Indian bank interest rates and common sense


Financial literature will explain adequately as to what should be the ideal rate of interest either charged or received by a customer. For example for an investor, if a deposit is made, he should be compensated for the inflation rate, length of deposit, risk premium and productivity. The current bank interest rates for varying periods of deposit tell you a different story. The interest rate for savings account earns around 4 percent while a 3 year deposit may fetch the investor 9 percent. The question now is whether money should be left with the bank given in this rate of interest. One of the macroeconomic variables to look at is the inflation rate. The current Indian inflation rate is around 6.46 percent as measured by the whole sale price index and 9.87 percent as measured by the Consumer Price Index. Given the income tax rate varying between 10 to 30 percent with a levy of 10 percent on the tax, it is easily understood that the depositors have been given a very unfair deal. For example, a person investing Rs 1 lakh for a period of 3 years. His interest income will be 100,000 x .09 = 9000 Rs. This is then taxed at the investor marginal tax rate of say 20%. His net interest income will then be 9000 x (1-0.20) = Rs 7200. He also pays a 10% surcharge on the tax of rupees 1800 which is an additional Rs 1800 x .10 = 180 Rs. When both are subtracted from the interest income he takes home Rs 9000 – Rs 1800 – Rs 180 = Rs 7020 or a net return of 7.02%. Given the Consumer Price Index at 9.87 percent, he is already loosing over 2.85% of the deposit. If the amount is kept in savings account he will take home Rs 4000 – Rs 800 – Rs 80 = 3120. Putting money in the bank is one sure way of wiping out ones wealth. This situation exists because there is no significant disapproval from the public.
Assuming that nothing will change even if one protested, it is wiser for the individual to place the funds elsewhere. Lots of choices are available. For example, Gold coin, Gold ETF are all good bets. For Gold ETF, if it is bought and held for more than a year, the gain is tax free. Of course gold prices are variable and is affected by changes. Indian rupee exchange rate. Given the inflation rate differential between the US and India exceeding 5 percent, Indian rupee is bound to go down in value at least by 5 percent. For example a 4 year forward contract is quoted at 71 Rs to a dollar.
India imports 60 billion dollar worth of gold every year. Rich investor grabs them with both hands as they have surplus cash and also know that it is an imported commodity. They know that a day will come the price of gold will be many times more than what is today. A simple example will illustrate this point well. In 1968, I was employed by the State Bank of India for a salary of paltry Rs 900 per month. At that time gold was 35 $ an ounce and the rupee was eight to the dollar. In other words for an amount $ 35 x 8 = 280 rupees. I could have bought 3 oz of gold with 900 rupees. Today even after a massive drop in price. Gold is trading around $ 1300 an oz. To buy 3 oz, I need an income of 1300 x 3 = 3900 US. In Indian rupees it is 3900 x 62 = 2, 241800. Basically what it means is that the purchasing power of rupee has practically diminished to a small fraction of what it used to be.
Gold is an extra ordinary metal. All the major treasuries in the world have lots of it. In fact, China is buying more and more for its treasury. US alone has 8100 tones of gold, while the Indian treasury has 557 tonnes.
Finally, keep only a small portion of your money in the bank for transaction purposes and buy systematically an affordable quantity of gold. You will realize soon that this has not been a bad decision after all.
If the bank in India are not investor supportive, it is at least very helpful to borrowers. At a borrowing rate of 14% (5% spread over 3 year deposit) and assuming it is invested in a business the real cost is only 14 x (1-.35) = 9.1%. It is almost free money to the borrower. If you are borrowing to invest in gold, you could be a double winner, namely cost of borrowing lower than the inflation rate and invest in gold which is perfect edge against inflation.
After all we work to earn and to save for our retirement. Spending the savings during post retirement one finds how depreciated the value of rupee is. Finally a retail investor in the stock market is at the mercy of FIIs and mutual funds. With gold he is totally in control.

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