Photographer: Vivek Prakash/Bloomberg

Modi Risks Middle-Class Backlash in Bid to Spur India Loans

  • Banks say savings programs prevented them from lowering rates
  • Fixed deposit rates to fall to 7.1% from 8.4% from April 1

Indian Prime Minister Narendra Modi risks a political backlash among the middle class as he seeks to coax banks into lowering interest rates.

Criticism is growing against his government’s move last week to slash interest rates on small savings programs used by as much as a third of India’s 1.3 billion people. Banks have long cited the government-backed schemes as a reason for failing to transmit rate reductions from the central bank.

Narendra Modi

Photographer: Nicky Loh/Bloomberg

The shift to link the programs with market rates is testing Modi’s resolve as he seeks to kickstart growth that remains shaky despite outpacing other major economies. A backlash already prompted him to backtrack on a budget proposal to tax the provident funds of 37 million employees, a sign of his reluctance to stick with difficult political decisions ahead of a slew of state elections.

"It will affect the political interests of the government," Satish Misra, an analyst at the Observer Research Foundation in Delhi, said of the rate reductions. "If economic growth revives it will definitely benefit the government and they will say more jobs have been created. Whether they will succeed is the question."

Modi has struggled to fend off opposition attacks that his government favors the rich over the poor, a narrative that prompted him to drop efforts to make it easier to acquire land. After his party got crushed at the polls in India’s third most-populous state Bihar in November, Modi sought to pivot with a pro-farmer federal budget last month.

Still, the cuts to small savings rates -- by as much as 130 basis points -- reflect the tensions over his broader goals to revive investment while keeping inflation under control in a nation where the majority of the population lacks social security and lives on a few dollars per day. The main opposition party Congress called the move "a criminal breach of trust with hapless people," while similar barbs followed on social media.

399 Million

Small savings include cash deposited at post offices, which dot the nation including in areas where there may be no bank branches. There are special incentives for vulnerable sections of the population such as senior citizens and girls, and the returns are often exempted from tax.

Indians invested a net $93 billion in small savings programs of post offices in the year through March 2015. That’s less than 7 percent of the $1.4 trillion poured into commercial bank deposits. Post offices, which have major share of small savings, had 399 million accounts last fiscal year. The number of customers may be smaller as many people have multiple accounts.

A reduction in small-savings rates is bad news for those with large balances in fixed deposits, especially senior citizens, said researchers at Angel Broking. It predicted that banks would cut base rates by about 100 basis points next year.

After the latest cut, a one-year fixed deposit in postal savings will fetch a person 7.1 percent from April 1, against 8.4 percent at present. India’s largest lender State Bank of India pays 7.25 percent on a deposit of similar maturity.

The S&P BSE Bankex Index, which tracks 10 lenders, advanced 1.7 percent in the past two trading sessions following the decision.

Indian central bank Governor Raghuram Rajan said last year that linking small-savings rates with market interest rates should improve transmission of monetary policy. As of early December, banks had passed on less than half of 125 basis points worth of cuts last year, according to the Reserve Bank of India.

‘Long Overdue’

Rajan is scheduled to review interest rates on April 5. Some analysts see him cutting borrowing costs by as much as 50 basis points, which would further put pressure on the government to reduce small savings rates.

Some analysts say the concerns of banks are overblown. Small savings have fallen from more than 20 percent of bank term deposits to 11 percent in the past five years, according to Nomura Holdings Inc. analysts Adarsh Parasrampuria and Amit Nanavati.

"The cut was long overdue," said Mohan Guruswamy, a former Finance Ministry official and chairman at New Delhi-based think tank Centre for Policy Alternatives. "It’s a bold move. It’s going to come at some cost."

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