Investing

Sensex falls 4% in a week but easy money rally will be back soon

deflationVivek Kaul  

The BSE Sensex has now been falling for close to a week now. As I write this, it’s trading at around 20,000 points, having fallen by nearly 4% since January 27, 2014.
The main cause of this fall has been the decision of the Federal Reserve of the United States, the American central bank, to go slow on printing money. In a meeting on January 29, 2014, the Fed decided to print $65 billion a month, in comparison to $75 billion earlier.
By doing this, the Fed signalled that it would be going slow on the easy money policy that it had unleashed a few years back, in order to revive the stagnating American economy. The money printed by the Federal Reserve was used to buy government bonds and mortgage backed securities, in order to ensure that there enough money going around in the financial system. This led to low interest rates and the hope that people would borrow and spend more money, and thus help in reviving the economy.
Investors had been borrowing at these low interest rates and investing money all over the world. But with the Federal Reserve deciding to go slow on money printing (or what it calls tapering), this game of easy money is likely to come to an end, soon. At least, that is the way the markets seem to be thinking. And that to a large extent explains why the Sensex has fallen by close to 4% in a week’s time.
One of the major reasons behind the Federal Reserve’s decision to print less money has been the falling rate of unemployment. For the month of December 2013, the rate of unemployment was down to 6.7%. In comparison, in December 2012, the rate had stood at 7.9%. This is the lowest unemployment rate that the American economy has seen, since October 2008, which was more or less the time when the financial crisis started. This measure of unemployment is referred to as U3.
A major reason for the fall in the unemployment numbers has been the fact that a lot of people have been dropping out of the workforce. In December 2013, nearly 3,47,000 workers left the labour force because they could not find jobs, and hence, were no longer counted as unemployed. This took the number of Americans not working to a record 102 million. As Peter Ferrara puts it on Forbes.com “In fact, all of the decline in the U3 headline unemployment rate since President Obama entered office has been due to workers leaving the work force, and therefore no longer counted as unemployed, rather than to new jobs created…Those 102 million Americans are the human face of an employment-population ratio stuck at a pitiful 58.6%. In fact, more than 100 million Americans were not working in Obama’s workers’ paradise for all of 2013 and 2012.” Interestingly, the labour force participation rate, which is a measure of the proportion of working age population in the labour force, has slipped to 62.8%. This is the lowest since February 1978. Also, in December 2013, the American economy added only 74,000 jobs. This was lower than the 1,96,000 jobs that Wall Street had been expecting and was the lowest number since January 2011.
What this means is that even though the rate of unemployment is at its lowest level since October 2008, things are not as well as they first seem to be. Interestingly, in December 2013, the U6 “rate of unemployment” which includes individuals who have stopped looking for jobs because they simply can’t find one and individuals working part-time even though they could work full-time, stood at 13.1%. This was about double the official rate of unemployment of 6.7%. Interestingly, through much of 2013, the U6 rate of unemployment was double the official U3 rate of unemployment.
What all this tells us is that the unemployment scenario in the US is much worse than it actually looks like.
In this scenario it is unlikely that the Federal Reserve can keep tapering or reducing the amount of money that it prints every month. Other than the rate of unemployment, the other data point that the Federal Reserve looks at is consumer price inflation as measured by personal consumption expenditure(PCE) deflator. The PCE deflator for the month of December 2013 stood at 1.1%. This is well below the Federal Reserve target of 2%.
If the PCE deflator has to come anywhere near the Federal Reserve’s target of 2%, the current easy money policy of the Federal Reserve needs to continue. As Bill Gross, managing director and co-CIO of PIMCO wrote in a recent column “the PCE annualized inflation rate– is released near the 20th of every month but you will not see CNBC or Bloomberg analysts waiting with bated breath for its release. I do. I consider it the critical monthly statistic for analyzing Fed policy in 2014. Why? Bernanke, Yellen and their merry band of Fed governors and regional presidents have told us so. No policy rate hike until both unemployment and inflation thresholds have been breached.”
Given these reasons, it is safe to say that foreign investors will continue to be able to raise money at low interest rates in the United States, in the months to come. Hence, the recent fall in the Sensex is at best a blip. The easy money rally will soon be back.
The article originally appeared on www.firstbiz.com on February 4, 2014
(Vivek Kaul is a writer. He tweets @kaul_vivek) 

SUUTI money belongs to UTI investors and not to the government

unit_trust_of_indiaVivek Kaul 
The Specified Undertaking of Unit Trust of India (SUUTI) has appointed three merchant bankers for the sale of 23.58% stake that it holds in Axis Bank, the third largest private sector bank in the country. As of January 21, 2014, the value of this stake works out to around Rs 13,157 crore. This sale will help the government control its burgeoning fiscal deficit. Fiscal deficit is the difference between what a government earns and what it spends.
But the question is does this money really belong to the government? In order to answer this question we need to go back more than ten years and understand why SUUTI was formed in the first place. By 2001, several assured return schemes as well as Unit Scheme-64 (US-64) of the Unit Trust of India (UTI), were in a mess. The government had to come to the rescue of the investors.
In the wake of the crisis, UTI assured unit holders having 5,000 or less units that their units would be redeemed any timebetween 1 August 2001 and 31 May 2003. The incentive to hold on was the promise of Rs 12 for every unit worth Rs 10, if it wasredeemed in May 2003. The assets of UTI were divided into UTI-I and UTI-II. The government took responsibility for UTI-I, to which US-64 and all theassured return schemes of UTI were transferred. UTI-I came to be known as SUUTI and UTI-II became UTI Mutual Fund.
SUUTI continued to repurchase units of US-64 even after May 2003. The first 5000 units were bought back at the rate of Rs 12per unit and the remaining at the rate of Rs 10 per unit. Alternatively, investors were offered 6.75% tax-free US-64 bonds maturing in five years, in lieu of their investments.
Of course, the investments that had been made by the assured returns schemes as well as US-64 were transferred to SUUTI. These investments included stocks like Axis Bank (or what was then known as UTI Bank), L&T and ITC.
Now given that the government rescued the investors in the scheme, shouldn’t it be cashing on the shares owned by SUUTI? The argument is not as straight-forward as that. A lot of investors who invested in UTI were essentially retail investors. They parked their hard earned money into the scheme on the understanding that UTI was a government undertaking.
The government, instead of managing the scheme well turned it into a Ponzi scheme. Take the case of US-64, the flagship scheme of UTI. US-64 was launched on July 1, 1964. It was designed to be a balanced fund sort of scheme, which invested both in shares as well as debt securities. But things started to change from 1993, once the government started disinvesting its stakes in public sector enterprises. These shares were offloaded by the government on to UTI and other government owned financial institutions.
In June 1987, debt securities formed nearly 64% of the corpus of the scheme. By June 2000, this had dropped to 26%. Hence, US-64 became an equity scheme from being a balanced scheme. Interestingly, a lot of the investment in equity went into shady companies. US-64 also accumulated a lot of investments in the so called K-10 stocks, which were being rigged by Ketan Parekh.
Other than making bad investments, US-64 was also paying dividends way beyond what it could afford. In its first year of operation US-64 had paid a divided of 6.1%. It gradually rose to around 10% by 1979-1980. By 1990-1991 this had gone up to 19.5%. This reached 26% in 1992-93, staying there for the next few years.
With the dividend payouts going up dramatically, the income of the scheme also needed to continually keep going up, in order to ensure that UTI could continue maintaing such high dividend levels. UTI had built up very high reserves as it retained a certain percentage of its income and did not give out its entire income left after accounting for expenses as dividend to the unit holders every year.
So UTI dipped into its reserves to continue paying a dividend of 26%, till 1995-1996 because it did not want to lower its dividends. Over the years the dividends paid out were larger than the income of the unit trust. It made up for the difference by dipping into its reserves. But it soon ran out of reserves as well. The next thing it did was that it started to use the money that the new investors brought into US-64 to pay the dividends.
US-64 thus degenerated into a Ponzi scheme, where money being brought in by the new investors was being used to pay off the older investors. On September 30, 1998, a shocked investing public came to know that the reserves of US-64 had turned negative by Rs 1098 crore. On 28th February 2001, UTI managed funds amounting to Rs.64,250 crore or more than 13% of themarket capitalization of the Bombay Stock Exchange. It was around this time that some serious bungling seemed to have taken place. UTI accumulated substantial holdings in what came to be known as the K-10 stocks. These were companies in whichleading stockbroker Ketan Parekh had made big investments. While Parekh withdrew from these stocks, UTI continued to holdonto them. In a private placement exercise, UTI picked up 3.45 lakh shares of Cyberspace Infosys at a price of Rs 930 when themarket price was Rs 1100. The price of the stock later fell to Rs.11.
UTI also accumulated significant stakes in unlisted entertainment and media companies, acquired at prices between Rs 250 andRs 500 per share. This again seemed to be an attempt to mirror Ketan Parekh’s strategy. After moving out of K-10 stocks, Parekhtook a fancy for the stocks of unlisted media and entertainment companies. Most of these companies put their Initial Public Offer(IPO) plans on hold, blocking UTI’s exit route.
This was the final nail in the coffin of US-64 and UTI, and the government had to come to its rescue. As Dhirendra Kumar writes in a column on www.valueresearchonline.com “The government supposedly mounted this rescue and gave the poor investors something. However, the fact that the investors lost out was not their fault. These weren’t people who invested in some shady Ponzi scheme. They trusted the Government of India and invested in that magnificent institution called the Unit Trust of India. Effectively, the government ran UTI to the ground, bought back the assets of its victims for a pittance by offering them a Hobson’s choice, and is now ready to make a killing by selling off those assets when the equity markets are much higher.”
Given this, the profits that the government is now likely to make by getting SUUTI to sell the stake that it holds in Axis Bank, actually belongs to the investors of the assured return schemes and US-64 of UTI.
The article originally appeared on www.firstpost.com on January 22, 2014
(Vivek Kaul is a writer. He tweets @kaul_vivek)

How deflation can spoil the global stock market rally

stock-chart Vivek Kaul  
There are stock market rallies that are currently on across various parts of the world. The stock market rally in the United States is now nearly 5 years old, having started in March 2009. But there is a small factor that investors who are driving up these markets are not taking into account. And that is the current low inflation scenario as well as the prospect of deflation.
As Gavyn Davies writes in The Financial Times “The vast majority of developed countries are currently reporting a headline inflation rate of below 1.5 per cent, with the trend in virtually all of them headed downward.”
Inflation in the Euro area (17 countries in Europe which use the euro as their currency) for the month of December 2013 stood at 0.8%. In December 2012 it had stood at 2.2%. The inflation in the European Union (which includes the euro area countries plus 11 more European countries) was at 1% in December 2013. It was at 2.3% in December 2012.
A similar trend seems to be playing out in the United States. For the month of November 2013, the consumer prices, as measured by the personal consumption expenditures deflator, rose by 0.9%. This number was at 1.7% in November 2012. The personal consumption expenditures deflator is a measure of inflation favoured by the Federal Reserve of United States, the American central bank. The Federal Reserve has an inflation target of 2%. Hence, to that extent consumer prices in the United States are rising at a much slower pace than the target favoured by the Federal Reserve.
As Davies writes “It is hard to remember a period, other than in the months immediately following the financial crash in 2008, when…headline inflation has been so low in so many different economies.”
And why is that a worry? Lets look at the European Union inflation data in a little more detail. Countries like Greece, Cyprus, Latvia and Bulgaria are facing deflation. This means that prices in these countries are falling. In other countries like Sweden, Spain, Italy, France and Portugal, the rates of inflation are less than 1%. In fact, in case of Spain and Portugal these rates are close to 0%.
When prices are falling or it looks like that they will soon start falling, consumers tend to postpone their consumption decisions in the hope of getting a better deal in the future. This has an impact on businesses, and, in turn, the economy in general.
When consumers postpone their buying, businesses try to attract them by cutting prices of their products. This means a loss of revenue and a further fall in the rate of inflation. And this might lead to consumers postponing their consumption even further. So the loop works.
Once countries get into what is known as a deflationary spiral, it is very difficult for them to get out. Japan is an excellent example of the same. The country has been trying to come out of a low inflation/deflation kind of scenario for close to two decades now, without much success.
Investors across the world have chosen to ignore this threat which has been lurking around the corner for a while now. As Albert Edwards of Society Generale writes in a research note titled Markets still refuse to price in deflation threat….. for now dated January 15, 2014, “Investors have yet to react to the deflationary threat however. They do not seem to care that they are sitting on the edge of a cliff. Markets remain stoic about the risks of outright deflation in the US and eurozone for one very simple reason – they simply do not believe a recession that would trigger outright deflation is on the horizon. Quite the reverse – they believe with all their heart that we are at the start of a self-sustained recovery. That is despite the fact that the US recovery is already noticeably longer than average, and that the classic signs of old age, such as rapidly slowing productivity growth and stagnant corporate profits, can clearly be seen.”
A reason for the confidence of the stock market investors is the fact that over the last few years, at the slightest sign of trouble, central banks around the world have printed money (or what they like to call quantitative easing or QE) to keep interest rates low. This has allowed investors to borrow at rock bottom interest rates and invest in financial markets throughout the world. And that will keep the stock market rallies going. As Edwards puts it “Because the market has firmly got it into its head that QE will always be good news for equities. So if the economy swoons, equities will look through any short-term disappointment as more QE will save the day. Investors see bad economic news as good news for equities.”
Hence, investors expect central banks to print more money once they start feeling that deflation is a serious threat to their economies. And the logic is that a lot of this money fill find its way into the stock market and drive prices higher. But there is a problem with this logic.
Until 2012, every time central banks cranked up the printing press, prices of commodities like gold rallied. But that hasn’t happened in the recent past, even though central banks continue to print money. Hence, the proposition that central banks printing money will lead to stock markets rallying, may not always hold true.
As Edwards puts it “I do believe this to be utter nonsense. For in the same way as investors believe, axiomatically that QE will drive up equity prices, they believed exactly the same thing of commodities until 2012. Commodities are a risk asset and benefited massively from QE1 and QE2, so why has QE3 had absolutely no effect on commodity prices? Exactly the same thing could happen to equities if a recession unfolds and profits plunge at the same time as the printing presses are running full pelt. Do not assume equities MUST benefit from QE.”
And this can really spoil the global stock market party. I had asked the well respected financial historian Russell Napier, who works for CLSA, in an October 2012 interview I did for the Daily News and Analysis, that by what level does he see the stock markets falling in the coming deflationary shock. And he had replied “I will just go back to my book Anatomy of the Bear, which was published in 2005 and in the book I forecasted that the equity market, the S&P 500 (an American stock market index constructed from the stock prices of the top 500 publicly traded companies) will fall to 400 points [On Thursday, January 16, 2014, the S&P 500 closed at 1,845.89]. As you know, in March 2009 it got to 666 points. It got somewhere there but it did not get to 400. So I am happy to stick with the number of 400.”
And once the S&P 500 starts to crash, the rest of the world will follow. Of course, till that happens, there is money to be made.
The article originally appeared on www.firstpost.com on January 17, 2014 
(Vivek Kaul is a writer. He tweets @kaul_vivek) 

How banks help keep real estate prices high

 India-Real-Estate-MarketVivek Kaul
 John Maynard Keynes, the greatest economist of the twentieth century, once remarked “markets can remain irrational longer than you can remain solvent.” In simple English, one of the interpretations of this statement is that the bubbles can keep running for a very long period of time.
The Indian real estate sector is an excellent example of the same. It has been a bubble for the last few years now, but hasn’t burst.
Before we go any further it is important to define the word ‘bubble’. The Financial Times Lexicon defines an asset bubble as follows: “When the prices of securities or other assets rise so sharply and at such a sustained rate that they exceed valuations justified by fundamentals, making a sudden collapse likely – at which point the bubble bursts.”
The problem with this definition is that no one really knows when the bubble will burst. The fundamentals may point out to the fact that the bubble might burst any time soon, but that may or may not happen.
Lets try and understand this in the context of Indian real estate. How good are the fundamentals? It is a well known fact that real estate companies are having a tough time trying to sell homes they have already built up (or what in technical terms is referred to as inventory). As a November 2013 report of Colliers International points out “Pressures of increasing unsold inventory and a liquidity crunch resulted in fewer project launches. There was an increase in the incentives being offered to sell property, such as easy payment plans, discounts and free gifts with bookings.”
So homes in projects that have already been built up are lying unsold. And the number of new projects being launched have come down. As a December 2013 report in the Business Standard points out “New property launches in the residential segment across cities declined 12 per cent in the year, with Chennai recording the sharpest drop at 39 per cent, followed by the National Capital Region at 33 per cent and Pune at 20 per cent, according to a report by Cushman & Wakefield. Mumbai recorded just 6 per cent growth in launches.”
What this tells us is that the demand for real estate has slowed down. So, why aren’t prices coming down is the logical question to ask? One reason is the fact that a lot of homes that have already been bought have been bought by investors, who are in no hurry to sell out. Shashank Jain executive director, PwC India explained this point in a recent interview to the Daily News and Analysis (DNA). He said that investors are largely of two types—those looking to deploy black money—and senior executives looking to invest in their in a second or third home.
“One, the business community with an element of unaccounted surplus being parked in realty. The government is trying to control them by imposing TDS (tax deducted at source) of 1% on an amount of Rs50 lakh and more. Two, a significant chunk of investment is made by white collar executives, especially in the metro micro markets. This class of investors is putting its surplus income in a second or third home. They don’t have exit pressure. That again means that prices will not come down significantly,” said Jain.
This explains to some extent why real estate prices are not falling. But it does not explain why real estate companies are not cutting prices to get rid of their surplus inventory. It only explains why investors are holding on to homes they have already bought.
It is important to understand that any bubble keeps running till money keeps coming into it. Between 2005 and 2012, a lot of money came into real estate through the private equity route. As Manish Bhandari of Vallum Capital writes in a report titled The End game of speculation in Indian Real Estate has begun “Private Equity investments drove in hordes after opening of Foreign Direct Investment (FDI) in real estate sector in the year 2005. The high structural growth story of India attracted a lot of private equity capital the in real estate industry during the Yr 2005-2012, with major inflows coming in the Year 2007-09. Close to $US 20 bn of inflow came to into real estate & construction business, which has put the prices on steroids.”
So, over a period of time, money coming in from the private equity investors has kept real estate prices high. But as Bhandari says private equity inflows peaked during the period 2007 to 2009. There has to be a more recent reason for real estate prices not falling.
The answer lies in some interesting data provided by the Reserve Bank of India (RBI). Between November 30, 2012 and November 29, 2013, the total loans given by banks (excluding food credit) grew by 14.7%. During the same period loans given to commercial real estate grew by a much faster 19.1%. This, in an environment where real estate companies have huge inventories and the launch of new projects has slowed down considerably. So, why are banks lending money to real estate companies? And what are real estate companies doing with that money?
The only possible explanation is that banks are essentially giving fresh loans to real estate companies so that the companies can repay their old loans. This has allowed real estate companies to not cut prices on their unsold inventory. If bank loans had not been so forthcoming, the real estate companies would have to sell off their existing inventory to repay their bank loans. And in order to do that they would have to cut prices.
But that hasn’t happened. Interestingly, between November 2008 and November 2013, total loans given by banks (excluding food credit) grew by 57.4%. During the same period lending to commercial real estate grew by 86.2%.
And this is what has kept real estate prices high. As Pankaj Kapoor, owner and managing director, Liases Foras, a real estate rating and research firm, told Business Today recently “if capital availability becomes difficult, developers may have to cut prices to push sales.”
It is also worth remembering that the average life of a private equity fund is seven to eight years. And all that money that private equity investors have brought in over the last few years, will now have to be returned by real estate companies. In order to do that real estate companies will have to sell the existing inventory that they have piled up.
As Bhandari points out “With the average life of private equity fund being around 7-8 years, the Year 2013 marks the beginning of private equity returning back to shores. The imperative is to see down inventory and return the capital back to investors…The exit of private equity, a fair weather friend of developer, is going to create distress sale situation in real estate industry, shortly. This would lead to depressing price situation for the next 18 months, scaring further fund raising in this sector.”
Another factor that could work towards real estate prices falling are the impending Lok Sabha elections. A lot of black money of politicians is locked up in real estate. And this will have to be unlocked in order to get money to fight elections. As Bhandari points out “According to various estimates an election for central government can cost upwards of US$ 5-6 bn, while average state government elections costing around one billion dollar. With impending central and state election in ten states, costing around US $15 bn, Real Estate will witness outflow of money to fund these elections over the next 18 months.” A similar trend played out before the 2009 Lok Sabha elections when prices fell by around 20% in many markets. But that was also an impact of the start of the current financial crisis with the investment bank Lehman Brothers going bust.
Whether this happens again remains to be seen, simply because as Keynes said ““markets can remain irrational longer than you can remain solvent.”
 The article originally appeared on www.firstpost.com on January 7, 2014
(Vivek Kaul is a writer. He tweets @kaul_vivek) 
 

How fiscal deficit killed Rajan's inflation indexed bonds

 ARTS RAJANVivek Kaul  
Before taking over as the governor of the Reserve Bank of India(RBI), Raghuram Rajan was the Chief Economic Advisor to the Ministry of Finance. As the Chief Economic Advisor, Rajan authored the Economic Survey, which was released before the budget presented in February 2013.
In this survey there was a detailed discussion on the fascination Indians have for gold. The survey came to the conclusion that Indians were buying gold to protect themselves against the high consumer price inflation prevailing for the last few years. It also said that there were no financial instruments in which Indians could invest ]in order to protect their purchasing power. Hence, they ended up buying gold.
“The overarching motive underlying the gold rush is high inflation and the lack of financial instruments available to the average citizen, especially in the rural areas,” wrote Rajan. “The rising demand for gold is only a “symptom” of more fundamental problems in the economy. Curbing inflation, expanding financial inclusion, offering new products such as inflation indexed bonds, and improving saver access to financial products are all of paramount importance,” he added.
The survey was released in February 2013. At that point of time India was dealing with high gold imports which were putting pressure on the rupee. India produces almost no gold of its own. Hence, all the gold that is consumed in this country needs to be imported. Every time, gold is imported, the importer needs to sell rupees in order to buy dollars, which he uses to pay for gold. As more gold is bought more rupees are sold to buy dollars to pay for gold. This puts pressure on the value of the rupee against the dollar.
In fact, on April 30, 2013, one dollar was worth Rs 53.81. By August 28, 2013, one dollar was worth Rs 68.83. The rupee rapidly lost value against the dollar.
Raghuram Rajan took over as the governor of the RBI on September 4, 2013, and very soon inflation indexed bonds for retail investors were launched. This was in line with what Rajan had written in the Economic Survey released in February 2013.
These bonds offer an interest rate of 1.5% over and above the rate of inflation measured through the consumer price index. So, if the inflation measured through the consumer price index is 10%, like it currently is, then the rate of interest offered on these bonds would be 11.5%.
This is higher than what any bank fixed deposit is offering at this point of time. But the trouble with these bonds is that the rate of interest will keep varying with the rate of inflation. And if the rate of inflation falls then the rate of interest on offer will fall as well.
In case of fixed deposits that is not the case. If an individual puts money in a five year fixed deposit
offering an interest of 9% right now, he will continue to get an interest of 9%, even if the inflation falls from the current 10% to let us say around 6%. In that case, the interest on the inflation indexed bonds will fall to 7.5% (6% inflation + 1.5%).
This uncertainty has been one of the reasons why these bonds haven’t really taken off among investors. As a report in the Daily News and Analysis(DNA) points out “A check at few private and public sector banks revealed that they haven’t seen a significant interest from consumers for this product.” In fact, in a bid to ensure that more people invest in these bonds, the RBI recently extended the deadline to invest in these bonds to March 31, 2014, from an earlier date of December 31, 2013.
These bonds are being sold through banks. For a bank, inflation indexed bonds are a direct competition with fixed deposits and, hence, any bank is unlikely to encourage people to invest in inflation indexed bonds on its own.
Unless, the bank is offered a high commission to do so. Insurance companies offer banks high commissions to sell investment plans masquerading as insurance. And that is what most banks are interested in selling these days. As the report in the DNA referred to earlier points out “Bankers also agreed that they are not marketing the products aggressively. This is not surprising considering that they have not been incentivised enough. RBI pays a nominal amount to banks for the sale of IIBs, this is way lower than the 1-5% that is paid by insurance companies as commission, explain bankers. Not surprisingly then, Ulips[unit linked insurance plans] and other life insurance products are offered as the top investment options by relationship managers in all banks.”
Given this lack of commission on inflation indexed bonds, it is unlikely that banks will ever get around to selling them to their customers. The new pension scheme(NPS) is an example of another excellent product which is there in the market, but practically no bank pushes it because they barely make any commission on it.
Hence, if the inflation indexed bonds are to take off, then the commissions that are offered by insurance companies on investment plans masquerading as insurance, need to be brought down further. The question is whether the government will get around to doing this?
While commissions offered by insurance companies have fallen over the years, but they still remain higher than the commissions offered on almost all other financial products. This ensures that banks and other financial firms are interested in only selling insurance.
The government is unlikely to cut commissions any further given that it needs the Life Insurance Corporation(LIC) of India to help finance its fiscal deficit. Fiscal deficit is the difference between what a government earns and what it spends. . A large portion of the money raised by LIC is used to buy government bonds. This helps the government finance its fiscal deficit easily.
The government also uses LIC to bailout its disinvestment programme. The government sells shares in public sector enterprises to help finance the fiscal deficit. On several occasions, stock market investors do not want to invest in these shares. On such occasions, LIC is directed to pick up these shares.
Hence, the government needs LIC to finance its fiscal deficit. The LIC needs to keep selling more and more insurance policies. And for that to happen, it needs to keep offering a high rate of commission to its agents all over the country.
This is the major reason why Raghuram Rajan’s grand plan of getting Indians to invest in inflation indexed bonds instead of gold, will not take off. It will take off only when insurance commissions are brought in line with commissions on offer on other financial products, so that banks and investment advisers are interested in selling a product that is best for their customer rather than the product which offers the highest commission. And that will happen only when the fiscal deficit is under some sort of control.
The article was published on www.firstpost.com on January 6, 2014
(Vivek Kaul is a writer. He tweets @kaul_vivek)