Shaktikanta Das, the governor of the Reserve Bank of India (RBI), projected optimism in the latest monetary policy by reminding us of the great Lata Mangeshkar song “aaj phir jeene ki tamanna hai (Now, again, I desire to live),” from the movie Guide.
The eternal message of optimism needed to be projected in order to defend the monetary policy committee’s decision to not raise the repo rate or the interest rate at which the RBI lends to banks. The repo rate has some impact on the interest rates at which banks carry out their lending. When a central bank raises the repo rate it’s essentially signalling that it is getting worried about inflation or the rate of price rise.
The RBI under Das started cutting the repo rate in February 2019, when it was at 6.5%. By May 2020, it was cut to 4%, which is where it has stayed since. So, the monetary policy has been in what economists like to call accommodative for close to two years. Along with cutting the repo rate, RBI also printed money and flooded it into the financial system by buying bonds.
The idea, in the aftermath of the covid pandemic, understandably, was to drive down interest rates, with the hope that people would borrow and spend more, and industries would borrow and expand, and the government would be able to borrow at low interest rates.
But the times are changing now, with inflation becoming a global phenomenon. As per the February 5th-11th issue of The Economist global inflation now stands at 6%. Retail inflation in the United States in January stood at 7.5%, the highest since February 1982. In December, the retail inflation in the Euro Area was at 5%, the highest it has ever been since data started to be collected in January 1997.
Not surprisingly, central banks all across the world have been raising interest rates. The Bank of England has already raised interest rates twice. The Federal Reserve of the United States will have to soon start raising rates to rein in the four-decade high retail inflation.
Retail inflation in India in December 2021 was at 5.6%, lower than 6% level above which RBI starts to get uncomfortable. Interestingly, the RBI believes that inflation during the next financial year will be at 4.5%. This, given the evidence on offer and the fact that we live in a highly globalized world, seems a tad unlikely.
Oil prices continue to remain high with the price of Brent crude being at $90 per barrel. Also, the supply chain problems, which had cropped all across the world due to the spread of the covid pandemic, haven’t gone away. Then there is the joker in the pack, on which, as always, a lot depends in the Indian case: a normal monsoon. As Dipanwita Mazumdar, an economist at the Bank of Baroda, puts it: “Another upside risk to inflation is the possibility of a below normal monsoon. Statistically, with six successive monsoons, there could be a sub-optimal one this year.”
Further, we have close to 6% retail inflation despite consumer demand at an aggregate level continuing to remain muted. Due to this, companies have been unable to pass on the increase in the cost of their inputs to the end consumers. This can be gauged from the fact that from April to December 2021, the wholesale inflation was at 12.5%, whereas retail inflation was at 5.2%. As Das put it in his statement: “The transmission of input cost pressures to selling prices remains muted in view of the continuing slack in demand”.
The lack of consumer demand has held retail inflation down. Nonetheless, companies have started raising prices as consumer demand has started to pick up. As the RBI’s monetary policy statement put it: “The pick-up in… bank credit, supportive monetary and liquidity conditions, sustained buoyancy in merchandise exports… and stable business outlook augur well for aggregate demand.”
This, in an environment of continued high oil prices, supply chain constraints and more expensive imports, implies higher retail inflation in the months to come, which means the RBI should have started raising the repo rate by now. But it hasn’t.
So, why has the RBI maintained a status quo? It’s the debt manager of the government. The government’s gross borrowing stood at Rs 12.6 lakh crore in 2020-21. It will end up borrowing Rs 10.5 lakh crore in 2021-22, with plans of borrowing Rs 15 lakh crore in 2022-23. Given this, the RBI has to help the government to borrow at low interest rates.
To cut a long story short, the RBI is not bothered about retail inflation, controlling which is its primary mandate. It’s more interested in ensuring that the government is able to borrow at low interest rates.
Finally, Das just quoted one line from the beautiful Lata song written by Shailendra and composed by SD Burman. The next line of the song goes like this: “aaj phir marne ka iraada hai ((Now, again, I desire to die)).” The translation doesn’t do justice to Shailendra’s writing which metaphorically captures the tormented state of mind of a married woman who has suddenly found love in another man, at once feeling both exhilaration and guilt and dejection.
The binaries in economics are never as strong as life and death, nonetheless, they do exist. It’s just that RBI under Das likes to be an optimistic cheerleader rather than an institution which should realistically assess the state of the Indian economy.
Hence, as far as projecting eternal optimism goes, Das should have been quoting the Gabbar Singh dialogue from Sholay written by Salim-Javed: “Jo darr gaya samjho mar gaya (the one who is afraid is dead),” and not Shailendra, SD Burman and Lata’s song.
(A slightly different version of this column appeared in the Deccan Herald on February 13, 2022.)
Anything can be money if individuals on both sides of the economic transaction are ready to accept it as money. As Yuval Noah Harari writes in Sapiens – A Brief History of Humankind: “Money is anything that people are willing to use in order to represent systematically the value of other things for the purpose of exchanging goods and services.” Of course, for something to emerge as a form of money at a societal level, it needs to be widely accepted.
This is the hope that the believers in bitcoin and other cryptocurrencies have been peddling for a while to make them look like attractive investments. That one day when enough number of people across the world are tired with the government backed fiat money or paper money as it more popularly known, cryptos will take over.
Of course, you can’t wait for that to happen, and you need to buy bitcoin now. This is one of the ways in which the fear of missing out or FOMO, is created.
So how logical is this argument? How much should we trust it? These are questions well worth asking.
If you look at the history of money, different things have been money at different points of time. In the prisoner-of-war camps of the Second World War, cigarettes emerged as a form of money. They are a great example of the fact that anything can be money if both the sides of the economic transaction are willing to accept so. Also, any system where conventional money is not around, like in a prison, does not continue to stay in a vacuum, and newer forms of money emerge.
Different agriculture commodities including tobacco have been money at different points of time. So have been different metals, everything from iron and bronze to silver and gold.
Hence, different things have been money at different points of time, during the course of human history. What this tells us is that as long as enough people accept something as a form of money, it can continue functioning as money, until it doesn’t.
This means that bitcoin and cryptocurrencies can also become a form of money, over a period of time. Nevertheless, if we leave it at just this, it will be lazy reasoning at best. Also, this is where things get a tad complicated.
Allow me to explain.
Pure paper money or fiat money or money not backed by any commodity (gold, silver, tobacco, iron, copper etc.) has been around for many centuries, nevertheless, it has flourished and been widely accepted only in the last hundred years.
Why is that the case? Why do people happily and readily accept money not backed by any commodity as a form of payment, on most days?
“The typical answer provided in textbooks is that you will accept your national currency because you know others will accept it. In other words, it is accepted because it is accepted. The typical explanation thus relies on an “infinite regress”: John accepts it because he thinks Mary will accept it, and she accepts it because she thinks Walmart will probably take it.”
To put it a tad simplistically, paper money is accepted because paper money is accepted. Are we saying there is a mass delusion at work? Is fiat money fiction?
“Money is a made-up thing, a shared fiction. Money is fundamentally, unalterably unalterably social. The social part of money—the “shared” in “shared fiction”—is exactly what makes it money. Otherwise, it’s just a chunk of metal, or a piece of paper, or, in the case of most money today, just a number stored on a bank’s computers.”
Now that maybe true, but that’s not important. What is important is to understand what keeps this shared fiction, this mass delusion, this myth, or whatever else you might want to call it, going. And this is where the government, which issues fiat money and controls the fiat money system, comes in.
For the government, it is important that its citizens continue to believe in the shared fiction of fiat money and continue accepting it as a form of payment. What keeps it going? Before answering this question, it is important to understand that there are three things that make a government a government: a) The right to tax. b) The right to legal violence. c) The right to create money out of thin air.
Two out of three rights are important to the context of bitcoin and cryptocurrencies. The right to tax and the right to create money out of thin air. In the past, I have talked extensively about the fact that any government letting bitcoin and cryptocurrencies operate smoothly is essentially giving away its right to create money out of thin air. And they aren’t exactly waiting to do it. (You can read about this here, here and here).
So, what about the right to tax that any government has?
As Wray writes:
“One of the most important powers claimed by sovereign government is the authority to levy and collect taxes (and other payments made to government, including fees and fines). Tax obligations are levied in the national money of account: Dollars in the United States, Canada, and Australia; Yen in Japan; Yuan in China; and Pesos in Mexico. Further, the sovereign government also determines what can be delivered to satisfy the tax obligation. In most developed nations, it is the government’s own currency that is accepted in payment of taxes.”
And not just in developed nations, even in lesser developed ones, the governments accept tax payments in the fiat money of the country. This is what keeps the fiat money system going. As Wray writes: “It is because anyone with tax obligations can use currency to eliminate these liabilities that government currency is in demand, and thus can be used in purchases or in payment of private obligations. The government cannot easily force others to use its currency in private payments, or to hoard it in piggybanks, but government can force use of currency to meet the tax obligations that it imposes.”
In simple terms, government taxes can only be paid in fiat money and that creates demand for fiat money or paper money not backed by anything, and keeps the system going.
A counter argument to this might be that while this might be true in countries where taxes form a significant part of the economy, but how does it work in countries where taxes are not a significant part of the economy. Why does the paper money system still hold?
The answer lies in the overall structure. Companies which operate in a country need to pay taxes to the government in fiat money. So, they carry out their business in fiat money; accept and make payments in it. This means their employees, suppliers (their employees), contractors (their employees), distributors (their employees) and so on, everyone gets paid in or must pay in paper money as well.
When people who are a part of the overall business system, which needs to pay different kinds of taxes, get paid in paper money, they go out and spend that paper money. Hence, individuals and institutions who sell to these people, must then accept paper money. So, the cycle keeps going. And there is demand for paper money or fiat money.
Also, it is worth mentioning here that taxes form a significant part of the economy in any developed country in the world. For any monetary revolution to happen, the governments in these countries need to buy the idea of bitcoin and other cryptos, and also actively promote them. El Salvador classifying bitcoin in a legal tender isn’t going to help that cause. Or the fact that Nigerians have taken on to bitcoin like no one else. These are exceptions to the rule.
The larger point here is that the structure of fiat money being needed to pay government taxes, keeps the paper money system going and will continue to keep it going in the time to come. The demand for fiat money will remain. As long as that is the case, bitcoin and other cryptos will be a sideshow at best, keeping the believers interested, at least for a while.
Also, governments are not going to give up on their right to create money out of thin air. This explains why money central banks are now in the process of planning and/or launching their respective central bank digital currencies.
Of course, people who do not like to pay their fair share of taxes also do not like the idea of being a part of the formal financial system (which is what fiat money system on its whole is at the end of the day). Therefore, people who are a part of the black economy like to convert their profits on which they haven’t paid cash, into other assets like real estate (held benami), gold (easy to store), precious stones (easy to move around) etc. It also explains why people operating in the black illegal economy love bitcoin and other new forms of crypto.
On the flip side, those who run the fiat money system have been abusing it post 2008, when the financial crisis broke out, and post late 2019, when the world was hit by the Covid pandemic.
A lot of fiat money has been created out of thin air, to get economic activity and economic growth going again. This is offered as a major reason by crypto believers, as to why the world should be shunning paper money and buying bitcoin and other cryptos. There is a lot of paper money being created out of thin air, but only 21 million bitcoin are only ever going to be mined.
Hence, the cryptosystem is built around the concept of scarcity whereas with more and more paper money being created, high inflation can become the order of the day and wealth stored in fiat money can lose value at a very fast pace.
The trouble with this argument is that while more bitcoin cannot be created, anyone and everyone, who understands these things, can create a new cryptocurrency. Which is why there are thousands of cryptos going around. As renowned investor Ray Dalio put it in a note on bitcoin: “Competition will, play a role in determining bitcoin and other cryptocurrency prices. In fact, I assume that better ones will come along and displace this one because that is the way the evolution of everything works.” Given this, in the years to come, gold will still be around, about bitcoin, we really don’t know.
So, the point is you don’t know which crypto is going to be around in the days to come. And given that, how do can you ensure that the value of your wealth remains the same, by investing in crypto. Plus, at the risk of sounding cliched, the price volatility of cryptos continues to remain a huge risk.
Something which falls by 50% in a matter of months, cannot even aim to be an asset class, forget being a form of money. The crypto believers now offer the example of stablecoins, which are basically cryptos pegged to paper or fiat money. They have price stability. But their stability comes from being linked to fiat money in the first place.
As Mark Carney writes in Value(s) — Building a Better World For All: “The highest-profile examples of stablecoins… are best thought of as payments systems rather than money per se since they derive their moneyness from the underlying sovereign currencies.”
To conclude, a small story. Before the crypto crash happened, a gentleman on Twitter very confidently told me that he would rather buy dogecoin, which was launched as a joke on bitcoin, than the US dollar. This is because the dogecoin wasn’t being created out of thin air (which is not true, given that the amount of dogecoin goes up every year, but we will ignore that here) and the dollar was.
His point was that the US dollar was not backed by anything. The US dollar is not backed by anything in the physical sense of the term, but it is backed by the US sovereign, the biggest economy in the world, perhaps the most innovative economy in the world and the biggest empire the world has ever seen. Also, the dollar has an exorbitant privilege. While other countries need to earn it, the US can simply print it. Which explains why the demand of for the dollar continues to remain solid, despite its abuse.
Yes, to that extent, it is not backed by anything and bitcoin and other cryptos are backed by everything.
What I can’t get my head around is that if you can’t trust the government (and there are reasons not to), how can you trust a few random guys launching their own crypto in their own backyard. Something which can be moved up and down by a few tweets. How is this fiction better than the government’s fiction? I really don’t have an answer for that.
For May 2021, inflation as measured by the consumer price index (CPI) stood at 6.3%. It was the highest since November 2020, when it had stood at 6.93%.
Of course, this has been splashed all over the media since yesterday evening when the figures were published. But do you ever sit back and think about what does inflation really mean for you? (I mean why would anyone sit back and think about inflation, but nonetheless please humour me for a bit). If you haven’t, let me set the cat among the pigeons.
1) The government publishes inflation as measured by the CPI every month. So, when it says inflation in May 2021 stood at 6.3%, does it mean that inflation for you, dear reader, also stood at 6.3%? Or that you paid 6.3% more for things on an average in May 2021 than you did in May 2020? Have you ever thought about this? The CPI consists of many items whose prices are regularly tracked by the government (specifically, by the ministry of statistics and programme implementation). All these items have a certain weight in the index.
So, food items overall have a weight of 39.06% of the index. The assumption here is that the average Indian makes nearly two-fifths of his expenditure every month on food.
If you are reading this, chances are your expenditure on food every month as a proportion of your total expenditure, is lower than 39.06%. I say this simply because you are reading this in English, and anyone who can read English in India, is likely to be better off than an average Indian.
Hence, inflation of 6.3%, isn’t your rate of inflation. It can be higher or lower than this, depending on stuff you regularly consume.
Take the case of petrol prices. They have risen by 62.28% in the last one year, if we look at the inflation as measured by the wholesale price index (this data as per inflation as measured by CPI, hasn’t been published in the recent months).
In inflation as measured by the wholesale price index, petrol prices have a weight of 1.6%. In inflation as measured by CPI, they have a weight of 2.19%. Your expenditure on petrol as a part of your overall expenditure, is likely to be more than this.
Also, on a slightly different note, rising petrol, diesel and gas prices, feed into food prices, because food needs to be moved from where it is produced to where it is consumed.
2)As people earn more, their spending on food as a proportion of their overall spending comes down. Also, within the food basket, spending on cereals comes down and spending on foods which have protein (eggs, pulses, meat, etc.), goes up. The spending on milk also goes up.
When it comes to the CPI, this can simply be gauged from the fact that the weightage that food has in the urban part of the CPI is much lower than the rural one. When it comes to urban India, the weightage of food items in the CPI stands at 29.62%. In case of rural India, the weightage is much higher at 47.25%.
This is primarily because the average urban Indian earns more than an average rural Indian and hence, incurs a lower proportion of the overall expenditure on food.
Of course, as people earn more, their spending on items other than food increases and that starts to matter more. Even here the stuff that CPI measures and your regular consumption basket may not intersect. Let’s take the case of household goods and services, a heading under CPI.
This heading keeps track of inflation of bedsteads, almirahs, dressing tables, chairs, furniture, bathroom and sanitary equipment, bedsheets, mosquito nets, air conditioners, sewing machines (yes, still!), washing machines, invertors, refrigerators, etc. In May 2021, the inflation for all these items overall stood at 3.89%.
Here is the thing. While these items are important in the overall scheme of comfortable middle class living, they do not have any impact on regular expenditure, given that they are one-off purchases. Hence, they don’t impact your regular consumption and, in the process, your regular inflation.
But this is a point that is not important for the government. The government is trying to figure out the rate of inflation for the society at large, so that this can help in other ways, like figuring out the adequate level of interest rates for one.
3)But there is a flip side to the above point as well. The health inflation in the last one year has been 8.44%. Now anyone who has had to deal with India’s urban private health system in the last one year, will tell you that is a load of bunkum. Prices have gone through the roof and the rate of inflation doesn’t really capture it.
Of course, going to the hospital is also not something that most people do regularly (I am not talking about basic visits to a personal physician here). Hence, anyone who has had to spend some time in a hospital this year, or has had to finance a close one’s stay, would have ended up spending a lot of money and paid significantly higher prices than last year.
So, one-off expenditures during a particular year can really make a mess of your finances, and that is something the inflation as measured by CPI doesn’t really capture.
Also, on a slightly different note, as Madan Sabnavis, the Chief Economist of CARE Ratings puts it: “Problem with most of the inflation numbers relating to personal care, health, recreation, transport is that once prices are increased they would not come down and hence becomes a new base.”
The point being that inflation measures the rate of increase in price over a period of one year. Hence, the annual inflation itself may not be high, but that doesn’t necessarily mean that things are not expensive.
4)Different states have different rates of inflation in different years. In 2019-20, among large states, Kerala had the highest rate of inflation at 6.1%. Bihar had the lowest at 2.2%.
Source: Reserve Bank of India.
What does this mean? It means that the inflation you experience also depends on which part of the country you are in and the inflationary pressures it is experiencing during a particular year. Of course, within a state, whether you are in an urban area, or a rural one, also makes a difference. 5)Clearly, the official rate of inflation doesn’t tell you much about anything. Hence, what can you do about it? First and foremost, you need to do an expenditure audit and figure out the things you spend your money on regularly (you will be surprised). This shouldn’t be so difficult if you make purchases online or make payments digitally or use plastic money.
The important point here is to identify the most important items and not every possible one, and keep track of expenditure on the important items, over a period. A simpler method is to just keep track of regular monthly expenditure and that too can give you some inkling which way your finances are headed, and whether you are spending more or less than you were doing in the past.
This is not a totally foolproof and methodical system but more of a crude method to get around the uselessness of the official rate of inflation at an individual level, when it comes to consumption. Of course, there are other implications which I do keep talking about.
I used to think if there was reincarnation, I wanted to come back as the President or the Pope or a .400 baseball hitter. But now I want to come back as the bond market. You can intimidate everybody. – James Carville.
The Reserve Bank of India (RBI) is unhappy with the bond market these days. Well, it hasn’t said so directly. A central bank rarely does. But a series of newsreports across the business media suggests so. (Oh yes, the RBI also leaks when it wants to).
The bond market wants the RBI to pay a higher yield on the government of India bonds it is currently issuing. The cost of the higher yield will have to be borne by the government of India, something that the RBI doesn’t want.
And this is where we have a problem (don’t worry I will explain this in simple English and not write like bond market reporters or experts tend to, for other bond market reporters and other bond market experts). Government bonds are financial securities which pay an interest and are issued by the government in order to borrow money.
Let’s try and understand this issue pointwise.
1) The government’s gross borrowings for 2020-21, the current financial year, had been budgeted at Rs 7.8 lakh crore. In May 2020, after the covid pandemic broke out and the tax collections crashed, the number was increased to Rs 12 lakh crore. The final borrowings are expected to be at Rs 12.8 lakh crore. In 2021-22, the gross borrowings of the government are expected to be at Rs 12.06 lakh crore.
Hence, over a period of two years, the government will end up borrowing close to Rs 25 lakh crore. It isn’t surprising that the bond market wants a higher rate of return or yield as it likes to call it, from government bonds, given that the financial savings in the country will not expand at the same rate as government borrowing is expected to. Also, there is no guarantee that the government will stick to borrowing what it is saying it will borrow. That’s a possibility the market is also discounting for.
2) Take a look at the following chart which plots the 10-year bond yield of the government of India. A 10-year bond is a bond which matures in ten years and the return on it on any given day is the per year return an investor will earn if he buys that bond on that day and holds on to it until maturity.
As can be seen from the above chart, the 10-year bond yield has largely seen a downward trend since January 2020, though since January 2021 it has gradually been rising. As of the time of writing this, it stood at 6.14%, having crossed 6.2% on February 22.
Media reports suggests that the RBI wants the yield to settle around 6%. The bond market clearly wants more. This explains why in the recent past bond auctions have failed with the bond market not buying bonds or the RBI refusing to sell them at yields the bond market wanted.
3)The question is why does the bond market now want a higher rate of return on bonds than it did in 2020. There are multiple reasons for it. Bank lending has largely collapsed during this financial year and has only improved since October. Between March 27, 2020 and January 29, 2021, the overall bank lending has grown by just Rs 3.34 lakh crore, with almost all of this lending carried out during the second half of the financial year.
This forms around 27% of the deposits of Rs 12.3 lakh crore that banks have managed to raise during the period. Clearly, the banks haven’t been able to lend out a large part of their fresh deposits.
Hence, it has hardly been surprising that a bulk of the bank deposits have been invested in government bonds. During the period Rs 6.94 lakh crore or 56% of the deposits have been invested in government bonds. Along with banks, other financial institutions have had few lending/investment opportunities, leading to a lot of money chasing government bonds, which has led to lower returns on them.
Over and above this, the RBI has flooded the financial system with money by cutting the cash reserve ratio (CRR) and by also printing money and buying bonds (something it refers to as open market operations), thereby driving down returns further.
4)What has changed now? The budget expects India to grow by 14.4% in nominal terms (not adjusted for inflation) in 2021-22. Even in real terms (adjusted for inflation), India is expected to grow by at least 10%. This basically means that bank and other lending will pick up. At the same time, the government borrowing will continue to remain high at Rs 12.06 lakh crore. Hence, there will be more competition for savings in 2021-22 than has been the case during this financial year, given that savings are not going to rise suddenly. Hence, yields or returns on government bonds need to go up accordingly. QED.
5)There is another point that needs to be made here. Thanks to the RBI wanting to drive bond yields and interest rates down, there is excess liquidity in the financial system right now. Lending to the government is deemed to be the safest form of lending. If lending to the government becomes cheaper, interest rates on everything else also tends to go down.
As of February 23, the excess liquidity in the financial system stood at Rs 5.7 lakh crore. This is money which banks have parked with the RBI.
On February 5, the RBI governor, Shaktikanta Das, had said: “A two phase normalisation of the cash reserve ratio (CRR) – which I am going to announce – needs to be seen in this context.”
The banks need to maintain a certain proportion of their deposits with the RBI. It currently stands at 3%. In April 2020, the RBI had cut the CRR by 100 basis points to 3%. One basis point is one hundredth of a percentage. With the banks having to maintain a lower proportion of their deposits with the RBI there was more liquidity in the financial system, which helped drive down yields and interest rates.
Now the RBI wants to increase the CRR in two phases. Assuming it wants to increase the CRR to 4%, this means that more than Rs 1.56 lakh crore (using data as of February 23) will be pulled out of the financial system by banks and be deposited with the RBI, in the months to come.
The bond market is discounting for this possibility as well, even with Das saying: “systemic liquidity would, however, continue to remain comfortable over the ensuing year.” What this basically means is that the RBI will continue to carry out open market operations by buying bonds and pumping money into the financial system as and when it deems fit.
Having said that, the overall liquidity in the financial system will go down, simply because once the RBI withdraws more than Rs 1.56 lakh crore through raising the CRR, it isn’t going to pump in the same amount of money back into the system, through open market operations, simply because then there would have been no point in increasing the CRR.
6)If your head is not spinning by now, dear reader, then you are clearly a bond market veteran. (Now isn’t the stock market so much simpler). Basically, the RBI is trying to play two roles here. It is the government’s debt manager and banker. At the same time, it also has the mandate of maintaining the rate of consumer price inflation between 2-6%. And at some level these objectives go against each other.
As the government’s debt manager, the RBI needs to ensure that the government is able to borrow at lower rates. In order to do that the RBI now and then floods the system with more money and drives down rates.
The trouble with flooding the system with more money in an economy which is recovering from a huge economic shock, is higher inflation as there is the risk of more money chasing the same amount of goods and services. Of course, with the manufacturing sector having a low capacity utilisation, they can always start more machines and pump up more goods, and ensure that inflation doesn’t shoot up. But the risk of inflation is there, given that money supply (M3) as of January 29, had gone up by 12.1%, year on year.
Over the years, there has been a lot of debate around whether the RBI should continue being the debt manager to the government or should that function be split up from the central bank and another institution should be created specifically for it, with the RBI just concentrating on managing inflation. I guess, in times like the current one, this suddenly starts to make sense.
7) Okay, there is more. The yield on the 10-year US treasury bond has been rising and as I write it has touched 1.33% from around 0.92% at the end of 2020. A major reason for this lies in the fact that the bond market is already factoring in the plan of the newly elected American president Joe Biden to spend more money in order to drive up economic growth.
Of course, with bond yields rising in the US, there is bound to be an impact everywhere else, given that the American government bond is deemed to be the safest financial security in the world. This has added to further pressure on the yields on the Indian government bonds.
8)After the finance minister presented the budget, the bond market realised that the government has huge borrowing plans even in 2021-22 and that even this financial year it would borrow Rs 80,000 crore more than the Rs 12 lakh crore it had said it would.
Accordingly, the 10-year bond yield moved up from 5.95% on January 29 to 6.13% on February 2, a day after the budget was presented. The RBI carried out open market operations worth Rs 50,169 crore between February 8 and February 12, on each of the days, to increase the liquidity in the financial system and push the yield below 6% to 5.99% on February 12.
Clearly, the bond market has made up its mind as far as yields are concerned. The way out of this for RBI is to print more money and buy more government bonds and drive down yields. Of course, this needs to be done regularly and by following a certain routine.
That’s the trouble with printing money. A major lesson in economics since 2008 has been that printing money by central banks leads to printing of more money in the time to come, given that the market gets addicted to the easy money.
Let’s see how the RBI comes out of this predicament, given that it has promised an “accommodative stance of monetary policy as long as necessary – at least through the current financial year and into the next year”.
9) We aren’t done yet. Other than being the debt manager to the government and having to manage the consumer price inflation between 2-6%, the RBI also needs to keep a look out for the dollar rupee exchange rate.
During the course of this financial year, the foreign institutional investors have brought in $35.4 billion to invest in the stock market. When they bring money into India they need to sell their dollars and buy rupees. This increases the demand for the rupee and leads to the rupee appreciating against the dollar.
When the rupee is appreciating against the dollar, the RBI typically sells rupees and buys dollars, in order to ensure that there is enough supply of rupees going around. In the process, the RBI ends up building foreign exchange reserves and it also ends up pumping more rupees into the financial system, thereby increasing the money supply, and pushing up the risk of a higher inflation.
Over and above this, the open market operations of buying bonds and cutting the CRR, this is another way the RBI ends up pumping money into the financial system. All this goes against its other objective of maintaining inflation.
One dollar was worth Rs 74.9 sometime in mid-November 2020. It has been falling since then and as I write this, it stands at Rs 72.4. What this means is that in the last few months, the RBI has barely been intervening in the foreign exchange market.
This brings us back to the concept of trilemma in economics, which the RBI seems to have hit. Trilemma is a concept which was originally expounded by the Canadian economist Robert Mundell. Basically, a central bank cannot have free international movement of capital, a fixed exchange rate and an independent monetary policy, all at the same time. It can only choose two out of these three objectives. Monetary policy refers to the process of setting of interest rates in an economy, carried out by the central bank of the country.
This explains why the RBI is letting the rupee appreciate, in order to ensure free movement of capital (at least for foreign investors) and an independent monetary policy. Let’s say the RBI kept intervening in the foreign exchange market in order to ensure that the rupee doesn’t appreciate against the dollar. In this situation, it would have ended up pumping more rupees into the financial system and thereby risking higher inflation in the process.
A higher inflation would have forced the RBI to start raising interest rates in an environment where the economy is recovering from a huge shock and the government is looking to borrow a lot of money. This would have led to the RBI losing control over its monetary policy. Clearly, it didn’t want that. (For everyone wanting to know about the trilemma in detail, you can read this piece, I wrote in September last year).
10) Finally, an appreciating rupee has multiple repercussions. People like me who make some amount of money in dollars, get hit in the process. (I would request my foreign supporters to keep this in mind while supporting me. Okay, that was a joke!)
Further, it makes imports cheaper, going against the entire narrative of atmabnirbharta being promoted right now. If imports become cheaper, the local products will find it even more difficult to compete. Of course, cheaper imports is good news for the consumers, given that the main aim of all economics is consumption at the end of the day.
An appreciating rupee also hurts the exporters as they earn a lower amount in rupee terms, making it more difficult for them to compete globally. And all this goes against the idea of promoting Indian exports and exporters to become a valuable part of global value chains and boosting Indian exports.
To conclude, and I know I sound like a broken record (millennials and gen Xers please Google the term) here, there is no free lunch in economics. That’s the long and short of it. All the liquidity created in the financial system to drive down yields on government bonds to help the government borrow at lower rates, is having other repercussions now. And there isn’t much the RBI can do about it.
Of course, if the bond market keeps demanding higher yields, the RBI’s dhishum dhishum with it will get even more intense in the days to come . If you are the kind who gets a high out of these things, well, continue watching this space then!
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.
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.
“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.