Myths on pensioners busted: Check out the real and false arguments

Published: December 13, 2017 4:17 AM

Our tight inflation targeting over the last 6-7 years is sought to be justified on (1) stable prices being a prerequisite for sustained growth and (2) that the pensioners, who largely rely on interest income, should be protected.

myths, inflation and pensioners, inflation impact on pensionersSuch targeting is being achieved by RBI through a higher interest rate regime. A similar argument is advanced against correcting our overvalued currency.

By- V Kumaraswamy

Our tight inflation targeting over the last 6-7 years is sought to be justified on (1) stable prices being a prerequisite for sustained growth and (2) that the pensioners, who largely rely on interest income, should be protected. Such targeting is being achieved by RBI through a higher interest rate regime. A similar argument is advanced against correcting our overvalued currency.

That the pensioners have suffered in the last few years and will suffer heavily if we loosen controls on interest is a big myth at this point in time, when coming out of low growth inertia and near nil new employment creation seems so vital.

Have they suffered recently?

The primary argument is that the pensioners with fixed income will suffer capital erosion through inflation and will have less and less real capital base to earn their future incomes. The argument goes that if interest income remains constant but expenditure keeps going up year on year due to inflation, progressively they will be left with smaller amounts to consume.

The accompanying table 1 shows that this argument is clearly overdone in the last 4-5 years. Ever since the 4% CPI inflation target has been articulated and rather doggedly pursued by maintaining higher interest rates, inflation has fallen steeply, whereas interest rates have not traced the same trajectory.

From the period 2005-06 till 2011-12, the interest on bank term deposits were 1.5% more than WPI inflation and 0.7% less than consumer price inflation. Since then, interest earners have had it good and interest rates have been more than both—by a whopping 5.6% over WPI and 1.5% over consumer inflation.

But why the all-round feeling of being left out by the pensioners now as the social media would have us believe, when in real terms their income is three times compared to the period before 2012? In the years since 1991, except for a brief period between 1998 to 2002, asset prices have always been going up; in many years faster than inflation. When there is asset price inflation, there is the wealth effect, which makes us feel wealthier and prone to spending more, as articulated by economists. But once again, in the last three years, real estate prices have hardly gone up. Without this illusory wealth effect backing, the pensioners may be feeling poorer off.

Interest earners and pensioners

People in agriculture tilling the land are unlikely to be living on interest income. They till as long as they can, and then rely on the family as the social security net on reverse mortgage of sorts—the family, in turn, supports them on the understanding that, on death, his/her property will pass onto them. This is 50-60% of rural population. Landless labour is unlikely to be hit due to interest rate variations; they would need a safety net of a different kind. Non-farm rural labour is unlikely to be living off bank deposits.

People who are largely living on interest income are most likely urban or middle class. Most of them hedge their bets and have houses, gold, etc, as safety nets, and only a portion of their savings is in interest bearing instruments.

Amongst these are retired government employees, whose pension is adjusted for inflation from time to time if they have been in service before 2004. They are a substantial proportion among pensioners. Those who joined after 2004 are unlikely to have retired by now. Those who are most likely sufferers are the ones who retired from private service.

The total term and savings deposits of the banking system—as of September 2017—is about `114 lakh crore, and with mutual funds, small savings and public deposits it would be about `130-135 lakh crore, which is about 80% of our GDP. The comparative figures for the US are more than 150%. At an average rate of 6.6%, this would give an income of `8.91 lakh crore, or 5.5% of GDP.

From this, we have to deduct the interest accruing to people who are still in service and government pensioners. The income accruing to those who are surviving on interest alone is likely to be less than 2% of population.

Effect of currency devaluation

One of the strident and stubborn arguments against correction of our overvalued currency is that it will lead to inflation and hurt the interest of the pensioners. The Urjit Patel Committee has summarised several studies (see table 2) on India estimating the inflation over the short term and the long term from a 10% movement in the rupee versus the dollar. With the singular exception of Ghosh and Rajan, the resultant incremental inflation (from currency alone) is likely to be 0.6% in the short term to about 1.5% over the long term. This is hardly worth the scare, given the real income of pensioners has risen three times since 2012.

Pensioners versus job seekers

Should our monetary system be so sensitive to such a small proportion of GDP and the group of people behind that (less than 2%)? A 2-3% drop in interest rate in line with inflation would help the investment climate substantially, especially in utilising capacities lying idle. The number of new job seekers is 0.75-1% of the total population each year. For years on end, job creation has suffered, and they will far outnumber the pensioners and it is time their aspirations are also met.

Deposits till death

If term deposit interest rates spread inflation had been the same post 2012 (as between 2005-06 and 2012), banks would be now saving Rs 1,64,000 crore on incremental deposits of Rs 40-odd lakh crore. If similar reduction had accrued on central government’s net additional borrowings, it would be an additional Rs 74,000 crore. These amounts saved would be sufficient to take care of those who purely depend on interest for survival.

The real sufferers can be taken care of by special deposits, which can yield 2% over CPI inflation subject to minimum of 5%. Deposits can be on joint names of spouses, and on death of the later to die, deposits can be given to the designated nominees after deducting tax.

If prematurely withdrawn by depositors, the interest can be recalculated as per past prevailing interest rates and the balance of deposit paid to the depositor. Those who are entirely dependent on interest alone could be easily taken care through this mechanism from the potential savings as earlier estimated.

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