Risk Hai Toh Ishq Hai: 20 Things You Can Learn About 1990s By Watching Scam 1992

Over the last weekend I saw Scam 1992—The Harshad Mehta Story. The OTT series is based on a book titled The Scam—From Harshad Mehta to Ketan Parekh written by Debashis Basu and Sucheta Dalal.

The 10-episode series is set around the Harshad Mehta scam where Mehta used banking funds illegally to drive up stock prices. Dalal, a journalist with The Times of India broke the story about Mehta’s shenanigans.

Basu who used to work for Business Today magazine at that point of time (not mentioned in the series) is shown to be helping her all along. The story is told from the point of view both Mehta’s and Dalal’s characters.

I enjoyed watching the series immensely and even tweeted saying that the brief Indian OTT era now needs to be divided into before and after Scam 1992.

Watching the series has also inspired me to write this fun piece where I highlight stuff which was very different in the 1990s vis a vis how things are now.

There might be some spoilers here as well (though very few). So, if you haven’t watched the series and plan to watch it, it’s best you stop reading this piece now. You have been warned 

Let’s take a look at this pointwise.

1) The word scam itself wasn’t very popular with the Indian media until Dalal broke the Harshad Mehta scam and weaved the word into the story she wrote for The Times of India (as shown in the series). The phrase used before this was the rather dull financial fraud.

2) A major part of the series is set in 1992, which was a pre-mobile phone era. Hence, all the action happens through landline phones (thankfully pushbutton landline phones had made an appearance by then and so had big cordless phones).

3) It was also the pre-internet era. You had to remember facts or have access to libraries or research departments. This also meant that if you had to verify a company’s address you had to go there physically and do it and couldn’t simply log onto the internet and do so.

4) Cable TV had just started making an appearance in late 1991. Hence, the government owned Doordarshan was the dominant TV channel. It was also the major source of news, which wasn’t a 24/7 business at that point of time. The newspapers came in the morning. All India Radio had news bulletins at fixed points of time during the day. Doordarshan had news in the evenings (and later even in the mornings).

5) You could just walk into the Bombay Stock Exchange, unlike now where you have to go through multiple levels of security and tell the security guys exactly who you are going to meet. So, for journalists to meet sources was easy. Also, unlike today, the sources could be more easily protected simply because there were no electronic /digital footprints being left anywhere.

6) The Bombay Stock Exchange had a trading ring where jobbers representing stockbrokers made the market by actually buying and selling stocks. This matching of the seller and the buyer happens electronically now. The circular trading ring still exists and is used as a hall for hire for events. The events of BSE as the Bombay Stock Exchange is now known as, also happen in what used to be the trading ring.

7) Unlike now, if you wanted to buy or sell a stock you had to call up your broker and ask him to buy or sell on your behalf. You couldn’t just simply login into your demat account and buy or sell whatever you wanted to.

8) India had 23 stock exchanges at that point of time. Bombay and Kolkata were the most important exchanges. Even Patna had one.

9) The drink offered to everyone visiting the Bombay Stock Exchange was masala tea and not machine coffee, as it is now.

10) The Securities and Exchange Board of India (Sebi), the stock market regulator, did exist, but it did not have statutory powers. Hence, even if they knew that financial shenanigans were happening, they weren’t in a position to do anything. That only happened once the Sebi Act came into being in April 1992.

11) The media newsrooms did not have many computers. The stories were still typed on a typewriter, which meant that one had to have the entire story written in one’s mind before one started typing it out on a typewriter. The way a story can be rewritten now on a computer was rather difficult at that point of time.

12) You could smoke inside a media office. (How journalists would love this).

13) You could smoke on an airplane.

14) You could smoke in restaurants and cafes.

15) The RBI Governor leaked news to the media directly.

16) Even short sellers were popular investors at that point of time. The short-seller Manu Manek was called the Black Cobra of the stock market. (In my two decades of following the stock market, I am yet to come across a short seller the market loves). Interestingly, the stock market’s current darling was also a short seller at that point of time. Short selling involves borrowing and selling stocks in the hope that the price will fall and the stock can then be bought later at a lower price, returned to whom it had been borrowed from, and a profit can be made in the process.

17) The BSE was controlled totally by the brokers in the 1990s. It could even open at midnight to change prices at which trades had happened to help certain brokers.

18) The cars on the road were primarily Premier Padmini, Ambassador and the Maruti. India hadn’t seen an explosion in a choice in car models.

19) Levis Jeans hadn’t made an appearance in India until then, though Debashis’s character is shown wearing them in the series. It was launched in India in 1995.

20) There is a scene in the second episode of the Scam 1992, in which a newsreader is seen saying that this year’s budget has a deficit of Rs 3,650 crore for which no arrangements have been made (or as the newsreader in the series said, jiske liye koi vyawastha nahi ki gayi hai). The reference was to the financial year 1986-87.

Given that the makers of the series have stuck to details of that era as closely as possible, I was left wondering if the Rs 3,650 crore number was correct or made up. I went looking for the budget speech of 1986-87 made by the then finance minister Vishwanath Pratap Singh, and found it.

This is what Singh said on page 32 (and point 168) of the speech: “The proposed tax measures, taken together with reliefs, are estimated to yield net additional revenue of Rs 445 crores to the Centre. This will leave an uncovered deficit of Rs 3650 crores. In relation to the size of our economy and the stock of money, [the deficit is reasonable and non-inflationary.”

The number used in the series is absolutely correct. Hence, the makers of the Scam 1992, have gone into this level of detailing.

But the point here being that back then, the government monetised the fiscal deficit. It simply asked the Reserve Bank of India (RBI) to print money and hand it over to the government to spend. This was stopped in 1997.

To conclude, the key dialogue in the series, which keeps getting made over and over again is, risk hai to ishq hai. The inference being only if you take high risk in the stock market do you earn a high return. The trouble, as was the case in 1992 and as is now, just because you take high risk in the stock market (or anywhere else in life) doesn’t mean you will end up with a high return. Investors who hero worshipped Mehta in the 1990s learnt that the hard way.

Investors still continue to learn this basic principle of the stock market, the hard way.

Not everything has changed.

Lower Interest Rates Good for Govt, Banks and Corporates, Not for Average Indian

The new monetary policy committee which met for the first time over the last two days has decided to keep the repo rate unmoved at 4%. Monetary policy committee is a committee which decides on the repo rate of the Reserve Bank of India (RBI). Repo rate is the interest rate at which RBI lends to banks and is expected to set the broad direction for interest rates in the overall economy.

The RBI has been trying to drive down the interest rates in the economy since January 2019. In January 2019, the repo rate was at 6.5%. Since then it has been cut by 250 basis points and is now at 4%. One basis point is one hundredth of a percentage.
This has had some impact in driving down fixed deposit interest rates of banks. Take a look at the following chart.

The Crash


Source: ICICI Securities, October 3, 2020.

From the peak they achieved between March and June 2019, fixed deposit interest rates have fallen by 170 to 220 basis points.
This in an environment where the inflation has been going up. In March 2019, inflation as measured by the consumer price index was at 2.9%. It had jumped slightly to 3.2% by June 2019. In August 2020, the latest data available for inflation as measured by the consumer price index, had jumped to 6.6%. Meanwhile, fixed deposit rates which were around 7-8%, are largely in the range of 4-6% now (of course, there are outliers to this).

Hence, inflation is greater than interest rates on fixed deposits, meaning the purchasing power of the money invested in fixed deposits is actually coming down.

In fact, interest rate on savings bank accounts, which in some cases was as high as 6-7%, has also come down. Take a look at the following chart.

Another crash


Source: ICICI Securities, October 3, 2020.

Savings bank accounts now offer anywhere between 2.5-3%.

The fall in interest rates is not just because of the RBI cutting the repo rate. A bulk of this fall has happened post the covid breakout. Banks haven’t lent money post covid.

Between March 27 and September 25, the outstanding non-food credit of banks has fallen by 1.1% or Rs 1.1 lakh crore to Rs 102 lakh crore. This means that people and firms have been repaying their loans and net-net in the first six months of this financial year, banks haven’t given a single rupee of a fresh loan.

Banks give loans to Food Corporation of India and other state procurement agencies to buy rice and wheat directly from the farmers. Once these loans are subtracted from overall lending by banks, what remains is non-food credit.

During the same period, the deposits of banks have risen by 5.1% or Rs 6.97 lakh crore to Rs 142.6 lakh crore. With people saving more, it clearly shows that the psychology of a recession is in place.

Banks have not been lending while their deposit base has been expanding at a rapid pace. The point being that banks are able to pay an interest on their deposits because they give out loans and charge a higher rate of interest on the loans than they pay on their deposits.

When this mechanism breaks down to some extent, as it has currently, banks need to cut interest rates on their deposits, given that they are not earning much on the newer deposits. This is bound to happen and accordingly, interest rates on fixed deposits have fallen.

While the supply of deposits has gone up, the demand for them in the form of loans, hasn’t. This has led to the price of deposits, which is the interest paid on them, falling.

But there is one more reason why interest rates have fallen. There is excess money floating around in the financial system. The RBI has printed money and pumped it into the financial system by buying bonds from financial institutions.

This excess money has also helped in driving down interest rates. While banks haven’t been able to lend at all in the first six months of the year, the government borrowing has gone through the roof. As the debt manager of the government, the RBI has printed and pumped money into the financial system to drive down the returns on government bond, in the process allowing the government to borrow at lower interest rates. Take a look at the following chart, which plots the returns (or yields) on 10-year bonds of the Indian government.

Going down

Source: Investing.com

The yield on a government bond is the return an investor can earn if he continues to own the bond until maturity. The above chart clearly shows that as the government has borrowed more and more through the year, the interest rate at which it has been able to borrow money has come down, thanks to the RBI and its money printing.

Of course, with banks not lending on the whole, they are happy lending to the government. In fact, in his speech today, the RBI governor Shaktikanta Das said that the central bank planned to print and pump another Rs 1 lakh crore into the financial system in the days to come.

With more money expected to enter the financial system the 10-year government bond yield fell from 6.02% yesterday (October 8) to 5.94% today (October 9), a fall of 8 basis points during the course of the day.

The monetary policy committee also decided to keep the “accommodative stance as long as necessary”, with only one member opposing it. In simple English this means that the RBI will keep driving down interest rates as long as necessary “at least during the current financial year and into the next financial year – to revive growth on a durable basis and mitigate the impact of COVID-19 on the economy.”

The assumption here is that as interest rates fall people will borrow and spend more and corporations will borrow and expand more. This will help the economy grow, jobs will be created and incomes will grow. While, this sounds good in theory, it doesn’t really play out exactly like that, at least not in an Indian context.

Let’s take a look at this pointwise.

1) A bulk of deposits in Indian banks are deposited by individuals. In 2017-18, the latest data for which a breakdown is available, individuals held around 55% of deposits in banks by value. This had stood at 45% in 2009-10 and has been constantly rising. Hence, it is safe to say that in 2020-21, the proportion of bank deposits held by individuals will clearly be more than 55%.

When interest rates on deposits (both savings and fixed deposits) go down individuals get hurt the most. There are senior citizens whose regular expenditure is met through interest on these deposits. When a deposit paying 8% matures and has to be reinvested at 5.5%, it creates a problem. Either the family has to cut down on consumption or start spending some of their capital (the money invested in the fixed deposit).

This also disturbs many people who use fixed deposits as a form of long-term saving. The vagaries of the stock market are not meant for everyone. Also, in the last decade returns from investing in stocks haven’t really been great.

2) When interest rates go down, the families referred to above cut down on consumption and do not increase it, as is expected with lower interest rates. This may not sound right to many people who are just used to economists, analysts, bureaucrats, corporates and fund managers, mouthing, lower interest rates leading to an increase in consumption all the time. But there is a significant section of people whose consumption does get hurt by lower interest rates.

3) It’s not just about bank interest rates going down. Returns on provident fund/pension funds which hold government bonds for long time periods until maturity and post office schemes (despite being higher than banks), also come down in the process.

4) Also, no corporate is going to invest just because interest rates are low right now. Corporates invest and expand when they see a future consumption potential. This is currently missing. Also, banks lending to industry peaked at 22.43% of the GDP in 2012-13. It fell to 14.28% of the GDP in 2019-20. During the period, interest rates have gone up and down, but corporate lending as a proportion of the GDP has continued to fall. So clearly increased borrowing by corporates is not just about interest rates.

But corporates love to constantly talk about high interest rates as a reason not to invest. This is just a way of driving down interest on their current debt.

As former RBI governor Urjit Patel writes in Overdraft:

“Sowing disorder by confusing issues is a tried-and-trusted, distressingly often successful routine by which stakeholders, official and private, plant the seeds of policy/regulation reversal in India.”

One can understand interest rates going down in an environment like the current one, but there is a flip side to it as well, which one doesn’t hear the experts talk about at all. Also, anyone has barely mentioned the excess liquidity in the financial system, which currently stands at Rs 3.9 lakh crore. Why is that? Let’s look at this pointwise.

1)  The equity fund managers love it because with interest rates going down further, many investors will end up investing money in stocks despite very high price to earnings ratio that currently prevails. The price to earnings ratio of the Nifty 50 index currently is at 34.7. This is a kind of level that has never been seen before.

But with post tax real returns from fixed deposits (after adjusting for inflation) in negative territory, many investors continue to bet on stocks, despite the lack of earnings growth.

2) The debt fund managers love it because interest rates and bond prices are negatively related. When interest rates come down, bond yields come down and this leads to bond prices going up. This means that the debt funds managed by these fund managers see capital gains and their overall returns go up. Hence, debt fund managers love lower interest rates.

3) Banks invest a large proportion of the deposits they gather into government bonds. When bond yields fall, bond prices go up. This leads to a higher profit for banks. This in an environment where banks aren’t lending. Hence, bankers love lower interest rates.

4) Corporates love lower interest rates at all points of time, irrespective of whether they want to borrow or not. I don’t think this needs to be explained.

5) The government loves low interest rates because it can borrow at lower rates. Second, with the stock market going up, it can sell a positive narrative. If the economy is doing so badly, why is the stock market doing well?

6) This leaves economists. Economists love lower interest rates because the textbooks they read, said so.

The question is do lower interest rates or interest rates make a difference when it comes to borrowing by an average Indian? Let’s take a look at non-housing retail borrowing from banks over the years. In 2007-08 it stood at 5.34% of the gross domestic product (GDP). In 2019-2020, it stood at an all-time high of 5.97% of GDP.

In a period of 12 years, non-housing retail borrowing from banks, has barely moved. What it tells us to some extent is that the idea of taking on a loan to buy something (other than a house), is still alien to many Indians.

So, the idea that interest rates falling leading to increased retail borrowing is a little shaky in the Indian context.

To conclude, today the RBI governor Shaktikanta Das gave a speech which was more than 4,000 words long. In this speech, the phrase fixed deposit interest rate did not appear even once.

A whole generation of savers is getting screwed (for the lack of a better word) and the RBI Governor doesn’t even bother mentioning it in his speech. The RBI seems to be constantly worried about the interest rate at which the government borrows.

A central bank which only bats for the government, corporates and bond market investors, is always and anywhere a bad idea.

Shaktikanta Das’ RBI is at the top of this bad idea.

 

Interest on Interest Case Can Open a Pandora’s Box. Govt and SC Need to Be Careful

Late last week the central government told the Supreme Court that it was ready to waive off the interest on interest (i.e. compound interest) on loans of up to Rs 2 crore during the moratorium period of six months between March and August 2020.

In an affidavit submitted to the Court, the government said: “The government… has decided that the relief on waiver of compound interest [interest on interest] during the six month moratorium period shall be limited to the most vulnerable category of borrowers. This category of borrowers, in whose case, the compounding of interest will be waived, will be MSME loans and personal loans up to Rs 2 crore.”

This response was as a part of the matter of Gajendra Sharma versus the Union of India.

The Reserve Bank of India refers to retail loans as personal loans. Hence, the types of loans which would get a waiver of compound interest for a period of six months of the moratorium are home loans, vehicle loans, education loans, consumer durables loans, credit card outstandings, normal personal loans and MSME loans. This benefit will be available to all borrowers who have taken loans of up to Rs 2 crore, irrespective of whether they opted for the moratorium or not.

Before offering my views on this, let’s first try and understand the concept of compound interest or interest on interest.

Let’s consider a home loan of Rs 2 crore to be repaid over a period of 20 years (or 240 months) at the rate of 8% per year. Let’s further assume that the loan was taken during the month of March and was immediately put under a moratorium (the need to make this assumption will soon become clear).

The moratorium lasted six months. The simple interest on the loan of Rs 2 crore amounts to Rs 8 lakh (8% of Rs 2 crore divided by 2). This is not how banks operate. They calculate interest on a monthly basis. At 8% per year, the monthly interest works out to 0.67% (8% divided by 12). The interest for the first month works out to Rs 1.33 lakh (0.67% of Rs 2 crore).

Since the loan is under a moratorium and is not being repaid, this interest is added to the loan amount outstanding of Rs 2 crore.
Hence, the loan amount outstanding at the end of the first month is Rs 2.013 crore (Rs 2 crore + Rs 1.33 lakh). In the second month, the interest is calculated on this amount and it works out to Rs 1.34 lakh (0.67% of Rs 2.013 crore).

In this case, we calculate interest on the original outstanding amount of Rs 2 crore. We also calculate the interest on Rs 1.33 lakh, the interest outstanding at the point of the first month, which has become a part of the loan outstanding.

At the end of the second month, the loan amount outstanding is Rs 2.027 crore (Rs 2.013 crore + Rs 1.34 lakh).  This happens every month, over the period of six months, as can be seen in the following table.

Interest on interest

 

Source: Author calculations.

At the end of six months, we end up with a loan outstanding of Rs 2.081 crore. This is Rs 8.134 lakh more than the initial loan outstanding of Rs 2 crore. As mentioned initially, the simple interest on Rs 2 crore at 8% for a period of six months works out to Rs 8 lakh.

Hence, the interest on interest works out to Rs 13,452 (Rs 8.134 lakh minus Rs 8 lakh).

What was the point behind doing all this math and trying to explain compound interest here?

The maximum amount on which the government is ready to waive off interest on interest is Rs 2 crore. For the kinds of loan under consideration Rs 2 crore outstanding is likely to be either on a home loan or a SME loan. In case of an SME loan, the interest rate will probably be more than 8%.

On a home loan of Rs 2 crore at 8% with 240 instalments (20 years) left to pay, the interest on interest for a period of six months works out close to Rs 13,500. The point is if an individual can afford to take on a loan of Rs 2 crore at 8% interest and pay an EMI of Rs 1.67 lakh, he can also pay an interest on interest of Rs 13,452. In case of an SME loan, the interest on interest would be higher than Rs 13,432, but it wouldn’t be an unaffordable amount. So, what’s the point of doing this?

An estimate made by Kotak Institutional Equities suggests that this move is likely to cost the government around Rs 8,000 crore (Rs 5,000 crore for banks + Rs 3,000 crore for non-banking finance companies (NBFCs)). While Rs 8,000 crore isn’t exactly small change but it’s not a very large amount for the central government.

But that’s not the point here. This move and the Supreme Court dabbling in this case will end up opening a pandora’s box. Let’s take a look at this pointwise.

1) Media reports suggest that the Supreme Court is not happy with the government’s offer to waive off interest on interest. A report on NDTV.com suggests that waiving interest on interest on loans of up to Rs 2 crore “was not satisfactory and asked for a do-over in a week”.

As the report points out: “The affidavit “fails to deal with several issues raised by petitioners”, the court said. The central government has been asked to consider the concerns of the real estate and power producers in fresh affidavits.” Clearly, neither the Court nor the companies are happy with interest on interest of loans of up to Rs 2 crore being waived off.
By offering to waive off interest on interest the government is trying to meet the Court halfway. Also, it is important that the Court along with the government realise that they are interfering with the process of interest setting by banks, something that largely works well.

What is interest at the end of the day? Interest is the price of money. By taking on this case, the Supreme Court has essentially gotten into deciding the price of money. When a bank pays an interest to a deposit holder, it is basically compensating the deposit holder for not spending the money immediately and saving it. This saving is then lent out to anyone who needs the money. This is how the financial intermediation process works.

The government and the Court are both trying to fiddle around with the price of money and that is not a good thing. Today one set of companies have approached the Court to decide on the price of money, tomorrow another set might do the same.

2) The companies are clearly not happy with the interest on interest waiver offer primarily because their loans are greater than Rs 2 crore and they want more. This is hardly surprising.

In the affidavit the government has said: “If the government were to consider waiving interest on all the loan and advances to all classes and categories of borrowers corresponding to the six-month period for which the moratorium was made available under the relevant RBI circulars, the estimated amount is Rs 6 lakh crore.”

To this, the response of the real estate lobby CREDAI was: “A lot of facts and figures in the government’s affidavit are without any basis and the finance ministry’s estimate that waiving off interest on loans to every category would cost banks Rs 6 lakh crore is wrong.”

It is easy to verify this with a simple back of the envelope calculation. As of March 2020, the non-food credit of banks was at Rs 103.2 lakh crore. The banks give loans to Food Corporation of India and other state procurement agencies to buy rice and wheat directly from farmers. Once these loans are subtracted from the overall loans of banks, what is left is non-food credit.

The weighted average lending rate of scheduled commercial banks was at 10% in March 2020 (This is publicly available data). Just the simple interest on non-food credit for six months works out to Rs 5.16 lakh crore (10% of Rs 103.2 lakh crore divided by 2).

Over and above this, there is lending carried out by NBFCs, on which interest on interest will have to be waived off as well. Also, once we take compound interest into account, Rs 6 lakh crore is clearly not a wrong figure as CREDAI wants us to believe.

The weighted average lending interest rate has fallen a little since March. In August, the weighted average lending rate of scheduled commercial banks was at 9.65%. Even after taking this into account, Rs 6 lakh crore is not an unrealistic number at all.  The government and the SC need to be careful regarding any demands of lowering interest rates on loans.

3) The real estate companies have an incentive in getting as much from the Court as possible. Financially, many of them are overleveraged. In fact, the former RBI Governor Urjit Patel in his book Overdraft refers to them as ‘living dead’ borrowers or zombies. And a living dead borrower will go as far as possible to survive at the cost of others. Any new bailout allows them to survive in order to die another day. Also, it allows them to continue not cutting home prices.

Clearly, companies want some reworking on the interest front (the interest on interest for a period of six months isn’t going to amount to much). But this raises a few fundamental questions.

If the Court and the government get around to cutting interest rates on loans, they will be deciding on the price of money. If they do it this one time, they are basically giving Indian capitalists the idea that they can approach the courts and challenge the price of money being charged. What stops it from happening over and over again?

While the government does try and influence the interest rates charged on loans by public sector banks, it can’t do so when it comes to private banks, which now form around 35% of the market when it comes to loans. Nevertheless, if any decision lowering interest rates is made they will end up influencing the price of money of private banks as well. And that isn’t a good thing. The last thing you want in a period of economic contraction is to try and disturb the banking system in any way.

4) Also, any interest rate waiver or reduction will give political parties ideas, like waiving off agricultural loans they can waive off other loans as well. And that can’t be a good thing for the stability of the Indian banking system.

5) If the government really wants to help businesses it can do so by reforming the goods and services tax and making it more user friendly. That will go a much longer way in helping the Indian economy without disturbing a process which currently works well. Any fiddling around with interest rates is largely going to help only zombie companies.

As Urjit Patel writes in Overdraft: “Sowing disorder by confusing issues is a tried-and-trusted, distressingly often successful routine by which stakeholders, official and private, plant the seeds of policy/regulation reversal in India.” This time is no different. Hence, both the government and the Supreme Court need to be very careful in how they deal with this. It is ultimately, the hard earned money of millions of Indians which is at stake. The Indian banking system is one of the few systems which people continue to trust. You wouldn’t want that to break down.

 

A Primer on Bank Interest Rates for Real Estate Companies, Lawyers, Judges, Government and Everyone Else

The Supreme Court is currently hearing the loan moratorium case. Arguments have been made from different sides, on whether banks should charge an interest on loans during the moratorium and if an interest should be then charged on that interest.

I wanted to discuss a few arguments being offered by lawyers who are representing borrowers of different kinds in the Supreme Court. Either their understanding of interest rates is weak, or even if they do understand, they are just ignoring that understanding in order to make a powerful argument before the Supreme Court.

Let’s look at the issue pointwise. Also, this piece is for anyone who really wants to understand how interest rates really work. Alternatively, I could have headlined this piece, Everything You Ever Wanted to Know About Interest Rates But were Afraid to Ask.

1) Appearing for the real estate sector, Senior Advocate C A Sundaram told a bench of Justices Ashok Bhushan, R S Reddy and M R Shah: “Even if the interest is not waived, then it must be reduced to the rate at which banks are paying interest on deposits.”

What does this mean? Let’s say a real estate company has taken a loan of Rs 100 crore from a bank. On this it pays an interest of 10% per year. For the period of the moratorium the company doesn’t pay the interest on the loan. At the end of six months, the interest outstanding on the loan is Rs 5 crore (10% of Rs 100 crore for a period of six months). In the normal scheme of things this outstanding interest needs to be added to Rs 100 crore and the loan the builder now needs to repay Rs 105 crore. Of course, in the process of repaying this loan amount, the company will end up paying an interest on interest. If it wants to avoid doing that it simply needs to pay the outstanding interest of Rs 5 crore once the moratorium ends and continue repaying the original loan.

What Advocate Sundaram told the Supreme Court is that even if the interest on the loan during the moratorium is not waived, the interest rate charged on it should be lower and should be equal to the interest rate that banks are paying on their deposits.

The question of not charging an interest rate on loans during moratorium is totally out of question. Banks raise deposits by paying a rate of interest on it. It is these deposits they give out as loans. If they don’t charge an interest on their loans, how will they pay interest on their deposits?

Bank deposits remain the most popular form of saving for individuals. Imagine the social and financial disruption something like this would create.

Even the point about banks charging an interest rate during the moratorium which is equal to the interest rate they are paying on their deposits, is problematic. Other than paying an interest rate on deposits, banks have all kinds of other expenditures. They need to pay salaries to employees and off-role staff, rents for the offices and branches they operate out of, bear the cost of insuring deposits and also take into account, the loan defaults that are happening.

If the banks charge an interest rate on loans equal to the interest rate they pay on deposits, how are they supposed to pay for all the costs highlighted above?

2) More than this, I think there is a bigger problem with Senior Advocate Sundaram’s argument. Allow me to explain. Interest on money is basically the price of money. When a bank pays an interest to a deposit holder, he is basically compensating the deposit holder for not spending the money immediately and saving it. This saving is then lent out to anyone who needs the money. This is how the financial intermediation business works.

If real estate companies could today ask the courts to decide on the bank’s price of money, the banks could do something similar tomorrow. They could approach the courts with the argument that real estate companies need to reduce home prices, in the effort to sell more units, so that they are able to repay all the money they have borrowed from banks.

If courts can decide on how banks should carry out their pricing, they can also decide on how real estate companies should carry out their pricing. This is something that needs to be kept in mind.

3) This is a slightly different point, which might seem to have nothing to do with interest rates, but it does. The real estate industry is in dire straits and hence, wants the government, Reserve Bank of India (RBI) and the Supreme Court, to help. (I am going beyond what Advocate Sundaram told the Court).

In fact, banks and non-banking finance companies, have already been allowed to restructure builder loans. Former RBI governor Urjit Patel refers to the commercial real-estate-sector as the living dead borrowers in his book Overdraft.

The real estate sector had a great time between 2002 and 2013, for more than a decade, when they really raked in the moolah.

While they did this, they obviously kept the after-tax profits with themselves and they didn’t share it with anyone else. So, why should they be supported now? Why should their losses be socialised? And if losses of real estate sector are socialised, where does the system stop? This is a question well worth asking.

If these losses are socialised, the banks will try making up for it through other ways. This would mean lower interest rates on deposits than would otherwise have been the case. This would also mean higher interest rates on loans than would otherwise have been the case. There is no free lunch in economics.

4) Senior Advocate Rajiv Datta said that banks should not take the moratorium as a default period to charge interest on interest to individual borrowers, including those repaying home loans. As he said: “Profiteering at the cost of individual borrowers during a pandemic is like Shylock seeking his pound of flesh. Individual borrowers were not defaulting.”

While I have no love-lost for bankers, but generations of bankers have had to suffer thanks to the way the William Shakespeare portrayed a Jewish money lender in his play The Merchant of Venice.

The question is why is everyone so concerned only about the borrowers. What about the savers? The average fixed deposit rate is now down to 6%. This, when the rate of inflation is close to 7%. The savers are already losing out. Why should they lose more?

5) Another argument was put forward by Senior Advocate Sanjay Hegde, where he said that banks never passed the benefit of lower repo rate to consumers in the whole of 2019 to garner bigger profits. “When there is a pandemic, they should not think of profiteering and pass on the benefits granted by the RBI to borrowers by lowering the interest rate on loans,” he said.

This is a fundamental mistake that many people make where they assume a one to one relationship between the repo rate and loan interest rates. Repo rate is the interest rate at which the RBI lends money to banks. The idea in the heads of people and often portrayed in the media is that the repo rate is coming down and so, should loan interest rates, at the same pace.

In December 2018, the repo rate was at 6.5%. Since then it has been reduced to 4%. There has been a cut of 250 basis points. One basis point is one hundredth of a percentage. During the same period, the weighted average lending rate on outstanding loans has fallen from 10.35% to 9.71%, a fall of a mere 64 basis points.

So is Senior Advocate Hegde right in the argument he is making? Not at all. As I said earlier, the link between the repo rate and the lending rate is not one to one. The reason for that is very simple. Banks raise deposits and lend that money out as loans. For lending interest rates to fall, the deposit interest rates need to fall.

The weighted average deposit interest rates since December 2018 have fallen from 6.87% to 5.96% or a fall of 91 basis points. We see that even the deposit interest rates do not share a one to one relationship with the repo rate.

Why is that the case? If a depositor invested in a deposit at 8% interest three years back, he continues to be paid that 8% interest, even when the repo rate is falling. Further, even though banks reduce the interest rate they pay on new fixed deposits, they cannot do so on the older fixed deposits. The fixed deposit interest rates are fixed and that is why they are called fixed deposits.

If the repo rate and the fixed deposit interest rates need to have a one to one relationship, meaning a 25 basis points cut in the repo rate leads to a 25 basis points cut in deposit rates, which translates into a 25 basis points cut into lending rates, then banks need to offer variable interest rate deposits and not fixed deposits. Again, that is a recipe for a social disruption.

If we look at fresh loans given by banks, the interest charged on them has fallen from 9.79% in December 2018 to around 8.52%, a fall of 127 basis points, which is much higher than the overall fall of just 64 basis points. This is primarily because the interest rate on fresh fixed deposits has fallen faster than the interest rates on fixed deposits as a whole.

This still leaves the question why has the overall lending rate fallen by 64 basis points when the overall deposit rate has fallen by 91 basis points. One reason lies in the fact that banks have a massive amount of bad loans and they are just trying to increase the spread between the interest they charge on their loans and the interest that they pay on their deposits, by not cutting the lending rate as fast as the deposit rate.

This will mean a higher profit, which can compensate for bad loans to some extent. Over and above this, there is some profiteering as well. But the situation is nowhere as bad as the lawyers are making out to be.

The reason for that is simple. There is a lot of competition in banking and if a particular bank tries to earn excessive profits, a competitor can easily challenge those profits by charging a slightly lower rate of interest and getting some of the business.

To conclude, allowing banks to set their own interest rates is at the heart of a successful banking business. And no one should be allowed to mess around with that. Also, for the umpteenth time, interest rates are not just about the repo rate.

Why is the stock market going up when the economy is going down?

The total collections of the goods and services tax (GST) between March and July stood at Rs 2.73 lakh crore. This is 34.5% lower than what the government earned during the same period in 2019.

The stock market index Nifty 50 has rallied by 53% to 11,648 points between March 23 and August 28. It had touched this year’s low of 7,610 points on March 23.

So, what’s the point in comparing the Nifty 50 with GST collections? The GST is basically a tax on consumption. If the GST collections are down by more than a third, what that basically means is that private consumption is down majorly.

When consumption is down, the company earnings are bound to take a beating. Take the case of two-wheelers and cars. When people don’t buy as many of them as they used to, their production takes a beating. When that happens, it has an impact right down the value chain. It means lower production of steel, steering, glass, tyres, etc. A lower production of tyres means a lower demand for rubber.

A lower production on the whole means lower demand for power. Industrial power largely subsidises farm power and home power (where power is stolen). If industrial power consumption goes down, the losses of state electricity boards go up. When this happens, their ability to keep paying power generation companies goes down. When these companies don’t get paid, they are in no position to repay loans they have taken from banks. So, the cycle works.

Many people buy two-wheelers and cars on loans from banks and non-banking finance companies. When the buying falls, the total amount of loans given by banks also comes down. When banks don’t get enough loans, they need to cut the interest rate on their fixed deposits.

When this happens, people who are saving towards a goal, need to save more. This means they need to cut down on their consumption. Further, people who are largely dependent on interest from bank deposits will see their incomes fall. This means they need to cut down on their consumption as well.

This cycle will also lead to a fall company earnings. A Business Standard results tracker for 1,946 companies reveals that the sales of these companies for April to June 2020 were down 23.1% in comparison to the same period in 2019. The net profit for these companies was down 60.8%.

The stock market does not wait for things to happen. It discounted for this possibility and the Nifty fell by 32.1% between end February and March 23. The market was adjusting for an era of falling company earnings. But it didn’t stay at those low levels and has rallied by more than 50% since then.

The trouble now is that the valuations are way off the chart. The price to earnings ratio of the Nifty 50 index, as of August 28, stood at 32.92. This means that investors are ready to pay close to Rs 33 for every rupee of earning for stocks that make up the Nifty 50 index. Such a level has never been seen before. Not during the dotcom bubble era and not even during early 2008 when the stock market rallied to its then highest level.

Why has the stock market jumped as much as it has? Does this mean that the company earnings will jump big time in the near future? Not at all. The covid-induced recession is not going to go anytime quickly. Also, the pandemic is now gradually making its way into rural India.

So, why is the stock market rallying? The Western central banks led by the Federal Reserve of the United States, the American central bank, have printed a lot of money post February, in order to drive down interest rates and get people and businesses to borrow and spend. The Federal Reserve has printed more than $2.8 trillion between February 26 and August 5. Some of this money has made it into India.

During this financial year, the foreign institutional investors have net invested a total of Rs 83,682 crore into Indian stocks, after going easy on investing in India over the last few years. This is clearly an impact of the easy money policies being run in much of the Western world.

Further, the participation of the retail investors in the stock market has increased during the course of this year. Between December 2019 and June 2020, the number of demat accounts has gone up by 39 lakhs or 10% to 4.32 crore accounts. In fact, between March end, after a physical lockdown to tackle covid was introduced, and up to June, the number of demat accounts has gone up by 24 lakhs.

The latest monthly bulletin of Securities and Exchange Board of India, the stock market regulator, points out: “We have seen a huge surge in participation of retail investors in the equity market in the last few months. The fact that there is also a surge in opening up of demat accounts suggests that many of these retail investors are perhaps first time investors in the stock market.”

With after tax return on bank fixed deposits down to 4-5% when inflation is close to 7%, these investors are coming to the stock market, in search of higher returns.

The question is, with the stock market at all time high valuations, will their good times continue? Or once the dust has settled, is another generation of investors ready to equate stock market investing to gambling? On that your guess is as good as mine.

This article originally appeared in the Deccan Herald on August 30, 2020.