What Do High Inflation And Low Interest Rates Mean For Your Savings?

With India’s retail inflation rising to 6.09 per cent in the month of June, a significant question arises about how it affects savings of the people given that the inflation rate is now much higher than bank deposit rates. As per the latest available data, the interest rate available on fixed deposit (FD) in SBI, the largest public sector bank, ranges between 5.1 per cent and 5.4 per cent for tenures ranging from one to 10 years. This means that the real interest rate on these deposits, that is the rate that has been adjusted to remove the effects of inflation, has fallen into the negative territory thereby eroding the value of people’s money over time. 

The interest rates are dependent on the RBI’s benchmark rates and we have already seen consecutive cuts collectively amounting to 115 basis points between March and May. Since February last year, the policy repo rate has been cut by a cumulative 250 bps, from 6.5 per cent to 4 per cent. With more future cuts expected, the real returns on bank savings may fall further.

Rachit Chawla, CEO, Finway, says it’s a cause of concern that with rising inflations, the gap between the inflation rate and the interest rate being offered by the banks continues to widen, because it means people are losing money from their bank account without even spending it. 

“Imagine that you have Rs 100 in your savings bank account and let’s say that the bank is giving an interest rate of 1 per cent. This effectively means that within a year, your account would have Rs 101. Although at first sight, it seems like you earned Re 1, it’s not really the case. If in the same year, the rate of inflation was, say 2 per cent, it means that you would require Rs 102 to have the same buying power that you began with. So although you’ve gained a rupee, you’ve lost your buying power. This effectively means that if your savings are growing at a rate slower than the inflation rate, you’re losing money. And the wider that gap is, the heavier is your loss,” he explains. 

According to Divakar Vijayasarathy, Founder and Managing Partner, DVS Advisors, the interest is the compensation for parting with money which makes sense only if it is higher than the depreciation in the value of money owing to inflation. For example, if the inflation is at 3 per cent and the interest rate is 5 per cent, the depositor earns an effective yield of 2 per cent. In a situation where the inflation rises without a corresponding increase in interest rate, the depositor's effective yield will shrink.

Prof. Manohar Lal, Assistant Professor – Finance, ITM Vocational University, says that the inflation in the Indian economy in the last two years has been on the higher side “increasing year on year by more than 2 per cent”.

“This implies that people’s savings had increased in real value during 2016, 2017 and 2018. However, during year 2019, the gap became negative meaning people’s real value of savings have turned negative. If we look closely in the past six months the negative trend has continued,” he explained. According to Lal, the value of real returns currently is close to negative two per cent currently, meaning instead of making good returns, the value of people’s savings is being eroded by two per cent annually.

Over the last quarter, we have seen interest rates on fixed-income investments such as FDs, PPF and other government schemes go down. This is concerning as it dents the savings of those who rely on deposit-natured instruments. 

Dipika Jaikishan, Co-Founder and COO, Basis (a financial services platform for women), adds that the only time one is growing their wealth is when savings are parked in investments that give you returns that are higher than inflation. 

“If your savings are not earning you inflation-beating returns, then you would need to save a lot more for certain financial objectives. Inflation can specifically hurt savings in the areas of future education and retirement goals. As money gets less valuable over time you may not be able to afford your current lifestyle at retirement,” she explained. 

Finway’s Chawla says that if one wants to avoid losing money to inflation, they’d have to invest that money somewhere other than a savings account, which obviously involves risk. “But given the plethora of options that are available, you can pick one according to your risk-bearing ability,” he said.

Nikhil Kamath, Co-founder and CIO, True Beacon and Zerodha, agrees and adds that in a cycle when interest rates are falling and inflation is increasing, savings are affected negatively as the interest one receives on their savings goes down, plus the value of money is also lost due to inflation. “This typically leads to investors seeking alpha, often investing in stock markets and other asset classes."

According to MrinAgarwal, financial educator and founder-director of Finsafe India, with real returns falling, investors would find it difficult to manage with current investments and will have to be careful about what they choose. "Switching from a bank FD to Non-convertible debentures (NCD) or a company deposit will mean higher risks. Investors will need to reassess their investment incomes if they are being used for monthly expenses," she concludes.