Cheaper EMI? Why all the hullabaloo around bank rate cuts is a bad joke


Vivek Kaul

In the press conference that followed yesterday’s monetary policy, Raghuram Rajan, the governor of the Reserve Bank of India(RBI), said: “Banks are sitting on money and their marginal cost of funding (has) fallen, the notion that it hasn’t fallen is nonsense, it has fallen.”
What Rajan meant here was that banks are able to raise deposits at a much lower interest rate than they had in the past. Given this, banks should be cutting the interest rates they charge on their loans.
Banks have been saying for a while that they can’t cut their lending rates because interest rates they pay on their deposits and other forms of borrowing continue to remain high. Rajan essentially said that this argument was basically “nonsense”.
Banks got the message immediately and by the end of the day three big banks, State Bank of India (SBI), HDFC Bank, and ICICI Bank, cut their base rates or the minimum rate of interest they charge to their customers.
Both SBI and HDFC Bank cut their base rate by 15 basis points (one basis point is one hundredth of a percentage) to 9.85%. ICICI Bank was a little more aggressive and cut its base rate by 25 basis points to 9.75%.
These base rate cuts have got the media very excited. Here are some of the headlines.
The Times of India says: “Top 3 Banks cut lending rates after Rajan push”. The Economic Times reports: “RBI doesn’t cut rates but forces others to do so”. The normally sedate Business Standard says: “Banks bow to RBI pressure”.
The question is will these base rate cuts really make any difference? Theoretically people are supposed to borrow more at lower interest rates. But is that really the case? Let’s run some numbers here.
For males, SBI offers a car loan at 45 basis points above its base rate. Hence, when the base rate is 10%, the car loan is available at 10.45%. When the base rate is at 9.85%, the car loan will be available at 10.30%. (For females the car loan is available at 40 basis points above the base rate).
Let’s consider a male who takes a car loan of Rs 3 lakh repayable over a period of 5 years.
The EMI at 10.45% would work out to Rs 6,440.74. The EMI at 10.3% works out to Rs 6,418.49 or Rs 22.25 lower.
So, is someone going to buy a car just because his EMI is lower by Rs 22? None of the newspapers which have run extremely detailed stories around the base rate cuts, have bothered to ask this basic question.
What about home loans? Home loans have a much larger ticket size than car loans, so shouldn’t the difference in EMIs there be huge? Let’s see.
Data from the National Housing Bank shows that the average home loan size in India in 2013-2014 stood at Rs 18-19 lakh. Let’s round it off to Rs 20 lakh, given that we are now in 2015-2016. For males, SBI offers a home loan at 15 basis points above its base rate (for females the home loan is available at 10 basis points above the base rate).
When the base rate was at 10%, the interest charged on a home loan to a male would be 10.15%. At a base rate of 9.85%, the interest rate charged on a home loan to a male would be 10%. Let’s consider a male who takes a home loan of Rs 20 lakh, repayable over a period of 20 years.
At 10.15% his EMI works out to Rs 19,499.62. At 10%, it is Rs 19,300.43 or Rs 199.18, lower. So is an individual going to buy a home because his EMI is will now be lower by Rs 199?
What if the loan size were bigger. Let’s say around Rs 60 lakh. How do things look then? In this case the EMI difference comes to around Rs 597.55. So, someone who can afford a home loan of Rs 60 lakh is definitely not going to be impacted by such a low amount. As I have often said in the past, in case of real estate, interest rates and EMIs are really not the problem. The problem is simply the price of homes. They have gone way beyond what most people can afford. And unless there is a correction there, no amount of rate cuts by banks is going to revive buying. This is a simple fact that everyone who makes a living through the real estate industry needs to realize.
What these calculations also tell us is that the impact interest rates have on consumption is terribly overrated. The media spends too much time analysing will the RBI cut the repo rate(I am guilty of the same). Then it spends even more time analysing whether banks will pass on the cut to their consumers. If banks do not pass on the cut it spends time on analysing why banks are not passing on the cut. It would do a whole lot of us more good if the ‘good’ journalists who cover banking start using the PMT function on MS Excel. (This function essentially helps calculate the EMI on a loan).
The issue is whether a minuscule base rate cut really makes a difference? And the answer as I have shown from the calculations above is, it does not. What makes a difference is basically how confident is the consumer feeling about the future. In India, we really do not measure this properly. The Consumer Confidence Survey carried out by the RBI “provides an assessment of the perception of respondents spread across six metropolitan cities viz., Bengaluru, Chennai, Hyderabad, Kolkata, Mumbai and New Delhi.” Given that it has limited use.
To conclude, it is best to quote something that the economist John Kenneth Galbraith wrote in T
he Affluent Society: “There is no magic in the monetary policy… It survives in esteem partly because so few understand it.” And that indeed will be the way how thing shall continue.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

The column originally appeared on Firstpost on Apr 8, 2015

RBI policy: Raghuram Rajan’s rate cuts have been useless till now. Here’s why

I like to often quote the American baseball coach Yogi Berra in pieces that I write, given that a lot of what he has said makes so much sense. One of Berra’s most famous quotes (which I have also used on numerous occasions) is: “In theory there is no difference between theory and practice. In practice there is.”
Raghuram Rajan, the governor of the Reserve Bank of India(RBI), more or less stated the same in the first monetary policy of this financial year, which was released today. Rajan decided to keep the repo rate at 7.5%. He has cut the repo rate twice this year, first in January and then in March. Repo rate is the rate at which RBI lends to banks and acts as a sort of a benchmark to the interest rates that banks pay for their deposits and in turn charge on their loans.
But these cuts amounting to a total of 50 basis points (one basis point is one hundredth of a percentage) have not been passed by the banks.
A recent Bloomberg newsreport pointed out that 43 out of the 47 scheduled commercial banks haven’t cut their base rates or the minimum interest rate a bank charges its customers. This means that EMIs on loans will continue to remain high.
Theoretically one expects banks to cut their lending rates after the RBI has cut its repo rate twice. But that hasn’t happened. As Rajan put it in the monetary policy statement: “Transmission of policy rates to lending rates has not taken place so far despite weak credit off take and the front loading of two rate cuts.” Offering this as a reason, Rajan and the RBI decided to maintain the repo rate at 7.5% in the monetary policy announced today.
Lending by banks has grown by a minuscule 9.5% in the last one year, data from the RBI points out. In comparison, the growth in deposits collected by banks has been at 11.4%. What also needs to be taken into account here is that the deposit growth has been on a higher base.
Hence, deposits have been growing at a much faster rate than loans. Theoretically, this should have led to banks cutting interest rates so that more people would borrow. But that hasn’t happened. There are multiple reasons for the same.
In order to cut their lending rates, banks need to reduce their base rate or the minimum interest rate that a bank charges to its customers. When a bank cuts its base rate, the interest rates that it charges on all its loans, fall. But the interest that it pays on its deposits do not work in the same way.
When a bank cuts the interest rate on its fixed deposit, only fixed deposits issued after the cut, get paid a lower rate of interest. The fixed deposits issued before the cut continue to be paid a higher rate of interest. While the interest a bank earns on its loans is floating, the interest it has to pay on its deposits is not. Hence, banks are reluctant to cut their lending rates even though the RBI has indicated to them very clearly that it is time that they started to do so.
Over and above this, most public sector banks have huge bad loans to deal with. And cutting interest rates would mean taking the risk of lower profits, hence, status quo is the preferred way.
Further, it might be worth pointing out here that it takes time for the impact of the RBI rate cuts to trickle down. A recent report by the International Monetary Fund (IMF) makes this point: “Pass-through to deposit and lending rates is relatively slow and the deposit rate adjusts more quickly to monetary policy changes than does the lending rate.”
The report further points out that it takes around 18.8 months (a little over one and a half years) for the lending rates to change. The deposit rates change in 9.5 months. Once these data points are taken into account it is easy to conclude that the two repo rate cuts by the RBI in January and March 2015, will take time to trickle down.
That just about answers the question why the repo rate cuts by the RBI haven’t benefited the end consumers. The next question I try and answer in this piece is what will it take for the RBI to cut the repo rate again?
As Rajan said in the press conference after the announcement of the monetary policy: “You shouldn’t expect direction to change in future.” What he was basically saying here is that the RBI remains on course to keep bringing down the repo rate in the days to come.
And what will it take for the central bank to do that? The monetary policy statement has the answer: “The Reserve Bank will await the transmission by banks of its front-loaded rate reductions in January and February into their lending rates. Second, developments in sectoral prices, especially those of food, will be monitored, as will the effects of recent weather disturbances and the likely strength of the monsoon, as the Reserve Bank stays vigilant to any threats to the disinflation that is underway.”
Unseasonal rains in North India have damaged a lot of
rabi crop. A March 27, 2015, press release by the ministry of agriculture points out: “As per the latest reports received from States, the area under rabi rice as on today stands at 39.43 lakh hectare as compared to 43.55 lakh hectare at this time last year. Total area under rabi rice and summer crops moves to 52.20 lakh hectare as compared to 55.28 lakh hectare at this time last year.” Pulse is another important rabi crop.
This crop damage is expected to push up food prices to some extent. An increase in the price of rice can be curtailed if the government chooses to release some of the huge stock of rice that it has. As on March 1, 2015, the government had a wheat stock of 195 lakh tonnes.
What will also help curtail food inflation is the fact that rural wage inflation has been on its way down for a while now. One of the major reasons that food prices were high between 2008 and 2013 was the rapid increase in rural wages.
As Chetan Ahya and Upasana Chachra of Morgan Stanley point out in a recent research note: “In the 2008-13 period, we believe intervention in the labour market artificially pushed rural wage growth to 18-20% year on year. With wages accounting for 50% of operating costs in food production and higher income growth into hands of rural labour without matching the increase in productivity, the rapid rise in wage growth resulted in persistently high inflation.”
But this increase is now a thing of the past. “The good news is that rural wage growth has been on a decelerating trend over the past 13 months as government intervention in rural labour markets has reduced. Since Jan-14, rural wage growth has decelerated at a quick pace and currently averages 6.2% for the 12 months ending Jan-15, compared with 16% for the 12 months ending Jan-14. Moreover, the latest data shows rural wage growth at 5.5% in Jan-15 – near a 9- year low,” the report points out.
This will ensure that food inflation spikes will be controlled in the days to come. And that should give some more space to Rajan to cut the repo rate.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

The column originally appeared on Firstpost on April 7, 2015

Dear Reader, are you still invested in gold?

In my previous avatar as a full time journalist working for a daily newspaper with a very strong business section, I happened to interview many gold bulls. This was primarily during the two year period between September 2008 and September 2010, in the aftermath of the financial crisis that broke out in mid September 2008.
I got a lot of predictions on what levels the gold price would run up to in the years to come. Almost each one of these bulls agreed that gold will cross $2,000 per ounce (one ounce equals 31.1 grams). Some of them thought gold would touch anywhere between $5,000 and $10,000 per ounce.
The highest prediction I got for gold was $55,000 per ounce. The trick with all these forecasts was that none of these gentlemen predicting the price of gold, gave me a date i.e. by such and such date, the price of gold would be at this level. All of them just gave me a price.
Interestingly, more than four and a half years later, gold prices have not gone anywhere near the levels the gold bulls had predicted. The logic offered was very straightforward—with all the money being printed by central banks all around the world, very high inflation would be the order of the day.
And in this environment people would do what they have always done—buy gold. This expectation drove up the price of gold and it touched around $1,900 per ounce, sometime in August 2011. After this, the price fell and currently stands at around $1,220 per ounce. In fact, the price of gold never even crossed $2,000 per ounce, let alone crossing $5,000 per ounce.
There are important lessons that emerge here. As Humphrey B. Neill writes in
The Art of Contrary Thinking: “The whole field of economics remains a “guessy” one. Little, if any, progress has been made over the years in attaining profitable accuracy in economic forecasting. And, mind you, this condition still exists, notwithstanding the extraordinary volume of statistics that is now available…which was not known to former forecasters.”
The Art of Contrary Thinking was first published in 1954 (even though I happened to read it only over the long weekend and I really wish I had read this book a decade back), and what Neill wrote then still remains valid.
Another interesting point that Neill makes is that people love opinions and forecasts which are definitive. Almost every gold bull I have interviewed over the years has told me with great confidence that the price of gold is going to explode in the years to come. And it’s the confidence with which they spoke that made their forecasts believable at the point of time they were made.
As Neill writes: “Forcing oneself to be definitive and specific can cause more wrong guesses and forecasts than anything I can think of. It has given rise to the cynical expression: “Often in error, but never in doubt.” It is this writer’s contention after over 30 years’ acquaintance with, and observation of, economics and Wall Street that being positive, specific, and dogmatic is about the most harmful habit one can fall into.”
What was true in the mid fifties when Neill wrote the book is even more true now, in the era of television and the social media. When you have to voice your opinion in 30 seconds or write everything that you know in 140 characters, there is no opportunity to be nuanced. You have to be as definitive as you can be, because that is what people love and there is no space for a detailed argument.
But as we have seen very clearly in the case of gold this clearly does not work. “The fault likes (1) in the pernicious desire of writers in the financial economic field [like yours truly] to forecast—to be oracles. Once bitten, it is difficult to effect a cure! Readers (2) are equally at fault in expecting that anyone can predict economic or market trends accurately and consistently,” writes Neill.
The gold bulls have been way off the mark in their predictions until now. One reason for this lies in the fact that all the money printing carried out by central banks hasn’t led to much conventional inflation. The reason as I have explained (you can read the pieces
here and here) in the past lies in the fact that people haven’t borrowed and spent money at low interest rates, as they were expected to. Given this, a situation where too much money chases too few goods and leads to inflation, never really arose. Though a lot of this newly printed money found its way into financial markets all over the world.
The broader point here is that it is very difficult to predict human behaviour. As Neill writes: “you may have all the statistics in the world at your finger tips, but still you do not know how or why people are going to act.” And given this, just because people have borrowed and spent money when interest rates were low in the past, doesn’t mean they will do so again.
Where does that leave gold? Will gold prices go up again? The answer is kind of tricky. Let me quote Nassim Nicholas Taleb here. As Taleb he writes in 
Anti Fragile: “Central banks can print money; they print print and print with no effect (and claim the “safety” of such a measure), then, “unexpectedly,” the printing causes a jump in inflation.”
James Rickard author 
Currency Wars: The Making of the Next Global Crises says the same thing: “They can’t just keep printing…All major central banks are easing…Eventually so much money will be printed that this will lead to inflation.”
What no one knows is when this will happen. And a forecast which does not come with a time frame is largely useless. What this also means is that if you are still betting your life on gold, please don’t. Okay, I think I am making a forecast again. Let me stop here.

Disclaimer: This writer has around 10% of his portfolio still invested in gold through the mutual fund route.

The column appeared on The Daily Reckoning on Apr 7, 2015

Why money printing hasn’t led to inflation Part 2

3D chrome Dollar symbolIn a column published on March 24 I had explained why despite all the money printed by the central banks of the world over the last six and a half years, we haven’t seen much conventional inflation. The central banks have printed money (or rather created it digitally through a computer entry) and used it to buy government and private bonds
By buying bonds, central banks pumped the printed money into the financial system. This was done primarily to ensure that with so much money floating around, the interest rates would continue to remain low. At low interest rates people would borrow and spend. This would help businesses grow and in turn help the moribund economies of the developed countries.
But money printing should have led to inflation as a greater amount of money chased the same amount of goods and services. Nevertheless, inflation continues to remain very low in most of the developed world.
This, as I had explained, is primarily because of the fact that the world is in midst of a balance-sheet recession (a term coined by Japanese economist Richard Koo). Between 2000 and 2007, people in the developed world had taken on huge loans to buy homes in the hope that prices would continue to go up forever.
A recent report titled
Debt and (not much) deleveraging brought out by the McKinsey Global Institute explores this point in great detail. As the report points out: “Between 2000 and 2007, household debt relative to income rose by 35 percentage points in the United States, reaching 125 percent of disposable income…In the United Kingdom, household debt rose by 51 percentage points, to 150 percent of income.” Other parts of the developed world also saw similar sort of increases in their household debt.
Much of this increase in household debt came from people taking on more and more home loans (or mortgage) to buy property. “In the United States, for example, household debt grew from just 16 percent of disposable income in 1945 to 125 percent at the peak in 2007, with mortgage debt accounting for 78 percent of the growth. Mortgage debt represents the majority of household debt growth in other countries as well. Our data show that mortgages now account for 74 percent of household debt in advanced economies,” the McKinsey report points out.
What is interesting is that this increase in home loans (or mortgage debt) in particular and overall household debt in general, was not accompanied by an increase in home-ownership rates. “In the United States, for instance, the rate of homeownership rose from 67.5 percent in 2000 to 69 percent at the peak of the market in early 2007, while household debt rose from 89 percent of disposable income to 125 percent. In the United Kingdom, the homeownership rate rose by 1.3 percentage points from 2001 to 2007, while the household debt ratio rose from 106 percent of income to 150 percent,” the McKinsey report points out.
As home loans were easily available at low rates of interest, more and more money was borrowed to buy homes. This pushed up home prices in most of the developed world. Between 2000 and 2007, home prices rose by 138 percent in Spain, 108 percent in Ireland, 98% in United Kingdom, 89%in Canada and 55% in the United States (on a slightly different note, real estate prices in India during the same period would have risen at a much faster rate. But we are talking about developed economies here where home-ownership rates are high and populations are stable or declining).
As home prices went up, this meant that the newer individuals wanting to buy homes had to take on a larger amount of home loan. This pushed up total household debt.
The correlation between rising home prices and increase in household debt to income ratio is very strong across countries. What also encouraged people to take on home loans was the fact that interest rates were very low, which meant that monthly EMIs required to pay off home loans were low as well. Hence, people could borrow much more than they would otherwise have.
Also, as home prices went up, people borrowed and bought homes not to live in them, but to just speculate, hoping that prices will continue to go up forever. A survey of home buyers carried out in Los Angeles in 2005, found that the prevailing belief was that prices would keep growing at the rate of 22 percent every year over the next 10 years. This meant that a house, which cost a million dollars in 2005, would cost around $7.3 million by 2015. So strong was the belief that home prices will continue to go up.
But that wasn’t to be. Once the bubble burst, housing prices crashed. This meant the asset (i.e., homes) people had bought by taking on loans had lost value, but the value of the loans continued to remain the same. Hence, people needed to repair their individual balance sheets by increasing savings and paying back debt.
Further, many of these loans had been issued at low interest rates. Once these interest rates started to go up, the EMIs also went up. As the McKinsey report points out: “In countries where many households have variable rate mortgages [home loans], such as the United Kingdom (and more recently Denmark), households are exposed to interest rate risk. When rates rise and monthly debt service charges are adjusted upward, some households may find they cannot afford their mortgages. This occurred in the United States prior to 2007, when households took out variable-rate mortgages with low “teaser rates,” but had trouble keeping up after a few years when the teaser rates expired.”
As EMIs went up and home prices crashed, more and more income was used to service the home loans. This had an impact on consumption. As the McKinsey report points out: “This dynamic is seen clearly across US states…A similar pattern can be seen across countries: the largest increases in household debt to income ratios occurred in Ireland (125 percentage points) and Spain (59 points), which also had the largest drops in consumption.”
As the accompanying table(from the McKinsey report) shows, households in many countries have been deleveraging since 2008, after the start of the financial crisis.
What this tells us clearly is that people are using more and more of their income to pay off their existing loans. Hence, even though central banks have ensured that low interest rates continue to prevail, people are no longer interested in borrowing and spending money. They are more interested in paying off their existing loans.
And that explains why all the money printing hasn’t led to conventional inflation though there has been a lot of asset price inflation. Investors have borrowed money at low interest rates from developed countries and invested them in financial markets all over the world, leading to stock markets rallying.

The column originally appeared on The Daily Reckoning on April 2, 2015

What happened when Pappu met Feku on April Fools’ Day


Look who we have here,” said Feku, when he ran into Pappu at the New Delhi Airport, early morning today.
Kahan hai re tu?” he asked.
“I was here only,” replied Pappu.
“In Surajkund.”
“Oh and everyone was speculating you are somewhere in Europe with your girl friend,” said a surprised Feku.
“Nah, I was with Jeejaji in Haryana. He knows the state very well na.”
But why did you disappear?” asked a slightly concerned Feku.
“Oh, this was an idea one of the brand managers who has joined us came up with,” replied Pappu. “Brand managers?” asked Feku. “And I thought I had already recruited all of them.”
Nah. So, you see no one was talking about me.”
“So, I was told that I if I disappeared everyone would be talking about me.”
“Ah. Interesting.”
“And newspapers would write about me on their front pages. Websites would write analytical pieces on my disappearance.”
“You devil! There is nothing like negative publicity. What an idea. I will also try it in the years to come, when people stop believing in acche din aane waale hain.
“With our party no longer in government we can’t put out those full page advertisements that we used to do, for all the publicity that we needed,” said a rather sad Pappu. “Ek wo din bhi the!”
Yes, yes. Ab to hamari baari hai!” 
“But don’t tell anyone yet, that I am back.”
“Why?” asked a concerned Feku.
“I want to officially come back on Easter.”
“Pop out of the Egg, you mean?” asked Feku and burst out into laughter.
He he. But I must tell you I am really inspired by you,” said Pappu immediately alerting Feku.
That’s nice. Now what have I done?”
Arre your party has become the biggest political party in the world.”
“Oh, that.”
“What an idea. Just make a missed call and become a member.”
“You see, all the brand managers I have hired, just keep coming up with these great ideas,” explained Feku.
But how does someone, who has become a member by making a missed call, resign if he wants to? Make a missed call again?” asked Pappu trying to give chabhi to Feku.
Pappu ji, now tell me, the nation wants to know when are you getting married?” asked Feku, trying to change the topic.
“Ah. You know Veronica my Spanish girl friend left me.”
“Awww. I am sorry to hear that . These women can drive you real crazy. But the family line also has to continue. It’s such a tricky call.”
“You must be talking from your ‘brief’ experience. My Spanish girl friend loved calling me Raul. I can still remember the way she used to twirl her tongue while calling out my name. “Raaaauuuullll,” still gives me goosebumps,” recalled a rather emotional Pappu.
“Never mind Pappu. It’s time to move on. As the Biggest B once said: “Jo beet gayi so baat gayi, maana woh behad pyara tha,”” said Feku, getting all poetic.
“But I still miss her you know. “Like the roses need the rain. Like the poets need the pain. Baby I want you,”” said Pappu, bursting out into a Bon Jovi song.
Lagta hai dard bahut gehra hai,” said Feku.
“The Spanish girl might want you to become a matador in a bull fight. Next time you should date a nice homely Gujarati girl. Worse come worse she will make you fly kites on Makar Sankranti and make you eat dhoklo, theplo, khakro and undiyo,” saidFeku, trying to feign some sympathy. 
And I can shout Kai Po Che,” said Pappu, all excited. “Once I cut your kite. Wo subah kabhi to aayegi!
If you want I could even look for a good Gujarati girl for you,” offered Feku,ignoring Pappu’s remark. 
Could you?” asked Pappu.
Yes, why not!”
But there is a slight problem with that?”
What? Madam won’t like it?” asked Feku. “Don’t worry I will talk to her.”
No. No. Ma is fine as long as I marry a girl.”
Well, I can’t call my girlfriend ben no. Also, she might turn out to be a Gujarat model. Not good for my party you see.”
Ye achi baat nahi hai,” screamed Feku and walked out of the room.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)  

The spoof originally appeared on Firstpost on April 1, 2015