Why Jaitley is Wrong to Want Lower Interest Rates

Instead of looking to long-term solutions, the Modi government is using interest rates as an easy scapegoat to promote the interests of a few.

Arun Jaitley. Credit: PTI.

With mounting NPAs, banks are unlikely to lend if interest rates are reduced. Credit: PTI.

On 9 July 2016, Arun Jaitley spoke at a function to unveil a commemorative postage stamp marking 140 years of the Bombay Stock Exchange (BSE) where he questioned the relatively high rate of interest on savings, concerned that it is holding back the economy’s true potential for growth. Worried about private investment, he remarked that India has a ‘”peculiarly high” rate of savings, which coupled with the high interest rate “creates an interest regime which is extremely costly and makes the economy sluggish.”

While the statement merely suggests interest rates should be lowered, which is not necessarily a guarantee of its implementation, the precedent is hardly promising. In the last six months, the Finance Ministry has slashed interest rates on a number of government saving schemes, including the Public Provident Fund, the Kisan Vikas Patra, the National Savings Certificate and the five-year Monthly Income Scheme. The government could just as well decide to lower the interest rate of government schemes, however the interest rate of savings in the private sector is a tool of monetary policy, and ultimately not in Jaitley’s hands but the RBI’s. Nonetheless, Jaitley’s remark is disconcerting when considered against two basic tenets of economics and the current state of India’s economy.

Defending the interest rate

Firstly, interest rates are both determined by, and used to control, inflation. Economic principles dictate that when inflation is high, interest rates should not be lowered. Low interest rates encourage higher consumption and investment (because borrowing money becomes cheaper), which leads to inflationary pressure as the economy’s capacity cannot keep up with rising demand. From 2012-2016, India’s inflation rate averaged 7.7%, reaching an all time high of 11.16% in November 2013. Although the overall inflation rate has decreased under the BJP government, it has remained consistently high, and even risen in crucial areas such as food. The suggestion to lower the interest rate would only increase inflationary pressure, forcing the common man to tighten his belt.

Secondly, when inflation is higher than the interest rate, the value of one’s savings decreases year on year. For example, if an economy has an inflation rate of 7% per year, and the interest rate is 5% per year, then in real terms, the value of your savings is decreasing by 2% per year. Simply put, a negative real interest rate is a disincentive to save. Jaitley’s remark about India having a “peculiarly high” savings percentage is meaningless unless these savings are looked at within the context of inflation. Moreover, it seems to overlook the fact that majority of India’s population falls into the middle and lower income bracket. Many of these small investors rely on the high interest rate, as the earnings from their savings constitute a supplemental income. As peculiar as the high rate of savings is, it also has a positive impact on private investment, the primary concern in Jaitley’s statement. After all, banks require sizeable saving deposits in order to finance and facilitate private investment, and high interest rates increase the banking sector’s capacity to do both.

The real peculiarity

In an economy with high inflation, there is only one party that benefits from lower interest rates: large corporations who are able to secure cheaper loans. In the last few years, most of India’s large corporations have racked up unsustainable debts, or what the financial world refers to as ‘non performing assets,’ a euphemistic term for loans that are unlikely to be repaid. Clearly, this has been an injurious experience for banks, causing them to be more cautious when it comes to lending. The fact that taking out a loan for private investment has become more difficult is a reason for sluggish economic growth. While Jaitley claims that lowering the interest rate may be the solution for boosting private investment, the truth is that banks are unlikely to lend more even if interest rates are reduced, as they would be undertaking similar levels of risk for a lower return.

Of course the real peculiarity is this: why come to the rescue of debt-ridden corporations, when they are at the root of the problem? The answer is simple: crony capitalism. From driving out Raghuram Rajan, the last RBI Governor, who pressured banks to tackle their NPA-crisis head-on by 2017, to driving out Greenpeace India, which made the costly mistake of exposing Modi’s old pal Adani and the environmental laws flouted by his company, it is clear that a corrupt political-corporate nexus drives much of our governmental apparatus today.

If sluggish economic growth was really the government’s concern, there are plenty of avenues to focus on. The first is to boost the global demand for Indian goods and services, which is all the more of a priority given the worldwide slump in global consumption. While ‘Make In India’ is a step in this direction, let’s hope that its rhetoric is translated into reality. Domestically, the government can also address structural hurdles in the labor market in order to increase the rate of job creation, which would directly boost domestic demand and expenditure. At the very least, it should not increase taxes further or impose new cesses, both of which it has done, and have most likely had an adverse impact on domestic demand. Thirdly, it could reduce bureaucratic hurdles, which would improve the ease of doing business, a popular mantra of the Modi government. However, instead of looking to long-term solutions, the government is using the interest rate as an easy scapegoat to promote the interests of a few.

Digant Raj Kapoor is the COO of Shaurya Furnishing in Kuwait. He holds an M.Phil in International Relations from Cambridge University, where he was a Commonwealth Trust Scholar. He blogs on Indian politics as The Inquisitive Indian.

Saanya Gulati is an MSc candidate in Politics and Communications at the London School of Economics, and previously worked as a LAMP (legislative assistant to a Member of Parliament) Fellow. She writes regularly about contemporary culture and politics at

  • ashok759

    As India greys, millions of families, lacking a strong social safety net, rely on interest income, hopefully many of them may be staying in homes they own. Apart from many sound economic reasons why low interest rates in a capital scarce, high inflation society are a terrible idea, the government should think of older citizens.

  • Raj Kanwar

    I fully endorse the views so eloquently expressed by Digant Raj Kapoor and Saanya Gulati in their excellent piece on “Why Jaitley is Wrong to Want Lower Interest Rates”. Perhaps, Mr. Jaitley does not know or pretends not to know that the bulk of the savings in various small savings, post office schemes and banks are typically made by retired people or senior citizens. They deposit their life’s savings in banks and post offices, and live on the interest that they get. I am an 86-year old retired businessman and much of my income now comes from banks’ interest and dividends. Until some time ago, the interest on term deposits in banks was 9.5% and 9%. My deposits recently renewed get me only 8%. The writers are absolutely right that this interest does not even cover the inflation. Why must banks lend thousand of crores rupees to industrialists with dubious projects? This is all due to the prevalent “crony capitalism”. It was so during the UPA rule and it is so now during the NDA government.