Interest Rates

On Homes and Home Loans

Yesterday evening I had gone to meet a cousin who lives in the Western suburbs of Mumbai. All along the way, there were billboards of Kotak Mahindra Bank advertising its home loans, which are available at an interest rate of 6.65%.

While the interest rate of 6.65% comes with terms and conditions, such low interest rates have rarely been seen before. It is possible to get a home loan these days at an interest rate of 7%.

A few things have happened because of these low rates. There have been scores of stories in the media citing surveys where everyone from women to HNIs to NRIs to millennials seem to want to buy a house and they want to do it right here and right now. 

Of course, these surveys have been carried out by real estate consultants, whose very survival depends on the real estate sector doing well. Incentives as they say.

Low interest rates on home loans also have led to stories in the media suggesting that this is best time to buy a house. The other thing that has happened is that analysts have been recommending stocks of home finance companies (HFCs).

The logic being that at lower interest rates people will take on more home loans. This will help the loan book of HFCs grow, making them good investment bets. How easy all this sounds? But is it?

All this stems from the flawed assumption that people borrow more at lower interest rates and live happily ever after. Let’s see if that is true or not.

Take a look at the following graph. It plots the increase in home loans outstanding during the period April to January, over the years.

 Source: Author calculations on data from Centre for Monitoring Indian Economy.

What does the above graph tell us? It tells us that despite very low home loan interest rates, the increase in home loans given by banks between April 2020 to January 2021, stood at Rs 78,577 crore. This was around half of the increase of Rs 1,56,362 crore between April 2019 to January 2020.

Even between April 2018 and January 2019, the increase stood at Rs 1,46,227 crore. Clearly, people borrowed much more when interest rates were higher. Hence, the logic that people borrow more when interest rates are lower, basically goes for a toss.

In fact, the increase between April 2020 to January 2021, was the second lowest in six years in absolute terms. The lowest increase of Rs 74,837 crore was between April 2016 to January 2017. This period included demonetisation when banks had more or less stopped doing everything else and concentrated on taking back the demonetised notes from the public.

If we look at the period between April 2016 to October 2016, before demonetisation happened, the increase in home loans had stood at Rs 64,501 crore. Clearly the disbursal of home loans slowed down in the post demonetisation months.

There is another point that needs to be made here. Other than banks, HFCs or home finance companies, also give out home loans. Typically, banks give out two-thirds of the home loans and HFCs, the remaining third. Nevertheless, the last couple of years haven’t been good for a few HFCs. This has meant that some of the business of home loans has moved from HFCs to banks.

Once we take these factors into account then we can conclude that the increase in home loans during this financial year, has been the worst in six years. And this despite the extremely low interest rates. In percentage terms, the increase in outstanding home loans during this financial year has stood at 5.97%, the lowest in six years, and the only time the increase has been less than 10%. 

Why is that the case? For economists and analysts, the interest rate is the most important parameter that people look at while taking a home loan, nevertheless, a little bit of common sense tells us that this isn’t the case.

Let’s try and understand this through an example. As per HDFC, India’s largest HFC, their average home loan size is Rs 28.5 lakh. Their average loan to value ratio at the time of giving the loan is 70%. This basically means that HDFC on an average gives up to 70% of the price of the home as a home loan.

This basically means that the average price of a home in the books of HDFC against which they give a home loan, stands at Rs 40.7 lakh (Rs 28.5 lakh divided by 70%). Let’s round this to Rs 41 lakh, for the sake of convenience.

What does this mean? It means that in order to buy a home, other than taking on a loan of the buyer first needs to make sure that he has savings of around Rs 12.5 lakh (Rs 41 lakh minus Rs 28.5 lakh) to make the downpayment on the home loan. Even if the money is available, he or she needs to make sure that they are in a position to spend that money.

This is not where it ends. In many parts of the country a portion of the real estate transaction is still carried out in black. Money needs to be available for that. Further, a stamp duty needs to be paid to the state government. Then there is the cost of moving into a new house (everything from transport to perhaps new furniture).

Once we factor these things into account, we can conclude that the home loan forms around 50-60% of the overall cost of buying a house. Further, in a time like present, any individual thinking of buying a house will have to weigh the decision against the possibility of losing their job or facing a drop in income in their line of work.

Now let’s consider the average home loan of Rs 28.5 lakh. At 7% interest and a tenure of 20 years, the EMI on this amounts to Rs 22,096. At 9%, the EMI would have worked out to Rs 25,642. Hence, the EMI is Rs 3,546 lower.

So, yes, the EMI is lower. But what will the buyer first look at? The lower EMI or the ability to be able to pay the lower EMI and be able to continue paying it in the days to come. Of course, the buyer will look at his ability to pay the EMI and be able to continue paying it. Also, it needs to be remembered that the interest rate on the home loan is a floating one, and can rise in the years to come.

Hence, this decision will be based on the confidence that the buyer has in his or her own economic future. This is not something that can be measured at an aggregate system level and varies from buyer to buyer. The point being that everything that is important cannot necessarily be measured in numerical terms.

Having said that, the confidence in the economic future will be currently low, with many individuals losing their jobs or seeing their friends, relatives and acquaintances lose jobs. Hence, other than losing a job, there is also the fear of losing the job. There has also been a drop in their income or in some cases small businesses have been shutdown. 

Also, whether it is the best time to buy a house or not, like most things in personal finance, it depends on your finances and more importantly your mental makeup of what you want from life. If you want to settle in life and make your parents and relatives happy, and have the money to do so, then now is as good a time as any to buy a home.

Please keep this in mind at every point of time in life when some expert tells you that this is the best time to do this or the best time to do that.

So, right now if you think you have enough money and enough confidence to keep paying the EMI, and want a home to live in, then please go ahead and buy one. Also, make sure that you have enough savings to pay the EMI for at least six months to a year, even without your main source of income.

To conclude, buying a home is not just about low interest rates. There are several other factors, which people who are in the business of selling real estate, seem to conveniently forget about.

Then there are surveys in which a high proportion of people end up saying they want to buy a home to live in. Of course, they do. But just wanting to do something doesn’t add to demand. I mean, I want to buy a house in central Mumbai, but I also know that ain’t going to happen. My finances don’t allow it.

Why RBI is Doing Dhishum Dhishum With Bond Market

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.

Source: www.investing.com

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.

But the yields have gone back up again and stand at 6.14% at the point of writing this. Interestingly, the yields on state government bonds have almost touched 7.2%.

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!

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.

Why RBI’s Monetary Policy Has Been a Bigger Flop Than Bombay Velvet

Mere paas kothi hai na car sajni,
Kadka hai tera dildar sajni.
— Rajkavi Inderjeet Singh Tulsi, Ravindra Jain, Kishore Kumar, Asha Bhonsle and Ashok Roy, in Chor Machaye Shor.

Okay, I didn’t have to wait for the Reserve Bank of India’s monetary policy declared today, to write this piece. I could have written this piece yesterday or even a month back. But then the news cycle ultimately determines the number of people who end up reading what I write, and one can’t possibly ignore that.

A few hours back, the Monetary Policy Statement was published by the RBI, after the monetary policy committee (MPC) met on 2nd, 3rd and 4th December. The MPC of the Reserve Bank of India (RBI) has the responsibility to set the repo rate, among other things. The repo rate is the interest rate at which the RBI lends to banks, and which to some extent determines the interest rates set by commercial banks for the economy as a whole.

The MPC has been driving down the repo rate since January 2019, when the rate was at 6.5%. The rate had been cut to 5.15% by February 2020, around the time the covid pandemic struck.

By May 2020, the MPC had cut the repo rate further by 115 basis points to an all-time low of 4%. One basis point is one hundredth of a percentage. The idea behind the cut was two-fold.

In the aftermath of the covid pandemic as the economic activity crashed, the tax collections of the government crashed as well, leading to a situation where the government’s borrowing requirement jumped from Rs 7.8 lakh crore to Rs 12 lakh crore.

The massive repo rate cut would help the government to borrow more at lower interest rates. The yield or the return on a ten-year government of India bond in early February was at 6.64%. Since then it has fallen to around 5.89% as of December 4. The government of India borrows by selling bonds. The money that it raises helps finance its fiscal deficit or the difference between what it earns and what it spends.

The second idea was to encourage people to borrow and spend more and businesses to borrow and expand, at lower interest rates. Take a look at the following chart. It plots the average interest at which banks have given out fresh loans over the years.

Source: Reserve Bank of India.

The data on average interest at which banks have given out fresh loans is available for a period of a little over six years, starting from September 2014 and up to October 2020. It can be seen from the above chart that the interest rates in the recent months, have been the lowest in many years. But has that led to an increase in lending by banks, that’s the question that needs to be answered?

As of October 2020, the total outstanding non-food credit of banks by economic activity, had gone up by 5.6% in comparison to October 2019. Banks give loans to the Food Corporation of India and other state procurement agencies to buy rice, wheat and a few other agricultural products directly from farmers. Once we subtract these loans out from the overall loans given by banks that leaves us with non-food credit by economic activity.

Also, it needs to be mentioned here that this is how banking data is conventionally reported, in terms of the total outstanding loans of banks.

When you compare this with how other economic data is reported, it’s different. Let’s take the example of passenger cars.

When passenger car sales are reported, what is reported is the number of cars sold during a particular month and not the total number of cars running in India at that point of time. In case of banks, precisely the opposite thing happens.

What is conventionally reported is the total outstanding loans at any point of time and not the loans given incrementally during a particular period. So, the total outstanding non-food credit of Indian banks by economic activity, as of October end 2020 stood at Rs 92.13 lakh crore. This increased by 5.6% over October 2019.

The way this data is reported does not tell us the gravity of the situation that the banks are in. That comes out when we look at just incremental loans from one year back. The way to calculate this is to take total outstanding loans as of October 2020 and subtract that from outstanding loans of banks as of October 2019. The difference is incremental loans for October 2020. Similarly, the calculation can be done for other months as well.

Let’s take a look incremental loans data over the last three years.

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As can be seen the above chart, the incremental loans every month in comparison to the same month last year, have been falling since late 2018, just a little before the RBI started cutting the repo rate. In October 2020, they stood at Rs 4.83 lakh crore, a three-year low.

What does this mean? It means that as the MPC of the RBI has gone about cutting the repo rate, the incremental loans given by banks have gone down as well. This is the exact opposite of what economists and central banks expect, that as interest rates fall, borrowing should go up.

And this has been happening from a time before the covid-pandemic struck. Covid has only accentuated this phenomenon. This also leads to the point I make often that for people to borrow more, just lower interest rates are not enough.

The main point that encourages people and businesses to borrow more is the confidence in their economic future. While the government will try and blame India’s currently economic problems totally on covid, it is worth mentioning here that India’s economic growth has seen a downward trend since March 2018. The economic growth for the period January to March 2018 had stood at 8.2% and has been falling since, leading to a lesser confidence in the economic future, both among individuals and corporates.

In fact, if we compare the situation between March 27, 2020, when covid first started spreading across India, and November 6, 2020, the total outstanding non-food credit of banks has grown by just Rs 2,221 crore (yes, you read that right, and this is not a calculation error).

During the same period, the total deposits of banks have grown by Rs 8.13 lakh crore or 6%. The incremental credit deposit ratio between March 27 and November 6, is just 0.27%. We can actually assume it be zero, given that it is so close to zero. Al these deposits have primarily been invested in government bonds.

Basically, on the whole, the banks have been unable to lend any of the deposits they have got from the beginning of this financial year. Only one part of banking is in operation. Banks are borrowing, they are not lending.

What does this tell us? It tells us that banking activity in the country has collapsed post covid, despite the RBI cutting the repo rate to an all-time low-level of 4%, where it’s 361 basis points lower than the latest rate of retail inflation of 7.61%. Other than cutting the repo rate, the RBI has also printed a lot of money and pumped it into the financial system, to drive down interest rates.

But despite that people and businesses are not borrowing. RBI’s monetary policy has been an even bigger flop than Anurag Kashyap’s Bombay Velvet, Raj Kapoor’s Mera Naam Joker and Satish Kaushik’s Roop ki Rani Choron ka Raja. (I name three different films so that readers of different generations all get the point I am trying to make here).

In the monetary policy statement released a few hours back, there is very little mention of this, other than:

“A noteworthy development is that non-food credit growth accelerated and moved into positive territory for the first time in November 2020 on a financial year basis .”

The governor’s statement has some general gyan like this:

“In response to the COVID-19 pandemic, the Reserve Bank has focused on resolution of stress among borrowers, and facilitating credit flow to the economy, while ensuring financial stability.”

No explanations have been offered on why the monetary policy has flopped. The current dispensation at India’s central bank is getting used to behaving like the current government.

It is important to understand here why monetary policy has been such a colossal flop this year. The answer lies in what the British economist John Maynard Keynes called the paradox of thrift. When a single individual saves more, it makes sense, as he prepares himself to face an emergency where he might need that money.

But when the society as a whole saves more, as it currently is, that causes a lot of damage because one’s man spending is another man’s income. As we have seen bank deposits during this financial year have gone up Rs 8.13 lakh crore or 6%. On the whole, people are cutting down on their spending and saving more for a rainy day.

The psychology of a recession at play and not just among those people who have been fired from their jobs or seen a fall in their income. It is obvious that such people are cutting down on their spending. But even those who haven’t faced any economic trouble are doing so.

They are doing so in the fear of seeing a fall in their income or losing their job and not being able to find a new one. When the individuals are cutting down on their spending, it doesn’t make much sense for businesses to borrow and expand. In fact, the overall bank lending to the industry sector has contracted by Rs 4,624 crore between October 2019 and October 2020.

Typically, in a situation like this, when the private sector is not in a position to spend, the government of the day steps in. The trouble is that the current government is not in a position to do so as tax revenues have collapsed this year. There other fears at play here as well.

In the midst of all this, Dinesh Khara, the chairman of the State Bank of India told the Business Standard, that bank lending rates “have actually bottomed”. Given that banks have barely lent anything this year, it makes me sincerely wonder what Mr Khara has been smoking. Clearly, it makes sense to avoid that.

To conclude, monetary policy should not get the kind of attention it gets in the business media, simply because, it is dead, and it has been dying for a while. The trouble is, there are one too many banking correspondents and even more central bank watchers, including me, who need to make a living.

And very few among us, are likely to ask the most basic question—why monetary policy is not working.

Le jayenge le jayenge dilwale dulhaniya le jayenge
— Rajkavi Inderjeet Singh Tulsi, Ravindra Jain, Kishore Kumar, Asha Bhonsle and Ashok Roy, in Chor Machaye Shor.

 

Should You Buy a Home This Festival Season?

In the last decade, afternoon naps have become a very important part of my life. In fact, it is safe to say that I live so that I can have the pleasure of taking afternoon naps and reading crime fiction. (Imagine all the economics I have to break my head on, for such simple pleasures in life).

After taking an afternoon nap yesterday I was trying to get my brain going again by drinking a cup of overboiled masala tea. At around 4.54 pm, a mail titled 10 Reasons to Buy a Home This Festive Season, hit my mailbox. The headline ensured that my brain was back to functioning at full strength.

In the economic environment that currently prevails, only someone closely associated with the real estate business could come up with a headline/title like this. Not surprisingly, this piece was written by someone working at a senior position for a real estate consultant, whose well-being depends on the sector doing well. His incentive is clearly misaligned with that of a prospective buyer looking to buy a home to live in.

Also, the festival season sales pick up is something that the real estate sector has been trying to sell for more than half a decade now. This tells you that bad ideas rarely go out of circulation.

This headline motivated me to write this piece titled should you buy a home this festival season, which you are currently reading.
Let’s take a look at this pointwise.

1) One of the reasons offered to buy a home in the mail I got, is the oldest cliché in the game, which goes like this: “Living in a rented house is a recurring financial drain without returns on investment”. This reasoning is bought by one too many people even though it is the rubbish of the highest order.

Let me explain through an example. I stay in central Mumbai, in what is euphemistically termed as a studio apartment. My monthly rental outgo is Rs 23,000. What sort of a home loan will I get if I am willing to pay the same amount as an EMI? At an interest rate of 7% per year on a home loan to be repaid over twenty years, I will get a home loan of around Rs 29.67 lakh. On this loan, the EMI works out to Rs 23,003.

Let’s say to this home loan I add my own savings of around Rs 10.33 lakh and I have a total of Rs 40 lakh, with which I can buy a flat. I will not get anything at this price around where I live unless I am willing to move into a shanty.

To get an apartment at this price I will have to move 35-40 km or even more from where I stay. And that will beat the entire idea because I like staying where I do and renting is the only way I can afford it. I am not looking to build an asset here. I just want to stay bang in the middle of the town.

2) Also, the rental yield typically tends to be 1.5-2% (annual rent divided by the market price of the house) or slightly higher. Even the cheapest home loan is 7%. Plus there are other costs associated with owning a home. When you a buy a house a stamp duty has to be paid to the state government. A property tax needs to be paid every year. Then there is the maintenance charge that needs to be paid to the housing society. On top of this there is the general risk of owning property in India.

3) Further, if I go and live 35-40km from where I am, I will end up paying for it in terms of the time I will have to spend to get anywhere. And time ultimately is money. So, yes one might end up building an asset but with almost no control over one’s time.

Hence, equating living in a rented house to a financial drain is top class rubbish which only someone working in the real estate industry can come up with and propagate  over and over again. This argument starts to make sense only when the rental yields and home loan interest rates are in a similar sort of territory. For that to happen, rental yields need to double and home loan interest rates need to halve (both will then be around 4%).

4) Another reason offered in the mail, to buy a house is: “Buying now equals buying at the lowest possible price.” Lowest possible price, vis a vis what? Entry level flats in the biggest cities, where the bulk of the demand is, cost at least Rs 40-50 lakh. Let’s consider a flat which costs Rs 40 lakh. A 20% downpayment works out to Rs 8 lakh. This means a home loan of Rs 32 lakh. The EMI on this works out to Rs 24,809 (7% interest, 20 years repayment period).

A bank typically assumes that around 35-40% of the after tax take home salary can go towards paying this EMI. If the assumption is that around 35% of the salary goes towards EMI, the total after-tax take home salary works out to around Rs 8.5 lakh. The pre-tax salary has to be even higher, more than Rs 10 lakh. How many people make that kind of money in a country where the per capita income is just over Rs  1.5 lakh, is a question well worth asking. This very conservative example explains why real estate in India remains beyond the level of most Indians.

5) There is another problem with the lowest possible price argument. Given the opaqueness surrounding the real estate sector in India, there is nothing like a market price at any given point of time. So how do you even know that the price offered to you is the lowest possible price? Do you just believe what the builder or his broker are saying? Do you have any idea what the price was last year or the year before that?

6) Also, we are told that “home loan interest rates are at 15-year low”. Hence, you should buy a house. The economy during the period April to June contracted by a nearly fourth. It is expected to contract by 10% this year, a level of contraction never seen since Indian independence. Just because home loan interest rates are low should you go out and buy a house? The more important question to answer as always is whether you are in a position to pay the EMI payable against the low interest rates. No wonder this very important point has been missed out on.

It is worth remembering that home loans are floating interest rate loans and interest rates can keep changing in the years to come. If you take on a 20-year home loan now, it doesn’t mean that interest rates will continue to remain low for the next 20 years.

7) And then there is this, my absolute favourite, which I have been hearing for years now: “The property market is poised on the cusp of a full-fledged revival. Once the revival kicks in, property prices will harden and asset appreciation begins in all seriousness.”

This statement reminds me of the different chairpersons that the State Bank of India has had in the last twelve years. Starting with 2009, each one of them has said at some point of time that when it comes to the banking sector in India, the worst is behind us. Well, it’s 2020, the banking sector still has official bad loans of close to Rs 9 lakh crore and they are expected to go up dramatically post-covid.

Every festival season for the last six years the real estate sector has been talking about an impending revival. This revival did not happen when the Indian economy was growing.  And now they expect the revival to happen in a year when the economy is contracting big time. The size that the Indian economy achieved in 2019-20, will now most likely be achieved again only in 2022-23. Jobs have been lost. Incomes have fallen. Small businesses have shut-down or are on the verge of shutting down and the real estate sector is talking about asset appreciation beginning in all seriousness.

I mean all selling involves some amount of fibbing but if you keep doing it all the time and it doesn’t turn out to be true, it loses its power. People start believing in the opposite narrative. As the old fable of the jackal shouting sher aaya sher aaya goes.

8) Here’s another reason the mail offered, to buy a house: “After a protracted period of financial upheaval, it has become necessary to revisit all expenses which represent undue pressure on personal finances. Living in a rented house is a recurring financial drain without returns on investment [emphasis added].”

The part italicised in the above paragraph I have already dealt with in the first point. Nevertheless, the above paragraph needs to be tackled on its own as well. What is the writer saying here? Given the tough economic conditions created by covid, it is time to revisit all expenses. Yes, that makes sense.

But then he goes on to say that renting doesn’t make any sense and you need to make an even bigger expenditure in buying a house and paying an EMI. Buying a house would involve running down savings to make a downpayment and paying a stamp duty. Then there would be moving charges.

At the same time an EMI would have to be paid on a home loan. The chances are that the EMI will be much more than the rental.

Why would anyone who is in financial trouble and trying to cut down on his expenses, be expected to take on higher expenses by buying a house? What’s the logic here? There is no logic to this except to confuse the prospective buyer.

Essentially you are being asked to be penny wise and pound foolish.

9) In the last couple of weeks, the real estate industry has been trying very hard to convince us that the buyers are back in the market and they are lining up to buy homes. Like the mail I got put it: “The best home options are being snapped up at a rapid pace.”

Similar stories have been seen in the media as well. Like the Mumbai edition of The Times of India points out today: “Unlocked MMR shines with 60% rise in home sales in Q2”. Only when you read the story carefully you realise that sales in the Mumbai Metropolitan Region (MMR) during July and September were 60% higher than sales during April to June. And that’s hardly surprising. There were barely any sales in April and May, due to the lockdown. Hence, this was bound to happen.

The real question is how do things look in comparison to July to September 2019. This reveals the real story. Sales between July to September 2020 are 40% lower than the same period last year. Of course, the newspapers are trying to project a real estate revival story given that they are dependent on huge advertisements from real estate companies. Also, it is worth remembering that a lot of home sales that happened in July to September must be pent up demand from April to June, which has spilled over.

10) Another tactic being employed here is to project a lack of supply. As the mail I got puts it: “Developers have curtailed new supply”. Maybe they have. But the larger point here is that lakhs of apartments were bought as an investment in the decade leading to 2015. Many investors are still sitting on it, hoping for a better return. But now due to covid, there are bound to be quite a few distress sales going around. So, it’s a matter of hanging around and looking for one.

As I have said in the past, the real estate market right now is going through a weird low supply low demand situation. There is low demand for real estate (given the high price) and there is low supply as well (given that real estate companies and individual owners are unwilling to cut prices). I may want to buy a home but unless I have enough money and the ability to borrow to do so, I am really not adding to demand. Just wanting something, without having the money to finance it, doesn’t really add to demand.

This situation can only turnaround if the demand improves or if the supply improves. The demand will improve only when the economy turns around and India grows at 7-8% for a sustainable period of time, leading to increased incomes. The supply will improve if prices fall (which means more people are willing to sell the homes they own), of course, that will lead to an increase in demand as well.

Dear reader, you must be wondering by now, itna gyan de diya, now tell us if we should buy a home or not. First and foremost, what does buying a house have to with one year’s festival season or for that matter any other’s? You are not buying a mobile phone, which you buy almost every couple of years and wait for the best deal during the festival season. A home is only bought once or twice during a lifetime.

You should buy a house if you want to live in it, can afford to make the downpayment and most importantly, have a stable income which will allow you to keep paying the EMI on the home loan in the years to come. This also includes the idea of buying a bigger home to adjust to the new reality of working from home.

As mentioned earlier, the most important part here is stable income. If your job or business is on shaky ground, now is not the time to buy a house. If you want to continue living in the posher area of the city, but can only afford to pay a rent for it, then now is not the time to buy a house.

Remember, while you might be building an asset by not paying a rent but by paying an EMI, you are probably also making a compromise in terms of the time you have at your disposal to live the life you want to. If you are comfortable with the idea of a daily rat race then please go ahead and buy a house.

On the flip side, there are advantages to owning a home. One is the fact that you don’t have to change homes frequently, like you have to if you are living on rent. Over the years, I have come to the conclusion that this fear is oversold. The days when landlords used to be only landlords are gone (of course a lot of such people do survive).

Now there are many landlords who have full-fledged corporate careers and are more interested in a regular rental than changing people who they rent out their homes to, every 11 months. Remember it’s a pain for them as well. Also there is the risk of not finding a tenant on time and losing out on a month’s rent. And any sensible landlord will want to avoid that.

The biggest advantage to owning a home is that it tends to make your parents happy (in terms of getting settled in life). Also, the kids can have a slightly stabler life. But it all boils down to whether you can afford to buy a home. On this front, every individual’s situation is different and you need to figure that answer out for yourself. If you feel comfortable with buying a house right now then please go ahead and do that. Don’t wait.

As far as investing in real estate is concerned so that you can flip it later, that idea went out of style in 2013 or 2014 at best. If you still believe in it then either you deal in a lot of black money or probably don’t realise that the times have changed.