Dilemma for savers

The Indian economy has reaped the benefits over the last few years of continuously falling interest rates. The benefits have flowed mostly to borrowers "" both corporate and retail "" as abundant money forced lenders to chase business at lower and lower rates.

A big chunk of the improvement in corporate profitability is the result of falling interest costs. Retail borrowers have benefited from cheap loans for housing, cars and consumer durables. The main casualty in this power shift, of course, has been the individual saver, especially people like pensioners.

Their nest egg now delivers a lot less in an era of lower interest rates. Last year, though, was a time of hope for savers, thanks to the boom in the stock markets.

Even people who were normally risk averse could hope to get good returns by redeploying a part of their savings in equity-related investments, including mutual funds. But now, the abrupt change of mood in the markets over the last two months has brought the saver back to square one.

With international investors moving out of the emerging markets and heading back to the US in the hope of higher interest rates, stock prices in markets like India are not seen as having a huge upside.

At the same time, outside the area of government-guaranteed instruments such as the 6.5 per cent tax-free RBI relief bonds, the LIC-administered pension scheme and various post office savings certificates, there are no real opportunities available for the attractive deployment of investment capital "" at least in the short term.

Indeed, the rates of interest on provident funds should be reduced to bring them in line with the rest of the market "" but the Left will not have any of this.

Outside of this limited area, if one were to assume inflation at around 5 per cent or more in 2004-05 because of the way oil prices are behaving "" "real" post-tax returns are unlikely to exceed 2 to 3 per cent, at best.

As for other avenues like real estate, there is now an abundant supply of new houses and apartments and therefore little chance of repeating the old scarcity-driven surpluses. Investing abroad, now permitted in limited doses, is not an option for most people due to the lack of appropriate investment expertise and advisory services.

Can anything be done to improve options for savers? In the short-term, probably not. The government has already gone out of its way to subsidise returns for people in vulnerable categories and it makes no sense to expand the folly.

But over the medium term, many things are possible. Take banks. Currently, the spread between most borrowing and lending rates is large. This will not change until there are greater opportunities for depositors to lend directly to borrowers "" through the popularisation of money market funds and other instruments of disintermediation.

If retail investors can invest safely in bank-guaranteed, securitised paper (like credit card dues and auto loans), they can earn higher rates of interest while leaving banks to develop fee-based sources of revenue.

Second, there is no option but to broaden and deepen the stock markets. Currently, the market fires on only one cylinder "" the FIIs. India needs strong long-term domestic flows into equity to sustain decent and stable returns "" and bear in mind that the average price-earning ratio in India is significantly lower than it is in the West.

This means allowing pension funds to invest in equity, with adequate safeguards. If the new government wants to improve the climate for savings and investment, these are the places to start. Dada-dadi bonds and other market-distorting instruments are not a superior alternative.