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 Large Economies Are In a Technical Recession

Almost all large economies in the world, other than China, are in the midst of a technical recession, with their gross domestic product (GDP) having contracted for two or more quarters. On Friday, India became the latest large economy to enter this list. The spread of the covid pandemic and a big fear of a possible second wave, have led to consumers and businesses being very careful in the way they spend their money and saving for a possible rainy day.

What is a technical recession?

When the GDP of any economy contracts for two consecutive quarters, economists refer to the situation as a technical recession. GDP is a measure of economic activity and size of a country. Let’s take the case of the United States. The GDP contracted by 9% between April and June 2020 in comparison with the same period in 2019. It contracted again by 2.9% between July and September 2020. So, as of end September, the American economy was in a technical recession.

If we consider the United Kingdom, the economy has contracted in each of the periods between January to March, April to June and July to September, by 2.1%, 21.5% and 9.6%, respectively. Hence, the country has been in a technical recession since the end of June. The only exception to this has been China, which has grown by 3.2% and 4.9%, respectively, between April and June and July and September.

How is a technical recession different from a recession?

An economic scenario where the economy of a country has been contracting for a long period of time, is referred to as a recession. The trouble is there is no standard definition for how long is long. The National Bureau of Economic Research in the United States defines a recession as “a significant decline in economic activity that is spread across the economy and lasts more than a few months”.

Hence, if the current decline in economic activity across countries continues in the months to come, then we can safely say that we are in the midst of a recession. The spread of covid has led to economic activity slowing down. Businesses in order to continue to exist have slashed salaries and/or fired people. Even those who haven’t been fired live with the fear of getting fired. All this has led to a slowdown in people and businesses spending money.

When was the last time the world was in a recession?

Lehman Brothers, the fourth biggest investment bank on Wall Street, went bust in mid-September 2008. Many other financial institutions came under huge financial stress and had to be rescued by the governments and the central banks of the United States and Europe. The trouble spilled from Wall Street to Main Street and a recession hit the Western economies.

The central banks in the Western world printed a huge amount of money to drive down interest rates, in the hope that people will borrow and spend, and businesses will borrow and expand. A lot of this money found its way into stock markets all across the world. The interesting thing is that even in 2020 the central banks are using the same formula. They have printed a lot of money to revive economies. The Federal Reserve of the United States has printed more than $3 trillion between end of February and now.

When did India enter a technical recession?

The Indian economy had contracted by 23.9% during the period April to July. This was the largest contraction among all large economies of the world. It contracted again by 7.5%, between July to September, thus entering a technical recession. Hence, as of end September the Indian economy has been in the midst of a technical recession.

Why has this happened? Private consumption, or the stuff that people buy, and which forms more than half of the Indian GDP, has completely collapsed. Between April and June, it contracted by 26.7%. It contracted by 11.3%, between July and September. As mentioned earlier, this is primarily because of people saving more for a rainy day. This can be gauged from the fact that deposits in the Indian banking system have gone up 6% or Rs 8.1 trillion between end of March, when covid first started to spread in the country, and now.

How can the world get out of this economic mess?

The British economist John Maynard Keynes had a term for a situation like this – the paradox of thrift. When a society as a whole saves substantially more, it hurts the economy, simply because one man’s spending is another man’s income. Hence, in recessionary times, when individuals and businesses are spending less money, the government needs to chip in and spend more money than it usually would have.

This spending puts more money in hands of people. And if they go out there and spend it, it helps in economic revival. The trouble is that thanks to a recessionary environment, tax collections have collapsed. Some governments have resorted to printing more money to finance extra expenditure and hoping to create growth. But not every country has this option because money printing can lead to higher prices or inflation, as a greater amount of money chases the same set of goods and services.

This piece originally appeared in the Khaleej Times on November 30, 2020.