Mr Stiglitz, India’s Obsession with Inflation is Correct

DAVOS-KLOSTERS/SWITZERLAND, 31JAN09 - Joseph E. Stiglitz, Professor, Columbia University, USA, at the Annual Meeting 2009 of the World Economic Forum in Davos, Switzerland, January 31, 2009. Copyright by World Economic Forum


Joseph Stiglitz, a Nobel prize winning economist, had some advice for Indian policymakers last week. Speaking in Bangalore, Stiglitz said: “Excessive focus on inflation almost inevitability leads to higher unemployment levels and lower growth and therefore more inequality.”

The point that Stiglitz was making is that the government of India should spend more than it currently plans to. Further, the Reserve Bank of India(RBI) should cut interest rates further and encourage people to borrow and spend more. Of course, all this extra spending will lead to some inflation, with more money chasing the same quantity of goods and services. But that will be a small price to pay for economic growth. This economic growth will lead to lower unemployment and in the process lower inequality.

This is precisely the kind of argument that was made during the Congress led United Progressive Alliance(UPA) regime, to justify the high rate of inflation that prevailed between 2008-2009 and 2013-2014.

The trouble is that there is enough evidence that suggests otherwise. Over the last five to six decades, countries which have grown at a very fast pace, have had very low rates of inflation.

As Ruchir Sharma writes in The Rise and Fall of Nations—Ten Rules of Change in the Post-Crisis World: “The miracle economies like South Korea, Taiwan, Singapore, and China, which saw booms, lasting three decades or more, rarely saw inflation accelerate to a pace faster than the emerging market average. Singapore’s boom lasted from 1961 to 2002, and during that period inflation averaged less than 3 percent.”

The same is the case with China. As Sharma puts it: “In China, the double digit GDP growth of the last thirty years was accompanied by an average inflation of around 5 percent, including an average rate of around 2 percent over the decade ending in 2010. China saw a brief surge in inflation in 2011, and economic growth in the People’s Republic has been slumping steadily since then.

The point is very clear, inflation is not good for economic growth. There is enough evidence going around to show that. The same can be said in the Indian case as well, when the inflation surged between 2008-2009 and 2013-2014. It ultimately led to economic growth collapsing.

YearInflation (in %)Economic Growth (in %)


In 2007-2008, inflation was at 6.2 per cent and the economic growth came in at 9.32 per cent. In the aftermath of the financial crisis that started in 2008-2009, the union government increased its expenditure in the hope of ensuring that the economic growth did not collapse.

The government expenditure budgeted for 2008-2009 was at Rs 7,50,884 crore. The final expenditure for the year was at Rs 8,83,956 crore, which was around 17.8 per cent higher. The expansive fiscal policy led to inflation, which in turn led to lower economic growth in the years to come.

The increased government spending led to high inflation in the years 2009-2010 and 2010-2011, but at the same time it also ensured that economic growth continued to stay strong in the aftermath of the financial crisis. Nevertheless, high inflation ultimately caught up with economic growth and it fell below 5 per cent during 2012-2013 and 2013-2014.

The point being that extra spending and lower interest rates leading to inflation might help bump up economic growth in the short-term, but over the longer term it clearly does not help. What made the situation even worse was that RBI did not get around to raising interest rates as fast as it should have.

As Vijay Joshi writes in India’s Long Road—The Search for Prosperity: “Since fiscal policy was expansive, the job of demand-side inflation control was left to the RBI. Given the strength of both demand and cost-push forces, monetary policy would have had to be tough to be effective. Put bluntly, the RBI muffed it. It took a softly-softly approach to raising interest rates. While this may perhaps have been understandable because it feared hurting investment and growth, it is surely no surprise that inflation proved to be persistent.”

High inflation also leads to a situation where the household financial savings fall. This is precisely how things played out in India. Between 2005-2006 and 2007-2008, the average rate of household financial savings stood at 11.6 per cent of the GDP. In 2009-2010, it rose to 12 per cent of GDP. By 2011-2012, it had fallen to 7 per cent of the GDP. In 2014-2015, the ratio had improved a little to 7.5 per cent of GDP.


Household financial savings is essentially a term used to refer to the money invested by individuals in fixed deposits, small savings schemes of India Post, mutual funds, shares, insurance, provident and pension funds, etc. A major part of household financial savings in India is held in the form of bank fixed deposits and post office small savings schemes.

A fall in household financial savings happened because the real rate of return on deposits entered negative territory due to high inflation.


This led to a situation where savers have moved their savings away from deposits and into gold and real estate. As RBI governor Raghuram Rajan said in a June 2016 speech: In the last decade, savers have experienced negative real rates over extended periods as CPI has exceeded deposit interest rates. This means that whatever interest they get has been more than wiped out by the erosion in their principal’s purchasing power due to inflation. Savers intuitively understand this, and had been shifting to investing in real assets like gold and real estate, and away from financial assets like deposits.”

If a programme like Make in India has to take off, low household financial savings cannot be possibly a good thing. This hasn’t created much problem in the recent past, simply because bank lending to industry has simply collapsed. Banks (in particular public sector banks) are not interested in lending to industry because industry has been responsible for a major portion of bad loans in the last few years.

But sooner or later, this situation is going to change. And then the low household financial savings ratio, will have a negative impact and push interest rates up. In this scenario, it is important that inflation continues to be under control and the real rates of return on deposits continue to be in positive territory. That is the only way, the household financial savings ratio is likely to go up.

As Joshi puts it: “In today’s world of low inflation, India’s long-run inflation target should certainly be no higher than 4 or 5 per cent a year.” And that is something both the RBI as well as the union government should work towards achieving and maintaining.

The column originally appeared in Vivek Kaul’s Diary on July 12, 2016

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

The column originally appeared on Firstpost on September 21, 2015

High price not EMIs: Dear Jaitley, here is why Indians are not buying homes

Fostering Public Leadership - World Economic Forum - India Economic Summit 2010Sometimes I wonder if the finance minister Arun Jaitley has ever heard of Abraham Maslow. Maslow was an American psychologist who among other things also came up with the law of the instrument, which is better known as Maslow’s hammer.
As Maslow put it: “I suppose it is tempting, if the only tool you have is a hammer, to treat everything as if it were a nail.”
The idea was also put forward by the American philosopher Abraham Kaplan, when he said: “Give a small boy a hammer, and he will find that everything he encounters needs pounding.”
What the idea essentially tries to communicate is the habit of using the one tool for all purposes. In Jaitley’s case this tool seems to be a cut in the “repo rate”, or the rate at which the Reserve Bank of India (RBI) lends to banks.
In the recent past, he has asked the RBI to cut the repo rate time and again. Once the RBI starts cutting the repo rate, banks will start cutting the interest rates at which they give loans, the belief is.
At lower rates people will borrow and spend more and the Indian economy will grow at a much faster rate. For Jaitley its all about lower interest rates. “Now time has come with moderate inflation to bring down the rates. If you bring down the rates, people will start borrowing from banks to pay for their flats and houses. The EMIs will go down,” he
said yesterday.
The statement was essentially a continuation of the pressure that Jaitley has been trying to build on the RBI to cut the repo rate. But will it make any difference?
Let’s try and understand this through an example of an individual trying to buy a home in Mumbai. In a recent research report the real estate research firm Liases Foras had pointed out that the weighted average price of a flat in Mumbai was Rs 1.34 crore.
I had written a piece around this data in early November showing how expensive flats in Mumbai and other cities were vis a vis the average income of people in living in those cities. One criticism that came in was that the weighted average price arrived at was on a higher side because the data had taken only premium projects into account.
There is enough anecdotal evidence to suggest that is not the case. Nevertheless let’s take that into account and assume that the actual weighted average price of a flat in Mumbai is 75% of the price that Liases Foras had arrived at.
This works out to around Rs 1 crore. Let’s say an individual decides to buy such a flat and takes on a home loan to do so. A bank would normally give around 80% of the market price of a house as a home loan. So, the individual takes a loan of Rs 80 lakh (80% of Rs 1 crore) to be repaid over a period of 20 years. The remaining Rs 20 lakh he puts from his savings.
The RBI governor Raghuram Rajan in a recent speech said that the average interest rate on a home loan these days was 10.7%. Let’s assume that the individual borrows at the average interest rate. The EMI on this loan works out to Rs 80,948.
Let’s say the interest rate on the home loan comes down by 50 basis points (one basis point is one hundredth of a percentage) to 10.2%. The EMI on this loan works out to Rs 78,265 or Rs 2,683 lower.
If the interest rates are cut by 100 basis points and the interest rate on the home loan falls to 9.7%, the EMI will fall by around Rs 5,330. So, will an individual who has the ability of making a downpayment of Rs 20 lakh and taking on a home loan of Rs 80 lakh, buy a home simply because the EMI is Rs 2,683-5,330 lower?
An individual who has the ability to take on a home loan of Rs 80 lakh must be making around Rs 1.65 lakh per month(
as per the home loan eligiblity calculator available on And that is clearly a lot of money. Only a small set of individuals make that kind of money, even in a city like Mumbai.
The same exercise can be repeated for other cities as well, and the results will remain the same. The larger point is that the fact that Indians are not buying homes has got nothing to do with high interest rates and EMIs and everything to do with the fact that homes are atrociously expensive. And instead of asking the RBI to cut interest rates, Jaitely should be looking at ways through which home prices can be brought down to more reasonable levels.
He could start with ensuring that better data on real state is available to the people of this country.
Currently, t
he National Housing Bank has the Residex index, which gives some idea of the prevailing price trends across various cities. But the information is not up-to-date enough to be of much use. As of now, the data is available only up to June 2014. Also, the data is declared every three months. Something of this sort should be declared on a monthly basis.
Further, anyone trying to buy a home essentially has no data that he can look at to figure out what the prevailing price trend is. Typically, he has to go with what the brokers tell him. And brokers are not normally thinking about the best interests of the individual trying to buy a home.
For starters, the government could try and aggregate the stamp duty data from the twenty biggest cities in India. This will tell us the average price at which “homes” are “supposedly” being sold. Along with that the number of transactions being registered will give us some idea of what the demand situation is.
Of course, given the black money transactions that happen in real estate, the average price that we get through this route may not be totally correct. Nevertheless, this is not a bad starting point. Further, in order to cut down on black money transactions the government needs to ensure that the circle rate is close to the prevailing market value in any area.
A property when it is sold needs to be registered at the actual transaction value or the prevailing circle rate, whichever is higher. The stamp duty needs to paid on this value. Typically, the market rate tends to be much higher than the prevailing circles rate. This essentially leads to a situation where transactions are declared at the circle rate and not the market rate, ensuring that a significant part of the transaction happens in black. It also leads to lower tax collections for the government.
Further, in areas where the difference between the market rate and the circle rate is high attract a lot of black money. As Anuj Puri chairman and country head, Jones Lang LaSalle India,
told Mint in September 2014, “Reduction in the gap between circle and market rates means that the region becomes less attractive for those who are seeking to offload unaccounted-for funds, and more attractive for genuine buyers.”
These are the steps that Jaitley should be thinking about instead of asking the RBI to cut interest rates almost every time he speaks.

The article appeared originally on on Dec 12, 2014

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

RBI keeps repo rate at 8%: Lower interest rates are not a solution to slow economic growth


Ramachandra Guha in a wonderful essay titled An Anthropologist Among Marxists writes about what he calls a “possibly, apocryphal anecdote.” As he writes “When Indira Gandhi was assassinated, her ashes were sent to different cities to allow public homage. When her ashes lay lay in Calcutta’s Government House they were visited one evening by the state’s finance minister. In the previous year this man had delivered no less than two hundred and sixty-two speeches on the discrimination against West Bengal in the release of funds from the central treasury. As the minister came out of the Government House, he was asked how he felt when confronting the mortal remains of his most resolute political opponent. He replied in character: Centre Kom Diye Che (the centre has again given us less than our rightful share).”
In another essay titled
Political Leadership Guha writes “Jyoti Basu’s government, it was said, began every discussion on federalism with the words, “Centre kom diye che.
The communists who ruled West Bengal for more than three decades liked to blame all the problems of the state on the central government, which they felt did not give the state a fair share of the funds.
Dear Reader, if you are wondering why am I talking about West Bengal and its politics in a piece which has the term “interest-rates” in the headline, allow me to explain. Over the last few years, everyone from politicians to businessmen to bankers have called for interest rates to be cut as a solution for reviving economic growth in India. The assumption is that at lower interest rates people will borrow and spend more and that will lead to economic growth.
In that sense, these individuals are not very different from the communist politicians of West Bengal for whom “
Centre kom diye che” was an explanation for all the problems of the state. Along similar lines, individuals calling for a cut in interest rates seem to believe that higher interest rates are a major reason for the slowdown in economic growth, and a cut can really get people borrowing and spending all over again.
The former finance minister P Chidambaram was a major propagator of this belief. His successor Arun Jaitley has carried of where Chidambaram left. Other than the politicians, bankers have also regularly asked the Reserve Bank of India (RBI) to cut interest rates.
Today with the RBI deciding to keep the repo rate unchanged at 8% in the fourth bi-monthly monetary policy, the interest-rate-
wallahs will be at it again. Repo rate is the rate at which the RBI lends to banks.
The RBI had its reasons for not changing the repo rate. As it pointed out in a statement “Since June, headline inflation has ebbed…The most heartening feature has been the steady decline in inflation excluding food and fuel…to a new low. With international crude prices softening and relative stability in the foreign exchange market, some upside risks to inflation are receding. Yet, there are risks from food price shocks as the full effects of the monsoon’s passage unfold, and from geo-political developments that could materialise rapidly.”
Nevertheless, over the next few days you will see bankers, real estate company owners, industry lobbies and possibly even the finance minister Jaitley, wondering why the RBI did not cut the repo rate, to get lending going again.
The most recent occasion when the interest-rate-wallahs came out in the open was when the bankers asked the RBI to cut the repo rate, after the growth in bank loans fell to a five year. As on September 5, 2014, the one year growth in bank loans stood at 9.7%. During the same time last year the number was at a significantly higher 17.9%.
The belief as explained earlier is that at lower interest rates people will borrow more. But as the American baseball coach Yogi Berra once famously said “In theory there is no difference between theory and practice. In practice there is.”
Lower interest rates do not always lead to more borrowing and revival of economic growth. An excellent example of this is what has happened in the aftermath of the financial crisis that broke out in September 2008. Western central banks brought down interest rates to very low levels in the hope that people will borrow and spend more, and help revive economic growth. But that did not happen. All it did was lead to many stock market bubbles all over the world.
Closer to home let’s take a look at car sales. The sales have revived from May 2014, after having continuously fallen for nine months. In August 2014, car sales grew by 15.16%, in comparison to the same period last year. This has happened without much change in interest rates. Why is that the case? Let’s try and understand this through a simple example. Let’s assume that an individual takes a car loan of Rs 4 lakh to be repaid over a period of five years at an interest rate of 10.5%. The EMI on this loan works out to around Rs 8,598.
Let’s say that interest rates were to come down by a massive 100 basis points (one basis point is one hundredth of a percentage)to 9.5%, all at once. At this interest rate, the EMI would work out to around Rs 8,401 or around Rs 200 lower than the earlier EMI. Now how many people will go and buy a car just because the EMI is now lower by Rs 200?
Anyone who has the ability to repay an EMI of Rs 8,401 can also repay an EMI of Rs 8,598. Hence, what people look at while taking on a loan is their ability to service the EMI. This involves at looking at factors like job prospects, the prospects of the company the individual works for and some idea of how he expects the broader economy to do. A major reason for the revival in car sales has been the election of Narendra Modi as the prime minister of India.
People have bought his election slogan “
acche din aane waale hain” and hence, have taken on car loans and bought cars because for now they believe that their future will be better than their past. Interest rates have had no role to play in the revival of car sales.
Let’s consider real estate next. Here again the belief is that if interest rates are cut people will borrow and buy homes. This logic again doesn’t really hold. Home prices are now way beyond what an average Indian can afford. Let’s consider the city of Mumbai.  
A July 2014 report in The Times of India quotes Pankaj Kapoor of property research firm Liases Foras as saying “In Mumbai, the average cost of a flat is Rs 1.2 crore.”
An estimate made by Forbes puts the average income of a Mumbaikar at $5900 or around Rs 3.54 lakh (assuming $1 = Rs 60) per year. This means it would need nearly 34 years of annual income (Rs 1.2 crore divided Rs 3.54 lakh) for an average Mumbaikar to buy a home in this city currently. What this tells us very broadly that homes in Mumbai are very expensive. Similar calculations done for other parts of the country are most likely to show similar results.
Hence, the point is that homes in most parts of the country are now much more expensive than what most Indians can afford. Given this, lower EMIs because of lower interest rates aren’t going to help much. The real estate market has priced itself out.
This was the demand side of things. Now let’s look at what the economists call the supply side. Investments made by corporates have fallen rapidly over the last few years. As Sanjeev Sanyal of Deutsche Bank Market Research writes in a research report titled
India 2020: The Road to East Asia and dated September 2014, “Gross Fixed Investment by the private corporate sector dropped from a peak of 14.3% of GDP in 2007-08 to 8.5% of GDP in 2012-13 (and likely even lower in 2013-14) with investments in machinery and equipment being particularly hit.”
The interest-rate-
wallahs would like us to believe that this fall in investment has primarily been because of the high interest rates that have prevailed over the last few years. Nevertheless is that really the case? As Rahul Anand and Volodymyr Tulin write in an IMF Working Paper dated March 2014 and titled Disentangling India’s Investment Slowdown “Our results suggest that real interest rates account for only one quarter of the explained investment downturn. However, we find that standard macro-financial variables (interest rates, external demand, relative prices, global financial market volatility and others) do not fully explain the recent investment slump. Finally, using the new measure of economic policy uncertainty, the results suggest that heightened uncertainty and deteriorating business confidence have played a key role in the recent investment slowdown.”
Hence, if the current government really wants to get corporate investment going it needs to bring in a lot of much delayed structural reform. Also, it is worth remembering here that a some of the major business groups in India have already borrowed a lot of money and are having tough time paying interest on the debt they already have. Hence, where is the question of borrowing more?
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. The household financial savings were at 12% of the GDP in 2009-10. Since then, they have fallen dramatically 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 has led to people moving their money into investments like gold and real estate, where they expected to earn more. If the household financial savings number has to go up the rate of interest on offer on fixed income investments needs to be higher than the rate of inflation. Only recently has the consumer price inflation fallen to levels below the rate of return available on fixed income investments. This situation has to be allowed to persist if the financial savings of India are to increase.
To conclude, calling for lower interest rates on almost every occasion is not a solution to anything. It is time the interest-rate-
wallahs understand this.

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