Base rate

All Bank Deposits Post Notebandi Have Been Invested in Govt Securities

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One of the many theories offered in favour of demonetisation or notebandi, has been that it has led to lower interest rates. The demonetised notes of Rs 500 and Rs 1,000 had to be deposited into the banks, where the money would be credited against the depositors’ name.

This has essentially led to the total amount of deposits with banks increasing at a rapid rate. Between October 28, 2016, before the demonetisation happened, and January 20, 2017, the total deposits of banks went up by 5.7 per cent. This increase in a period of under three months is huge.

With an increase in deposits, banks have cut interest rates. The logic offered by many experts was that this cut in interest rates will lead to an increase in lending by banks and that would be good for the economy. But the data suggests that anything like that hasn’t happened.

Take a look at Figure 1. It essentially shows the portion of bank deposits that have been invested in government securities, in the recent past.

Figure 1:

 

What does Figure 1 tell us? As on October 28, 2016, before demonetisation was carried out, around 29 per cent of bank deposits had been invested in government securities. As on January 20, 2017, the latest data that is available, the proportion had jumped to 34.1 per cent. Banks need to compulsorily invest just 20.5 per cent of their deposits in government securities.

Further, between October 28, 2016, and January 20, 2017, the total amount of money banks got as deposits stands at Rs 5.63 lakh crore. During the same period, the total amount of money banks invested in government securities was Rs 6.99 lakh crore. This basically means that during the period under consideration 124 per cent of the money that came in as bank deposits was invested into government securities. Hence, not only all the deposits that came in between October 28, 2016, and January 20, 2017, have been invested by banks into government securities, some of the earlier deposits have also been invested into government securities.

Given that cash is fungible, this basically means that on the whole banks haven’t loaned out any of the deposits that have come after demonetisation. All that money has been invested into government securities.

Now let’s take a look at Figure 2. This essentially plots the portion of bank deposits which have been given out as loans (i.e. non-food credit). Banks give working-capital loans to the Food Corporation of India to carry out its operations, those have been adjusted for.

Figure 2: 

What does Figure 2 tell us? It tells us that before demonetisation banks had loaned out 73.3 per cent of the deposits. This has since fallen to 69.7 per cent. This isn’t surprising given that banks cannot immediately lend out all the money that has come in.

There is another question that needs to be answered here. Given that interest rates have fallen because of demonetisation, how much has bank lending gone up by, before and after demonetisation? Between October 28, 2016, and January 20, 2017, lending by banks went up by a minuscule 0.45 per cent. This basically means that the lending has more or less been flat.

Also, given that all the deposits that have come in since October 28, 2016, have been invested in government securities, this essentially means that some of the deposits that had come in earlier, have been lent out.

This, also tells us, all over again, that lower interest rates are not the only factor that leads to increased borrowing. Hence, the theory of lower interest rates leading to increased borrowing leading to better economic well-being, due to monetisation, does not really work. The data does not show that at all.

There is another point that needs to be made here. A significant amount of investments made by banks in government securities has been made under the market stabilisation scheme(MSS). The government securities issued under the market stabilisation scheme has all the characteristics of regular government securities. But, unlike the regular government securities, these securities are not issued to finance the fiscal deficit of the government. Fiscal deficit is the difference between what a government earns and what it spends and is financed by issuing financial securities referred to as government securities.

What this basically means is that money borrowed under the market stabilisation scheme lies idle. It isn’t used to finance the expenditure of the government. On December 2, 2016, the RBI increased the ceiling of the government securities that could be issued under the market stabilisation scheme to Rs 6 lakh crore. Earlier the limit was Rs 30,000 crore.

As the RBI pointed out in a press release: “After the withdrawal of the legal tender character of the Rs 500 and Rs 1000 denomination notes with effect from November 9, 2016, there has been a surge in the deposits with the banks. Consequently, there has been a significant increase of liquidity in the banking system which is expected to continue for some time.”

The government securities issued under the market stabilisation scheme sucked out this liquidity. But this money has been lying idle with the RBI. Earlier it was a part of the financial system and was helping people carry out transactions. This has reduced the velocity of money. And a lower velocity of money leads to lower economic activity.

Over and above this, the surfeit of deposits coming in has led to banks slashing the interest rates on their fixed deposits. Take a look at Figure 3.

Figure 3: Repo, Base Lending Rate and Term Deposit Rate (Per cent) 

Let’s analyse Figure 3 in some detail. The base rate is essentially the interest rate below which a bank cannot lend i.e. the interest rate at which a bank lends to its best customer. The term deposit rate is essentially the interest rate that a bank pays on its fixed deposits.

Since January 2014, the term deposit rate of banks has fallen. At the same time, the base rate has also fallen. Nevertheless, the term deposit rates have fallen much more and at a far greater speed than the base rates.

This is something that becomes clear by looking at Figure 3 carefully. The gap between the average base rate and the average term deposit rates has increased considerably between January 2014 and December 2016. The base rate has barely moved from 10 per cent to around 9.5 per cent. On the other hand, the term deposit rate has moved from around 8.5 per cent and is now below 7 per cent.

As the Economic Survey points out: “By December 2016 the gap between the average term deposit rate and the average base rate had grown to 2.7 percentage points, from 1.6 percentage points in January 2015.”

The question is why have the banks done this? Over the longer term, the banks have been trying to make up for their bad loans by doing this. As the Economic Survey points out: “They have tried to compensate for the lack of earnings from the non-performing part of their portfolio by widening their interest margins.”

Over the short term, they are simply doing this because of the surfeit of deposits that have come in. They have invested this money in government securities (a large part), which do not pay a high rate of return like lending that money out would. To compensate for this, the banks have cut interest rates on their fixed deposits faster than the interest rates on their loans.

Hence, notebandi or demonetisation has led to lower interest rates on fixed deposits. A major part of the household financial savings in India are held in the form of bank fixed deposits. Anyone looking to meet an investment goal now must save a greater amount and this will leave a lower amount of money for consumption.

Further, lower interest rates haven’t led to a higher lending by banks. All this has led to is money lying idle with the RBI. And that is something that India cannot afford.

(The column originally appeared on Equitymaster on February 16, 2017)

Explained: What Raghuram Rajan Just Did To Make Monetary Policy More Effective

ARTS RAJAN
In the last monetary policy statement released by the Reserve Bank of India(RBI) on December 1, 2015, the governor Raghuram Rajan had said: “Since the rate reduction cycle that commenced in January [2015], less than half of the cumulative policy repo rate reduction of 125 basis points [one basis point is one hundredth of a percentage] has been transmitted by banks. The median base lending rate has declined only by 60 basis points.” Repo rate is the rate at which RBI lends to banks and acts as a sort of a benchmark to the interest rates that banks pay for their deposits and in turn charge on their loans.

What this means is that even though the Rajan led RBI has cut the repo rate by 125 basis points, banks in turn have cut their lending rate by only around 60 basis points on an average. This clearly tells us is that the monetary policy of the RBI (or the process of setting interest rates) has only been half effective.

Why is that the case? A major reason for this lies in the way the banks calculate their base rate or the minimum interest rate that a bank can charge its customers. How is this base rate calculated? As the RBI Draft Guidelines on Transmission of Monetary Policy Rates to Banks’ Lending Rates released earlier this year pointed out: “At present, banks follow different methodologies for computing their Base Rate. While some use the average cost of funds method, some have adopted the marginal cost of funds while others use the blended cost of funds (liabilities) method. It was observed that Base Rates based on marginal cost of funds are more sensitive to changes in the policy rates.”

What does this statement mean? Some banks follow the average cost of funds method to decide on the base rate of their lending. The average cost of funds is the average interest rate that a bank pays on the fixed deposits and other borrowings that it raises. In this scenario if the average cost of funds of the bank is high, a cut in the repo rate is not going to lead to a similar cut in the base rate of the bank.

Hence, even if the RBI cuts the repo rate, the chances of the bank passing on a similar interest rate cut to its prospective borrowers remains low. The trouble here is that banks do go ahead and cut their deposit rates without cutting their lending rates. Hence, they pay a lower rate of interest rate on their deposits but continue to charge a higher rate of interest on their loans. They make more money in the process. Over the last few years, the public sector banks have piled up a lot of bad loans and it has been interest to cut deposit rates without cutting lending rates. It also leads to a situation where the RBI repo rate cut does not percolate through the financial system, making the monetary policy only partially effective.

On the other hand, some banks use the marginal cost of funds to decide on their base rate. The RBI found that banks which used this method where much more faster in cutting interest rates on their loans. Marginal cost of funds is essentially the interest rate that a bank pays on its new deposits as well as other borrowings.

As the RBI Draft Guidelines referred to earlier point out: “The marginal cost should be arrived at by taking into consideration all sources of fund other than equity. Cost of deposits should be calculated using the latest interest rate/card rate payable on current and savings deposits and the term deposits of various maturities. Cost of borrowings should be arrived at using the average rates at which funds were raised in the last one month preceding the date of review. Each of these rates should be weighted by the proportionate balance outstanding on the date of review.”

In a release last week, the RBI said that from April 1, 2016 onwards it wants all banks to follow the marginal cost of funding method to decide on their base rate. This means that if the banks cut their deposit rate in the aftermath of a RBI repo rate cut, they will have to cut their lending rates as well, because their marginal cost of funding will automatically fall. By doing this the RBI has essentially ensured that new borrowers of the bank will have access to lower interest rates automatically once the bank decides to cut its deposit rates.

Further, banks cannot lend below the marginal cost of funds based lending rate. This rate needs to be declared every month on a given date, though during the first year banks have been allowed to declare this rate once every three months.

Also, banks have been asked to declare a marginal cost of funds based lending rate for  overnight loans, one-month, three-months, six-months and one-year loan. The banks have been given the option of publishing the marginal costs of funds based lending rate of maturities longer than one year as well.

What this means is that the banks now have the opportunity of matching their loans with their deposits. Hence, a loan being given out for a period of one year can be given out at the marginal rate of interest that the bank pays on a deposit (or any other borrowing) for a one- year period plus a certain spread over and above it.

As R.K. Bansal, executive director at IDBI Bank Ltd told Mint: “The differentiation based on tenor will be a big positive for banks as now we would be able to price our loans based on the deposits of the corresponding tenor, rather than the older practice of considering 3-6 month deposit rate for computing base rates for all loans.” Following this process banks can now largely avoid the asset-liability mismatch between their loans and their deposits, that they used to get into earlier.

How will this work for new borrowers? They will pay the rate of interest determined by the marginal cost of funds method until the date of the next reset. The reset date has to be one year or lower and has to be a part of the loan contract.

And how will this work for old borrowers i.e. those who have already borrowed from the bank under the old base rate regime? In this case, the borrowers will continue to pay their EMIs as they have been during the past. The banks will keep publishing the base rate as per the old method. In fact, old borrowers have an option of moving “to the Marginal Cost of Funds based Lending Rate (MCLR) linked loan at mutually acceptable terms.” The RBI has asked the banks not to treat this as a foreclosure of existing facility.

This methodology is expected to help banks to react faster to the repo rate cuts by the RBI by passing on similar interest rate cuts on their lending to new borrowers. In fact, once banks move on to this new way of calculating lending rates, new borrowers are likely to pay a lower rate of interest on their loans, in comparison to what they currently are.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

The column originally appeared in Swarajya Mag on December 23, 2015

Why EMIs and interest rates fall more on front pages of newspapers than real life

newspaperRegular readers of The Daily Reckoning would know that I am not a great believer in the repo rate cuts leading to an increase in home buying and as well as consumption, with people borrowing and spending more, at lower interest rates. Repo rate is the rate at which the Reserve Bank of India (RBI) lends to banks and acts as a sort of a benchmark to the interest rates that banks pay for their deposits and in turn charge on their loans.

A basic reason is that the difference in EMIs after the rate cut is not significant enough to prod people to borrow and buy things. Further, they should be able to afford paying the EMI in the first place, which many of them can’t these days, at least when it comes to home loan EMIs.

These reasons apart there is another problem, which the mainstream media doesn’t talk about enough. All they seem to come up with are fancy tables on how interest rates and EMIs are going to fall and how this is going to revive the economy. And how acche din are almost here. Now only if it was as simple as that.

A cut in the repo rate is not translated into exact cuts in bank lending rates. After any repo rate cut, banks quickly cut their deposit rates. They cut their lending rates as well, but not by the same quantum.

As a recent study carried out by India Ratings and Research points out: “In the recent policy cycle, RBI has cut policy rates since January 2015 by a cumulative 125 basis points, banks have cut one year deposit rates by an average 130 basis points and lending by 50 basis points, which includes the base rate cuts in the last one week. Base rate is the rate below which a bank cannot lend. In the last 18 months three-month commercial paper and certificate of deposit rates have fallen by 150 basis points. Thus transmission of policy rates has been more through market rates and banks deposit rates in the last one year.” One basis point is one hundredth of a percentage.

In an ideal world, a 125 basis points cut in the repo rate by the RBI should have led to a 125 basis points cut in the lending as well as deposit rates. But that doesn’t seem to have happened. While the one-year deposit rates have been cut by 130 basis points, the lending rates have gone down by just 50 basis points.

And this is a trend which is not just limited to the current spate of rate cuts by the RBI. This is how things have played out in the past as well. As Crisil Research had pointed out in a report released in February 2015: “Lending rates show upward flexibility during monetary tightening but downward rigidity during easing. Between 2002 and 2004, while the policy rate declined by 200 basis points, lending rates dropped by just 90-100 basis points. Conversely, in 2011-12, when the policy rate rose by 170 basis points, lending rates surged 150 basis points.”

So, the point being that when the RBI starts to raise the repo rate, banks are quick to pass on the rate increase to their borrowers, but the vice-versa is not true.

As India Ratings and Research points out: “The policy cycle is being used by banks to their advantage. A study of the last 10 years shows, that in most cases when policy rates have reduced, deposit rates have comedown faster and the quantum has also been higher compared to lending rates. The same was also true when policy rates were hiked, where lending rates went up and the quantum was also higher compared to deposit rates.”

Also, this time around banks have been quick to cut their base rates, the minimum interest rate a bank charges its customers, after the RBI cut the repo rate by 50 basis points to 6.75%, in September. Having cut their base rates, banks have increased their spreads, and negated the cut in base rate to some extent.
Take the case of the State bank of India. The country’s largest bank cut its base rate by 40 basis points to 9.3%, in response to RBI cutting the repo rate by 40 basis points.

This meant that the interest rate on home loans should have fallen by 40 basis points as well. Nevertheless, the interest rate on an SBI home loan will fall by only 20 basis points. Why is that? Earlier, the bank gave out home loans to men at five basis points above its base rate (or what is known as the spread). To women, the bank gave out home loans at the base rate. Now it has decided to give out home loans to men at 25 basis points above the base rate. In case of women it is 20 basis points.

Hence, interest rate on a SBI home loan taken by a man will be now be 9.55% (9.3% base rate plus 25 basis points). Earlier, the interest rate was 9.75%. This means a fall in interest rate of 20 basis points only and not 40 basis points, as should have been the case.
ICICI Bank has done something along similar lines as well. And this step has essentially negated the cut in the base rate to some extent.

Further, the public sector banks have a problem of huge bad loans, which are piling on. Given this, they are using this opportunity to ensure that they are able to increase the spread between the interest they charge on their loans and the interest they pay on their deposits. This extra spread will translate into extra profit which can hopefully take care of the bad loans that are piling up.

The bad loans will also limit the ability of banks to cut their lending rates. As Crisil Research points out: “High non-performing assets [NPAs] curb the pace at which benefits of lower policy rate are passed on to borrowers. Data shows periods of high NPAs – such as between 2002 and 2004 (when NPAs were at 8.8% of gross advances) – are accompanied by weaker transmission of policy rate cuts. This time around, NPA levels are not as high as witnessed back then, but still remain in the zone of discomfort.”

Another reason banks often give for not cutting interest rates is the presence of small savings scheme which continue to give high interest when banks are expected to cut interest rates. As India Research and Ratings points out: “In the last decade small saving deposit schemes have offered rates between 8-9.3% unrelated to the up-cycle or down-cycle in policy rates. These rates are also politically sensitive since a bulk of this saving is made by elders, farmers and low income groups. In fact in 2009 when repo rates were at a low of 4.75%, PPF and NSC both continued to offer 8% return and in 2012 when the repo rate moved up to 8.5%, PPF offered 8.8% and NSC offered 8.6% return.”

Nevertheless, this time around banks have cut interest rates on their one year deposits by 130 basis points. This is more than the 125 basis points repo rate cut carried out by the RBI during the course of this year.

A more informed conclusion could have been drawn here if there was data available on the kind of interest rate cuts that banks have carried out on their fixed deposits of five years or more. This would have allowed us to carry out a comparison with small savings scheme which typically tend to attract long term savings.

Long story short—EMIs and interest rates fall more on the front pages of business newspapers than they do in real life.

The column originally appeared on The Daily Reckoning on October 8, 2015

Rajan doesn’t have much scope to cut repo rate further

ARTS RAJAN
The Reserve Bank of India(RBI) governor Raghuram Rajan presented the first monetary policy for this financial year, yesterday. He kept the repo rate at 7.5%, after having cut it by 25 basis points(one basis point is one hundredth of a percentage) each in January and March, earlier this year. Repo rate is the rate at which RBI lends to banks and acts as a sort of a benchmark to the interest rates that banks pay for their deposits and in turn charge on their loans.
Rajan further said that “going forward, the accommodative stance of monetary policy will be maintained.” This meant that the RBI would continue to bring down the repo rate subject to a few factors.
First, Rajan said that the banks had not passed on the earlier cuts in the repo rate to the end consumers by cutting their base rates or the minimum interest rate a bank charges its customers. Without this happening there is no point in the RBI cutting the repo rate. (In a column earlier this month I had explained why banks are not cutting their base rates. You can read it here).
Secondly Rajan said that “ developments in sectoral prices, especially those of food, will be monitored, as will the effects of recent weather disturbances and the likely strength of the monsoon.” The northern part of the country has seen unseasonal rains and that has led to rabi cop being damaged. This is expected to push food prices up. Governor Rajan wants to monitor this for a while and see how it pans out, before deciding to cut the repo rate further.
Third, the RBI is watching what the government is doing on the policy front to “ to unclog the supply response so as to make available key inputs such as power and land.” And fourth, the Rajan led RBI is watching “for signs of normalisation of the US monetary policy”. This essentially means that the RBI is closely observing as to when the Federal Reserve of the United States, will start raising interest rates in the United States.
Depending on how these factors play out, the RBI will decide if and when to cut the repo rate further. But the question is how much room does the RBI have to cut the repo rate any further? Rajan has often said in the past that he wants to maintain a real interest rate level of 1.5-2%. Real interest is essentially the difference between the rate of interest (in this case the repo rate) and the rate of inflation.
The current repo rate at which the RBI lends stands at 7.5%. In the monetary policy statement released yesterday RBI said: “The Reserve Bank will stay focussed on ensuring that the economy disinflates gradually and durably, with CPI inflation targeted at 6 per cent by January 2016.”
If we consider the rate of inflation of 6% and add a real rate of interest of 1.75%(the average of 1.5% and 2%) to it, we get 7.75%. The current repo rate is at 7.5%, which is 25 basis points lower than 7.75%.
What if, we consider the latest rate of inflation as measured by the consumer price index? For the month of February 2015, the inflation stood at 5.4%. If we add 1.75% to it, we get 7.15%, which is lower than the prevailing repo rate of 7.5%. If we add 1.5% to the prevailing rate of inflation, we get 6.9%, which is sixty basis points lower than the prevailing repo rate of 7.5%.
What both these calculations clearly tell us is that there is not much scope for the RBI to cut the repo rate further. At best it can cut the repo rate by another 50 basis points. This is assuming that Rajan maintains his previous stance of maintaining a real interest rate level of 1.5-2%.
As of now there is no evidence to the contrary. As Rajan had said in September 2014: “Have we artificially kept the real rate of interest somehow below what should be the appropriate natural rate of interest today and created bad investment that is not the most appropriate for the economy?”
This is a very important statement and needs to be dealt with in some detail. Look at the accompanying chart.
The government of India between 2007-2008 and 2013-2014 was able raise money at a much lower rate of interest than the prevailing inflation. The red line which represent the estimated average cost of public debt(i.e. Interest paid on government borrowings) has been below the green line which represents the consumer price inflation, since around 2007-2008.
And if the government could raise money at a rate of interest below the rate of inflation, banks couldn’t have been far behind. Hence, the interest offered on fixed deposits by banks and other forms of fixed income investments was also lower than the rate of inflation, between 2007-2008 and 2013-2014.
This essentially ensured that household financial savings fell from 12% of the GDP in 2009-2010 to 7.2% of the GDP in 2013-2014. As the rate of interest on bank fixed deposits was lower than the rate of inflation, people moved their money into real estate and gold. Household financial savings is essentially the money invested by individuals in fixed deposits, small savings scheme, mutual funds, shares, insurance etc.
If the household financial savings rate has to be rebuilt, the rate of interest on offer to depositors has to be significantly greater than the rate of inflation. Given this, a real rate of interest of 1.5-2% that Rajan has talked about makes immense sense, if household financial savings need to be rebuilt all over again.
And if a real interest rate of 1.5-2% has to be maintained then the RBI doesn’t have much scope to cut the repo rate further—around 50 basis points more.

The column originally appeared on The Daily Reckoning on April 8, 2015 

Cheaper EMI? Why all the hullabaloo around bank rate cuts is a bad joke

SBI-logo.svg

Vivek Kaul

In the press conference that followed yesterday’s monetary policy, Raghuram Rajan, the governor of the Reserve Bank of India(RBI), said: “Banks are sitting on money and their marginal cost of funding (has) fallen, the notion that it hasn’t fallen is nonsense, it has fallen.”
What Rajan meant here was that banks are able to raise deposits at a much lower interest rate than they had in the past. Given this, banks should be cutting the interest rates they charge on their loans.
Banks have been saying for a while that they can’t cut their lending rates because interest rates they pay on their deposits and other forms of borrowing continue to remain high. Rajan essentially said that this argument was basically “nonsense”.
Banks got the message immediately and by the end of the day three big banks, State Bank of India (SBI), HDFC Bank, and ICICI Bank, cut their base rates or the minimum rate of interest they charge to their customers.
Both SBI and HDFC Bank cut their base rate by 15 basis points (one basis point is one hundredth of a percentage) to 9.85%. ICICI Bank was a little more aggressive and cut its base rate by 25 basis points to 9.75%.
These base rate cuts have got the media very excited. Here are some of the headlines. The Times of India says: “Top 3 Banks cut lending rates after Rajan push”. The Economic Times reports: “RBI doesn’t cut rates but forces others to do so”. The normally sedate Business Standard says: “Banks bow to RBI pressure”.
The question is will these base rate cuts really make any difference? Theoretically people are supposed to borrow more at lower interest rates. But is that really the case? Let’s run some numbers here.
For males, SBI offers a car loan at 45 basis points above its base rate. Hence, when the base rate is 10%, the car loan is available at 10.45%. When the base rate is at 9.85%, the car loan will be available at 10.30%. (For females the car loan is available at 40 basis points above the base rate).
Let’s consider a male who takes a car loan of Rs 3 lakh repayable over a period of 5 years.
The EMI at 10.45% would work out to Rs 6,440.74. The EMI at 10.3% works out to Rs 6,418.49 or Rs 22.25 lower.
So, is someone going to buy a car just because his EMI is lower by Rs 22? None of the newspapers which have run extremely detailed stories around the base rate cuts, have bothered to ask this basic question.
What about home loans? Home loans have a much larger ticket size than car loans, so shouldn’t the difference in EMIs there be huge? Let’s see.
Data from the National Housing Bank shows that the average home loan size in India in 2013-2014 stood at Rs 18-19 lakh. Let’s round it off to Rs 20 lakh, given that we are now in 2015-2016. For males, SBI offers a home loan at 15 basis points above its base rate (for females the home loan is available at 10 basis points above the base rate).
When the base rate was at 10%, the interest charged on a home loan to a male would be 10.15%. At a base rate of 9.85%, the interest rate charged on a home loan to a male would be 10%. Let’s consider a male who takes a home loan of Rs 20 lakh, repayable over a period of 20 years.
At 10.15% his EMI works out to Rs 19,499.62. At 10%, it is Rs 19,300.43 or Rs 199.18, lower. So is an individual going to buy a home because his EMI is will now be lower by Rs 199?
What if the loan size were bigger. Let’s say around Rs 60 lakh. How do things look then? In this case the EMI difference comes to around Rs 597.55. So, someone who can afford a home loan of Rs 60 lakh is definitely not going to be impacted by such a low amount. As I have often said in the past, in case of real estate, interest rates and EMIs are really not the problem. The problem is simply the price of homes. They have gone way beyond what most people can afford. And unless there is a correction there, no amount of rate cuts by banks is going to revive buying. This is a simple fact that everyone who makes a living through the real estate industry needs to realize.
What these calculations also tell us is that the impact interest rates have on consumption is terribly overrated. The media spends too much time analysing will the RBI cut the repo rate(I am guilty of the same). Then it spends even more time analysing whether banks will pass on the cut to their consumers. If banks do not pass on the cut it spends time on analysing why banks are not passing on the cut. It would do a whole lot of us more good if the ‘good’ journalists who cover banking start using the PMT function on MS Excel. (This function essentially helps calculate the EMI on a loan).
The issue is whether a minuscule base rate cut really makes a difference? And the answer as I have shown from the calculations above is, it does not. What makes a difference is basically how confident is the consumer feeling about the future. In India, we really do not measure this properly. The Consumer Confidence Survey carried out by the RBI “provides an assessment of the perception of respondents spread across six metropolitan cities viz., Bengaluru, Chennai, Hyderabad, Kolkata, Mumbai and New Delhi.” Given that it has limited use.
To conclude, it is best to quote something that the economist John Kenneth Galbraith wrote in The Affluent Society: “There is no magic in the monetary policy… It survives in esteem partly because so few understand it.” And that indeed will be the way how thing shall continue.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

The column originally appeared on Firstpost on Apr 8, 2015