With Kisan Vikas Patra 2.0 now invest your black money with the government

indian rupeesIf you can’t beat them, join them,” goes the old adage.
The government of India has done just that by relaunching the Kisan Vikas Patra (KVP). An investment in the newly launched KVP will double in 100 months. This means a return of 8.7% per year. It also comes with a lock-in of two and a half years.
There are no tax benefits, neither at the time of investment nor when the investment matures. Initially, the KVPs will be sold through post offices. But over a period of time the government plans to sell KVPs through some designated branches of public sector banks as well.
“The basic aim is to provide an investment opportunity to people who do not know where to invest and put their money into options like Ponzi schemes,”
the finance minister Arun Jaitley said at the relaunch of the scheme.
A ponzi scheme is a fraudulent investment scheme in which money is repaid to old investors by using money being brought in by new investors. The scheme runs as long as the money being redeemed by the old investors is lower than the money being brought in by the new investors. The moment this reverses, the scheme collapses.
In the recent past, the country has seen a whole host of Ponzi schemes like Sahara, Saradha, Rose Valley etc. But how will the KVP stop people from investing in Ponzi schemes?
A major reason why people invested in Ponzi schemes over the last few years lies in the fact that real returns (i.e. nominal return minus the rate of inflation) on fixed income investments (like fixed deposits, post office savings schemes etc.) was negative over the last few years.
Between 2008 and 2013, both consumer price inflation and food inflation were greater than 10%, for large periods of time. In this scenario, the returns on offer on fixed income investments were lower than the rate of inflation.
Given this, individuals had to look at other modes of investment, in order to protect the purchasing power of their accumulated wealth. A lot of this money found its way into real estate and gold, which delivered good returns for most of that period. And some of it also found its way into Ponzi schemes, which promised a slightly higher rate of return than fixed deposits and other fixed income investments.
Inflation has fallen over the last few months, and after many years, the real return on fixed income investments is in the positive territory. This is, as true for KVPs, as it is for fixed deposits offered by public sector banks.
Take the case of a fixed deposit of less than Rs 1 crore with a tenure of one year to less than five years, offered by the State Bank of India. Such a deposit pays an interest of 8.75% per year, which is as good as the return of 8.7% per year offered by KVPs.
Further, the fixed deposit doesn’t come with a lock-in, unlike KVPs which have a lock-in of two and a half years. Also, those who have dealt with post offices on a regular basis will know that dealing with (even) public sector banks is relatively easier than dealing with a post office.
So, there is no basic case for investing in a KVP. Also, for those investing for the long term, instruments like PPF which are not taxed on maturity, remain a considerably better bet. Those comfortable with investing in debt mutual funds are also likely to get higher after tax returns in the long term, once indexation(or inflation in simple terms) is taken into account while calculating capital gains.
And as far as not investing in Ponzi schemes is concerned, the returns offered on KVP are not high enough to stop people from investing in Ponzi schemes.
The government also wants to increase savings by getting people to invest in this scheme. As Jaitley said at the launch “Over the last two three years, when economic growth slowed, our savings rate declined…So it is very necessary to encourage people to increase domestic savings.”
The latest RBI annual report points out that “the household financial saving rate remained low during 2013-14, increasing only marginally to 7.2 per cent of GDP in 2013-14 from 7.1 per cent of GDP in 2012-13 and 7.0 per cent of GDP in 2011-12…the household financial saving rate [has] dipped sharply from 12 per cent in 2009-10.”
Household financial savings is essentially the money invested by individuals in fixed deposits, small savings scheme, mutual funds, shares, insurance etc. It has come down from 12% of the GDP in 2009-10 to 7.2% in 2013-14. A major reason for the fall has been the high inflation that has prevailed since 2008. The return on offer on KVPs is similar to other forms of fixed-income investments available in the market and there is no reason that it should lead to higher financial savings.
So that brings us to the question, why did the government launch KVPs then? Before we understand that, here are a few more features of the scheme. The KVPs as mentioned earlier come with a lock-in of two and a half years. They come in denominations of Rs 1000,Rs 5,000, Rs 10,000 and Rs 50,000 and there is no upper limit to the number of KVP certificates that can be bought. Hence, there is no limit to the amount of money that can be invested in the scheme.
As far as fulfilling know your customer requirements are concerned,
the gazette notifications states that the individual buying the KYC will have to provide proof of name and residence. No PAN card details will have to be provided.
And here comes the clincher—
the KVP will be a bearer instrument, which will not carry the name of the investor. Jaitley stated this at the event to relaunch the KVP. “So people with currency can invest in this,” Jaitley said. “This will be a bearer instrument just like currency and easy to encash,” he added.
So what does this really mean? There are some basic know your customer norms that need to be followed. But the KVP certificate will not carry any name on it, and that essentially makes it an anonymous instrument, once it has been issued.
With this move, the government is hoping that the KVPs will be used to launder black money. In fact, this was precisely the reason the scheme was discontinued in November 2011,
a recent report in the Business Standard points out.
Black money over the years has gone into gold and real estate, where it isn’t productive enough. If it finds its way into the coffers of the government, it can be used more productively, or so the government would like to believe.
It would also lead to higher financial savings and in the process lower interest rates. The government will benefit because it will be able to finance the fiscal deficit at lower interest rates. Fiscal deficit is the difference between what a government earns and what it spends and is financed through borrowing.
The fact that the relaunched KVP is a bearer instrument, without the name of the investor and without any need to provide an identity proof, makes it ideal to invest black money in.
As R Jagannathan writes on Firstpost.com “Since it is a bearer certificate without limit, KVPs are likely to be more popular with the better off than just the poor…Rs 1 crore invested in KVPs of the face value of Rs 50,000 each will involve the creation of only 200 certificates. Not a very big pile and very portable for black money holders.” In fact, given the fact that it is a bearer instrument, KVPs can almost be used as a currency as well.
In the old days when the government wanted to access the black money in the country, it used to launch income tax amnesty schemes, where individuals could pay a one time tax on their accumulated black money and escape punishment. In its current form, the KVP looks more like a quasi-amnesty scheme. In fact, it is even better given that no tax needs to be paid on it.
It would have been a good idea to demand the PAN number from those investors who buy KVPs of Rs 1 lakh or more.
Nevertheless, the question is, should a government which has strong views on “black money” actually be launching a scheme, which makes it convenient for people to invest black money and that too with the government?

The article originally appeared on www.equitymaster.com on Nov 20, 2014

Don’t blame Rajan: It’s time the interest-rate-wallahs stopped punching the RBI

ARTS RAJANVivek Kaul

It fashionable these days to criticize the Reserve Bank of India at the drop of a hat. The senior columnist Prem Shankar Jha is the latest person to join this bandwagon. The newest interest-rate-wallah on the block in a column in The Times of India held the RBI responsible for India’s slow economic growth over the last few years. As he writes “[The] Indian economy is not on the road to recovery. The reason is the sustained high interest rate regime of the past four years. Industry has been begging for cuts in the cost of borrowing since March 2011… On August 5, RBI governor Raghuram Rajan surprised the country by announcing that he would not lower interest rates, because at 8% consumer price inflation was still too high.”
I guess Jha must have among the few people surprised by Rajan’s decision given that among those who follow the workings of the Indian central bank closely, almost no one had expected Rajan to cut interest rates.
The premise on which
interest-rate-wallahs work is that at lower interest rates people will borrow and spend more, which will lead to economic growth. But the entire premise that low interest rates will lead to a pick up in consumption and hence, higher economic growth, doesn’t really hold. (As I have explained here).
The other big reason offered is that companies can borrow at lower rates of interest. The bigger question that
interest-rate-wallahs tend to ignore is how much control does the RBI really have over interest rates that banks pay their depositors and in turn charge their borrowers? Over the last few weeks, banks have cut interest rates on their fixed deposits. The list includes State Bank of India, Punjab National Bank and Central Bank of India. (You can read about here, here and here). The Indus Ind Bank also cut the interest it pays on its savings account to 4.5% from the earlier 5.5% for a daily balance of up to Rs 1 lakh, starting September 1, 2014.
All these cuts in interest rates have happened despite the RBI maintaining the repo rate at 8%. Repo rate is the interest rate at which the RBI lends to banks. So what has changed that has allowed these banks to cut the interest rates at which they borrow?
Let’s look at some numbers. As on October 3, 2014, over a period of one year, the loans given by banks rose by 9.87%. During the same period the deposits raised by banks rose by 11.54%. How was the situation one year back? As on October 4, 2013, over a period of one year, the loans given by banks had risen by 15.18%. During the same period the deposits had grown by 12.9%.
Hence, the rate of loan growth for banks has fallen much faster than the rate at which their deposit growth has fallen. Given this, it is not surprising that banks are cutting fixed deposit rates, given that their rate of loan growth is falling at a much faster rate.
As Henry Hazlitt writes in
Economics in One Lesson “Just as the supply and demand for any other commodity are equalized by price, so the supply of demand for capital are equalized by interest rates. The interest rate is merely a special name for the price of loaned capital. It is a price like any other.”
As Hazlitt further points out “If money is kept…in…banks…the banks are eager to lend and invest it. They cannot afford to have idle funds.”
Hence, given that the rate of loan growth is much slower than the rate of deposit growth, it is not surprising that banks are cutting interest rates on their fixed deposits. Given this, the impact that RBI’s repo rate has on interest rates is at best limited. It is more of a broad indicator from the RBI on which way it thinks interest rates are headed.
Further, it also needs to be remembered that financial savings in India have fallen dramatically over the last few years. The latest RBI annual report points out that “the household financial saving rate remained low during 2013-14, increasing only marginally to 7.2 per cent of GDP in 2013-14 from 7.1 per cent of GDP in 2012-13 and 7.0 per cent of GDP in 2011-12…the household financial saving rate [has] dipped sharply from 12 per cent in 2009-10.”

Household financial savings is essentially the money invested by individuals in fixed deposits, small savings scheme, mutual funds, shares, insurance etc. It has come down from 12% of the GDP in 2009-10 to 7.2% in 2013-14. A major reason for the fall has been the high inflation that has prevailed since 2008.
The rate of return on offer on fixed income investments(like fixed deposits, post office savings schemes and various government run provident funds) has been lower than the rate of inflation. This led to people moving their money into investments like gold and real estate, where they expected to earn more. Hence, the money coming into fixed deposits slowed down leading to a situation where banks could not cut interest rates., given that their loan growth continued to be strong.
What also did not help was the fact that the borrowing requirements of the government of India kept growing over the years.
The RBI was not responsible for any of this. The only way to bring down interest rates is by ensuring that inflation continues to remain low in the months and the years to come. If this happens, then money flowing into fixed deposits will improve and that, in turn, will help banks to first cut interest rates they offer on their deposits and then on their loans.
The government needs to play an important part in the efforts to bring down inflation. In fact, it has been working on that front. In a recent research report analysts Abhay Laijawala and Abhishek Saraf of Deutsche Bank Market Research write that the “the government is firmly ‘walking the talk’ on fiscal consolidation” through a spate of “recent administrative moves on curbing food inflation (such as fast liquidation of surplus foodstock, modest single-digit hike in MSPs, an effort to eliminate fruits and vegetables from ambit of APMC etc.)”
To conclude, RBI seems to have become everyone’s favourite punching bag even though its impact on setting interest rates is rather limited. It is time that
interest-rate-wallhas like Jha come to terms with this.

The article originally appeared on www.FirstBiz.com on Oct 22, 2014

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

This economic number shows all that is wrong with Indian economy

rupeeVivek Kaul 
The Reserve Bank of India released the financial stability report on June 27, 2013. The page 14 of the points out “Gross Domestic Saving as a proportion to GDP has fallen from 36.8 per cent in 2007-08 to 30.8 per cent in 2011-12.”
In the year 2004-2005, the total domestic savings had stood at 32.4% of the gross domestic product. Hence, there has been a tremendous drop in savings during the time the Congress led United Progressive Alliance (UPA) has governed this country. And this as we shall see is one number that is a broad representation of all that is wrong with the Indian economy in its current state.
The total amount of money that a country saves essentially comes from three sources: households, the private corporate sector, and the public sector. The worrying thing here is that household savings have fallen dramatically during the last seven years.
As the Economic Survey released in February 2013 pointed out “On average, households accounted for nearly three-fourths of gross domestic savings during the period 1980-81 to 2011-12. The share declined somewhat in recent years, and in the period from 2004-05 to 2011-12, it averaged 70.1 per cent of total savings.”
The other worrying factor is the dramatic fall in financial savings, which have pushed down overall domestic savings as well. As the RBI report points out “A large part of this decline has been due to fall in financial savings of households which have declined from 11.6 per cent of GDP to 8 per cent of GDP over the corresponding period (i.e. between 2007-08 to 2011-12.” Financial savings essentially accounts for savings in the form of bank deposits, life insurance, pension and provision funds, shares and debentures etc. In fact between 2010-2011 and 2011-2012, the household financial savings fell by a massive Rs 90,000 crore.
So the question is why have households savings and within them household financial savings, fallen so dramatically over the last few years? A straight forward answer is high inflation. The high inflation that has plagued the country during the course of UPA’s second term has meant that people have had to spend more money to buy the same basket of goods as they were doing the same. And this has meant lower savings. What this also tells us is that newspaper stories that talk about salaries in India going up in double digit terms, need to be taken with a pinch of salt, given that inflation has also more or less gone up at the same rate.
Also high inflation has meant that the real rate of returns after adjusting for inflation on products like public provident fund, bank deposits and post office deposits, which pay out a fixed rate of interest every year, have gone down. In fact, a fixed deposit paying an interest of 8-9% per year currently has a negative real rate of return in an environment where the consumer price inflation is greater than 9%. “Much of the financial savings of the household sector are in the form of bank deposits (around 30 per cent in the 2000s)..These were also the years when the real rate of interest was generally declining,” the Economic Survey pointed out.
In such an environment a lot of money has gone into gold and real estate which had a prospect of giving higher returns. As the Economic Survey pointed out “The last three years have seen a substantial rise in gold imports (the value of gold imports increased nine times between January 2008 and October 2012)…Gold imports are positively correlated with inflation.” High inflation reduces the ‘real’ return adjusted for inflation on other financial instruments and leads to people buying gold.
Given that a lot of savings have gone into gold and real estate, this has pulled down overall financial savings. As financial savings have fallen dramatically the interest rates on loans has been high for the last few years. In fact this is one reason why Indian businesses have been borrowing a lot of money abroad rather in India over the last few years. 
As the Business Standard reports “Beginning 2004, the central bank(i.e. RBI) has approved nearly $220 billion worth of external commercial borrowings and foreign currency convertible bonds (FCCB), at the rate of a little over $2 billion a month. Nearly two-thirds of this amount was approved in the past five years.”
Both gold and external borrowings have added to India’s dollar problem. India produces very little gold. Hence, almost all the gold that is consumed in the country is imported. Gold is bought and sold in dollars internationally. And every time an Indian importer buys gold, dollars are needed. This pushes up the demand for dollars in the market and puts pressure on the rupee. Gold imports are one reason why the rupee has lost value against the dollar through much of this year.
The finance minister P Chidambaram has been asking people time and again not to buy gold, without addressing the basic problem of “inflation”. Gold is finally just a symptom of the problem i.e. inflation. “The rising demand for gold is only a “symptom” of more fundamental problems in the economy,” the Economic Survey pointed out.
As far as foreign borrowings by Indian businesses are concerned, they need to repaid. To do this, Indian businesses will have to sell rupees and buy dollars, and this will push up the demand for dollars and put further pressure on the rupee. As the 
Business Standard points out “Much of this external commercial borrowing will come up for repayment this financial year, putting further pressure on the rupee.”
So financial savings going down due to inflation has created several problems for the country. Another reason for the financial savings being hit is the tremendous mis-selling of insurance by insurance companies. The RBI report says that the “credibility of the financial institutions” has been hit “in the wake of mis-selling of products and financial frauds”. The government hasn’t been able to do much on this front as well.
The article originally appeared on www.firstpost.com on June 28, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)