Why Rajan should not jump into bed with Jaitley

There have been a spate of media articles recently about how all is not well between the finance ministry (i.e. Arun Jaitley) and the Reserve Bank of India(i.e. Raghuram Rajan). In fact, so loud has been the noise around the “supposed differences,” that the finance minister
Arun Jaitley had to recently clarify that: “There has always been and shall continue to be regular and continuous interaction between the central bank and the government. We have completely free and frank discussions and therefore there is no issue of a disconnect [the emphasis is mine]. I have routinely clarified that.”
It is important to note that Jaitley used the word disconnect. He did not say that there were no differences between the RBI and the finance ministry. Jaitley was talking in the specific context of the setting up of the monetary policy committee.
One of the things that he had
announced in the budget speech was: “To ensure that our victory over inflation is institutionalized and hence continues, we have concluded a Monetary Policy Framework Agreement with the RBI…This Framework clearly states the objective of keeping inflation below 6%. We will move to amend the RBI Act this year, to provide for a Monetary Policy Committee.”
World over the monetary policy of a central bank is essentially decided by its monetary policy committee. In India setting the interest rate is the personal responsibility of the RBI governor.
A report in The Hindu points out that the finance ministry wants the monetary policy committee to have eight members with a government nominee who wouldn’t have any voting rights.
The RBI on the other hand wants a five member committee where the majority would determine monetary policy decisions (for example whether or not to increase the repo rate). The governor would act only as a tiebreaker if a member is not present during the course of a meeting. The RBI also wants two outside experts in the committee which it would pick. And there is no space for a government nominee in RBI plans.
Jaitley was essentially referring to this issue when he said: “there is no disconnect”. Interestingly, Rajan clarified that: “overtime, as the Finance Minister said, we will figure out the details of the committee.”
Nevertheless, there is a much larger point that comes out of this. As I said earlier Jaitley (who is a lawyer and chooses his words very carefully) used the word “disconnect” and not “differences”. If he had said that there are no differences between the finance ministry and the RBI, that would have had me worried.
There has to be some friction in the relationship between a regulator and the government for the regulator to be effective.
Alan Greenspan, the former chairman of the Federal Reserve of the United States, recounts in his book The Map and the Territory that in his more than 18 years as the Chairman of the Federal Reserve of the United States, he did not receive a single request from the US Congress urging the Fed to tighten money supply, increase interest rates and thus not run an easy money policy.
In simple English, what Greenspan means is that the American politicians always wanted low interest rates. India is no different on that front. Arun Jaitley has made enough noises since taking over as the finance minister asking the RBI to cut the repo rate. Repo rate is the interest at which RBI lends to banks and acts as a benchmark to the loans that banks make.
If there would have been no differences between the RBI and the finance ministry, the central bank would have cut interest rates every time Jaitley asked it to. And given the number of times Jaitley has asked for lower interest rates, the repo rate would have been close to 0% by now. But would that have led to lower interest rates in general? And would that have been the best for the Indian economy? The obvious answer to both the questions is no.
At times when politicians ask for low interest rates they are essentially batting for industrialists.
As Rajan had said in a speech in February 2014: “what about industrialists who tell us to cut rates? I have yet to meet an industrialist who does not want lower rates, whatever the level of rates.”
He further went on to elaborate that: “Will a lower policy interest rate today give him more incentive to invest? We at the RBI think not. First, we don’t believe the primary factor holding back investment today is high interest rates. Second, even if we cut rates, we don’t believe banks, which are paying higher deposit rates, will cut their lending rates.”
Rajan was making a very important point here. The politicians and the industrialists just think about one side of the interest rate i.e. the borrowing side. At lower interest rates, borrowers are likely to borrow and spend more (at least theoretically, though I don’t buy this theory in totality). This would mean better prospects for business and faster economic growth.
At lower interest rates businesses also will end up paying lower interest on the debt that they have managed to accumulate, leading to higher profits, if everything else stays the same.
But what about the people who invest their hard earned money in fixed deposits? The politicians and the industrialists are not bothered about them. These people also need to be paid a certain rate of interest on their bank fixed deposits. Between 2008 and 2013, the fixed deposit interest rate was lower than the prevailing rate of inflation.
This led to a lot of money going into gold and land, where people thought the returns would be better. Many of them were also lured into investing into Ponzi schemes.
Long story short—the RBI has to look at all sides of the equation while making a decision to change the interest rates. That is not the case with politicians and industrialists. Given this, it is vital that there are some differences between the RBI governor and the finance minister. Hence, it is important that the RBI governor should not jump into bed with the finance minister.

The column originally appeared on The Daily Reckoning on Mar 26, 2015

The one assurance that Narendra Modi needs to give bankers…

Vivek Kaul

The ministry of finance has organised a two day retreat for public sector banks in Pune over January 2 and 3, 2015. The retreat is being attended by the RBI governor Raghuram Rajan and the deputy governors as well. It will end today with brief presentations being made to the prime minister Narendra Modi. After the presentations the the prime minister will interact and address the gathering.
A press release issued by the ministry of finance basically outlined four objectives for this retreat, which are as follows:
(i) To create a platform for formal and informal discussions around the issues which are important for banking sector reforms.

(ii) To achieve a broad consensus on what has gone wrong and what should be done both by banks as well as by the government to improve and consolidate the position of PSBs.

(iii) To get some out of box ideas from prominent experts in the field as also from the top level managers attending the retreat.

(iv) The final objective would be to prepare a blue print of reform action plan once adopted which could then be implemented by the banks as well as by the government.

On paper this sounds like a good idea. It shows that the government is serious about figuring out what is wrong with the banking sector in India and working on it, instead of just letting things drift. Nevertheless, the retreat shouldn’t boil down into an excercise of exerting pressure on the public sector banks (PSBs) to lend more. With officials of ministry of finance attending the retreat as well, there are chances of that happening.
The total amount of loans being given by banks have slowed down in the recent past. Data released by the RBI shows that in November 2014 loans to industry increaed by 7.3% in comparison to November 2013. The loans had increased by 13.7% in November 2013 in comparison to November 2012. “Deceleration in credit growth to industry was observed in all major sub-sectors, barring construction, beverages & tobacco and mining & quarrying,” a RBI press release pointed out. Loans to the services sector grew at 9.9 per cent in November 2014 as compared with an increase of 18.1 per cent in November 2013.
The finance minister Arun Jaitley has time and again blamed high interest rates for this slowdown in bank lending as well as economic growth.
In a speech he made on December 29, 2014, Jaitley said: “The cost of capital…I think in recent months or years…is one singular factor which has contributed to slowdown of manufacturing growth itself.”
This and other statements that Jaitley has made over the last few months tend to look at credit (or banks loans) as a flow. But is that really the case? As James Galbraith writes in
The End of Normal: “Credit is not a flow. It is not something that can be forced downstream by clearing a pie. Credit is a contract. It requires a borrower as well as a lender, a customer as well as a bank. And the borrower must meet two conditions. One is creditworthiness…The other requirement is a willingness to borrow, motivated by the “animal spirits” of business enthusiasm. In a slump, such optimism is scarce. Even if people have collateral they want security of cash.”
Further, as Jeff Madrick points out in
Seven Bad Ideas—How Mainstream Economists Have Damaged America and the World: “Business investment is not just affected by the supply of national savings but by the state of optimism. If consumer demand for goods is not strong, a business will have little incentive to invest, no matter how great profits are or how low interest rates are on bank loans.” These are very important points that the mandarins who run the ministry of finance in this country need to understand.
So how good is the creditworthiness(or the ability to repay a loan) of Indian companies? The answer for this is provided in the recent Mid Year Economic Analysis released by the ministry of finance. As the report points out: “M
ore than one-third firms have an interest coverage ratio of less than one (borrowing is used to cover interest payments). Over-indebtedness in the corporate sector with median debt-equity ratios at 70 percent is amongst the highest in the world.”
Interest coverage ratio is the earnings before income and taxes of a company divided by the interest it needs to pay on its debt. If the ratio is less than one what it means is that the company is not earning enough to repay even the interest on it debt. The interest then needs to be repaid by taking on more debt. This works just like a Ponzi scheme, which keeps running as long as money being brought in by new investors is greater than the money that needs to be paid to the old investors.
In this situation it is not surprising that the bad loans of banks, particularly public sector banks have gone up dramatically. As the
latest financial stability report released by the RBI points out: “The gross non-performing advances (GNPAs) of scheduled commercial banks(SCBs) as a percentage of the total gross advances increased to 4.5 per cent in September 2014 from 4.1 per cent in March 2014.”
The stressed loans of banks also went up. “Stressed advances increased to 10.7 per cent of the total advances from 10.0 per cent between March and September 2014. PSBs continued to record the highest level of stressed advances at 12.9 per cent of their total advances in September 2014 followed by private sector banks at 4.4 per cent.”
The stressed asset ratio is the sum of gross non performing assets plus restructured loans divided by the total assets held by the Indian banking system. The borrower has either stopped to repay this loan or the loan has been restructured, where the borrower has been allowed easier terms to repay the loan (which also entails some loss for the bank) by increasing the tenure of the loan or lowering the interest rate.
What this means in simple English is that for every Rs 100 given by Indian banks as a loan(a loan is an asset for a bank) nearly Rs 10.7 is in shaky territory. For public sector banks this number is even higher at Rs 12.9.
The question that crops up here is why is the stressed asset ratio of public sector banks three times that of private sector banks? The financial stability report has the answer for this as well. As the report points out: “Five sub-sectors: infrastructure, iron and steel, textiles, mining (including coal) and aviation, had significantly higher levels of stressed assets and thus these sub-sectors were identified as ‘stressed’ sectors in previous financial stability reports. These five sub-sectors had 52 per cent of total stressed advances of all SCBs as of June 2014, whereas in the case of PSBs it was at 54 per cent.”
As is well known that these sectors are full of crony capitalists who were close to the previous political dispensation. This forced the public sector banks to lend money to these companies and now these companies are either not in a position to repay or have simply fleeced the bank and not repaid.
The report further points out that the public sector banks have the highest exposure to the infrastructure sector: “Among bank groups, exposure of PSBs to infrastructure stood at 17.5 per cent of their gross advances as of September 2014. This was significantly higher than that of private sector banks (at 9.6 per cent) and foreign banks (at 12.1 per cent).”
Public sector banks haven’t been able to recover these loans from businessmen who have defaulted on them. Given this, if there is one assurance that Narendra Modi needs to give to public sector banks, it has to be this—he needs to assure them that there will be absolutely no pressure on them from his government to lend money to crony capitalists who are close to the current political dispensation.
This single measure, if followed, will go a long way in improving the situation of public sector banks in this country. It will be one solid move towards the promised
acche din.

The article originally appeared on www.equitymaster.com as a part of The Daily Reckoning on Jan 3, 2015

What India Inc needs to understand about interest rates


Vivek Kaul

Big business has been after the Reserve Bank of India (RBI) to cut the repo rate or the rate at which the central bank lends money to the banks.
There seems to be a certain formula to the whole thing. Before any monetary policy the business lobbies make a series of statements asking the RBI to cut interest rates. And when the RBI does not cut the repo rate, they make another series of statements explaining why the RBI should have cut the repo rate.
The belief is that a cut in the repo rate will lead to banks cutting the interest rates at which they lend. The statements made by the business lobbies normally try to explain how a cut in interest rates will lead to people borrowing and consuming more and companies borrowing and investing more. The RBI hasn’t entertained them till now.
In the monetary policy statement released on December 2, 2014, the RBI said that it might start cutting the repo rate sometime early next year.
The business lobbies immediately issued statements expressing their disappointment on the RBI not cutting the repo rate. Confederation of Indian Industries (CII), one of the three big business lobbies,
said in a statement: “At this juncture, even a symbolic cut in policy rates would have sent a strong signal down the line that both the government and the RBI are acting in concert to harness demand and take the economy to the higher orbit of growth.”
The phrase to mark here is harness demand (which I have italicized). As explained earlier the logic is that when the RBI cuts the repo rate, banks will cut their lending rates as well and people will borrow and spend more. This will mean businesses will earn more and will lead to economic growth.
Only if it was as simple as that: .
As John Kenneth Galbraith writes in
The Affluent Society: “Consumer credit is ordinarily repaid in instalments, and one of the mathematical tricks of this type of repayment is that a very large increase in interest brings a very small increase in monthly payment.” And vice versa—a large cut in interest rate decreases the monthly payment by a very small amount.
Let’s understand this through an example. An individual decides to take a car loan of Rs 4.5 lakh at 10.5%, repayable over a period of five years. The monthly payment or the EMI on this loan amounts to Rs 9,672. Now let’s say the RBI decides to cut the repo rate by 50 basis points (one basis point is one hundredth of a percentage).
The bank works in perfect coordination with RBI (which is not always the case) and decides to cut the interest loan on the car loan by 50 basis points to 10%. The new EMI now stands at Rs 9,561 or around Rs 111 lower.
If the interest rate is cut by 100 basis points to 9.5%, the EMI falls by around Rs 221.5. Hence, a nearly one tenth cut in interest rate (from 10.5% to 9.5%) leads to the EMI falling by around 2.3% (Rs 221.5 expressed as a percentage of Rs 9,672, the original EMI).
Now will people go and buy cars just because the EMI is Rs 111 or Rs 221.5 lower? Obviously not. People spend money when they feel confident about their economic future. And that is not just about lowering interest rates.
For loans of smaller ticket sizes (consumer durables, two wheeler loans etc.) the difference between EMIs when interest rates are cut, is even more smaller. Hence, the logic that a cut in interest rates increases borrowing, isn’t really correct. As Galbraith puts it: “During periods of active monetary policy, increased finance charges have regularly been followed by large increases in consumer loans.”
What about the corporates? The business lobby CII felt that if the RBI had cut interest rates it would have “improved the poor credit offtake by industry”. In simple English this means that corporates would have borrowed and invested more, only if, the RBI had cut the repo rate.
But is that really the case? As John Kenneth Galbraith points out in
The Economics of Innocent Fraud: “If in recession the interest rate is lowered by the central bank, the member banks are counted on to pass the lower rate along to their customers, thus encouraging them to borrow. Producers will thus produce goods and services, buy the plant and machinery they can afford now and from which they can make money, and consumption paid for by cheaper loans will expand.”
But that doesn’t really happen. “The difficulty is that this highly plausible, wholly agreeable process exists only in well-established economic belief and not in real life. The belief depends on the seemingly persuasive theory and on neither reality nor practical experience.
Business firms borrow when they can make money and not because interest rates are low [the emphasis is mine], Galbraith points out.
The last sentence in the above paragraph summarizes the whole situation. And it is difficult to believe that corporates do not understand something as basic as this.
This was also pointed out in a recent research report titled
Will a rate cut spur investments?Not really, brought out by Crisil Research. (I had referred to this report in detail on an earlier occasion).
In this report it was pointed out that investment growth in fiscals 2013 and 2014 fell to 0.3%, despite negative real interest rates (repo rate minus retail inflation). The real interest rate during the period was at minus 2.1%, whereas the real lending rate was only at 2.8%.
In contrast for the period between 2004 and 2008, had a real interest rate of 7.4%, and the average investment growth stood at 16.4% per year, during the period. Why was that the case? “The rate of return on investments – as proxied by return on assets (RoA) of around 10,000 non-financial companies as per CMIE Prowess database – have fallen sharply to 2.8% in fiscal 2013 and 2014 from 5.9% in the pre-crisis years,” Crisil Research points out.
This is precisely the point Galbraith makes— Business firms borrow when they can make money and not because interest rates are low.
To conclude, Indian businesses seem to have great faith in monetary policy doing the trick, when there are too many other factors holding back growth (I haven’t gone into these factors partly because they are well known and partly because that’s a separate column in itself).
Indian businessmen are not the only ones who seem to have great faith in monetary policy. This is a trend that is prevalent throughout the world. The central bankers are expected to use monetary policy and come to the rescue of the beleaguered economies all over the world.
Where does this faith stem from? Galbraith explains this beautifully in
The Affluent Society: “There is no magic in the monetary policy…[It] is a blunt, unreliable, discriminatory and somewhat dangerous instrument of economic control. It survives in esteem partly because so few understand it…It survives, also because active monetary policy means that, at times, interest rates will be high – a circumstance that is far from disagreeable for those with money to lend.”

The article appeared on www.equitymaster.com as a part of The Daily Reckoning, on Dec 8, 2014

What Arun Jaitley can learn from marketers and real estate agents

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

I need to confess at the very start that I should have written this column a few days back. But more important things happened and this idea had to take a back seat. Nevertheless, as they say, it’s better late than never.
So, let’s start this column with two examples—one borrowed and one personal. The idea behind both the examples is to illustrate two concepts from behavioural economics—contrast effect and anchoring.
In the book
The Paradox of Choice: Why More is Less, Barry Schwartz discusses an example of a high-end catalog seller, who was selling an automatic bread maker for $279. As he writes “Sometime later, the catalog seller began to offer a large capacity, deluxe version for $429. They didn’t sell too many of these expensive bread makers, but sales of the less expensive one almost doubled! With the expensive bread maker serving as anchor, the $279 machine had become a bargain.”
Essentially, there are two things that are happening here. The buyer first gets “anchored” on to high price of the deluxe version of bread maker which is priced at $429. After this the contrast effect takes over. The bread maker priced at $279 seems cheaper than the deluxe version and people end up buying it.
As John Allen Paulos writes in A Mathematician Plays the Stock Market “Most of us suffer from a common psychological failing. We credit and easily become attached to any number we hear. This tendency is called “anchoring effect.””
And once an individual is anchored on to a number, he then tends to compare it with other numbers that are thrown at him. Marketers exploit this very well. As Schwartz points out “When we see outdoor gas grills on the market for $8,000, it seems quite reasonable to buy one for $1,200. When a wristwatch that is no more accurate than one you can buy for $50 sells for $20,000, it seems reasonable to buy one for $2,000. Even if companies sell almost none of their highest-priced models, they can reap enormous benefits from producing such models because they help induce people to buy cheaper ( but still extremely expensive) ones.”
This was the borrowed example. Now let me discuss the personal example. Sometime in May 2006, I was suddenly asked to leave the apartment that I lived in because the landlord had not been paying the society charges for a very long time. And thus started the search for another apartment to rent. Affordable apartments in Central Mumbai tend to be in buildings that are not in best shape.
Given this, real estate agents use a trick where they try and exploit the contrast effect. The first few apartments that they show are in a really bad shape. After having done this they show an apartment which is slightly better than the ones shown earlier, but the rent is significantly higher.
The attractiveness of the apartment shown later is increased significantly by showing a few “run down” apartments earlier.
The idea behind sharing these two examples was to explain the idea of anchoring and contrast effect. I hope both these concepts are clear by now. Now let me move on to real issue that I want to talk about in this column.
On November 18,
the finance minister Arun Jaitley said in a speechInflation, especially food inflation, has moderated in the last few months and global fuel prices have also come down. Therefore, if RBI, which is a highly professional organisation, in its wisdom decides to bring down the cost of capital, it will give a good fillip to the Indian economy.”
In simple English, Jaitley, as he has often done in the past, was asking the Reserve Bank of India (RBI) to cut the repo rate. Repo rate is the interest rate at which RBI lends to banks. The idea is essentially that at lower interest rates, people will borrow and spend more, and companies will invest and expand. This will lead to faster economic growth. While this sounds good in theory, as I had argued a few days back,
it isn’t as simple it is made out to be.
One argument offered by those asking the RBI to cut interest rates is that inflation as measured by the consumer price index has fallen to 5.52% in October 2014. It was at 6.46 % in September 2014 and 10.17% in October 2013.
Nevertheless, is inflation really low? Or are Jaitley and others like him who have been demanding an interest rate cut just becoming victims of anchoring and the contrast effect?
The inflation figure of greater than 10% which had been prevalent over the last few years is anchored into their minds. And in comparison to that an inflation of 5.52% does sound low. Hence, the contrast effect is at work here.
Further, it is worth remembering that this so called low inflation has been prevalent only for a few months. Chances are that food prices might start rising again. The government has forecast that the output of 
kharif crops will be much lower than last year and this might start pushing food prices upwards all over again. Also, recent data showsthat vegetable and cereal prices have started rising again because of the delayed monsoon.
Central banks of developed countries typically tend to have an inflation target of 2%. In the recent past they have been unable to meet even that number. Large parts of the world might now be heading towards deflationary scenario, where prices will fall.
In October, the consumer price inflation in China stood
at 1.6%, well below the targeted 3.5%. Also, in January earlier this year the Report of the Expert Committee to Revise and Strengthen the Monetary Policy Framework set up by RBI had recommended that the Indian central bank should set an inflation target of 4%, with a band of +/- 2 per cent around it .
The committee had said “transition path to the target zone should be graduated to bringing down inflation from the current level of 10 per cent to 8 per cent over a period not exceeding the next 12 months and 6 per cent over a period not exceeding the next 24 month period before formally adopting the recommended target of 4 per cent inflation with a band of +/- 2 per cent.”
Once, these factors are taken into account, the latest inflation number of 5.52% as measured by the consumer price index, isn’t really low, even though it seems to be low in comparison to the very high inflation that had prevailed earlier. But as explained this is more because of anchoring and the contrast effect at work.
Also, as I had written earlier, more than anything people still haven’t come around to the idea of low inflation, given that inflationary expectations(or the expectations that consumers have of what future inflation is likely to be) continue to remain on the high side.
As per the
Reserve Bank of India’s Inflation Expectations Survey of Households: September – 2014, the inflationary expectations over the next three months and one year are at 14.6 percent and 16 percent. In March 2014, the numbers were at 12.9 percent and 15.3 percent. Hence, inflationary expectations have risen since the beginning of this financial year.
If inflationary expectations are to come down, then low inflation needs to be prevail for some time. Just a few months of low inflation is not enough. As RBI governor
Raghuram Rajan had said in a speech in February this year “ the best way for the central bank to generate growth in the long run is for it to bring down inflation…Put differently, in order to generate sustainable growth, we have to fight inflation first.”
Rajan is trying to do just that, and it’s best that Jaitley allows him to do that, instead of demanding a cut in interest rates every now and then.

The article appeared originally on www.equitymaster.com on Nov 21, 2014

Mr Mahindra and Mittal, low interest rates do not always lead to faster economic growth

indian rupeesVivek Kaul

The Reserve Bank of India releases sectoral deployment of bank credit data every month. The latest data shows that loan growth of banks for the one year period between September 20, 2013 and September 19, 2014, slowed down to 8.7%.
Interestingly, in the one year period between September 21, 2012 and September 2013 it had stood at 17.9%. What is worrying is that the bank loan growth in this financial year has almost come to a standstill. Between March 21, 2014 and September 19, 2014, the bank loan growth stood at a very low 1.8%. The growth between March 22,2013 and September 20, 2013 had stood at 6.7%.
Not surprisingly, calls for a repo rate cut by the Reserve Bank of India (RBI) have become very fashionable these days. Repo rate is the rate at which the RBI lends to banks.
A PTI report quotes industrialist Anand Mahindra as saying “It might be time for the RBI to think of a rate cut.” “The need of the hour has changed and its time to start to look to support growth,” Mahindra added. Sunil Mittal, chief of Bharti Airtel, also suggested the same when he told CNBC TV 18 that the finance minister Arun Jaitley “had spoken for the nation,” when had asked for an interest rate cut. In a recent interview to The Times of India Jaitley had said “Currently, interest rates are a disincentive. Now that inflation seems to be stabilizing somewhat, the time seems to have come to moderate the interest rates.”
The logic is that if the RBI cuts the repo rate, banks will also cut interest rates, and this in turn will lead to people borrowing and spending more. Companies will also borrow more and expand and invest in new projects. And this will lead to faster economic growth.
Nevertheless, the thing is that economic theory and practice don’t always go together. So, a cut in interest rates doesn’t always lead to an increase in investment by the corporate sector. As Crisil Research points out in a report titled
Will a rate cut spur investments? Not really “the monetary policy tool of cutting the interest rate is conventionally used to energise a flagging economy. But this does not hold true under all circumstances.”
Crisil Research comes to this conclusion after comparing the last two financial years with the pre-crisis years of 2004-2008. During 2004-2008, private corporate investment increased despite high interest rates. The same has not been true during the last two years. As the report points out “Investment growth, particularly private corporate investment, plummeted in the fiscals 2013 and 2014, despite low real interest rates. During this time, the policy rate in real terms – repo rate minus retail inflation – has been negative, and real lending rates averaged 2.4%. This is significantly lower than the 7.4% seen in the pre-crisis years (2004-2008). Yet investment growth dropped to 0.3%, down from an average 16.2% seen in the pre-crisis years.”
The question to ask why has that been the case? Most corporates while making a decision to increase their investment take a look at the expected return. “Investments are undertaken when the expected returns on them are more than the real lending rate (real borrowing cost for corporates). The average rate of return on corporate investment (non-financial firms) – as proxied by return on assets – fell sharply to 2.8% in fiscal 2013 and 2014 from nearly 6% in the pre-global financial crisis years,”Crisil Research points out.
A very good example of this is the road construction sector where investments are made by looking at the internal rate of return on the project. The internal rate of return on road projects during the period 2008-2009 was between 16-18%. It has since fallen to 8-14%. And the major reason for this is cost overrun for which corporates are themselves responsible to a large extent and delays in projects clearances by the government. These projects have also found it difficult to acquire land. Interest rates have had almost no role to play here.
This is basic economics at work. And our politicians and businessmen need to be aware of this. Further, what our politicians and businessmen do not talk about is the fact that many large business groups are heavily indebted and this has led to their interest costs shooting up. One sector where companies are heavily indebted is infrastructure. As Crisil Research points out “The ratio of interest cost to operating income for infrastructure companies has increased sharply in recent years from 4.7% in fiscal 2010 to 13.2% in 2014. However, the analysis suggests that this worsening had more to do with high indebtedness of infrastructure companies than elevated interest rate.”
Also, India has fallen constantly in the global competitiveness rankings. India’s position in the Global Competitiveness Index fell to 71 in 2014. It was at 60 in 2013 and 49 in 2009. The RBI was not responsible for any of this. This was a mess made the politicians of the Congress led UPA which ruled the country for a decade and the businessmen who went on a borrowing spree and underestimated costs of setting up projects.
Also, the Indian consumer is not ready to get his shopping bags out as yet though he flattered to deceive briefly, after Narendra Modi was elected as the prime minister. This is reflected in a variety of numbers from low manufacturing inflation to low index of industrial production and car sales.
The reason for this is that inflationary expectations ((or the expectations that consumers have of what future inflation is likely to be) continue to remain high. Hence, the Indian consumer is still not convinced that the high inflation that he has had to deal with over the last few years has finally been killed.
The Reserve Bank of India’s Inflation Expectations Survey of Households: September – 2014 which was a survey of 4,933 urban households across 16 cities, and which captures the inflation expectations for the next three-month and the next one-year period. The median inflation expectations over the next three months and one year are at 14.6 percent and 16 percent. In March 2014, the numbers were at 12.9 percent and 15.3 percent. Hence, inflationary expectations have risen since the beginning of this financial year.
lnflationary expectations be reined in once inflation remains low for an extended period of time. And consumer demand is likely to pick up only after this happens.
To conclude it has become fashionable for the government and the businessmen to blame RBI for slow economic activity in the country. Nevertheless, it is time they started to get their own act right. The RBI can only do so much.

The piece originally appeared on www.FirstBiz.com on Nov 5, 2014

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