Low interest rates

2021 – The Chinese Problem in Your Personal Finance

Dear Reader, before you start thinking that I have click-baited you one more time, let me assure you that’s not true. Your personal finances in 2021 will actually face a Chinese problem.

But before we go into this, let’s first understand a few aspects about the Chinese saving habit over the years. Let’s look at this pointwise.

1) As is well known, the Chinese physical infrastructure over the years was funded through massive domestic savings being invested in bank deposits. As Charles Goodhart and Manoj Pradhan write in The Great Demographic Reversal: “Interest rates were set well below the rate of growth and the rate of inflation. While the economy grew on average by around 10% over 1990–2010, the inflation-adjusted deposit rate over the same period averaged −3.3% (for a 1.4% average for the nominal deposit rate versus an average annual inflation rate of 4.75%).”

Hence, the rate of interest rate was lower than the prevailing rate of inflation, for a period of two decades. If one were to state this in a simple way, the low interest rates acted effectively as a tax on Chinese households.

2) This tax did not matter much because the savings were channelised into investments. This created economic growth and the average income of a Chinese kept going up, year on year. Hence, while the interest being earned on the accumulated wealth was low, the regular yearly income kept going up.

3) Low interest rates led to an interesting behaviour at the household level. As Goodhart and Pradhan point out, there was “a negative correlation between urban savings and the decline in real deposit rates.” “When banks fail to protect household savings, households tend to save more, not less, in order to achieve a ‘target’, whether that is for education or the purchase of a home.”
Basically, given the negative real rate of interest on bank deposits, where inflation was higher than the interest rate, Chinese households saved more money in bank deposits in order to achieve their targeted savings. Options of investing in other avenues were extremely limited.

Now the question is how does all this apply to your personal finance in India in 2021. Allow me to explain pointwise.

1) Interest rates on bank fixed deposits have collapsed. The interest offered on fixed deposits of more than one year, currently stands at around 5.5% on an average. This when the rate of inflation as measured by the consumer price index in November 2020 stood at 6.93%. Hence, the real rate of interest is in negative territory. If after tax the rate of return on fixed deposits is taken into account, the gap gets even bigger.

2) The major reason for this collapse in interest rates has been a collapse in bank lending. Given that banks, on the whole, have barely given out fresh loans since March, they possibly couldn’t keep paying a high rate of interest on deposits. Hence, the crash in interest rates. But what has added to this is the Reserve Bank of India (RBI) policy of flooding the financial system with money, in order to drive down interest rates further. The excess money in the financial system, which the banks deposit with the RBI, stood at Rs 6.25 lakh crore as of December 31, 2020.

3) From the indications that the RBI has given, this excess liquidity in the financial system is likely to continue. The idea is to help ease the burden on current loans of corporates. In a year the tax collections have collapsed this also helps the government to borrow at extremely low interest rates. At the same time, the hope is at lower interest rates corporates will borrow and expand. But that is not happening. Data from the Centre for Monitoring Indian Economy shows that announcements of new investment projects in terms of value fell by 88.3% during the period October to December 2020. Investment projects completed were down by 74%. So, the corporates aren’t in the mood to borrow and expand.

There are a couple of reasons for this. Many corporates continue to remain over-leveraged. Still others don’t have enough confidence in India’s economic future, irrespective of what they say in the public domain. As they say, the proof of the pudding is in the eating.

4) What does all this have to do with personal finance? What happened in China is happening in India as well. The bank savings have gone up dramatically during 2020. Between March 27 and December 18, they were up by Rs 9.15 lakh crore. In comparison, the increase during similar periods in 2019 and 2018, had stood at Rs 4.35 lakh crore and Rs 3.90 lakh crore, respectively. Of course, all this increase in saving is not just because of low interest rates. Some of it is because of fewer opportunities to spend money in 2020. Some of it is because of the general uncertainty that prevails. Some of it is because of jobs losses and the fear of job losses. And some of it is because Indians, like the Chinese, are saving more, in order to achieve the savings target for the education of their children or their weddings, or for the purchase of a home.

5) This has repercussions. With people saving more and with banks being unable to lend that money, interest rates have come down. And people saving more in response to the lower interest rates, means extended lower interest rates. This is not good news for savers. It is also not good news for consumption. If people are saving more, they are clearly spending lesser. This is the paradox of thrift or saving. When an individual saves more, it makes sense for him or her at an individual level. When the society as a whole saves much more than it was, it hurts the economy simply because one man’s spending is another man’s income. Over a period of time, this leads to job losses, more paradox of thrift and further job losses.

At the risk of sounding very cliched, there is no free lunch in economics. The RBI’s policy of flooding the financial system with money in order to help the corporates and the government, is basically hurting individual savers, consumption and the overall economy. The savers are paying for this lunch. And unlike the corporates, the savers have no unified voice. The government, obviously, is the government.

While, there is no denying that with lending not happening bank deposit rates had to fall, but the RBI policy of driving them down further, is something that is hurting the economy.

6) So, where does that leave the Indian saver? Some individual savers are betting on the stock market. But the price to earnings ratio of the Nifty 50 index as of January 1, stood at 38.55, an all-time high level. If you have the heart to invest in stocks at such a level, best of luck to you. Some others are betting on bitcoin, which has given a return of more than 75% in dollar terms, in the last one month.

Also, unlike the Chinese, the prospects of an increase in the yearly income of an average Indian, over the next years, at best remain subdued. Hence, the humble Indian fixed depositor, who liked to fill it, shut it and forget about it, so that he could concentrate on many other issues that his or her life keeps throwing up, clearly has a problem in 2021.

To conclude, all of you who write to me asking for a safe way of investing so that you can earn a 10% yearly return, well, sorry to disappoint you, no such way exists. At least not in 2021. Of course, there are always Ponzi schemes to invest in, some fraudulent, and some not so fraudulent.

The choice is yours to make.

PS: Wishing all my readers a very Happy New Year. Hope 2021 is much better than 2020 was for each one of you.

Should You Buy a Home This Festival Season?

In the last decade, afternoon naps have become a very important part of my life. In fact, it is safe to say that I live so that I can have the pleasure of taking afternoon naps and reading crime fiction. (Imagine all the economics I have to break my head on, for such simple pleasures in life).

After taking an afternoon nap yesterday I was trying to get my brain going again by drinking a cup of overboiled masala tea. At around 4.54 pm, a mail titled 10 Reasons to Buy a Home This Festive Season, hit my mailbox. The headline ensured that my brain was back to functioning at full strength.

In the economic environment that currently prevails, only someone closely associated with the real estate business could come up with a headline/title like this. Not surprisingly, this piece was written by someone working at a senior position for a real estate consultant, whose well-being depends on the sector doing well. His incentive is clearly misaligned with that of a prospective buyer looking to buy a home to live in.

Also, the festival season sales pick up is something that the real estate sector has been trying to sell for more than half a decade now. This tells you that bad ideas rarely go out of circulation.

This headline motivated me to write this piece titled should you buy a home this festival season, which you are currently reading.
Let’s take a look at this pointwise.

1) One of the reasons offered to buy a home in the mail I got, is the oldest cliché in the game, which goes like this: “Living in a rented house is a recurring financial drain without returns on investment”. This reasoning is bought by one too many people even though it is the rubbish of the highest order.

Let me explain through an example. I stay in central Mumbai, in what is euphemistically termed as a studio apartment. My monthly rental outgo is Rs 23,000. What sort of a home loan will I get if I am willing to pay the same amount as an EMI? At an interest rate of 7% per year on a home loan to be repaid over twenty years, I will get a home loan of around Rs 29.67 lakh. On this loan, the EMI works out to Rs 23,003.

Let’s say to this home loan I add my own savings of around Rs 10.33 lakh and I have a total of Rs 40 lakh, with which I can buy a flat. I will not get anything at this price around where I live unless I am willing to move into a shanty.

To get an apartment at this price I will have to move 35-40 km or even more from where I stay. And that will beat the entire idea because I like staying where I do and renting is the only way I can afford it. I am not looking to build an asset here. I just want to stay bang in the middle of the town.

2) Also, the rental yield typically tends to be 1.5-2% (annual rent divided by the market price of the house) or slightly higher. Even the cheapest home loan is 7%. Plus there are other costs associated with owning a home. When you a buy a house a stamp duty has to be paid to the state government. A property tax needs to be paid every year. Then there is the maintenance charge that needs to be paid to the housing society. On top of this there is the general risk of owning property in India.

3) Further, if I go and live 35-40km from where I am, I will end up paying for it in terms of the time I will have to spend to get anywhere. And time ultimately is money. So, yes one might end up building an asset but with almost no control over one’s time.

Hence, equating living in a rented house to a financial drain is top class rubbish which only someone working in the real estate industry can come up with and propagate  over and over again. This argument starts to make sense only when the rental yields and home loan interest rates are in a similar sort of territory. For that to happen, rental yields need to double and home loan interest rates need to halve (both will then be around 4%).

4) Another reason offered in the mail, to buy a house is: “Buying now equals buying at the lowest possible price.” Lowest possible price, vis a vis what? Entry level flats in the biggest cities, where the bulk of the demand is, cost at least Rs 40-50 lakh. Let’s consider a flat which costs Rs 40 lakh. A 20% downpayment works out to Rs 8 lakh. This means a home loan of Rs 32 lakh. The EMI on this works out to Rs 24,809 (7% interest, 20 years repayment period).

A bank typically assumes that around 35-40% of the after tax take home salary can go towards paying this EMI. If the assumption is that around 35% of the salary goes towards EMI, the total after-tax take home salary works out to around Rs 8.5 lakh. The pre-tax salary has to be even higher, more than Rs 10 lakh. How many people make that kind of money in a country where the per capita income is just over Rs  1.5 lakh, is a question well worth asking. This very conservative example explains why real estate in India remains beyond the level of most Indians.

5) There is another problem with the lowest possible price argument. Given the opaqueness surrounding the real estate sector in India, there is nothing like a market price at any given point of time. So how do you even know that the price offered to you is the lowest possible price? Do you just believe what the builder or his broker are saying? Do you have any idea what the price was last year or the year before that?

6) Also, we are told that “home loan interest rates are at 15-year low”. Hence, you should buy a house. The economy during the period April to June contracted by a nearly fourth. It is expected to contract by 10% this year, a level of contraction never seen since Indian independence. Just because home loan interest rates are low should you go out and buy a house? The more important question to answer as always is whether you are in a position to pay the EMI payable against the low interest rates. No wonder this very important point has been missed out on.

It is worth remembering that home loans are floating interest rate loans and interest rates can keep changing in the years to come. If you take on a 20-year home loan now, it doesn’t mean that interest rates will continue to remain low for the next 20 years.

7) And then there is this, my absolute favourite, which I have been hearing for years now: “The property market is poised on the cusp of a full-fledged revival. Once the revival kicks in, property prices will harden and asset appreciation begins in all seriousness.”

This statement reminds me of the different chairpersons that the State Bank of India has had in the last twelve years. Starting with 2009, each one of them has said at some point of time that when it comes to the banking sector in India, the worst is behind us. Well, it’s 2020, the banking sector still has official bad loans of close to Rs 9 lakh crore and they are expected to go up dramatically post-covid.

Every festival season for the last six years the real estate sector has been talking about an impending revival. This revival did not happen when the Indian economy was growing.  And now they expect the revival to happen in a year when the economy is contracting big time. The size that the Indian economy achieved in 2019-20, will now most likely be achieved again only in 2022-23. Jobs have been lost. Incomes have fallen. Small businesses have shut-down or are on the verge of shutting down and the real estate sector is talking about asset appreciation beginning in all seriousness.

I mean all selling involves some amount of fibbing but if you keep doing it all the time and it doesn’t turn out to be true, it loses its power. People start believing in the opposite narrative. As the old fable of the jackal shouting sher aaya sher aaya goes.

8) Here’s another reason the mail offered, to buy a house: “After a protracted period of financial upheaval, it has become necessary to revisit all expenses which represent undue pressure on personal finances. Living in a rented house is a recurring financial drain without returns on investment [emphasis added].”

The part italicised in the above paragraph I have already dealt with in the first point. Nevertheless, the above paragraph needs to be tackled on its own as well. What is the writer saying here? Given the tough economic conditions created by covid, it is time to revisit all expenses. Yes, that makes sense.

But then he goes on to say that renting doesn’t make any sense and you need to make an even bigger expenditure in buying a house and paying an EMI. Buying a house would involve running down savings to make a downpayment and paying a stamp duty. Then there would be moving charges.

At the same time an EMI would have to be paid on a home loan. The chances are that the EMI will be much more than the rental.

Why would anyone who is in financial trouble and trying to cut down on his expenses, be expected to take on higher expenses by buying a house? What’s the logic here? There is no logic to this except to confuse the prospective buyer.

Essentially you are being asked to be penny wise and pound foolish.

9) In the last couple of weeks, the real estate industry has been trying very hard to convince us that the buyers are back in the market and they are lining up to buy homes. Like the mail I got put it: “The best home options are being snapped up at a rapid pace.”

Similar stories have been seen in the media as well. Like the Mumbai edition of The Times of India points out today: “Unlocked MMR shines with 60% rise in home sales in Q2”. Only when you read the story carefully you realise that sales in the Mumbai Metropolitan Region (MMR) during July and September were 60% higher than sales during April to June. And that’s hardly surprising. There were barely any sales in April and May, due to the lockdown. Hence, this was bound to happen.

The real question is how do things look in comparison to July to September 2019. This reveals the real story. Sales between July to September 2020 are 40% lower than the same period last year. Of course, the newspapers are trying to project a real estate revival story given that they are dependent on huge advertisements from real estate companies. Also, it is worth remembering that a lot of home sales that happened in July to September must be pent up demand from April to June, which has spilled over.

10) Another tactic being employed here is to project a lack of supply. As the mail I got puts it: “Developers have curtailed new supply”. Maybe they have. But the larger point here is that lakhs of apartments were bought as an investment in the decade leading to 2015. Many investors are still sitting on it, hoping for a better return. But now due to covid, there are bound to be quite a few distress sales going around. So, it’s a matter of hanging around and looking for one.

As I have said in the past, the real estate market right now is going through a weird low supply low demand situation. There is low demand for real estate (given the high price) and there is low supply as well (given that real estate companies and individual owners are unwilling to cut prices). I may want to buy a home but unless I have enough money and the ability to borrow to do so, I am really not adding to demand. Just wanting something, without having the money to finance it, doesn’t really add to demand.

This situation can only turnaround if the demand improves or if the supply improves. The demand will improve only when the economy turns around and India grows at 7-8% for a sustainable period of time, leading to increased incomes. The supply will improve if prices fall (which means more people are willing to sell the homes they own), of course, that will lead to an increase in demand as well.

Dear reader, you must be wondering by now, itna gyan de diya, now tell us if we should buy a home or not. First and foremost, what does buying a house have to with one year’s festival season or for that matter any other’s? You are not buying a mobile phone, which you buy almost every couple of years and wait for the best deal during the festival season. A home is only bought once or twice during a lifetime.

You should buy a house if you want to live in it, can afford to make the downpayment and most importantly, have a stable income which will allow you to keep paying the EMI on the home loan in the years to come. This also includes the idea of buying a bigger home to adjust to the new reality of working from home.

As mentioned earlier, the most important part here is stable income. If your job or business is on shaky ground, now is not the time to buy a house. If you want to continue living in the posher area of the city, but can only afford to pay a rent for it, then now is not the time to buy a house.

Remember, while you might be building an asset by not paying a rent but by paying an EMI, you are probably also making a compromise in terms of the time you have at your disposal to live the life you want to. If you are comfortable with the idea of a daily rat race then please go ahead and buy a house.

On the flip side, there are advantages to owning a home. One is the fact that you don’t have to change homes frequently, like you have to if you are living on rent. Over the years, I have come to the conclusion that this fear is oversold. The days when landlords used to be only landlords are gone (of course a lot of such people do survive).

Now there are many landlords who have full-fledged corporate careers and are more interested in a regular rental than changing people who they rent out their homes to, every 11 months. Remember it’s a pain for them as well. Also there is the risk of not finding a tenant on time and losing out on a month’s rent. And any sensible landlord will want to avoid that.

The biggest advantage to owning a home is that it tends to make your parents happy (in terms of getting settled in life). Also, the kids can have a slightly stabler life. But it all boils down to whether you can afford to buy a home. On this front, every individual’s situation is different and you need to figure that answer out for yourself. If you feel comfortable with buying a house right now then please go ahead and do that. Don’t wait.

As far as investing in real estate is concerned so that you can flip it later, that idea went out of style in 2013 or 2014 at best. If you still believe in it then either you deal in a lot of black money or probably don’t realise that the times have changed.

Why No One is Worried About Savers

Economists are like sheep. They like to move in a herd.

If one of them says that the Reserve Bank of India (RBI) and banks need to cut interest rates in order to revive the economy, largely everyone else follows.

This basically stems from the fact that the practitioners of economics like to think of the subject as a science, having built in all that maths into it over the decades.

In science, controlled experiments can be run and results can be arrived at. If these experiments are run again, the same results can be arrived at again.

The economists like to think of economics along similar lines. But then economics is not a science.

Take the case of the idea of a central bank and banks cutting interest rates when the economy of a country is not doing well. Why do economists offer this advise? The idea is that as banks cut interest rates, people will borrow and spend more.

At the same time corporates will borrow and expand, by setting up more factories and offices. This will create jobs. People will earn and spend more. Businesses will benefit. The economy will do better than it did in the past. And everyone will live happily ever after.

Okay, the economists don’t say the last line. I just added it for effect. But they do believe in everything else. Hence, they keep hammering the point of banks having to cut interest rates to get the economy going, over and over again. The corporates who pay these economists also like this point being made.

The trouble is that what the economists believe in doesn’t always turn out to be true. Or to put in a more nuanced way, there is a flip side to what they recommend. And I have seen very few professional economists talk about it till date. In fact, low interest rates hurt a large section of the population especially during an economic recession and contraction.

In India, a section of the population, is dependent on the level of interest rate on bank deposits (especially fixed deposits). Currently, the average interest rate on a fixed deposit is around 5.5% per year.

The inflation as measured by the consumer price index in September stood at 7.34%. Hence, the actual return on a fixed deposit is in negative territory. It has been in negative territory through much of this year. This doesn’t even take into account the fact that interest earned on fixed deposits is taxable at the marginal rate. After taking that into account the real return turns further negative.

This hurts people living off interest income, in particular senior citizens. Senior citizens whose fixed deposits have matured in the recent past have seen their interest income fall from around 8% per year to around 5.5% per year, in an environment where food inflation is higher than 10%.

The only way to keep going for them is to cut monthly expenses or start using their capital (or the money invested in fixed deposits) for regular expenses. It is worth remembering that India has very little social security and health facilities for senior citizens, as is common in developed nations.

Lower interest rates also impacts a large section of the population which saves for the future through bank fixed deposits. It is worth remembering that it is this section of the population which actually drives the private consumption in the country. When returns on their savings fall, the logical thing is to cut consumption and save more. If this is not done, then the future gets compromised on.

Lower interest rates hurt institutions like non-government organisations, charitable trusts etc., which save through the fixed deposit route.

The stock market wallahs love lower interest rates because a section of the population continues to bet on stocks despite the lack of company earnings. The price to earnings ratio of the stocks that constitute the Nifty 50, one of India’s premier stock market indices, is currently at more than 34.

Such high levels have never been seen before. It’s not the chances of future high earnings which have driven up stock prices but the current low interest rates, leading to more and more people trying to make a quick buck on the stock market. The government likes this because it feeds into their all is well narrative.

At the same time, given that the government is cash-starved this year, the stock market needs to continue to be at these levels for it to be able to sell its stakes in various public sector enterprises to raise cash.

Between March 27 and October 9, the deposits of banks (savings, current, fixed, recurring etc.) have increased by a whopping Rs 7.4 lakh crore or 5.4%. In the same time, the total loans of banks have shrunk by Rs 38,552 crore or 0.4%. This basically means people are repaying loans instead of taking on fresh ones, despite lower interest rates.

In this environment, with banks unable to lend out most of their fresh deposits, it is but natural that they will cut interest rates on their fixed deposits. You can’t hold that against them. That is how the system is adjusting to the new reality. But what has not helped is the fact that the RBI has been trying to drive down interest rates further by printing money and pumping it into the financial system.

Between early February and September end, the central bank has pumped more than Rs 11 lakh crore into the financial system.

Not all of it is freshly printed money, but a lot of it is. This has apparently been done to encourage corporates to borrow. The bank lending to industry peaked at 22.43% of the gross domestic product (GDP) in 2012-13. Since then it has been falling and in 2019-20, it stood at 14.28% of the GDP. Clearly, Indian industry hasn’t been in a mood to borrow and expand for a while. Hence, the so-called high interest rates, cannot be the only reason for it.

The real reason for the RBI pumping in money into the financial system and driving down interest rates has been to help the government borrow money at low interest rates. As tax collections have fallen the government needs to borrow significantly more this year than it did last year.

All this has hurt the saver. But clearly unlike the corporates and the government, the savers are not organised. Hence, almost no one is talking about them. In the latest monetary policy committee meeting, there was just one mention of them.

One of the members had this to say: “With retail fixed deposit rates currently ranging between 4.90-5.50 per cent for tenors of 1-year or more and the headline inflation prevailing above that for some months now, there has been a negative carry for savers.”

We already know that no economist talks about this phenomenon or more specifically the fact that low interest rates and high inflation should have led to a cut down in consumption. How big and significant is that cutdown? How is it hurting the Indian economy?

Is this cutdown in consumption more than the loans given by banks because of low interest rates?

These are questions that need answers. But the problem is that to a man with a hammer everything appears like a nail. For economists interest rates are precisely that hammer which they like using everywhere. This situation is no different.

The trouble is their hammer doesn’t necessarily work all the time.

A shorter version of this column appeared in the Deccan Chronicle on October 25, 2020.

Auto Sector Recovery is Not Real. It’s a Mirage Created by Inventory Pileup

All is well, when it comes to two-wheeler and passenger-vehicle sales. Or so we have been told over the last few days.

The small industry which has developed over the last few months, and whose main job is to shout recovery recovery at a drop of a hat, is at it again.

But should we believe them? Or rather how much should we believe them?

As per Autocar domestic sales of passenger vehicles (of India’s major car companies) in September 2020, went up by around 35% to a little over 2.75 lakh units. The September 2019 sales had been at a little over 2.04 lakh units.

In fact, August 2020 sales of the same set of companies had been at around 2.01 lakh. When we take that into account, the recovery has been very good.

As per Rushlane, the domestic sales of India’s major two-wheeler companies in September 2020 stood at 17.81 lakh, up 11.6% from September 2019, when sales had stood at 15.95 lakh.

Varied reasons have been offered for this recovery. Let’s take a look at these reasons pointwise.

1)  The pent-up demand is leading to higher sales (How do you argue against something like that?)

2) The economy is getting back on track. (Well!)

3) People do not want to use public transport due to the fear of the covid-pandemic and hence, are buying two-wheelers and cars. (Common sense and how do you argue against something like that).

4) Very low interest rates offered by banks on car loans. Take a look at the following chart.

Low interest rates

Source: ICICI Securities.

Car loan interest rates are as low as 6.5%. This has also helped push up sales. Along with low interest rates, many banks are offering very high loan to value, when it comes to entry-level cars. This means if the price of the car is Rs 5 lakh, some banks are willing to offer 95-100% of this price as a loan.

Also, as a research note authored by ICICI Securities analysts, Kunal Shah, Renish Bhuva and Chintan Shah points out, banks are offering, “cost-optimised financing schemes (tenure up to 7-8 years, step-up EMI, balloon EMI, low down payment options, scheme for low EMI for three months, etc).”

So, not only can customers borrow easily, they can do so in many different ways.  They have better choice and all this is encouraging them to borrow (But are they borrowing is the real question?).

5) Also, the agriculture sector continues to do well, and this has meant increased purchasing power in rural India, which has led to an increase in the purchase of two-wheelers. (This is a story as old as the ages, when urban India doesn’t do well, rural India has to).

These are the reasons that have been offered for India’s automobile sector doing well. Now let’s take a look at whether a recovery has really happened.

1) What automobile companies refer to as domestic sales are essentially dispatches to dealers or factory gate shipments. These are units leaving the manufacturing facility for sales to consumers. They haven’t been sold as such. Generally, company dispatches are a reasonable indication of end consumer sale. But this time companies are building up inventory at the dealer levels in the hope of sales picking up during the so-called festival season. The building up of inventory has been necessitated by the new BS VI environmental norms, which has led to the requirement of building new inventory.

This does not mean that the whole dispatch ends up as dealer inventory but a substantial portion does.

2) Hence, a better way of looking at data is to look at the number of registrations. This data is released by the Federation of Automobile Dealers Association (FADA). As per this data, in August 2020, 1.79 lakh passenger vehicles were registered. This is around 25,000 units lower than the dispatches of 2.04 lakh units carried out by major car companies during August.

When it comes to two-wheelers, the gap is bigger. In August 2020, as per FADA nearly 8.99 lakh two-wheelers were registered. In comparison 14.94 lakh two-wheelers from major companies had been dispatched.  There is a gap of close to six lakh units, which has ended up as inventory.

Take a look at the following table, which gives registration numbers of different kinds of vehicles.

Who is really buying?

2W = Two wheelers. 3W = Three wheelers. CV = Commercial vehicles. PV = Passenger Vehicles (Cars). TRAC = Tractors.

The sales and registration of commercial vehicles remains down in the dumps. This is hardly surprising given that the investment in the economy has totally collapsed. As per the Centre for Monitoring Indian Economy, the value of total new investments announced during July to September 2020, stood at Rs 58,601 crore, the lowest in fifteen years (without adjusting for inflation).

In fact, tractors are the only vehicles which have shown an increase in registration. This is due to the agriculture sector doing well and the rural rich doing well.

As per the VAHAN data released by the government, the total number of motor cars (as they call it) registered in August stood at 1.75 lakh . As per this data around 8.81 lakh two-wheelers were registered in August 2020, telling us the same story. Clearly, a significant portion of dispatches until August were for building inventory.

(Vahan data covers 1,242 out of 1,450 RTOs in the country. Hence, there is bound to be some discrepancy between company dispatches and registration numbers. But six lakh units, which is the difference in August in case of two-wheelers, is too huge to be just explained by this. FADA also refers to the Vahan database)

We do not have the September data for registrations as yet. But what we know clearly is that dealers have a lot of inventory piled up in the months up to August. And there is no reason for this to have stopped in September as well.

3) In fact, there is another factor that needs to be taken into account and that is the base effect. Two-wheeler and passenger vehicle registrations were already slow around this time last year. Hence, it makes sense to compare the 2020 numbers with the registrations that happened around this time in 2018. The registrations of motorcars as per Vahan data in August 2018 stood at around 1.96 lakh (compared to 1.75 lakh in August 2020). When it comes to two-wheeler registrations they stood at 12.12 lakh (compared to 8.81 lakh in August 2020). Hence, in that sense we are two-years behind when it comes to real consumer sales.

4) Let’s take a look at bank loans on this front. This is where things get very interesting. More than three-fourth of cars and two-wheelers were bought on loans before the covid-pandemic struck. The RBI does not give a proper division of different kinds of ‘vehicle loans’. But I guess even an overall number can be used to draw some inferences. The overall vehicle loans given by banks between end of March and August have contracted a little. This means that on the whole, people have been repaying loans and net-net banks haven’t given any fresh vehicle loans. While net-net between end March and end August there has been no fresh lending of vehicle loans by banks, some lending has happened in July and August. This stands at Rs 5,167 crore.

The question is if banks aren’t giving out vehicle loans how are all these vehicles being bought? Of course, banks aren’t the only financiers of vehicle loans, the non-banking finance companies (NBFCs) also finance the buying of vehicles.

Are NBFCs filling up this space? The NBFCs are also dependent on banks for financing. This means that NBFCs borrow from banks and then lend that money out.  The overall bank lending to NBFCs has contracted by 1.3% or Rs 10,620 crore, between end March and end August.

Hence, the ability of NBFCs to continue financing vehicles, when their borrowing from banks has come down, is rather limited.
This does not mean that banks are not interested in financing any kind of vehicle. They seem to be interested in financing cars but not two-wheelers. What this means is that if “genuine sales” don’t pick up, the huge inventories that the two-wheeler dealers have built up will become a problem for them. Car dealers will face the same problem though not of the same proportion.

5) Also, as far as financing goes, while banks are looking to finance a higher loan to value for entry level cars, that doesn’t seem to the case for cars as a whole. As Vinkesh Gulati, the president of FADA told Bloomberg Quint: “It has come to down to 65%-70%.”

6) Finally, what is surprising is that September also had the 16-day Shraad period from September 1 and September 17, when people believe it’s inauspicious to make purchases. In this scenario, it becomes even more difficult to believe that passengers vehicle sales (car sales) went up by as much as 35% during the month. It’s looking more and more like an inventory pile up at dealer level than genuine sales.

As Gulati had told Moneycontrol.com in mid-September: “This year all festivities will begin a month after Shraadh gets over and this period is also not considered to be good for sales in the North, East and West of the country. We are expecting September to be below August and also below last September.”

To conclude, as the economy opens up, automobile sales are bound to improve gradually. Nevertheless, there are several nuances that need to be kept in mind, before announcing an auto sector recovery. The auto-sector in India forms around half of the manufacturing sector and hence, is very important. And given that, it is important to analyse it carefully.

From the looks of it, the difference between genuine registrations at the retail level and the company dispatches, will only go up in September as the inventory pile up continues.

In fact, this inventory build-up might also be responsible to some extent for the increase in goods and services tax collections seen during September. The trouble is that the end consumer is yet to pay this tax.

 

How Low Interest Rates Have Hurt Economic Recovery

satyajit das
In the aftermath of the financial crisis that broke out in September 2008, after the investment bank Lehman Brothers went bust, central banks all across the Western world drove interest rates close to 0%.

This was referred to as the zero interest rate policy or ZIRP. The hope was that with ZIRP the interest rates on loans offered by banks would remain very low and in that environment people would borrow and spend more.

They would buy more cars…More homes…More TVs..

And this would ensure an economic recovery. QED.

But things did not turn out to be as simple as that. As Satyajit Das writes in his new book The Age of Stagnation—Why Perpetual Growth is Unattainable and the Global Economy is in Peril: “Low rates also discourage savings. But sometimes, in a complex cycle of cause and effect, they may perversely reduce consumption as lower returns force people to save more for future needs.”

And in fact low interest rates may also lead to lower consumption. How is that possible? As Das writes: “Citigroup equity strategist Robert Buckland has argued that low rates and QE reduce employment and economic activity, rather than increasing them. These policies encourage a shift from bonds into equities.”

Interestingly, those who have retired from work have had to shift their money into stocks because of low interest rates. As Das writes: “In October 2014 an American retiree with US$1 million invested in secure, two-year US government bonds would have earned US$3900 in annual interest, 92 percent less than the US$48,000 they would have received in 2007. The retired and savers in advanced economies were forced to purchase riskier securities or invest in dividend-paying stocks to earn a return.”

And these investors were looking for income from the investments they had made in stocks. As Das writes: “As investors are looking for income rather than capital growth, they force companies to increase dividends and undertake share buybacks. To meet these pressures, companies must boost cash flow and earnings, by shedding workers and reducing investments to cut costs. The process increases share prices and returns for shareholders of the company, but is bad for the overall economy.”

What does this mean? With interest rates on bank deposits and other fixed income investments at very low levels, people have moved their money to equity. These investors force companies to increase dividends and at the same time buyback its own shares. When a company buys back its own shares a lesser number of shares remain in the open market, pushing up the earnings per share. With fewer shares going around, it also increases the chances of a higher dividend per share.

Interestingly, with interest rates at such low levels, companies have been borrowing money to buy back their own shares. As Albert Edwards of Societe Generale wrote in a research note in November: “The primary driver for the rapid rise in bank lending…has been borrowing by US corporates and we all know they have been using the Fed’s free money not to invest in capacity expanding expenditures, but rather to buy back mountains of their own shares…Corporate debt borrowing at an $674bn annual rate [is] closing in rapidly on the all-time borrowing splurge of 2007!”

Also, in the pressure to boost earnings companies have had to fire people and at the same time reduce investments to cut costs. This has led to hire share prices but it has also led to a situation where employees have been fired from their existing jobs and new jobs haven’t been created. Any person who has been fired or is likely to be fired is unlikely to go out shopping, as the basic idea behind lower interest rates is.

This has an impact on consumption and economic growth. Hence, in a very perverse sort of way, low interest rates may have had a negative impact on consumption. And this has meant economic growth has not recovered as fast as it was expected to.

Also, the ZIRP has pushed up stock markets all over the developed world and in the process helped the rich become richer. As L Randall Wray writes in Why Minsky Matters—An introduction to the Work of a Maverick Economist: “According to a study by Pavlina Tcherneva, 95 percent of the benefits of the recovery from the global financial crisis have gone to the top 1 percent of the income distribution. Another study finds that the top one-thousandth (top 0.1 percent) of the U.S. population now owns fifth of all the wealth.”

The trouble is that the rich do not increase their consumption if they get richer. As Das writes: “Higher income households have a lower marginal propensity to consume, spending a lower portion of each incremental dollar of income than those with lower incomes. US households earning US $35,000 consume an amount from each additional dollar of income that is around three times that of a household with an income of US$200,000. Given that consumption constitutes around 60-70 percent of economic activity, concentration of income at the higher end limits growth in demand.”

And this explains why low interest rates through large parts of the Western world haven’t had the kind of impact that they were expected to. What this tells us is that there are no universal solutions to problems even though economists and politicians often sound very confident while offering them.

And this is something dear readers that you need to keep in mind the next time you hear a politician or an economist, talk about the economy, with great confidence. Economics is not an exact science.

Disclosure: Satyajit Das wrote the foreword to my book Easy Money: Evolution of Money from Robinson Crusoe to the First World War

The column appeared on the Vivek Kaul Diary on January 18, 2016