Sunday, March 27, 2016

Are Lower Interest Rates Good for India?

Recently the Modi government's finance minster Arun Jaitley announced a big reduction in the interest rates of major small saving schemes like the PPF (Public Provident Fund) and Post Office Term Deposit: The government announced new interest rates on small savings instruments on Friday, slashing the returns on Public Provident Fund savings from 8.7 per cent to 8.1 per cent and one year post office deposits from 8.4 per cent to 7.1 per cent (source). Before this big cut in the rate of interest of these small saving schemes, Mr. Jaitley also dared to impose a tax on EPF (Employee Provident Fund) withdrawal in his fresh budget. He had to rollback this tax proposal later on after a big backlash from the salaried class people of India (see here)!

After the announcement of this rate cut, there surely was another uproar in the country from the savers class. Mr. Jaitley, to do the damage control work, came out and defended these interest cuts by saying the following:
The economy needs lower interest rates to become more efficient and high deposit rates would keep it “sluggish.”
“Interest rates had risen a lot, so the cost of borrowing for the government and others was high, but now they have come down. The way the economy is moving, we cannot have a situation where lending rates are going down but deposit rates remain high,”
To make the economy more efficient rather than sluggish, the country has to move towards lower interest rates in both,” (source)
So is there any Truth in what Jaitley is saying? Is the Indian economy right now sluggish because of the higher interest rates? Is the government's policy of lowering interest rates going the make the Indian economy more "efficient"? In my latest economic analysis below I give real answers of these questions.