation, we have seen initiatives from the government earlier, in the form of inflation-linked bonds, where the return to the investor is adjusted for inflation. The first were the wholesale price index (WPI)-linked bonds and the next were linked to the consumer price index (CPI).

If inflation is higher, the payout would be higher accordingly. However, both these bonds were not successful, due to different reasons, but in essence their product design had certain constraints. 

 For senior citizens, it is not just the interest rate but the real interest rate that matters. Inflation is currently on the lower side, and real interest rate is high, according to India’s historical standards.

In this scenario, it may seem a bit out of place to talk of high inflation and low real return. However, the best time to prepare for war is during peace.

Let us deliberate on what is a better solution.

One solution is to bring another issuance of CPI-linked bonds so that in case inflation moves up, senior citizens are compensated to that extent. But in that case, they will have to go through the rigmarole of understanding and applying for the bonds.

The better solution is to instead offer higher returns to senior citizens on deposits, to guarantee a minimum real return, with conditionalities. The deployment avenue—which everyone understands, even rural investors—is term deposits.  

The deposit product design could be something with a tenure of 5-8 years. Premature withdrawal would be allowed, but without inflation protection. The minimum age would be 60 years, and the maximum investment allowed can be Rs10 lakh per person.

Most importantly, the real return would be guaranteed at 3% per year, linked to the consumer price index. 

The benefit of guaranteeing a minimum real return vis-à-vis inflation-indexed bonds will be as follows: 

• Senior citizens would be spared the effort of having to understand a new product, that is, inflation-indexed bonds. Many of them park their savings in deposits anyway, which have to be linked with PAN and Aadhaar to satisfy the conditions of minimum age and maximum amount. 

• The administration would be simple. The earlier products, the WPI and CPI bonds, did not succeed due to flaws in their design.

While a lot of research may have gone into designing the two bonds, there were limitations. Instead of another attempt in the same direction, it would be simpler to have a link to bank and post office deposits. 

• Access to term deposits would be better. Majority of the target population would be covered as public sector banks and post offices are located across the country.

People who prefer physical investments over financial investments, particularly in rural areas, can be weaned to inflation-linked deposits, thereby enhancing the habit of financial savings. 

• The product will offer more flexibility to senior citizens. An inflation-indexed bond will have a defined tenure as it is not possible to customize it for various investor preferences. On the other hand, term deposits within a defined maturity bracket would qualify for real interest rate.

This would give senior citizens some choice, and even those who are not financially savvy can understand term deposits. 

• The cost to the government can be taken care of in a pragmatic manner. Going by the current levels, with a bank fixed deposit rate of 6.5% (or 7% for senior citizens) and latest CPI inflation data of 2.36%, the real interest rate is 4.14% (or 4.64% for senior citizens).

The government need not guarantee the current level of real return; it can be set as per historical levels and expected realistic levels on inflation. 

• While there will still be a cost for the government, this will be a social benefit measure, with a positive impact on voter base.

Let’s admit it, governments work for social good but with an eye on the vote bank.

The cost will be much lower than agriculture loan waivers where the entire loan is waived. This will be just a marginally incremental interest payout for a section of the depositors. 

Joydeep Sen is managing partner at Sen & Apte Consulting Services LLP.

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