Everybody Loves a Good Interest Rate Cut…Except the Savers

My main life lesson from investing: self-interest is the most powerful force on earth, and can get people to embrace and defend almost anything – Jesse Livermore.

Late in the evening of March 31, the department of economic affairs, ministry of finance, put out a press release saying that the interest rates on small savings schemes for the period April to June 2021, have been cut.

The social media got buzzing immediately. And almost everyone from journalists to economists to analysts praised the decision. It was seen as yet another effort by the government to push down interest rates further.

With the state of the economy being where it is, lower interest rates are expected to perk up economic growth. People are expected to borrow and spend more. Corporates are expected to borrow and expand. At lower interest rates individuals who have already taken on loans will see their EMIs go down, leaving more cash in hand, and they are likely to spend that money, helping the economy grow.

That’s how it is expected to work, at least in theory. Hence, everybody loves a good interest rate cut… except the savers.

On April 1, the social media woke up to the finance minister Nirmala Sitharaman’s tweet announcing that “interest rates of small savings schemes… shall continue to be at the rates which existed in the last quarter of 2020-2021.” She further said that the order had been issued by oversight and would be withdrawn.

Later in the day, the department of economic affairs put out a press release to that effect.

The fact that lower interest rates are good for the economy is only one side of the story. They also hurt the economy in different ways. People who are dependent on interest income for their expenditure (like the retired senior citizens) see their incomes fall and have to cut down on their expenditure. This impacts private consumption negatively. 

While this cannot be measured exactly, it does happen. Also, a bulk of India’s household savings (close to 84% in 2019-20) are made in fixed deposits, provident and pension funds, life insurance policies and small savings schemes. Lower interest rates bring down the returns of all these products and this negatively impacts many savers.

As the economist Michael Pettis writes about the relationship between interest rate and consumption in case of China, in The Great Rebalancing:

“Most Chinese savings, at least until recently, have been in the form of bank deposits…Chinese households, in other words, should feel richer when the deposit rate rises and poorer when it declines, in which case rising rates should be associated with rising, not declining, consumption.”

The same logic applies to India as well, with lower interest rates being associated with declining consumption, at least for a section of the population.

This is not to say that interest rates should be higher than they currently are (that is a topic for another day), nonetheless the fact that lower interest rates impact savers and consumption negatively is a point that needs to be made and it rarely gets made. I made this point in a piece I wrote for livemint.com, yesterday. 

Also, borrowing is not just about lower interest rates. It is more about the confidence that the borrower has in his economic future and the ability to keep paying the EMI over the years. I wrote about this in the context of home loans, a few days back.

This leaves us with the question that why doesn’t anyone talk about the negative side of low interest rates. The answer lies in the fact that they don’t have an incentive to do so. Let’s try and look at this in some detail.

1) Fund managers: Fund managers love lower interest rates because it leads a section of the savers, in the hope of earning a higher return, to move their savings from bank fixed deposits to mutual funds and portfolio management services which invest in stocks. In the process, their assets under management go up. More money coming into the stock market also tends to push up stock prices.

All in all, this ensures that fund managers increase their chances of making more money and hence, they love lower interest rates because their acche din continue.

2) Analysts: Analysts love lower interest rates because it leads a section of the savers, in the hope of earning a higher return, to move their savings from bank fixed deposits to stocks. In order to buy stocks, they need to open a demat account with a brokerage. When the new investors buy stocks, the brokerage earns commissions.

Further, it also means that the interest cost borne by corporates on their debt goes down, leading to higher profits. The stock market factors this in and stock prices go up. Given this, analysts have an incentive to love interest rate cuts.

3) Corporates: Do I need to explain this? Lower interest rates lead to a lower interest outflow on debt that a corporate has taken on and hence, higher profits or lower losses for that matter. This explains why corporate honchos are perpetually asking the Reserve Bank of India to cut the repo rate or the interest rate at which it lends to banks.

4) Banks: Banks love lower interest rates simply because at lower interest rates the value of the government bonds they hold goes up. Interest rates and bond prices are inversely related. Higher bond prices mean higher profits for banks or lower losses in case of a few public sector banks. This is why bankers almost always come out in support of interest rate cuts.

This also explains why the bankers hate the idea of small savings schemes offering higher returns than fixed deposits. Lower interest rates on small savings schemes pushes the overall interest rates in the financial system downwards. 

5) Economists: Most economists are employed by stock brokerages, mutual funds, banks, corporates or think tanks. As explained above, stock brokerages, mutual funds, banks and corporates, all benefit from lower interest rates. If your employer benefits from something, you also benefit in the process. Hence, your views are in line with that.

When it comes to think tanks, many are in the business of manufacturing consent for corporates. Their economists act accordingly. 

6) Journalists: With the media being dependent on corporate advertising as it is, it is hardly surprising that most journalists love interest rate cuts. Further, the main job of anchors on business news channels is to keep people interested in the stock market because that is what brings in advertising. And this can only happen, if stock prices keep going up. In this environment, anything, like interest rate cuts, that drives up stock prices, is welcomed.

Of course, some mainstream TV news channels also run propaganda for the government. So, in their case every government decision needs to be justified. That is their incentive to remain in the good books of the government.

7) Government: The central government will end up borrowing close to Rs 25 lakh crore during 2020-21 and 2021-22. Hence, even a 1% fall in the interest rate at which it borrows, will help it save Rs 25,000 crore. It clearly has an incentive in loving low interest rates. 

The point is everyone mentioned above tends to benefit if interest rates keep going down or continue to remain low. Further, they are organised special interests with direct access to the mainstream media. The savers though many more in number aren’t organised to put forward their point of view.

Also, it is easier to do the math around the benefits of interest rate cuts and low interest rates than its flip side. As economist Friedrich Hayek said in his Nobel Prize winning lecture, there is a tendency to simply disregard those factors which “cannot be confirmed by quantitative evidence” and after having done that to “thereupon happily proceed on the fiction that the factors which they can measure are the only ones that are relevant.”

That’s the long and the short of it. 

Vehicle Scrapping Policy is Half-Baked and More About Feeding a Constant Narrative

Late last week the central government announced the vehicle scrapping policy (VSP). As the Minister for Road Transport and Highways, Nitin Gadkari, put it in the Parliament, the aim of the VSP is to create “an eco-system for phasing out of unfit and polluting vehicles”.

So how will this be put into action? Using the public private partnership (PPP) model involving the state governments, private sector and the automobile companies, the central government plans to promote the setting up of automated fitness centres (AFCs). 

These AFCs will issue vehicle fitness certificates to private vehicles and commercial vehicles based on emission tests, braking, safety equipment among many other tests which are as per the Central Motor Vehicle Rules, 1989.”

A commercial vehicle which is 15 years old and fails the vehicle fitness test will be declared an end of life vehicle and scrapped. Similarly, a private vehicle which is 20 years old and fails the vehicle fitness test will be declared to be an end of life vehicle and scrapped. Further, if owners don’t renew the registration certificate, their vehicle may be declared as an end of life vehicle and scrapped.

In order to disincentivise commercial vehicle owners who own vehicles which are 15 years old, from continuing to use them, even if they clear the vehicle fitness test, the fee for the fitness certificate and the fitness test will be set on the higher side. For private vehicle owners with vehicles which are 15 years old, the re-registration fee will be set on the higher side.

The point being that if you have a private vehicle which is 20 years old or perhaps even older, the government wants you to stop using the vehicle and buy a new one, irrespective of what state it is in. For commercial vehicles, the same logic applies for vehicles which are at least 15 years old.

And the expectation is this will lead to lower pollution, newer cars, safer pedestrians, more spending, more investment and more jobs. QED.

The minister expects additional investments of Rs 10,000 crore and 35,000 job opportunities to be created because of this.

It will also lead to banks and non-banking finance companies (NBFCs) giving out more loans. Of course, given that the auto industry and the auto-ancillary industry use a lot of contract workers, one could possibly argue that this could lead to more work opportunities for them as well. 

The question is how will things really play out? Let’s try and understand that in some detail.

Economics is basically the study of incentives and second order effects. The trouble is that politicians and policy makers don’t keep this in mind while designing policy, particularly the second order effects of what they are proposing.

Let’s try and understand this pointwise.

1) There are a total of 1.02 crore vehicles, both commercial and private, which fall under the defined category of older vehicles. Even if a small proportion of these vehicles are scrapped they will generate a huge amount of non-biodegradable waste.

What plans do we have to handle all this waste coming our way? As the press release announcing the policy pointed out: “Efforts are also being made to set up Integrated Scrapping Facilities across India.” Even while taking into account that this policy will be implemented over the next few years, this sounds too much like work in progress than definitive economic policy. One needs a lot more clarity on this front. 

2) As a way to get the scheme going, the government first plans to scrap its older vehicles. As the press release announcing the plan puts it: “It is being proposed that all vehicles of the Central Government, State Government, Municipal Corporation, Panchayats, State Transport Undertakings, Public Sector Undertakings and autonomous bodies with the Union and State Governments may be de-registered and scrapped after 15 years from the date of registration.” This is supposed to be implemented from April 1, 2022 onwards, or little over a year from now.

Why have this blanket policy at a time when governments, in particular state governments, are already short of money? Why not look at the fitness of vehicles and then decide? If at all, vehicles of the central government and the public sector enterprises tend to be decently maintained.

3) Also, the assumption here is that only older vehicles cause pollution. The manufacturing of newer vehicles needs electricity. Most electricity in India is generated by burning coal, which causes pollution. Steel goes into the making of vehicles. The process of making of steel, releases carbon dioxide into the atmosphere. That causes pollution as well. The same is true of plastic and pretty much everything else which goes into the making of vehicles. Hence, every new vehicle that is produced has a carbon footprint. 

Of course, all this pollution doesn’t show up in cities where most private vehicles are driven and tends to be well distributed across the country. But shouldn’t a policy that has lower pollution as one of its key points, take this basic factor into account as well? Further, we need to consider the fact that many older private vehicles are not constantly in use. 

4) As I have explained earlier, the government wants private and commercial vehicle owners to buy new cars. Of course, as and when this happens, the automobile companies are supposed to benefit. This explains why companies have come out in favour of this policy (or even otherwise, when do Indian businessmen ever disagree with the government). But this doesn’t take a very basic factor into account.

Whatever we might like to say about the new India and such things, we are a poor country at the end of the day. And covid has only made things even more difficult by pushing many more people into poverty, as health bills have mounted, incomes have crashed and small businesses have gone bust.

Hence, assuming that people will go out and buy new vehicles if the older vehicles are scrapped or because re-registration is made more expensive, is just looking at first order effects of policy, in the same way that economists tend to believe that lower interest rates always push up consumption. 

Private vehicle owners who are not heavy users of their vehicles, might just prefer to use Uber or Ola or even the metro infrastructure coming up across India’s major cities. (This reminds me of a time when the government kept telling us that slower automobile sales were primarily because of Uber and Ola).

Further, owners might financially not be in a position to buy a new vehicle. Already, the trucking industry has spoken up against the idea.

Also, even if owners buy a new vehicle, they might cut consumption on something else given that there is only so much money going around. Hence, net-net, the impact on the overall economy may not be much.

The trouble is that the costs of second order effects are not so obvious and straightforward, whereas the supposed benefits are easy to convey in a simplistic way. And politicians love stuff which they can convey in a simplistic way.

5) Kitna deti hai (how much does it give?), goes a Maruti advertisement, telling us that Indians are price conscious value for money consumers. And there is nothing wrong with this, given that an automobile is probably the second most expensive thing we buy during our lifetime. So, while the idea that old polluting vehicles need to be discarded is a noble one, what is in it for the consumer?

This is what the government is planning. a) The owner will be paid 4-6% of the showroom price of a new vehicle, when his old vehicle is scrapped. b) The state governments may be advised to offer a road- tax rebate of up to 25% for personal vehicles and up to 15% for commercial vehicles. c) The vehicle manufacturers are also advised to provide a discount of 5% on purchase of new vehicle against the scrapping certificate. d) The road transport minister has requested the finance minister and states to give a concession in goods and services tax (GST) on purchase of new vehicles.

There are too many ifs and buts in the above paragraph. As usual, the government seems to be in a hurry to announce and implement a policy. As I have said in the past a massive cut in GST on automobiles will encourage buying. What the government will lose out on per unit of sales, it is more than likely to make up for through volumes. 

One understands that the road transport minister cannot ensure all of this on his own, which is why it is important that the government spends some time in discussing and figuring out how to design and implement policy. Also, it is important to carry out small experiments in union territories, before announcing policies which need to be implemented across the length and the breadth of the country.

As Vijay Kelkar and Ajay Shah write In Service of the Republic

“The safe strategy in public policy is to incrementally evolve—making small moves, obtaining feedback from the empirical evidence, and refining policy work in response to evidence.”

But the trouble is that small moves involve a lot of time, effort and thinking, which is very difficult for a government which believes in constant action and constantly creating new narratives to keep people busy and happy. The narrative also feeds into the idea that the government is trying to do new things. 

6) Take a look at what happened to two-wheeler sales in 2019-20 (This is before covid struck). Sales fell by nearly 18% year on year to 17.42 million units, as the price went up due to various reasons. Hence, India is a very price sensitive market and the point is that there has to be a huge benefit involved in buying a new vehicle in a tough economic environment.

While the notion of pollution control is a noble one, it is not something which is going to get people to go out and buy new vehicles, unless it is very clear what is in it for them. Ultimately, if you want people at large to behave in a certain way, the right incentive should be on offer, something this half-baked policy, like the policy to encourage electric vehicles before it, lacks.

To conclude, one does wonder, what were they doing all these years, given that the policy has been on the anvil for a while now. 

10 Things You Need to Know About Indian Real Estate in 2021

If you are the kind who follows the business media closely, you would probably be thinking that for the last few months all people have done across India is buy homes to live in. But is that really true? The short answer is no, though sales did pick up during October to December 2020, in comparison to the three month period before that. But whether that was pent up demand or genuine demand coming back, only time will tell.

A thriving real estate sector really helps the overall economy grow at a fast pace. But given the mess that the Indian real estate sector has been in for many years, and the fact that the deep state of Indian real estate won’t allow market forces to work to help clean it up, that isn’t really going to happen.

Let’s look at the issue in more detail.

1) As per the annual roundup of residential real estate published by PropTiger Research, sales in 2020 contracted by 47% to 1.83 lakhs across eight large cities (Delhi NCR, Mumbai, Pune, Ahmedabad, Chennai, Bengaluru, Hyderabad, Kolkata).

In short, 2020 was a bad year for real estate. Having said that, sales during October to December 2020 picked up and 58,914 units were sold, which was 68% more in comparison to the number of units sold during July to September 2020. In comparison to October to December 2019, sales were down 27%, during the period.

Of course, the real estate sector wants us to believe that demand is back and all is well with the sector. Nevertheless, this jump in sales can be because of pent up demand. Whether it sustains in the months to come remains to be seen. This is an important caveat to keep in mind.

2) More than half of these sales have happened in Mumbai and Pune. The reason offered for this is the cut in stamp duty carried out by the state government. The Maharashtra government cut the stamp duty applicable on real estate transactions from 5% to 2%. This was applicable until December 31, 2020.

The stamp duty cut driving up builder sales, is true to some extent. Given that the price of an apartment in a city like Mumbai runs into crores, even a 3% saving on the price runs into a decent amount of money. But more than the stamp duty cut, a substantial drop in prices, especially for homes priced at more than Rs 2 crore, is the main reason for the sales in the city picking up.

Independent real estate expert Vishal Bhargava has pointed this out in the past in his columns (Those who like to follow Mumbai’s real estate scene, should seriously read all that Vishal writes).

Of course, you haven’t read about this in the mainstream media simply because the mainstream media depends on advertisements from real estate companies and needs to keep driving the notion that real estate prices don’t fall, over and over again. (Another reason you need to support my work).

One reason for a fall in prices is the fact that businessmen who run small and medium enterprises have been facing a tough time since covid broke out. And they are looking at alternate avenues to raise money to keep their businesses going. This includes selling the real estate assets they have accumulated in the past. There is some distress sale as well.

Also, other than Mumbai and Pune, the other six cities account for less than half the sales. This tells us clearly that real estate sales in these cities are at best sluggish.

3) The clearest trend in the PropTiger data is that 48% of the sales have been for apartments selling at a price of less than Rs 45 lakh. What this tells us is that high prices remain the biggest challenge of owning a home in India. It also tells us that while home prices haven’t really fallen, on the whole across India, despite the lower demand, the demand that remains is primarily at the lower end of the price spectrum. Hence, the market has corrected itself in its own way, despite home prices not coming down in absolute terms. This is an important lesson that the real estate industry needs to learn.

Also, 74% of the sales have happened for home prices of less than Rs 75 lakh.

4) As far as prices are concerned, the PropTiger report points out: “Weighted average prices for new launched projects across the top-eight cities remained stagnant in the past few quarters, with prices moving in close ranges.”

This is something that is also reflected in Reserve Bank of India’s 10 city house index, though the cities tracked by this index are not the same as the cities tracked by PropTiger.

Source: Centre for Monitoring Indian Economy.

The cities tracked by the RBI’s 10-city house index are Mumbai, Delhi, Chennai, Kolkata, Bengaluru, Ahmedabad, Lucknow, Kanpur, Jaipur and Kochi. The index tells us that the average one-year return of owning real estate in India during the period July to September 2020, stood at 1.13%. This is the lowest since the index came into existence. The index also tells us that the return on real estate during 2020 has been marginally negative.

What this means is, and as I have often said in the past, Indian real estate is going through a time correction and not a price correction. The inflation seen over the last two years has been around 6% per year on an average. This means in real terms, the prices have already corrected by more than 12%, over a two year period.

5) This trend is likely to continue given the huge amount of inventory that remains piled up with builders. The overall inventory stock is at 7.18 lakh units across eight cities as per PropTiger. It has come down from 7.91 lakh units in 2019, simply because builders aren’t launching as many new projects as they used to.

Having said that, with the sales slowing down, at the current sales pace it will take around 47 months to clear the remaining inventory. Even though all this inventory is not ready to move in, a significant portion is. Also, it is worth remembering that the prospective buyers have a choice when it comes to buying a home. Over the years, investors across the country have ended up buying a huge number of homes in the hope of a price appreciation. Many of these homes have remained locked and are available for sale.

As Bhargava wrote in a recent column: “Resale transactions are traditionally 2/3rd of the market.” Even if this proportion were to come down, resale transactions of locked homes will continue to form a significant chunk of the market, making it difficult for builders to cut down their inventory quickly. Also, even if builders don’t offer ready to move in homes, there is a significant supply that will keep coming in from individuals who have bought real estate as an investment over the years.

6) Homes priced below Rs 45 lakh form 48% of the inventory. What does this tell us? It tells us that the real demand for homes is at a price even below Rs 45 lakh, probably below Rs 25 lakh. This is something that the builders need to keep in mind. It may not work in a city like Mumbai, where land available is limited and expensive, but it will definitely work for the other seven cities that PropTiger tracks and other parts of India, where cities can expand in all directions and land is really not an issue.


7) It is worth remembering here that builders have benefitted because of the Reserve Bank of India allowing banks and non-banking finance companies, to restructure commercial real estate loans.

As former RBI governor Urjit Patel writes in Overdraft—Saving the Indian Saver:

“In February 2020, ‘living dead’ borrowers in the commercial real-estate sector – under a familiar guise (‘a ghost from the past’, if you will) viz., ad hoc ‘restructuring’ – have been given a lifeline. It is estimated that over one-third of loans to builders are under moratorium.”

Patel does know a thing or two about banks and lending and hence, needs to be taken seriously. It remains to be seen for how long will the RBI continue supporting the builders. The longer, the RBI supports the builders, the longer they can hold on to a significant price cut. This also means that inventory will take longer to clear and home prices will continue to stagnate. It is all linked.

8) At a macro level this means that the ability of real estate to create jobs for the unskilled and the semi-skilled, will continue to remain limited. It is also worth remembering that real estate as a sector can have a huge multiplier effect on the overall economy.

The real estate sector has forward and backward linkages with 250 ancillary industries. This basically means that when the real estate sector does well, many other sectors, right from steel and cement to furnishings, paints, etc., do well.

If this were to happen, the Indian economy would really benefit in the post-covid times. But sadly it won’t, given that the deep state of Indian real estate which includes, builders, banks and politicians, will make sure that the sector is continued to be treated with kids gloves and any problems which could lead to a price cut, are kicked down the road. Trying to maintain the status quo in the sector is not helping the Indian economy.

9) Dear reader, some of you by now must be like all this gyan is fine, but tell me one simple thing, should I buy home or should I hold on to my money. The answer as always is, it depends. It is worth remembering here, that what we can possibly do with our money is a very individual thing.

If you are looking to buy a home to live in and have the capacity to pay an EMI and arrange for a down-payment, then this is a good time as any to buy a home. Owning a house has its own set of advantages. Parents and in-laws feel you have settled in life. There is no danger of the landlord acting cranky. And once you have children it gives them some kind of stability with friends, activities as well as the school they go to. Of course, address proofs don’t need to change, every time you move house.

Having said that do keep in mind that we live in tough times and the negative economic impact of covid is yet to go away. Also, there can be further cycles of the spread of the virus. Before taking on a home loan, ensure that you have some money in the bank to be able to continue paying the EMI in case you lose your source of income.

When it comes to investing in a house, it continues to remain a bad idea on the whole. Of course, there will always be some good opportunities and some distress sales happening.

10) Finally, everyone who makes a living out of selling real estate will spend 2021 trying to tell us that demand is coming back, people are buying homes, new trends are springing up and all is well.

As PropTiger points out:

“By making bare the limitations involved in other investment assets, the pandemic has forced people to rethink their investment strategies, tilting it in favour of home ownership.”

This is basically rubbish which has been written well. Why would anyone in their right mind during tough economic times, invest a large part of their savings and/or take on a large loan to buy an illiquid asset?

Some people who can afford it, may have definitely bought new homes in order to adjust to the new reality of work from home, but beyond that the proposition that PropTiger is making, remains a difficult one to buy.

If it were true, some of the massive amount of easy money that is currently floating around in the financial system, would have gone into real estate as well. But given that sales have crashed 47% during 2020 tells us that it clearly hasn’t.

In fact, the outstanding home loans of banks between March 2020 and November 2020 have gone up by just Rs 44,463 crore. This is around two-fifths of the increase (38.7% to be precise) in outstanding home loans of Rs 1,14,636 crore seen between March 2019 and November 2019. This is despite the fact that home loan interest rates have come down to as low as 7%.

So, people are generally being careful when it comes to buying a home by taking on a loan and that is the right strategy to follow at this point of time.

[email protected],000 – How RBI Played a Part in Creating the Stock Market Bubble

The BSE Sensex, India’s premier stock market index, crossed 50,000 points today in intra day trading. It has risen by more than 80% from around the end of March, when it had fallen to 27,591 points, in the aftermath of the covid pandemic hitting India.

This astonishing rise has now got the Reserve Bank of India (RBI) worried. The RBI Governor Shaktikanta Das, writing in the foreword to the latest Financial Stability Report, pointed out:

“The disconnect between certain segments of financial markets and the real economy has been accentuating in recent times, both globally and in India.”

People who run central banks are not always known to talk in simple English. Das is only following tradition here. The statement basically refers to stock prices. Das feels they have risen too fast in the recent past and have become disconnected from the overall economy.

While the overall Indian economy is expected to contract this year, the stock market has rallied by more than 80%. How is this possible? Or as you often get to hear these days, if the economy is doing badly, why is the stock market doing so well.

Theoretically, a possible explanation is that the stock market discounts the future and the stock market investors think that the future of the Indian economy is bright. Another explanation offered often by the stock market investors is that corporate profits this year have been at never seen before levels.

But even after taking these reasons into account, the current high level is really not justified. As Das put it in his foreword: “Stretched valuations of financial assets pose risks to financial stability.” One way to figure out whether valuations are stretched is to look at the price to earnings ratio of the stocks that constitute the Sensex index.

In January 2021, the price to earnings ratio has been at around 34. This means that investors are ready to pay Rs 34 as price, for every rupee of earning of the companies that make up for the Sensex. Such a high level of the price to earnings ratio has never been seen before. Not even in late 2007 and early 2008, when stock prices rallied big time or the first half of 2000, when the dotcom bubble was on.

Clearly, stock prices are in extremely bubbly territory. The current jump in corporate earnings isn’t sustainable for the simple reason that corporates have pushed up earnings by cutting employee costs as well as raw material costs. This means the incomes of those dealing with corporates from employees to suppliers and contractors, have fallen.

This fall in income has limited the ability of these individuals to spend money. This will lead to lower private consumption in the months to come, which, in turn, will impact corporate revenues and eventually profits. A sustainable increase in profits can only happen when people keep buying things and corporate revenues keep going up.

This brings us back to the question as to why stock prices are going up, when the overall economy is not doing well. A part of the reason is the RBI, though the central bank, rather expectedly, glosses over this totally in the latest edition of the Financial Stability Report.

Since February 2020, the RBI has pumped in a massive amount of money into the financial system through various measures, some of which involve the printing of money. By flooding the financial system with money, or what central banks refer to as liquidity, the RBI has ensured that interest rates in general and bank deposits in particular, have fallen.

The idea here is threefold. A drop in interest rates allows the government to borrow at lower interest rates. This became necessary because thanks to the pandemic, the tax collections of the government have dropped during this financial year. Between April and November 2020, the gross tax revenue stood at Rs 10.26 lakh crore, a drop of 12.6% in comparison to the same period in 2019.

Secondly, lower interest rates ensured that the interest costs of corporates on their outstanding loans, came down. Also, the hope was that at lower interest rates, corporates will borrow and expand.

Thirdly, at lower interest rates, the hope always is that people will borrow and spend more, and all these factors will lead to a faster economic recovery.

But there is a flip side to all this as well. A fall in interest rates has got people looking for a higher return. This has led to many individuals buying stocks, in the hope of a higher return and thus driving up prices to astonishingly high levels.

This can be gauged from the fact that in 2020, the number of demat accounts, which are necessary to buy and sell stocks, went up by nearly a fourth to 4.86 crore accounts. One of the reasons for this is the rise of Robinhood investing in India. This term comes from the American stock brokerage firm Robinhood which offers free online trading in stocks. India has seen the rise of similar stock brokerages offering free trading.

What has added to this is the fact that many unemployed individuals have turned to stock trading to make a quick buck. All it needs is a smartphone, a cheap internet connection and a low-cost brokerage account.

Of course, this search for a higher return isn’t local, it’s global. Hence, foreign institutional investors have invested a whopping $31.6 billion in Indian stocks during this financial year, the highest ever. This stems from the fact that Western central banks, like the RBI, have printed a huge amount of money to drive down interest rates.

This has pushed more and more investors into buying stocks despite the fact that the global economy isn’t doing well either.

A slightly different version of this column appeared in the Deccan Herald on January 17, 2021. It was updated after the Sensex first crossed 50,000 points during intra day trading on January 21, 2021.

2021 – The Chinese Problem in Your Personal Finance

Dear Reader, before you start thinking that I have click-baited you one more time, let me assure you that’s not true. Your personal finances in 2021 will actually face a Chinese problem.

But before we go into this, let’s first understand a few aspects about the Chinese saving habit over the years. Let’s look at this pointwise.

1) As is well known, the Chinese physical infrastructure over the years was funded through massive domestic savings being invested in bank deposits. As Charles Goodhart and Manoj Pradhan write in The Great Demographic Reversal: “Interest rates were set well below the rate of growth and the rate of inflation. While the economy grew on average by around 10% over 1990–2010, the inflation-adjusted deposit rate over the same period averaged −3.3% (for a 1.4% average for the nominal deposit rate versus an average annual inflation rate of 4.75%).”

Hence, the rate of interest rate was lower than the prevailing rate of inflation, for a period of two decades. If one were to state this in a simple way, the low interest rates acted effectively as a tax on Chinese households.

2) This tax did not matter much because the savings were channelised into investments. This created economic growth and the average income of a Chinese kept going up, year on year. Hence, while the interest being earned on the accumulated wealth was low, the regular yearly income kept going up.

3) Low interest rates led to an interesting behaviour at the household level. As Goodhart and Pradhan point out, there was “a negative correlation between urban savings and the decline in real deposit rates.” “When banks fail to protect household savings, households tend to save more, not less, in order to achieve a ‘target’, whether that is for education or the purchase of a home.”
Basically, given the negative real rate of interest on bank deposits, where inflation was higher than the interest rate, Chinese households saved more money in bank deposits in order to achieve their targeted savings. Options of investing in other avenues were extremely limited.

Now the question is how does all this apply to your personal finance in India in 2021. Allow me to explain pointwise.

1) Interest rates on bank fixed deposits have collapsed. The interest offered on fixed deposits of more than one year, currently stands at around 5.5% on an average. This when the rate of inflation as measured by the consumer price index in November 2020 stood at 6.93%. Hence, the real rate of interest is in negative territory. If after tax the rate of return on fixed deposits is taken into account, the gap gets even bigger.

2) The major reason for this collapse in interest rates has been a collapse in bank lending. Given that banks, on the whole, have barely given out fresh loans since March, they possibly couldn’t keep paying a high rate of interest on deposits. Hence, the crash in interest rates. But what has added to this is the Reserve Bank of India (RBI) policy of flooding the financial system with money, in order to drive down interest rates further. The excess money in the financial system, which the banks deposit with the RBI, stood at Rs 6.25 lakh crore as of December 31, 2020.

3) From the indications that the RBI has given, this excess liquidity in the financial system is likely to continue. The idea is to help ease the burden on current loans of corporates. In a year the tax collections have collapsed this also helps the government to borrow at extremely low interest rates. At the same time, the hope is at lower interest rates corporates will borrow and expand. But that is not happening. Data from the Centre for Monitoring Indian Economy shows that announcements of new investment projects in terms of value fell by 88.3% during the period October to December 2020. Investment projects completed were down by 74%. So, the corporates aren’t in the mood to borrow and expand.

There are a couple of reasons for this. Many corporates continue to remain over-leveraged. Still others don’t have enough confidence in India’s economic future, irrespective of what they say in the public domain. As they say, the proof of the pudding is in the eating.

4) What does all this have to do with personal finance? What happened in China is happening in India as well. The bank savings have gone up dramatically during 2020. Between March 27 and December 18, they were up by Rs 9.15 lakh crore. In comparison, the increase during similar periods in 2019 and 2018, had stood at Rs 4.35 lakh crore and Rs 3.90 lakh crore, respectively. Of course, all this increase in saving is not just because of low interest rates. Some of it is because of fewer opportunities to spend money in 2020. Some of it is because of the general uncertainty that prevails. Some of it is because of jobs losses and the fear of job losses. And some of it is because Indians, like the Chinese, are saving more, in order to achieve the savings target for the education of their children or their weddings, or for the purchase of a home.

5) This has repercussions. With people saving more and with banks being unable to lend that money, interest rates have come down. And people saving more in response to the lower interest rates, means extended lower interest rates. This is not good news for savers. It is also not good news for consumption. If people are saving more, they are clearly spending lesser. This is the paradox of thrift or saving. When an individual saves more, it makes sense for him or her at an individual level. When the society as a whole saves much more than it was, it hurts the economy simply because one man’s spending is another man’s income. Over a period of time, this leads to job losses, more paradox of thrift and further job losses.

At the risk of sounding very cliched, there is no free lunch in economics. The RBI’s policy of flooding the financial system with money in order to help the corporates and the government, is basically hurting individual savers, consumption and the overall economy. The savers are paying for this lunch. And unlike the corporates, the savers have no unified voice. The government, obviously, is the government.

While, there is no denying that with lending not happening bank deposit rates had to fall, but the RBI policy of driving them down further, is something that is hurting the economy.

6) So, where does that leave the Indian saver? Some individual savers are betting on the stock market. But the price to earnings ratio of the Nifty 50 index as of January 1, stood at 38.55, an all-time high level. If you have the heart to invest in stocks at such a level, best of luck to you. Some others are betting on bitcoin, which has given a return of more than 75% in dollar terms, in the last one month.

Also, unlike the Chinese, the prospects of an increase in the yearly income of an average Indian, over the next years, at best remain subdued. Hence, the humble Indian fixed depositor, who liked to fill it, shut it and forget about it, so that he could concentrate on many other issues that his or her life keeps throwing up, clearly has a problem in 2021.

To conclude, all of you who write to me asking for a safe way of investing so that you can earn a 10% yearly return, well, sorry to disappoint you, no such way exists. At least not in 2021. Of course, there are always Ponzi schemes to invest in, some fraudulent, and some not so fraudulent.

The choice is yours to make.

PS: Wishing all my readers a very Happy New Year. Hope 2021 is much better than 2020 was for each one of you.