Month: August 2015 | Page 5

7 August, 2015

Here is some basic maths that the real estate wallahs need to learn

I had thought that I will keep The Daily Reckoning free from any writing on real estate this week. But that won’t happen I guess.

Now getting back to the topic at hand. Earlier this week, the Reserve Bank of India led by governor Raghuram Rajan, presented the third monetary policy statement for this year. The RBI decided to maintain the repo rate at the current level of 7.25%. Repo rate is the rate at which RBI lends to banks and acts as a sort of a benchmark for the interest rates that banks pay for their deposits and in turn charge on their loans.

As is the case always whenever the RBI does not cut the repo rate, there were immediate calls from real estate companies, lobbies and others associated with the sector (or what I call the real estate wallahs) that the RBI should start cutting the repo rate in order to get the sector going again.

Manoj Gaur, president, CREDAI NCR, a real estate lobby told The Economic Times that he hopes that the RBI would cut the repo rate in the time to come. Pradeep Jain, chairman of Parsvnath Developers also told The Economic Times that reduction in the repo rate “will be key to revive sentiment in the real estate sector”. There is nothing surprising here given that the real estate wallahs have been doing this for a while now.

In the monetary policy statement, the RBI said: “Since the first rate cut in January, the median base lending rates of banks has fallen by around 30 basis points, a fraction of the 75 basis points in rate cut so far.”

What this means is that even though the RBI has cut the repo rate by 75 basis points (one basis point is one hundredth of a percentage), the banks have cut the interest rates at which they lend only by around 30 basis points on an average. Hence, home loan interest rates haven’t fallen by as much as the repo rate has.
The real estate wallahs caught on to this point as well. David Walker, managing director of SARE Homes told The Economic Times: “We urge the banks who have only cut rates by about 30 basis points to pass on the full benefit of the 75 basis points cut in rates by the RBI.”

All these quotes essentially give the impression that the RBI is responsible for the crisis in the real estate sector in India and all will be well once the home loan rates come down. Nothing can be more untrue.

Let’s do some basic maths and see. The RBI puts out the sectoral deployment of credit data every month. As per this data as on June 26, 2015, the total amount of home loans given by scheduled commercial banks stood at Rs 6,53,400 crore. Home loans have grown by a very good 15.6% over the last one year. This when the overall lending growth of banks stood at a much slower 7.3%.

How were things last year? As on June 27, 2014, the total amount of home loans given by banks had stood at Rs 5,65,000 crore. Home loans had grown by 17.1%. The overall lending by banks had grown by 12.8%, during the course of one year ending on June 27, 2014.

Between June 2014 and June 2015, overall lending growth of banks over a one year period, has crashed from 12.8% to 7.3%, a fall of 550 basis points. In comparison, home loan growth has fallen from 17.1% to 15.6%, fall of a much lower 150 basis points.

Let me throw in some more numbers. In the last one year, banks gave out home loans worth Rs 88,400 crore. This formed nearly 21% of the total loans given out by banks. Hence, for every Rs 100 worth of loans given out by banks, Rs 21 went towards home loans. This is much more than in the past.

How was the situation in June 2014? In a period of one year ending June 27, 2014, the total amount of home loans given out by banks stood at Rs 82,570 crore. This formed 12.7% of the total amount of loans given by banks. This number as on June 28, 2013, had stood at 12.2%.

What this clearly shows us is that there has been no slowdown on banks giving out home loans, despite interest rates continuing to remain high (in the words of the real estate wallahs). In fact, banks have lent more home loans as a proportion of their total loans in the last one year, than they did in the two years before that. So, home loan lending has no clear link with interest rates as the real estate wallahs would like us to believe.

The question is even though home loans are being given why has there been a fall in demand for homes, leading to builders ending up with a massive amount of unsold inventories. One explanation may lie in the fact that even though the total amount of home loans being given out has gone up at a steady pace, the total number of home loans being given out may be declining. This maybe happening primarily because of the massive increase in home prices over the last few years. And this massive increase has essentially ensured that even though the total amount of home loans has been going up, the total number of home loans may not be growing at the same pace. The RBI does not put out data regarding the total number of home loans.

The RBI sectoral deployment of credit data gives us some hint on this front. The home loan data can be divided into priority sector lending (essentially loans of up to Rs 25 lakh are categorised as priority sector) and non-priority sector lending.

The priority sector home loan lending has grown by just 3.8% during the last one year. On the other hand the non-priority sector home loan lending has grown by a massive 30%. The same numbers as of the end of June 2014 had stood at 7.9% and 30.7%.

Also, as on June 26, 2015, the priority sector home loans of upto Rs 25 lakh given over a one year period formed around 49.1% of total home loans. As on June 28, 2013, to years earlier, the priority sector home loans given over a one year period had formed nearly 59.4% of the total loans. As on June 29, 2012, the priority sector home loans given over a one year period had formed nearly 62.5% of total home loans.

What this tells us very clearly is that priority sector home loans (i.e. loans of Rs 25 lakh or lower) have been falling. And the only possible explanation for this is an increase in home prices.

To conclude, that is where the problem is. The real estate sector cannot be revived by cutting interest rates. It can only be revived by builders cutting prices. Further, a cut in prices will also get the black money wallahs looking for a good deal back into the market. The ball is in the builders’ court. There is nothing that the RBI can do about it.

Postscript: I will be taking a break from writing The Daily Reckoning next week. I will be back after the independence day.

(The column originally appeared on The Daily Reckoning on Aug 7, 2015)

6 August, 2015

The land acquisition process will continue to remain at a standstill

Vivek Kaul

It seems we are going to go back to the Land Acquisition Act 2013, which was passed during the time when the Manmohan Singh led UPA government was in power.

The 2013 Act which replaced the 1894 Land Acquisition Act had made the entire process of acquisition of land extremely difficult and time taking. The 2013 Act is the exact antithesis of the 1894 Act, which given the fact that it had been introduced during the time the British ruled India, allowed the government to acquire land at a drop of a hat and very quickly.

The 1894 Act had something called as the “urgency” clause. As Jairam Ramesh and Muhammed Ali Khan write in Legislating for Justice—The Making of the 2013 Land Acquisition Law: “Section 17 of the Land Acquisition Act, 1894 was used to forcibly disposes people of their land in a frequent and brutal fashion by suspending the requirement for due process…Section 5A…allowed for a hearing of objections to be made but put no responsibility on the Collector to take those claims into consideration.”

What this meant was that people could complaint against the acquisition of land, but it was up to the Collector of the area where the land was being acquired whether to give them a hearing or not. Also, there was no clear definition of urgency. It was left “to the authority carrying out the acquisition.”

This clause allowed the collector to “take possession of the land within fifteen days of giving notice”. He could take possession of a building within 48 hours of giving notice. “The Outer Ring Road Project of Hyderabad and the Expressway in Uttar Pradesh are both striking (and recent) examples of acquisitions where large tracts fell pray to the urgency clause,” write Ramesh and Khan.

Given this, it was only right that the 1894 Land Acquisition Act was done away with. In fact, it should have been done away with long before it finally was. The trouble is that the 2013 Act that replaced it, as I said was at the other extreme, and made the process of land acquisition next to impossible.

In fact, Ramesh and Khan even write: “The law was drafted with the intention to discourage land acquisition. It was drafted so that land acquisition would become a route of last resort.” Ramesh was one of the key movers behind the 2013 Act. Economist Rajiv Kumar estimated that it could take more than four years to acquire land, if all the processes were followed.

The Modi government tried to dilute the provisions of the 2013 Act and brought in the Land Acquisition, Rehabilitation and Resettlement (Amendment) Ordinance, 2014, which made a few changes to the 2013 Act. The ordinance was signed by President Pranab Mukherjee on December 31, 2014. It made some changes to the 2013 Act.

As Anand Ranganathan wrote in a column on www.newslaundry.com: “Projects relating to national security or defence, including preparation for defence, defence production; rural infrastructure including electrification; affordable housing and housing for the poor people; industrial corridors; infrastructure, social infrastructure and PPP projects where government holds the land, there is no longer any need to obtain prior consent of 80% (for private projects) or 70% (for PPP projects).”

This was a step in the right direction. In the months to come a lot of noise was made around how land would be taken away from farmers and be handed over to corporates. This was totally incorrect. As Rajiv Kumar pointed out in a column in The Economic Times: “As many as 59% of rural households do not own any land. Another 28% have land holdings of less than 0.5 hectares. Therefore, 87% of the rural population is desperate to end their dependence on agriculture.
Only 0.5% of India’s farmers have land holdings larger than 10 hectares and in the vicinity of urban centres. They are the only ones who could be adversely affected by the proposed amendments to [Land Acquisition Act].”

But this was a point that the government did not manage to communicate to the people of this country. Narendra Modi addressed the issue in one of his mann ki baat programmes but there never really any follow up to that. Finally, the rhetoric against the ordinance unleashed by the Congress party seems to have gained credibility.

This probably explains the decision of the Modi government to go back to the 2013 Law. Further, there is an assembly election scheduled in Bihar later this year and this could have become a huge issue. Bihar is very important for the Modi government given that it elects 16 members to the Rajya Sabha, where the Bhartiya Janata Party does not have a majority. And the only way to get partymen elected to the Rajya Sabha is to first win the assembly election. Also, the Bihar election will decide if the Modi magic still persists. Given these factors, the land acquisition ordinance will be given a burial, at least for the time being.

One of the face saving gestures that has been put forward is that the states can go in for their own land acquisition laws. But what needs to be kept in mind is the fact that a state law cannot go against the central law. If there is a conflict between the two laws, the central law prevails.

Also, states cannot dilute the provisions in the central law. As Jairam Ramesh told Scroll.in: “For instance, if the central stipulates that consent of 80% of landowners be obtained, the states cannot reduce it to 70% but they can make it 90%…They can’t even do away with the consent clause.”

What this means is that the states cannot come up with a law which is radically different from the 2013 Land Acquisition Act. And this means that the land acquisition process for the setting up of industry and for building public infrastructure will continue to remain at a standstill.

The column originally appeared on The Daily Reckoning on Aug 6, 2015

6 August, 2015

Home Prices, And Not Buyers, Are Unrealistic

Vivek Kaul

Columnist Gautam Mukherjee wrote an article on real estate published on this website on August 3, 2015. In this column Mukherjee had this to say about prospective buyers looking to buy a home to live-in: “These worthies [i.e. the prospective buyers], expecting a crash in prices as the crisis deepens, are gleefully seeking ever more unrealistic bargains before committing themselves. To them, the builders are profiteers, bloated on black money, and unethical, one-sided, contractual arrangements.”

I really wonder why prospective buyers have been called “worthies” here. And what is wrong about hoping to find a home to live in at a price which one can afford? Further, are the prospective buyers really seeking “unrealistic bargains” or are home prices at unrealistic levels? From all the data that is available it seems to be the latter.

Data put out by real estate research and rating firm Liases Foras tells us that the weighted average price of a flat in a city like Mumbai was Rs 1.3 crore as of March 2015. In the National Capital Region it is Rs 74 lakh. In Bangalore the price is Rs 86 lakh. And so is the situation almost all over the country.
I would like to ask Mr Mukherjee, among the people who he calls “worthies”, how many make the kind of money that is needed to be able to afford these homes? Let’s do some back calculation and see.

The weighted average price of a flat in Mumbai is Rs 1.3 crore. A bank would finance 80% of this. This means that the bank would give a home loan of up to Rs 1.04 crore. The remaining Rs 26 lakh the prospective buyer would have to arrange as a down-payment. This assuming that the builder does not ask for any payment to be made in black. I know that this is an unrealistic assumption, but just humour me for a bit.

The State Bank of India currently charges an interest of 10% on home loans above Rs 1 crore. For a twenty year loan the EMI works out to Rs 96,502. Typically, while lending banks ensure that up to 40% of the salary goes towards the EMI. Hence, to get a loan of around Rs 1.04 crore and to be able to pay an EMI of Rs 96,502, the salary of the borrower has to be around Rs 2.41 lakh per month(Rs 96,502 divided by 40%) or around Rs 29 lakh per year (Rs 2.41 lakh multiplied by 12).

Even in Mumbai how many people make that kind of money? The Maharashtra State Economic Survey for the year 2014-2015 points out that the average per capita income in Mumbai during 2013-2014 stood at Rs 1.88 lakh. So it’s not the “prospective buyers” who are being unrealistic, it’s the prices that builders want to be paid for the homes that they have built, which are unrealistic.

Given this, it is not surprising that, as the latest Economic Survey points out: “At present urban housing shortage is 18.8 million units [i.e. homes].”

As mentioned earlier Mukherjee writes: “To them [prospective buyers], the builders are profiteers, bloated on black money, and unethical, one-sided, contractual arrangements.”

What is wrong with this thinking? As analysts Saurabh Mukherjea and Sumit Shekhar of Ambit write in a recent research report titled Real Estate: The unwind and its side effects: “Another big source of generation of black money is the real estate sector which has witnessed an unprecedented boom in the past ten years or so. In Delhi, the ratio of unaccounted value of real estate transactions to the total value is as high as 78%. The same ratio is 50% in Kolkata and Bangalore. In smaller towns and semi urban centres, nearly 100% of property transactions are conducted in cash.” In Mumbai, they put the ratio of black money to total value at between 10-30%. The Ambit analysts were quoting from data put out by National Institute of Public Finance and Policy in July 2014.

I guess Mukherjee may not want to believe this. So here is something out of a report on black money published by the business lobby FICCI in February 2015. As the report points out: “The Real Estate sector in India constitutes for about 11 % of the GDP of Indian Economy, as these transactions involve high transaction value. In the year 2012-13, Real Estate sector has been considered as the highest parking space for black money.” FICCI is a business lobby and not an association of buyers looking to buy homes to live-in. Given these things Mukherjee’s sarcasm towards prospective buyers who cannot afford homes at their current prices, was really uncalled for.

In the example considered above the weighted average price of a flat in Mumbai is Rs 1.3 crore. If the builder asks 20% of this in black (and I am being fairly conservative here), the prospective buyer has to arrange for Rs 26 lakh.

This leaves Rs 1.04 crore, which becomes the price of the flat on which the bank will give a home loan. Now remember, the bank gives a home loan of up to only 80% of the price of the flat. Hence, the bank will give a loan of up to only Rs 83.2 lakh. The remaining Rs 20.8 lakh would have to be paid by the buyer as a down-payment. This means that the buyer needs savings of at least Rs 46.8 lakh(Rs 26 lakh paid in black plus Rs 20.8 lakh to be paid as a down-payment) to buy a flat. How many people have savings of this kind?

And Mumbai has low levels of black money required to buy a home in comparison to other cities. So, if prospective buyers see builders as profiteers who are bloated on black money, there is absolutely nothing wrong with that. Further, many builders have just taken money from buyers and disappeared. There are many others who have endlessly delayed projects. Hence, if other buyers look at them in a negative light, you can’t blame them for it.
Mukherjee further asks: “But what is the government, specifically the RBI and Finance Ministry doing about the high interest rates, the recapitalisation of banks, and renegotiation of all the stressed loans to builders/ industry, which are about to become irretrievable NPAs?.”

He also suggests: “Also, in the interim, the assumption is that the construction industry will receive new lines of credit/ rescheduled debts from the banks and lending institutions to finish their half-built projects.”

The tone is that the government and the banks should come to the rescue of the real estate companies which are in a mess. There are multiple points that need to be made here. First and foremost why can’t builders cut home prices and sell the massive number of unsold homes that they are sitting on.

Second, why should banks lend more to a borrower who is unable to repay his past debt? It is important to understand the main purpose of a bank, which is to ensure that the money deposited by individuals with it, remains safe and earns some return in the process. What Mukherjee is suggesting is that banks throw good money after bad. Why? Just because a few builders are going to go bust?

Also, it is worth asking where did all the money that the builders raise for building projects go? They took money from prospective buyers. They took money from banks. Where did all this money go? Guess Mukherjee can give us an answer for that.

Further, the builders have made potloads of money between 2002 and 2013, when the bull run in real estate drove home-prices to the current unrealistic level. So how is it fair that prices were allowed to rise, but now when the prices are falling (or should be falling), they should not be allowed to fall?

John Kenneth Galbraith, who was probably the most read economist in the mass media in the twentieth century, once said: “In America, the only respectable type of socialism is socialism for the rich.” Mukherjee along these lines wants the government to bailout the builders. I am no capitalist but socialism for the rich, is socialism of the worst kind.

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

The column originally appeared on SwarajyaMag on Aug 5, 2015

6 August, 2015

Land acquisition mess: Will the real Narendra Modi please stand up?

Vivek Kaul

The Narendra Modi government seems to have agreed to drop the politically unpopular clauses in the Bhartiya Janata Party’s version of the land acquisition bill. This is not a move in the right direction.

One of the key planks of Narendra Modi’s electoral campaign for the 2014 Lok Sabha elections was economic development and job creation. In a country where most electoral rhetoric has been based around “garibi hatao”, this was like a breath of fresh air.

And given that 13 million Indians are entering the job market every year, creation of new jobs should be one of the top priorities of any government.
What also needs to kept in mind is the fact that the average holding size of agricultural land has come down over the years. As per Agriculture Census 2010-11, small and marginal holdings of less than 2 hectare account for 85 per cent of the total operational holdings and 44 per cent of the total operated area. This could have only gotten worse since 2010-11. And what this means people need to be moved away from agriculture into other areas where they can make a living.
How does a country like India create jobs? As Cambridge University economist Ha-Joon Chang writes in Bad Samaritans—The Guilty Secrets of Rich Nations & the Threat to Global Prosperity: “History has repeatedly shown that the single most important thing that distinguishes rich countries from poor ones is basically their higher capabilities in manufacturing, where productivity is generally higher, and more importantly, where productivity tends to grow faster than agriculture and services.”

An important part of building a vibrant manufacturing sector is the ease with which land can be acquired. Over and above this, the quality of physical infrastructure (roads, railways, ports etc.) in India remain abysmal. If this infrastructure has to improve, the ease of land acquisition remains very important.
Narendra Modi became the prime minister of India on May 26, 2014. One of the things he did at the very beginning was to try and figure out what were the factors holding back investment in India. The answer that he got was the Land Acquisition Act of 2013 was one of the key reasons holding back investment.

In fact, the latest economic survey released in February earlier this year pointed out that “land acquisition” was a top reason for 161 stalled government projects. The Survey also pointed out: “India’s recent PPP [public-private partnership] experience has demonstrated that given weak institutions, the private sector taking on project implementation risks involves costs (delays in land acquisition, environmental clearances, and variability of input supplies, etc.).”

Arvind Panagarya the vice-chairman of the NITI Aayog in a recent speech said: “The Land Act, 2013 is an onerous Act under which by all calculations it will take up to five years for acquiring land assuming that all steps progress smoothly,” Panagariya said.

The question is what led to the Land Acquisition Act 2013? Before 2013, the process of land acquisition in India was governed by the Land Acquisition Act 1894. This was a law introduced during the time when the British ruled India and it managed to survive for more than 65 years after India attained independence from the British in 1947.

Given that the law was passed during British times it essentially ensured that the government could acquire land for almost any purpose and pay a pittance for it. As Jairam Ramesh and Muhammed Ali Khan write in Legislating for Justice—The Making of the 2013 Land Acquisition Law: “The 1894 Act was a comparatively short legislation that left much to the discretion of the acquiring authorities.”

The government basically acquires land from the public for what it calls “public purpose”. Given this, it is very important to define the term public purpose properly. But as Ramesh and Khan write: “‘Public Purpose’ which was the raison d’etre for any acquisition initiated was drafted in such wide terms that essentially any activity could be constituted as public purpose, as long as the Collector [of the district where the land was being acquired] felt it did…’Public

Purpose’ became what ever the Government or acquiring authority defined it to include.”
And if this wasn’t enough, a 1984 amendment to the 1894 Act allowed the government to “acquire lands for a public purpose ‘or for a private company’”. So, as per the 1894 Act the government could acquire land even for a private company. This clause was at the heart of the nexus that evolved between builders and politicians, over the years.

Given this, such a law had to be done away with it. This finally happened in 2013. The land acquisition law that was brought in was towards the other extreme, and seems to have made land acquisition almost next to impossible. (For those interested in the entire procedure, they should read Ramesh and Khan’s book, to realise how complicated and time taking the 2013 law is).

The 2013 law calls for consent from 70% of families in case of public private partnership projects and 80% if the land is being acquired for a private company. A social impact assessment also needs to be carried out. This assessment needs to answer questions like whether the “proposed acquisition serves public purpose” and “whether land acquisition at an alternate place has been considered and found not feasible”.

As mentioned earlier, after coming to power, the Modi government figured out that land acquisition law of 2013 was acting as a substantially barrier to investment. It brought in The Right to Fair Compensation and Transparency in Land Acquisition, Rehabilitation and Resettlement (Amendment) Ordinance, 2014, which made a few changes to the 2013 Act. The ordinance was signed by President Pranab Mukherjee on December 31, 2014.

In the ordinance the requirement of getting prior consent from those affected has been done away in certain cases. As Swaminathan Aiyar writes in a column in The Economic Times: “It substantially diluted the clauses relating to a social impact assessment and consent of 70-80% of people affected. It provided exemptions for 1 km on either side of railway and industrial corridors, rural infrastructure, affordable housing, and PPP infrastructure projects.”

This was a step in the right direction to get investment going again. Land required for the defence, electrification, affordable housing, and industrial corridors etc., also needed to be made available as soon as possible. Also, Ramesh and Khan write: “The law was drafted with the intention to discourage land acquisition.

It was drafted so that land acquisition would become a route of last resort.” Ramesh was a key player behind the Act.
A land acquisition Act which discourages land acquisition cannot be of much help to an economy which needs to create jobs for 13 million individuals entering the work force every year.

Now with the government planning to go back to the 2013 law the status quo will return. If Arvind Panagariya is right in estimating that it will take five years to acquire land then there is no way that the Narendra Modi government is going to get around to delivering its promise on creating jobs and economic development.

Also, Modi’s pet “Make in India” programme is unlikely to get anywhere. You can’t make in India without being able to get land to set up the necessary infrastructure.

Aiyar summarised it the best when he said: “[Modi] seems happier coining slogans than in implementing tough decisions.” Tough decisions on the economic front is what this country needed. Alas, it is not going to get them even under Modi, who for a while flattered to deceive. And by the time the 2019 Lok Sabha election is here, “garibi hatao” might be the order of the day again.

It is worth asking here, if the plank of economic development and jobs, was also an electoral jumla? From how things are going right now, that is how it seems like.

To conclude, the Narendra Modi that we saw in the run-up to the 2014 Lok Sabha elections was a different man, from the Narendra Modi we are seeing now. Will the real Narendra Modi please stand up?

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)
The column originally appeared on Firstpost on Aug 5, 2015

5 August, 2015

Monetary policy needs to be decided by a committee, and not just the RBI governor

Vivek Kaul

The Reserve Bank of India (RBI) led by Raghuram Rajan presented the third monetary policy statement for the current year, yesterday. In the monetary policy it decided to maintain the repo rate at 7.25%. Repo rate is the rate at which RBI lends to banks and acts as a sort of a benchmark for the interest rates that banks pay for their deposits and in turn charge on their loans.

The decision of the RBI not to raise interest rates was widely along expected lines and needs no further discussion. Nevertheless, something that RBI governor Raghuram Rajan said during the course of the press conference that followed the monetary policy statement yesterday, is something that needs to be discussed.
Rajan talked about the merits of having a monetary policy committee (MPC) to decide on the monetary policy. The governor currently makes the monetary policy decisions. He is advised by the technical advisory committee which was set up during the time YV Reddy was the governor of the RBI between 2003 and 2008. At the end of the day the technical advisory committee just advises and the final decision lies with the RBI governor.

In the budget speech made in February earlier, this year the finance minister Arun Jaitley had said that: “We will move to amend the RBI Act this year, to provide for a Monetary Policy Committee.”

In the press conference that followed the monetary policy statement Rajan laid out the advantages of having a monetary policy committee decide on the interest rates, instead of just the governor. Rajan basically pointed out three advantages. As he said: “First, a committee can represent different viewpoints and studies show that its decisions are typically better than individuals.”

What does Rajan mean here? As James Surowiecki writes in The Wisdom of Crowds—Why the Many Are Smarter Than the Few: “Diversity and independence are important because the best collective decisions are the product of disagreement and contest, not consensus or compromise. An intelligent group, especially when confronted with cognition problems, does not ask its members to modify their positions in order to let the group reach a decision everyone can be happy with.”

So what does the group do? “Instead, it figures out how to use mechanisms—like…intelligent voting systems—to aggregate and produce collective judgements that represent not what any one person in the group thinks but rather, in some sense, what they all think. Paradoxically, the best way for a group to be smart is for each person in it to think and act as independently as possible,” writes Surowiecki.

And this is precisely what Rajan must be expecting from a monetary policy committee making monetary policy decisions rather than just the RBI governor. Rajan further pointed out that: “spreading the responsibility for decision making can reduce the internal and external pressure that falls on an individual.”

This is an interesting point. A RBI governor comes under tremendous pressure from the government as well as businessmen to cut interest rates, when he personally may not believe in doing so. The current finance minister (and even the previous one) has regularly spoken to the media and asked the RBI to cut interest rates.

Businessmen and lobbies representing them do the same thing as well. As Rajan said in a speech in February 2014: “what about industrialists who tell us to cut rates? I have yet to meet an industrialist who does not want lower rates, whatever the level of rates.” With a monetary policy committee all the pressure which is currently on the RBI governor can be distributed across the members of the committee.

Also, a monetary policy committee “will ensure broad monetary policy continuity when any single member, including the governor, changes.”
By making these three points, Rajan explained why a monetary policy committee is the way forward for RBI. A section of the media essentially projected this as Rajan falling in line with the government thinking on the issue. And that is totally incorrect. Allow me to explain.

Rajan took over as the RBI governor in September 2013. One of the first reports to be released after he took over was titled Report of the Expert Committee to Revise and Strengthen the Monetary Policy Framework (better known as the Urjit Patel committee). It was released by the RBI in January 2014.

As this report pointed out: “Drawing on international experience, the evolving organizational structure in the context of the specifics of the Indian situation and the views of earlier committees, the Committee is of the view that monetary policy decision-making should be vested in a monetary policy committee.”

Hence, there is no way Rajan could have been against a monetary policy committee. If that were to be the case this paragraph would have never made it to the Urjit Patel committee report. So what made people say that Rajan had fallen in line?

The Urijit Patel committee had recommended that the monetary policy committee should have five members. As the report pointed out: “The Governor of the RBI will be the Chairman of the monetary policy committee, the Deputy Governor in charge of monetary policy will be the Vice Chairman and the Executive Director in charge of monetary policy will be a member. Two other members will be external, to be decided by the Chairman and Vice Chairman on the basis of demonstrated expertise and experience in monetary economics, macroeconomics, central banking, financial markets, public finance and related areas.”

The recently released Indian Financial Code did not agree with this. . Article 256 of the code points out: “The Monetary Policy Committee will comprise – (a) the Reserve Bank Chairperson as its chairperson; (b) one executive member of the Reserve Bank Board nominated by the Re- 20 serve Bank Board; (c) one employee of the Reserve Bank nominated by the Reserve Bank Chairperson; and (d) four persons appointed by the Central Government.”

The Indian Financial Code gave the government a majority in the monetary policy committee, with 4 out of seven members being appointed by the government. This was unworkable given that the government has entered into an agreement with the RBI. As per this agreement, the RBI will aim to bring down inflation below 6% by January 2016. From 2016-2017 onwards, the rate of inflation will have to be between 2% and 6%.

This clearly was not possible with government nominees dominating the monetary policy committee. The government always wants lower interest rates. And given that it would have been very difficult for the RBI to control inflation.

There were a lot of negative comments on this attempt by the government to indirectly take over the functioning of the RBI. Not surprisingly the government has now washed its hands of this recommendation.

During the course of the press conference Rajan hinted at the kind of structure he would prefer the monetary policy committee to take. He talked about the former finance minister P Chidambaram’s column in The Indian Express on August 2, 2015.

In this column Chidambaram talked about a six member committee, with three members from the RBI and three members appointed by the government. “In the case of a tie, let the governor have a casting vote. The minutes must be made public. Assuming the three internal members vote alike, the governor needs to persuade at least one external member to agree with him, and on most occasions he will. In situations where all three external members disagree with the three internal members, it will be a brave governor who will vote, every time, in his own favour to break the tie,” wrote Chidambaram.

I am no fan of Chidambaram, but I think for once he makes some sense.

The column was originally published on The Daily Reckoning on August 5, 2015