Vivek Kaul
P Chidambaram, the finance minister, made the routine let’s not get worried statement, over the rupee’s recent fall against the dollar.“We are watching the situation. RBI will take whatever action it has to take. We will (do) whatever has to be done…My request is you should not react in panic. It’s happening around the world,” he said.
This was something that was reiterated by Arvind Mayaram, secretary of the department of economic affairs, in the ministry of finance. “No, I don’t think the government needs to take any measures…We are watching the situation closely…If you see weakening of all currencies vis-a-vis the dollar, the rupee is also not unaffected in that sense…this panic in the market is unwarranted.”
A finance minister and his bureaucrat are expected to defend a falling currency. And yes, it’s true a lot of currencies have lost value against the dollar recently. But does that make the pain any lesser for India? Are there no reasons to worry as Mayaram wants us to believe?
Chidambaram’s “it is happening around the world” argument can be tackled with a simple analogy. Let’s say one of your neighbours starts a fire by mistake, which eventually spreads to your house. What do you do in such a situation? You try and stop the fire from spreading further, rather than sitting and blaming your neighbour for it or saying that I should not panic because I did not start the fire. Irrespective of where the fire started, the damage is yours, if you do not work towards putting it off.
Even though the rupee is falling against the dollar because of certain actions taken by the Federal Reserve of United States, it is clearly damaging India.
A depreciating rupee means that India has to pay more in rupee terms, for its oil imports. The price of the Indian basket of crude oil was at around $98 per barrel at the beginning of June.
It rose to $104 per barrel on June 19, 2013. On June 20, 2013, it fell to $101.8 per barrel. The rupee during the same period has fallen to Rs 60 to a dollar(Rs 59.75 as I write this) from around Rs 56.5 at the beginning of .
What this means is that India’s oil import bill has gone up in rupee terms. If the government decides to pass on this increase to the final consumer in the form of an increase in the price of diesel, petrol and kerosene, then it will lead to inflation or higher prices.In fact CNG prices have already been hiked in Delhi by Rs 2, because of a weaker rupee.
If it decides to take on a part of the increase then it means greater expenditure for the government. A greater expenditure in turn means a higher fiscal deficit for the government. Fiscal deficit is the difference between what a government earns and what it spends. A higher fiscal deficit means that the government has to borrow more to finance its expenditure and this leads to higher interest rates, which holds back economic growth.
Coal is another big import item. With the rupee losing value against the dollar the cost of importing coal is going up. Coal in India is imported typically by private power companies to produce power. The government owned Coal India Ltd, does not produce enough coal to meet the needs. The Cabinet Committee on Economic Affairs recently decided to allow private power companies to pass on the rising cost of imported coal to consumers.
This will lead to a higher cost of power, which will add to inflation. As Anand Tandon writes in The Economic Times “Inflation at the consumer level will start hotting up in the third quarter of the fiscal year as increases in power and fuel cost work their way through the system.”
A depreciating rupee will benefit Indian exporters, or so goes the argument. As rupee loses value against the dollar, an exporter who gets paid in dollars, gets more rupees, when he converts those dollars into rupees, thus boosting his profits.
This argument doesn’t really hold. The Economic Times quotes Anup Pujari, director general of foreign trade (DGFT), on this issue. “It is a myth that the depreciation of the rupee necessarily results in massive gains for Indian exporters. India’s top five exports — petroleum products, gems and jewellery, organic chemicals, vehicles and machinery — are so much import-dependent that the currency fluctuation in favour of exporters gets neutralised. In other words, exporters spend more in importing raw materials, which in turn erodes their profitability.”
The other thing that seems to be happening is that in a tough global economic environment, buyers are renegotiating contracts with Indian exports as the rupee loses value against the dollar.”The moment the rupee falls sharply against the dollar foreign buyers try to renegotiate their earlier deals. As most exporters give in to the pressure and split the benefits, the advantages of a weak rupee disappear,” Pujari told The Economic Times.
What this means is that a weaker rupee is unlikely to lead to higher exports. This means that the trade deficit or the difference between imports and exports will continue to remain high, which can weaken the rupee further against the dollar.
In fact, a depreciating rupee has rendered nearly 25,000 diamond workers in Surat jobless, reports The Times of India. “The depreciating rupee has resulted in nearly 1,200 small and medium diamond unit owners in shutting shops as they are unable to purchase rough stones whose prices have touched an all-time high. This has led to at least 25,000 workers being rendered jobless since last Thursday,” the report points out.
The rupee could have fallen to a much lower level against the dollar, but it did not. This is primarily because the Reserve Bank of India(RBI) has been defending the rupee, by selling dollars from its foreign exchange reserves, and buying rupees.
But the question is till when can the RBI keep selling dollars? “Foreign exchange reserves are barely sufficient to cover seven months of imports — the lowest it has been in the last 15 years. As a comparison, the other Bric members have 19-21 months of import cover,” writes Tandon. According Bank of America-Merril Lynch, the RBI can sell up to $30 billion to support the rupee.
The RBI cannot create dollars out of thin air, only the Federal Reserve of United States can do that.
Given this, there are reasons to worry. And yes, the Chidambaram’s UPA government did not start this rupee fire, but that does not mean that India is not burning because of it.
The article originally appeared on www.firstpost.com on June 25, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)
P Chidambaram
Mr Chidambaram, India's love for gold is just a symptom, not a problem
Vivek Kaul
P Chidambaram, the union finance minister, has been urging Indians not to buy gold. But we just won’t listen to him.
In the month of May 2013, India imported $8.4 billion worth of gold, up by 90% in comparison to May 2012. This surge in gold imports pushed up the trade deficit to $20.14 billion in May. It was at $17.8 billion during April 2013. Trade deficit is the difference between the merchandise imports and exports. Commerce Secretary S R Rao said “As far as trade deficit is concerned, it is very worrisome…It is largely contributed by heavy imports of gold and silver.”
A trade deficit means that the country is not earning enough dollars through exports to pay for all that it is importing. To correct this, it either needs to increase its exports and earn more dollars to pay for imports or cut down on its imports. Indian exports have been growing at a very slow pace. In fact they fell by 1.1% in May 2013 to $24.5 billion. Imports on the other hand rose by 7% to $44.65 billion.
The trouble is that when India imports gold it pays for it in dollars. Indian rupees are sold to buy these dollars. Given this there is a surfeit of rupees in the market and a scarcity of dollars, pushing up the value of the dollar against the rupee. This leads to the country paying more for imports in rupee terms.
Hence, the logic goes that India should not be importing as much gold as it is. Or as Chidambaram said a few days back “I would once again appeal to everyone please resist the temptation to buy gold…If I have one wish which the people of India can fulfill is don’t buy gold.”
But the same logic applies to oil as well. India imported $15 billion worth of oil in May 2013. Of course, oil is more useful than gold, and we need to import it because we don’t produce enough of it.
And given that gold is as useless as something can be, we don’t need to import it. Or as Chidambaram said “I continue to hope and suppose if the people of India don’t demand gold if we don’t have to import gold for a year just imagine the whole situation will so dramatically change. Every ounce of gold is imported. You pay in rupees, we have to provide dollars.”
So what comes out of all this is that the government does not want Indians to buy gold. It recently increased the import duty on gold to 8% from 6% earlier. Chidambaram even set a personal example when he recently said “I don’t buy gold, I put my money in financial instruments and I am happy.”
There are multiple problems with what Chidambaram is saying. The first and foremost is the fact that buying or not buying gold is a free economic decision that people choose to make. Or as economist Bibek Debroy wrote in a column in The Economic Times “The gold policy is futile because buying gold is a free decision of rational economic agents and gold imports are a symptom, not the disease.”
And what is the symptom? The symptom is the high consumer price inflation that prevails. People have been buying gold to hedge themselves against that inflation. As the Economic Survey of the government for the year 2012-2013, released in February pointed out “Gold imports are positively correlated with inflation: High inflation reduces the return on other financial instruments. This is reflected in the negative correlation between rising imports and falling real rates.”
What this means is that because inflation is high the real rate of return on financial instruments is very low. Why would people invest in a financial instrument like a fixed deposit or a PPF account or a National Savings Certificate, at an interest of 8-9%, when the consumer price inflation is higher than that? So what do they do? They invest in gold because they have been told over the generations, that gold holds its value against inflation.
Chidambaram has asked people not to buy gold and even gone to the extent of saying that he does not buy the yellow metal and puts his money in financial instruments. Of course, being the finance minister of the country he is unlikely to face any problems while investing in financial instruments.
But here is a small suggestion. Chidambaram should try investing in a mutual fund once on his own without going through a bank or an agent. And the bizarre number of requirements that need to be fulfilled to invest in a mutual fund, will give him a real flavour of how difficult it is to invest for an individual to invest in a mutual fund.
Or take the case of a senior citizen who invests his retirement funds in the senior citizen savings scheme run by the post office and is given a thorough run-around every time he has to go and collect the interest on the money that he has deposited.
Or take case of the spate of smses banks recently sent out to their customers asking them to furnish documents and account opening recommendations, even when customers have had accounts for more than a decade.
Given this, it is not surprising that people buy gold which is available hassle free over the counter. The Economic Survey nailed it when it said “The overarching motive underlying the gold rush is high inflation and the lack of financial instruments available to the average citizen, especially in the rural areas. The rising demand for gold is only a “symptom” of more fundamental problems in the economy. Curbing inflation, expanding financial inclusion…and improving saver access to financial products are all of paramount importance.” Hence, people will continue to buy gold when they want to, irrespective of the appeals made by Chidambaram.
Inflation is something that the government of this country has created. And when people protect themselves against it, you can’t hold them responsible for creating other problems.
When a country runs a trade deficit it doesn’t earn enough dollars to pay for its imports through exports. What happens in this situation is that dollars coming in through other sources like foreign direct investment, foreign institutional investment and citizens living abroad, are used to finance imports.
In India’s case remittances a well as deposits made by NRIs play an important part in filling up the trade deficit gap. As Andy Mukherjee points out in a column in the Business Standard “For every rupee of time deposits that Indian banks have raised from residents in the past year, 13
paise has come from the estimated 25 million people of Indian origin who live in other countries.”
World over interest rates on savings deposits are at very low levels. The same is not true about India where interest rates continue to remain high and hence it makes sense for NRIs to invest money in India.
But this investment carries the currency risk. Lets understand this through an example. An NRI decides to invest $100,000 in India. At the point of time he gets his money into India, one dollar is worth Rs 50. So he has got Rs 50 lakh to invest. He invests this in a bank which is offering him 10% interest. At the end of the year he gets Rs 55 lakh (Rs 50 lakh + 10% interest on Rs 50 lakh).
Now lets say a year later $1 is worth Rs 55. So when the NRI converts Rs 55 lakh into dollars, he gets $100,000 (Rs 55 lakh/55) or the amount that he had invested initially. Hence, he does not make any return in the process. This is because the Indian rupee has depreciated against the dollar, which is something that has been happening lately. This is the currency risk.
In this scenario, the NRIs are likely to withdraw their deposits from India because if the rupee keeps losing value against the dollar, chances are they might face losses on their investments. When NRIs repatriate their money, they sell rupees and buy dollars. This leads to a surfeit of rupees and shortage of dollars in the market, and thus leads to the rupee depreciating further.
This is a scenario that is likely to play out in the days to come. Over and above this there is also the danger of foreign institutional investors continuing to withdraw money from the Indian debt market, as they have in the recent past.
This danger has become even more pronounced with Ben Bernanke, the Chairman of the Federal Reserve of United States, the American central bank, announcing late last night that they would go slow on money printing.
As he said “the Committee currently anticipates that it would be appropriate to moderate the monthly pace of purchases later this year.”
The Federal Reserve prints dollars and uses them to buy bonds to pump money into the financial system. This ensures that interest rates continue to remain low as there is enough money going around.
As and when the Federal Reserve goes slow on money printing, the American interest rates will start to go up (in fact they have already started to go up). Given this the investors who had been borrowing in the United States and using that money to invest in India, would be looking at a lower return as they will have to pay a higher interest on their borrowing.
A prospective lower return could lead to some of these investors to sell out of India. In fact as I write this the bond market has come to a halt because there are only sellers in the market and no buyers. Such has been the haste to exit India.
When foreign investors sell out of bonds (and stocks for that matter) they get paid in rupees. This money needs to be repatriated to the United States and hence needs to be converted into dollars. So the rupees are sold to buy dollars from the foreign exchange market.
When this happens there is a surfeit of rupees in the market and a huge demand for dollars. This has led to the rupee rapidly losing value against the dollar. Around one month back one dollar was worth Rs 55. Now its worth close to Rs 60 ($1 equals Rs 59.9 to be precise).
A lower rupee means that the price of gold is likely to go up in rupee terms. And this can attract more investors into gold pushing up India’s gold import bill further. But then do we blame for the gold investor for that? And if that is the case why not ban all speculation, starting with real estate.
The article originally appeared on www.firstpost.com on June 20, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)
RBI may cut rates, but your loan rates may not fall
Vivek Kaul
The monetary policy review of the Reserve Bank of India(RBI) is scheduled for March 19,2013 i.e. tomorrow. Every time the top brass of the RBI is supposed to meet, calls for an interest rate cut are made. In fact, there seems to be a formula that has evolved to create pressure on the RBI to cut the repo rate. The repo rate is the interest rate at which RBI lends to banks.
The formula includes the finance minister P Chidambaram giving statements in the media about there being enough room for the RBI to cut interest rates. “There is a case for the Reserve Bank of India (RBI) to cut policy rates, and the central bank should take comfort from the government’s efforts to cut the fiscal deficit,” Chidambaram told the Bloomberg television channel today.
Other than Chidambram, an economist close to the Prime Minister Manmohan Singh also gives out similar statements. “The budget has also gone a long way in containing the fiscal deficit, both in the current year and in the following year, and played its role in containing demand pressures in the system. Therefore, in some sense there is greater space for monetary policy now to act in the direction of stimulating growth,” C Rangarajan, former RBI governor, who now heads the prime minister’s economic advisory council, told The Economic Times. What Rangarajan meant in simple English was that conditions were ideal for the RBI to cut interest rates.
And then there are bankers (most those running public sector banks) perpetually egging the RBI to cut interest rates. As an NDTV storypoints out “A majority of bankers polled by NDTV expect the Reserve Bank to cut interest rates in the policy review due on Tuesday. 85 per cent bankers polled by NDTV said the central bank is likely to cut repo rates.”
Corporates always want lower interest rates and they say that clearly. As a recent Business Standard story pointed out “An interest rate cut, at a time when demand was not showing any sign of revival, would boost sentiments, especially for interest-rate sensitives like the car and real estate sectors, which had been showing negative growth, a majority of the 15 CEOs polled by Business Standard said.”
So everyone wants lower interest rates. The finance minister. The prime minister. The banks. And the corporates.
Lower interest rates will create economic growth is the simple logic. Once the RBI cuts the repo rate, the banks will also pass on the cut to their borrowers. At lower interest rates people will borrow more. They will buy more homes, cars, two wheelers, consumer durables and so on. This will help the companies which sell these things. Car sales were down by more than 25% in the month of February. Lower interest rates will improve car sales. All this borrowing and spending will revive the economic growth and the economy will grow at higher rate instead of the 4.5% it grew at between October and December, 2012.
And that’s the formula. Those who believe in the formula also like to believe that everything else is in place. The only thing that is missing is lower interest rates. And that can only come about once the RBI starts cutting interest rates.
So the question is will the RBI governor D Subbarao oblige? He may. He may not. But the real answer to the question is, it doesn’t really matter.
Repo rate at best is a signal from the RBI to banks. When it cuts the repo rate it is sending out a signal to the banks that it expects interest rates to come down in the days to come. Now it is up to the banks whether they want to take that signal or not.
When everyone talks about lower interest rates, they basically talk about lower interest rates on loans that banks give out. Now banks can give out loans at lower interest rates only when they can raise deposits at lower interest rates. Banks can raise deposits at lower interest rates when there is enough liquidity in the system i.e. people have enough money going around and they are willing to save that money as deposits with banks.
Lets look at some numbers. In the six month period between August 24, 2012 and February 22, 2013 (the latest data which is available from the RBI) banks raised deposits worth Rs 2,69,350 crore. During the same period they gave out loans worth Rs 3,94,090 crore. This means the incremental credit-deposit ratio in the last six months for banks has been 146%.
So for every Rs 100 that banks have borrowed as a deposit they have given out Rs 146 as a loan in the last six months. If we look at things over the last one year period, things are a little better. For every Rs 100 that banks have borrowed as a deposit, they have given out Rs 93 as a loan.
What this clearly tells us is that banks have not been able to raise enough deposits to fund their loans. For every Rs 100 that banks borrow, they need to maintain a statutory liquidity ratio of 23%. This means that for every Rs 100 that banks borrow at least Rs 23 has to be invested in government securities. These securities are issued by the government to finance its fiscal deficit. Fiscal deficit is the difference between what the government earns and what it spends.
Other than this a cash reserve ratio of 4% also needs to be maintained. This means that for every Rs 100 that is borrowed Rs 4 needs to be maintained as a reserve with the RBI. So for every Rs 100 that is borrowed by the banks, Rs 27 (Rs 23 + Rs 4) is taken out of the equation immediately. Hence only the remaining Rs 73 (Rs 100 – Rs 27) can be lent. This means that in an ideal scenario the credit deposit ratio of a bank cannot be more than 73%. But over the last six months its been double of that at 146% i.e. banks have loaned out Rs 146 for every Rs 100 that they have raised as a deposit.
So how have banks been financing these loans? This has been done through the extra investments (greater than the required 23%) that banks have had in government securities. Banks are selling these government securities and using that money to finance loans beyond deposits.
The broader point is that banks haven’t been able to raise enough deposits to keep financing the loans they have been giving out. And in that scenario you can’t expect them to cut interest rates on their deposits. If they can’t cut interest rates on their deposits, how will they cut interest rates on their loans?
The other point that both Chidambaram and Rangarajan harped on was the government’s effort to cut/control the fiscal deficit. The fiscal deficit for the current financial year (i.e. the period between April 1, 2012 and March 31,2013) had been targeted at Rs 5,13,590 crore. The final number is expected to come at Rs 5,20,925 crore. So where is the cut/control that Chidambaram and Rangarajan seem to be talking about? Yes, the situation could have been much worse. But simply because the situation did not turn out to be much worse doesn’t mean that it has improved.
The fiscal deficit target for the next financial year (i.e. the period between April 1, 2013 and March 31, 2014) is at Rs 5,42,499 crore. Again, this is higher than the number last year.
When the government borrows more it “crowds out” and leaves a lower amount of savings for the banks and other financial institutions to borrow from. This leads to higher interest rates on deposits.
What does not help the situation is the fact that household savings in India have been falling over the last few years. In the year 2009-2010 (i.e. the period between April 1, 2009 and March 31, 2010) the household savings stood at 25.2% of the GDP. In the year 2011-2012 (i.e. the period between April 1, 2011 and March 31, 2012) the household savings had fallen to 22.3% of the GDP. Even within household savings, the amount of money coming into financial savings has also been falling. As the Economic Survey that came out before the budget pointed out “Within households, the share of financial savings vis-à-vis physical savings has been declining in recent years. Financial savings take the form of bank deposits, life insurance funds, pension and provident funds, shares and debentures, etc. Financial savings accounted for around 55 per cent of total household savings during the 1990s. Their share declined to 47 per cent in the 2000-10 decade and it was 36 per cent in 2011-12. In fact, household financial savings were lower by nearly Rs 90,000 crore in 2011-12 vis-à-vis 2010-11.”
While the household savings number for the current year is not available, the broader trend in savings has been downward. In this scenario interest rates on fixed deposits cannot go down. And given that interest rate on loans cannot go down either.
Of course bankers understand this but they still make calls for the RBI cutting interest rates. In case of public sector bankers the only explanation is that they are trying to toe the government line of wanting lower interest rates.
So whatever the RBI does tomorrow, it doesn’t really matter. If it cuts the repo rate, then public sector banks will be forced to announce token cuts in their interest rates as well. Like on January 29,2013, the RBI cut its repo rate by 0.25% to 7.75%. The State Bank of India, the nation’s largest bank, followed it up with a base rate cut of 0.05% to 9.7% the very next day. Base rate is the minimum interest rate that the bank is allowed to charge its customers.
A 0.05% cut in interest rate would have probably been somebody’s idea of a joke. The irony is that the joke might be about to be repeated in a few day’s time.
The article originally appeared on www.firstpost.com on March 18,2013.
(Vivek Kaul is a writer. He tweets @kaul_vivek)
Dear PM, those who live in glass houses don't throw stones at others
The nation came to the realisation yesterday that the Prime Minister Manmohan Singh actually has a voice. And then we all came to the conclusion that just because he decided to speak, he spoke well. One commentator even went onto christen the event as “Manmohan on steroids”.
The part that the media loved the most was when Singh told the Parliament ‘Jo garajte hain, woh baraste nahi(Thunderous clouds do not bring showers)’, a clichéd statement which was supposed to put the Bhartiya Janata Party (BJP), the main opposition party, in its place.
As far as clichés go, I would take this opportunity, to bring to your notice, dear readers, a dialogue written by Akhtar-Ul-Iman and delivered with great panache by Raj Kumar in the Yash Chopra directed Waqt. The line goes like this: “Chinoi Seth…jinke apne ghar sheeshe ke hon, wo dusron par pathar nahi feka karte (Chinoi Seth…those who live in glass houses don’t throw stones at others).”
Now Singh may not have time to sit through a movie which runs into 206 minutes, given that he is the Prime Minister of the nation, and probably has decisions to make and things to do. But he would be well-advised to watch this 18-second YouTube clip and hopefully come to the realisation that those who live in glass houses, like Singh and his government, do not throw stones at others.
In fact, Singh’s speech to the Parliament yesterday was riddled with many inconsistent and wrong claims. It is a real surprise that the BJP has not caught onto rubbishing the arguments presented by Singh. Let us examine a few claims made by Singh:
Even BIMARU states have also done much better in UPA period than previous period: BIMARU is an acronym used for the states of Bihar, Madhya Pradesh, Rajasthan and Uttar Pradesh. These are states which have lagged in economic growth for a long period of time. There has been a recent spurt in their economic growth and this claims Singh has been because of the UPA government.
Three out of the four states (except Rajasthan) have had a non Congress-non UPA government for the entire duration of the UPA rule in Delhi. Rajasthan has had a Congress government since December 2008.
So trying to claim that the growth in these states has been only because of the UPA government is misleading to say the least. The argument is along similar lines where Congress politicians and some experts have tried to claim over and over again that Bihar has grown faster than Gujarat. Yes it has in percentage terms. But what they forget to tell us is that Gujarat is growing on a much higher base, meaning the absolute growth in Gujarat is higher. In fact, it is three times higher than that of Bihar (The entire argument is explained here).
If we look at the MSP across various commodities, they have increased by 50 to 200% since 2004-05: The government offers a minimum support price on various commodities including rice and wheat. At this price, the Food Corporation of India (FCI), or a state agency acting on its behalf, purchase primarily rice and wheat, grown by Indian farmers. The theory behind setting the MSP is that the farmer will have some idea the price he would get when he sells his produce after harvest. What it has led to is that more and more farmers are selling to the government because they have an assured buyer at an assured price. The government now has nearly Rs 60,000 crore of rice and wheat in excess of what it needs to maintain a buffer stock. While the government is hoarding onto more rice and wheat than it needs, there is a shortage of wheat and rice in the open market pushing up their prices and in turn food inflation and consumer price inflation. It has also pushed up food subsidies and fiscal deficit. Fiscal deficit is the difference between what the government earns and what it spends. And if the government continues with this policy there are likely to be other negative consequences as well. (The entire argument is explained here)
The current slowdown in industrial growth is a concern: This was the most tepid statement in the entire speech. Is it just a concern? Some of the biggest Indian industrialists have gone on record to say that they would rather invest abroad than in India. As Kumar Manglam Birla recently said in an interview “Country risk for India just now is pretty elevated and chances are that for deployment of capital, you would look to see if there is an asset overseas rather than in India…We are in 36 countries around the world. We haven’t seen such uncertainty and lack of transparency in policy anywhere.” The Birlas have known to be very close to the Congress party for a very long time.
And numbers bear this story. Indian corporates are investing abroad rather than India. In 2001-2002 this number was less than 1% of the gross domestic product (GDP) and currently it stands at 6% of the GDP (Source: This discussion featuring Morgan Stanley’s Ruchir Sharma and the Chief Economic Advisor to the government Raghuram Rajan on the news channel NDTV). So the situation is clearly more than just a concern. If Indian industrialists don’t want to invest in India who else will? Is it time to say good bye to industrial growth? Maybe the Prime Minister has an answer for that.
The economic growth has slowed down in 2012-13, because of the difficult global situation: This is something which the finance minister P Chidambaram also alluded to in his budget speech. What it tells us is that there is very little acknowledgement of mistakes that have been made by this government led by Manmohan Singh over the years.
When India was growing at growth rates of 8% and greater, there was a lot of chest thumping by various constituents of the government, that look we are growing at such a high rate. Now that we are not growing at the same speed its because of a difficult global situation.
Ruchir Sharma in a post budget discussion on the news channel NDTV made a very interesting point. India has consistently been at around 24-26th position among 150 emerging market countries when it comes to economic growth over the last three decades.
We thought we were growing at a very fast rate over the last few years, but so was everyone else. As Sharma put it “The last decade we thought we had moved to a higher normal and it was all about us. Every single emerging market in the world boomed and the rising tide lifted all boats including us.”
But now that we are not growing as fast as we were it is because the global economy has slowed down. Sharma nicely summarised this disconnect when he said “When the downturn happens it is about the global economy. When we do well its about us.” India currently has fallen to the 40th position when it comes to economic growth.
Will bring the country back to 8% growth rate: This is kite flying of the worst kind. As Sharma of Morgan Stanley told NDTV “I see people in government today including the Prime Minister talking about 8% GDP growth rate as if that is the level we should be. There is nothing to suggest that is our potential.”
Singh said that the government was committed to achieving a 8% growth rate for the period of the 12th five year plan period of 2012-2017. In the first year of this plan i.e. the financial year 2012-2013 (the period between April 1, 2012 and March 31, 2013), the Indian economy is expected to grow at around 5%(numbers projected by the Central Statistical Organisation).
What that means is that if the 8% target is to be achieved, the economy has to consistently grow at 9% per year for the remaining four years of the plan. And India has never experienced such consistent high growth ever in the past.
Given that Singh’s statement needs to be taken with a pinch of salt. It is essentially rhetoric of the worst kind. As Nate Silver writes in The Signal and the Noise “Sometimes economic forecasts have expressively political purposes too. It turns out that economic forecasts produced by the White House , for instance, have historically been among the least accurate of all, regardless of whether it’s a Democrat or Republican in charge. When it comes to economic forecasting, however, the stakes are higher than for political punditry. As Robert Lucas pointed out, the line between economic forecasting and economic policy is very blurry: a bad forecast can make the real economy worse.” Singh’s 8% growth statement needs to be viewed along similar lines.
There were many things that Singh did not talk about. Among 150 emerging markets, the fiscal deficit of the Indian government is currently at the 148th number. When it comes to inflation, India is currently at the 118-119th position. The current account deficit (which Singh did talk about) will touch an all time high during the course of the financial year 2012-2013. Interest rates have stubbornly refused to come down. And so on.
To conclude, Manmohan Singh was in poetic mood yesterday. “Humko hai unse wafa ki umeed, jo nahi jaante wafa kya hai (We hope for loyalty from those who do not know the meaning of the word),” the prime minister said quoting the Urdu poet Mirza Ghalib, while taking pot-shots at the BJP.
It’s time the BJP got back to him with what are the most famous lines of the poet Akbar Allahabadi.
“Hum aah bhi karte hain to ho jaate hain badnam,
wo qatl bhi karte hain to charcha nahi hota.”
(badnam = infamous. Qatl = murder. Charcha = discussion)
This article originally appeared on www.firstpsost.com on March 7, 2013, with a different headline.
(Vivek Kaul is a writer. He tweets @kaul_vivek)
Why Subbarao can’t cut rates; only Chidambaram can
Vivek Kaul
If politicians and corporates are to be believed then India’s much beleaguered economy can be put back on track only if the Reserve Bank of India(RBI) brought down interest rates. The finance minister P Chidambaram did not mince words when he said in an interview to The Economic Times that “reduction in interest rates will certainly help get us to 6.5% (economic growth).” In another article in the Business Standard several CEOs (including those of real estate firms) have come on record to say that the RBI should cut interest rates in order to revive the economy.
The RBI meets next on March 19. And both CEOs and politicians seem to be clamouring for a repo rate cut. Repo rate is the interest rate at which RBI lends to banks. So the logic is that once the RBI cuts the repo rate (as it did when the last time it met in late January) the banks will get around to passing that cut by bringing down the interest rates they charge on their loans. Given this people will borrow and spend more. They will buy more houses. They will buy more cars. They will buy more two wheelers. They will buy more consumer durables. Companies will also borrow and expand. All this borrowing and spending will revive the economic growth and the economy will grow at 6.5% instead of the 4.5% it grew at between October and December, 2012. And we will all live happily ever after.
Now only if life was as simple as that.
Repo rate at best is a signal from the RBI to banks. When it cuts the repo rate it is sending out a signal to the banks that it expects interest rates to come down in the time to come. Now it is up to the banks whether they want to take that signal or not. And turns out they are not.
Several banks have recently been raising interest rates on their fixed deposits. Of course, if banks are raising interest rates on their deposits, they can’t be cutting them on their loans, given money raised from deposits is used to fund loans. And hence interest rates on loans has to be higher than those on deposits. Banks have raised interest rates despite the fact that the RBI cut the repo rate by 25 basis points (one basis point is equal to one hundreth of a percentage) when it last met on January 29, 2013.
So why are banks raising interest rates when the RBI has given the opposite signal? The answer for that lies in the Economic Survey released on February 27, 2013. The gross domestic savings of the country were at 36.8% of the Gross Domestic Product (GDP) during the course of 2007-2008 (i.e. the period between April 1, 2007 and March 31, 2008). They had fallen to 30.8% of the GDP during the course of 2011-2012 (i.e. the period between April 1, 2011 and March 31, 2012). I wouldn’t be surprised if they have fallen further once figures for the current financial year become available.
The household savings (i.e. the money saved by the citizens of India) have also been falling over the last few years. In the year 2009-2010 (i.e. the period between April 1, 2009 and March 31, 2010) the household savings stood at 25.2% of the GDP. In the year 2011-2012, the household savings had fallen to 22.3% of the GDP.
What this means is that the country as a whole is saving lesser money than it was before. A straightforward explanation for this is the high inflation that has prevailed over the last few years. People are possibly spending greater proportions of their income to meet the rising expenses and that has lead to a lower savings rate.
Interestingly the financial savings have been falling at an even faster rate than overall savings. As the Economic Survey points out “Within households, the share of financial savings vis-à-vis physical savings has been declining in recent years. Financial savings take the form of bank deposits, life insurance funds, pension and provident funds, shares and debentures, etc. Financial savings accounted for around 55 per cent of total household savings during the 1990s. Their share declined to 47 per cent in the 2000-10 decade and it was 36 per cent in 2011-12. In fact, household financial savings were lower by nearly Rs 90,000 crore in 2011-12 vis-à-vis 2010-11.”
One reason for this (explained in the Economic Survey) is that a lot of savings have been going into gold. And why have the savings been going to gold? The government would like us to believe that it is our fascination for gold that is driving our savings into gold. But then our fascination for gold is not a recent phenomenon. Indians have always liked gold.
People buy gold as a hedge against inflation. When inflation is high the real returns on fixed income instruments are low. Real return is the difference between the rate of interest offered on let us say a fixed deposit, minus the prevailing rate of inflation.
As the Economic Survey puts it “High inflation reduces the return on other financial instruments. This is reflected in the negative correlation between rising(gold) imports and falling real rates.” (As can be seen from the following table).
What this means is that when inflation is high, the real return on fixed income investments like fixed deposits is low. Consumer Price Inflation has been close to 10% in India over the last few years. And this has meant that investment avenues like fixed deposits have been made unattractive, leading people to divert their savings into gold. “The overarching motive underlying the gold rush is high inflation…High inflation may be causing anxious investors to shun fixed income investments such as deposits and even turn to gold as an inflation hedge,” the Economic Survey points out.
What does this mean in the context of b
anks? It means that banks have had a lower pool of savings to borrow from. One because the overall savings have come down. And two because within overall savings the financial savings have come down at a much faster rate due to lower real rates of interest, after adjusting for inflation. This means that banks need to offer high rates of interest on their fixed deposits to make it attractive for people to deposit their money into banks. It is a simple case of demand and supply.
And who is the cause for all the inflation that the country has seen over the last few years and continues to see? Not you and me.
High inflation has been caused by the burgeoning subsidies provided by the government. The total subsidy in 2006-2007(i.e. The period between April 1, 2006 and March 31, 2007) stood at Rs 53,462.60 crore. This has gone up by nearly five times to Rs 2,57,654.43 crore for the year 2012-2013 (i.e. the period between April 1, 2012 and March 31, 2013).
All this expenditure of the government has landed up in the hands of people and created inflation. The Economic Survey admits to the same when it states “With the subsidies bill, particularly that of petroleum products, increasing, the danger that fiscal targets would be breached substantially became very real in the current year. The situation warranted urgent steps to reduce government spending so as to contain inflation.” So the Economic Survey equated the high government spending to inflation.
The subsidy bill for the year 2013-2014 (i.e. the period between April 1, 2013 and March 31, 2014) is expected to be at Rs 2,31,083.52 crore. This is number seems to be underestimated as this writer has explained before. And so the inflationary scenario is likely to continue.
Given that people will want to deploy their savings to other modes of investment rather than fixed deposits. And hence banks will have to continue offering higher interest rates to get people interested in fixed deposits.
As the Economic Survey points out “The rising demand for gold is only a “symptom” of more fundamental problems in the economy. Curbing inflation, expanding financial inclusion, offering new products such as inflation indexed bonds, and improving saver access to financial products are all of paramount importance.”
To conclude, there is very little that the D Subbarao led RBI can do to push down interest rates. In fact interest rates are totally in the hands of the government. If the government can somehow control inflation, interest rates will start to come down automatically. For that to happen subsidies in particular and the high government expenditure in general, will have to be controlled. And that is not going to happen anytime soon.
The article originally appeared on www.firstpost.com on March 4, 2013
(Vivek Kaul is a writer. He tweets at @kaul_vivek)