Alignment is key

The editorial, “Time to align” (April 11), reinforcing the need to align interest rates with market yields is timely. No economy can afford ponzi schemes to thrive nor delink from real interest rates.

Recall former Reserve Bank of India governor Raghuram Rajan’s apt explanation of the difference between nominal interest rates and real interest rates by citing the example of movement of prices of dosa. While the stability of macroeconomic conditions ensures that savers remain in the positive range on real interest rates, it is essential that intermediaries sustain themselves in the market on the basis of their operational efficiency.

Thus, while aligning interest rates to market yields is fundamental for the sustainability of the economy, financial intermediaries should be allowed to thrive on the basis of their efficiency indexed with the interest rates they can afford to quote.

The arithmetic of interest rates is simple: The market yield minus the cost of intermediation plus the profit of entrepreneur. Intermediaries should be allowed to use “cost plus pricing” to ensure minimum acceptable rate of profit for the entrepreneur.

The interest rate system on savings should therefore automatically adjust to these dynamics so that efficiency in the market is maintained but all forms of savings in the economy converge towards market yields. Divergence from market yields, if any, can emerge as an efficiency benchmark and as entrepreneurial profits, where savers can opt for any savings product that serves their purpose and suits their risk appetite.

The epicentre of interest rates on savings should always be aligned towards market yields, preferably with quarterly rests, but can be different in terms of yield to savers well aligned to their risk appetite. Only then will competition for efficiency sustain on the fulcrum of market yields.

K Srinivasa Rao Noida