Who is Benefitting from Lower Interest Rates?



Over the last one year, bank interest rates have fallen majorly, at least in theory (it will become clear later in the column, why I say this). The question is, who is benefitting from the lower interest rates? The savers, whose fixed deposits have matured, have had to reinvest them at significantly lower interest rates. This includes retirees who have seen interest rates on their deposits, fall from nine per cent to six per cent in a short period of time. In the process, their incomes have crashed by a third. Not surprisingly, they are having a tough time.

People have suggested that senior citizens should invest with the post office where higher interest rates are on offer. Anyone who has actually invested money with the post office for generating a regular income, would never suggest anything like this. Their service levels are abysmally low. They can give a thorough run around to anyone looking to get paid regularly on the investment he has made with the post office.

In fact, I know of several retirees who have reluctantly moved their investments into mutual funds (both equity and debt), given the low after-tax returns on fixed deposits. Even if the returns on mutual funds are the same as bank fixed deposits, the different tax treatment for both these forms of investing, helps generate higher after-tax returns in case of mutual funds.

This investing strategy has worked well for retirees in the last one year, given that the stock market has rallied massively. Nevertheless, is this a sustainable strategy in the long-term for anyone who is looking to generate a regular income out of his accumulated corpus, given the volatility that comes with investing in a mutual fund?

In a country with almost no social security and a health care system which keeps getting expensive by the day, this is a fair question to ask.

Another set of savers who has lost out due to low interest rates are people saving for their future, the wedding and education of their kids, and their own retirement. These people now need to save more in order to meet their long-term investment goals. Of course, these people still have the option of discovering the power of compounding by investing in mutual funds through the systematic investment plan (SIP) route.

But given the abysmal levels of financial literacy that prevail in the country, the chances that they will be mis-sold a unit linked insurance plan(ULIP) by a private insurance company or an endowment or a money-back policy by Life Insurance Corporation of India, remain very high. These forms of investing remain the worst way you can invest your money.

Also, consumption growth and interest rates are closely linked. Conventional economic logic tells us that at lower interest rates people borrow and spend more, and this increases private consumption growth and in turn helps economic growth. QED.

While that may be true for developed countries, it doesn’t quite work like that in India. In India, if interest rates fall, the retirees need to cut down on their regular expenditure because their regular income also falls. People who are saving for the long-term also need to save more in order to meet their investment goals.

Given that most household financial savings get invested in fixed deposits, a fall in interest rates makes people feel less wealthy and this has an impact on their consumption. Due to these reasons people end up cutting down on their expenditure. This is reflected to some extent in Figure 1, which plots the growth in private consumption expenditure over the last few years.

Figure 1: 

As interest rates have fallen through 2017, the growth in private consumption expenditure has collapsed from 11.1 per cent to 6.5 per cent. As of December 2016, private consumption expenditure formed 59 per cent of the Indian gross domestic product. Since then, it has fallen to 54 per cent. So, much for lower interest rates.

There are two sides to interest rates, the saving side which I was talking about up until now, and the borrowing side, which I will talk about in the remaining part of this column.

The total non-food lending carried out by Indian banks has actually contracted during this financial year. But weren’t lower interest rates supposed to help increase lending? Now only if economic theory and reality played out same to same, the world would be such a different place.

Banks are extremely quick to cut interest rates on their fixed deposits, as well as raising interest rates on their loans. Nevertheless, the same cannot be said about a situation where they need to pass on the benefit of lower interest rates to their borrowers.

Let’s take the example of people who have taken on home loans from banks as well as housing finance companies. Over the last one year, the interest rate on a home loan has fallen from 80 to 100 basis points. One basis point is one-hundredth of a percentage.

The trouble is in many cases the banks and the housing finance companies haven’t bothered to inform the borrower, about the lower interest rate. And the borrower has unknowingly continued to pay the higher EMI. This never happens when the banks and the housing finance companies need to raise interest rates on their home loans. In that case, the letter/sms/email arrives right on time.

In fact, I have heard cases where people have pointed this dichotomy out to a leading housing finance company, and they have been told that they are expected to come to the office of the housing finance company and keep checking. So much for market competition which is supposed to lower interest rates. Of course, the stock market rewards such companies with a higher price to earnings ratio, given that they can do these things, get away with it, and make more money in the process.

The media which is quick to announce lower EMIs whenever RBI cuts the repo rate, never goes back to check whether EMIs have actually fallen. This is simply because it is easier to take the theoretical way out and announce lower EMIs when RBI cuts the repo rate, whereas actual checking would involve doing some legwork and speaking to banks, housing finance companies and borrowers. And who wants to work hard? It’s worth pointing out here that banks are huge advertisers in the media.

The question is when higher interest rates are passed on immediately, why is the same not true with lower home loan interest rates? What are the Reserve Bank of India (RBI) and the National Housing Bank (the RBI subsidiary which regulates housing finance companies) doing about this? Aren’t the regulators also supposed to take care of the consumers? Or are they just there to bat for those who they regulate? Or is it a case of “regulatory capture” where those who are regulated (i.e. the banks and the housing finance companies) given that they are organised, manage to get their point of view to the regulator, but the borrowers, given that they are not organised, cannot do that.

Whatever it is, it is not fair. And the RBI and the National Housing Bank need to do something about it. Consumer protection is something that should be high on their agenda, even though it may be the most unglamorous of things that they are supposed to do.

The column originally appeared in Equitymaster on December 14, 2017.

The Luck of Investing in Real Estate


When flying out of the terminal 2 at the Chatrapati Shivaji International Airport in Mumbai, I like to follow a certain routine.

This includes eating a sandwich along with a cup of coffee and watching airplanes take off and land. The entire routine lasts for around 15 minutes. And this is precisely what I was doing two days back, when I saw a person walking towards me. I wouldn’t call him a long-lost friend but he was someone I had come to know during my course of work.

Don’t we all know a bunch of people we know, but we really don’t know? So, he was one of those.

“And who have we run into,” he said, sitting down in front of me. After the mandatory hello, this gentleman got to the issue straight away. “So why are you so against investing in real estate?” he asked.

“Well, I am not against anything. I am only against things which don’t make sense to me at a certain point of time. And as of now it doesn’t make sense to invest in real estate, in my humble opinion. But if you want to buy a home to live-in, that is a different issue altogether,” I explained, extremely irritated at having been disturbed.

“Oh, you know but the value of the home I bought has gone up four times,” he said with great confidence.

This is the oldest argument made by those still confident about investing in real estate. It comes in two forms. One form was just cited above. The other form is to talk about a third person who seems to have made money by investing in real estate. This can include Sharma ji, Verma ji, Gupta ji, Mr Banerji or Mr Subramanian, one of whom lives down the road.

This argument deals in absolutes. “I bought for Rs. 10 lakh and I sold it for Rs. 50 lakh,” is how you go about selling this point. The trouble is that it doesn’t take into account any expenses incurred in between.

This includes the maintenance cost that needs to be paid to the society every month. Or the property tax that needs to be paid to the municipality every year. Or the cost of insuring the home. Or the interest on the home loan. Or the cost of buying an insurance on the home loan. On the positive side, it does not include any rent that comes in and any tax deductions that are made.

The point being that no one calculates the return on investment on investing in property. In fact, there is no such number going around. If you want to know the past returns of a stock or a mutual fund, it is very easy to find that. But if you want to know about the past returns on real estate, there are only absolute numbers going around.

There are only stories. And people like to believe in stories, not numbers.

“So when did you buy this home?” I asked the gentleman.

“Around 2005,” he replied.

“You were lucky,” I blurted out.

“What do you mean?” he asked.

I had made the proverbial mistake of attributing the success of a person to his luck. And given that I would have to explain what I meant.

“Well, if you had invested in real estate any time post 2009, there is a reasonably good chance that your investment would have ended up in a mess,” I explained.

“What do you mean?” he asked again.

“Many people who invested in real estate post 2009, still haven’t got the homes they had invested in. The builders have either run out of money or in some cases simply disappeared.”

“Oh,” he replied, rather nonchalantly.

“So, in many cases people who thought they are buying a home to live in, have had to continue paying the rent on the home that they live in, along with the EMIs.”

“Oh,” he said again.

“They are basically screwed.”

“But what are you trying to say?”

“Success in real estate investing like many other things in life is also a matter of timing. You think you have made money because you invested in 2005. Many others who invested in 2009 or after, are stuck. And unlike other forms of investing there is no exit route. Also, given that the amount involved in this case is large, there is no getting back from it,” I explained.

“Oh, but all that doesn’t apply to me,” he said rather confidently.

“Really? So, this home you bought and which has gone up four times in value, have you ever tried selling it?” I asked.


“And for how long have you been trying to sell it?”

“For the last six months.”

“And you still haven’t managed to find a buyer for it?”

“No. I think it is worth a certain price. But the stupid buyers haven’t been willing to pay.”


“My broker also thinks it is worth the price that I think it’s worth.”

“Oh, really. The price you and your broker have, is in your head. That is certainly not the market price, because if it was, your home would have been sold by now.”

“That is not the case,” he responded very aggressively.

“You are anchored on to a price and are not willing to sell for anything less than that price. But in the time to come, as your home continues to remain unsold, you will revise your expectations and be ready to sell at a lower price,” I said, gulped my cup of coffee, and started walking towards gate number 87 to catch my flight.

To conclude, if you are unable to sell a house that you had bought as an investment, that doesn’t make the buyer stupid.

The column originally appeared in Vivek Kaul’s Diary on October 26, 2016

Jaitley needs to talk about high home prices, not just high EMIs

Fostering Public Leadership - World Economic Forum - India Economic Summit 2010

Sometimes I think that the finance minister Arun Jaitley has this constant need to talk and in the process he ends up saying stuff which looks rather silly.
Like he said yesterday in Hong Kong: “RBI historically has been a very responsible institution. Now, as somebody who wants India’s economy to grow and who wants domestic demand to grow, I will want the rates to come down…Real estate, for example, can give a big push to India’s growth and this is a sector which is impacted by high policy rates. Therefore, if the policy rates come down over the next year or so, certainly this is one sector which has a huge potential to grow.”

In fact, this is something that Jaitley has said in the past as well. As he said in December 2014: “now time has come with moderate inflation to bring down the rates. If you bring down the rates, people will start borrowing from banks to pay for their flats and houses. The EMIs will go down.”

There is nothing wrong in Jaitley wanting interest rates to come down. Politicians all over the world like lower interest rates because they believe that lower interest rates lead to more borrowing which translates into economic growth. Hence, one really can’t hold that against Jaitley. He was only saying what others of his tribe firmly believe in.

But believing that lower interest rates will lead to the revival of the real estate sector is rather simplistic. The logic here is that since interest rates are high, the EMIs on home loans are high as well. And at higher EMIs people are postponing the home purchase decision.

If interest rates are cut, EMIs on home loans will come down, people will buy homes and this will lead to the revival of the real estate sector.  QED.

But as I said earlier in the piece, this reasoning is rather simplistic. Allow me to explain. Every month the Reserve Bank of India puts out sectoral deployment of credit data. This data gives a breakdown of the various sectors banks have loaned money to, including home loans.

Between July 25, 2014, and July 24, 2015, the total amount of home loans given by banks grew by 17.8%. In comparison, the home loans between July 26, 2013 and July 25, 2014, had grown at 17.4%. So, home loans given by banks continue to grow at a very fast pace.

The overall lending by banks between July 2014 and July 2015 grew by 8.2%. Between July 2013 and 2014, the overall lending by banks had grown by 12.6%.

Hence, during the last one year, the growth of overall lending by banks has fallen. Nevertheless, the total amount of home loans given by banks has gone up at a much faster pace of 17.8%, in comparison to 17.4% earlier.

Hence, despite the high interest rates, home loans continue to grow at a fantastic pace. Also, in the last one year, home loans formed around 21.6% of the overall lending carried out by banks. Between July 2013 and July 2014, the number was at 13.2%.

What this clearly tells us is that home loan lending has not slowed down because of high interest rates. It continues to grow at a fast pace. Hence, Jaitley’s logic goes out of the window completely. But how do you explain the fact that the real estate developers are sitting with so many unsold homes?

In a recent research report PropEquity estimated that the “housing sales in the 19 tier II cities fell by 17 per cent as against a 32 per cent decline in the top 14 Tier I cities in the last two years.” Why are home sales falling despite home loans going up?

One of the possible answers is that the number of home loans being given by banks has come down over the years, as property prices have risen at a very rapid rate. This cannot be said with surety given that RBI does not share this data.

The basic problem with Indian real estate is high prices. And unless prices fall, there is no way sales are going to pick up, lower interest rates or not.

It is worth mentioning here that a fall in interest rates does not have a significant impact on EMIs. A home loan of Rs 50 lakh, at an interest rate of 10% and a tenure of 20 years, leads to an EMI of Rs 48,251. At 9.75%, it leads to an EMI of Rs 47,426, which is around Rs 800 lower. The point being that no one is going to buy a home because the EMI is Rs 800 lower.

Also, in order to get a home loan of Rs 50 lakh, the individual interesting in buying a home would need to arrange Rs 12.5 lakh for a down-payment (assuming an optimistic ratio of 80:20). Further, over and above this, some portion of the price will have to be paid in black as well. The question is even in Tier I cities how many people are in a position to spend this kind of money? Not many.

Jaitley needs to realise this. If the real estate sector has to pick up, the government has to go after real estate prices. And Jaitley given that he is so used to saying things, must also start talking about high real estate prices, instead of just high interest rates. That would be a nice change from the usual and will possibly have more impact as well.

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

The column originally appeared on Firstpost on September 21, 2015

Chidu expects you to spend Rs 25,000 to save Rs 2,500

A seemingly popular measure announced in today’s budget is the increase in the tax deduction allowed on home loan interest by Rs 1 lakh. Currently a deduction of Rs 1.5 lakh is allowed to someone buying his first home.
The extra deduction of Rs 1 lakh comes with caveats. The first caveat is that the house should be bought during the period between April 1, 2013 and March 31, 2014. The home loan taken should not be more than Rs 25 lakh. And the value of the house being bought should not exceed Rs 40 lakh (something that the finance minister P Chidambaram did not talk about in his budget speech). Chidambaram felt that this move will “promote home ownership and give a fillip to a number of industries like steel, cement, brick, wood, glass etc. besides jobs to thousands of construction workers.”
Let us try and understand why nothing of that sort is going to happen anywhere other than the imagination of Chidambaram. Let us say an individual who falls in the top tax bracket of 30%, takes a home loan of Rs 25 lakh at an interest of 10.5% to be repaid over a period of twenty years. The equated monthly instalment (EMI) to repay this loan would work out to around Rs 24,960. Lets assume this to be Rs 25,000 for the ease of calculation.
What is the extra saving that the individual makes? He gets a tax break of extra Rs 1 lakh. Given that he is in the 30% tax bracket, this means an yearly saving of Rs 30,000 (again lets ignore the 3% education cess for the ease of calculation). This essentially means an added saving of Rs 2,500 per month (Rs 30,000/12).
So what Chidambaram wants us to believe is that people of this country would start paying EMIs of Rs 25,000, in order to make an extra saving of Rs 2,500? No wonder he went to Harvard.
There are other problems with this deduction as well. The deduction is available only for the financial year 2013-2014 (or the assessment year 2014-2015). If the complete deduction is not used in 2013-2014, the remaining part can be used in 2014-2015(or the assessment year 2015-2016). 
The point is that the deduction is largely available only once. To imagine that people would buy homes to make use of what is essentially a one time deduction is stretching it rather too much. Of course the market understands this. The BSE Realty Index is down around 2.7% from yesterday’s close as I write this.
People don’t buy homes to get a tax deduction. The average middle class Indian buys a home to stay in it. And for that to happen a couple of things need to happen. The real estate prices need to fall from their current atrocious levels. And interest rates also need to fall for EMIs to become affordable.
In fact this is where another comment made by Chidambaram during the course of the speech that makes immense sense. As he said “There are 42,800 persons – let me repeat, only 42,800 persons – who admitted to a taxable income exceeding Rs 1 crore per year.”
This is nothing but a joke. There must be more people earning more than Rs 1 crore in South Delhi, let alone all of India. What this tells us very clearly is that there is a tremendous amount of black money in this country. And all these ill gotten gains are stashed away by buying real estate. This ensures that there are more investors/speculators in the real estate market, than genuine buyers.
Unless this nexus is broken down there is no way anyone who actually needs a house to live in, to be able to actually buy one.
As far as EMIs are concerned they will only come down once interest rates start falling. And for that to happen the government needs to control its borrowing. The borrowing will fall only once the fiscal deficit is under control. Fiscal deficit is the difference between what a government earns and what it spends.
And I don’t see any of these two things happening in the near future. Neither will black money in the system come down nor will the fiscal deficit fall leading to a fall in interest rates.
Chidambaram ended his speech by quoting his favourite poet Saint Tiruvalluvar. Let me end this piece by quoting one my favourite poets, Bashir Badr. 

Musaafir ke raste badalte rahe,
muqaddar mein chalna thaa chalte rahe
Mohabbat adaavat vafaa berukhi,
kiraaye ke ghar the badalate rahe

So the moral of the story is that we will continue to live in rented houses, changing them every 11 months, when the contract runs out.
The article originally appeared on www.firstpost.com on February 28, 2013

(Vivek Kaul is a writer. He tweets at @kaul_vivek)