Vivek Kaul
The Reserve Bank of India(RBI) finally threw in the towel today. Over the past several days it had been selling dollars in the foreign exchange market and had thus managed to hold back the rupee to under 60 to a dollar.
The RBI tried halting the fall of the rupee by selling dollars today as well. A report on www.livemint.com points out that “The Indian central bank(i.e. the RBI) intervened by selling the dollar at 59.98, earlier in the day, according to currency dealers, who added that a foreign bank had aided RBI by selling dollars in the market.”
This helped the rupee to recover to around 59.93 to a dollar. But it soon crossed 60 to a dollar. At the end of trading today, one dollar was worth Rs 60.73.
The question being asked is could the RBI have continued to sell dollars and help stem the fall? As on June 14, 2013, India had foreign exchange reserves of $290.66 billion. This is tenth largest in the world.
So it seems that the RBI has enough dollars that it can sell to halt the rupee’s fall against the dollar. But things are not as simple as that. Indian imports during the month of May 2013, stood at $44.65 billion. This basically means that the current foreign exchange reserves are good enough to cover around six and a half months of imports ($290.66 billion of foreign exchange reserves divided by $44.65 billion of monthly imports).
This is a very low number when we compare it to other BRIC economies(i.e. Brazil, Russia and China),which have an import cover of 19 to 21 months. What does not help is the huge difference between Indian exports and imports. In May 2013, Indian exports fell by 1.1% to $24.51 billion. This meant that India had a trade deficit (or the difference between imports and exports) of more than $20 billion. The broader point is that India is not exporting enough to earn a sufficient amount of dollars to pay for its imports.
In this scenario the RBI can use only a limited portion of its foreign exchange reserves to defend the dollar. An estimate made by Bank of America- Merrill Lynch suggests that the RBI can use upto $30 billion to defend the rupee. If it chooses to do that the foreign exchange reserves will come down to around $260 billion, which would mean an import cover of around 5.8 months ($260billion divided by $44.65 billion of imports). This will be a very precarious situation and was last seen in the early 1990s, when India had just started the liberalisation programme.
This is one reason behind why the RBI cannot stop the rupee from falling beyond a point. More than that it does not make sense for any central bank (unless we are talking about the People’s Bank of China) to obsess with a certain currency target against the dollar. This was the learning that came out from the South East Asian crisis of the late 1990s.
Various South East Asian currencies were pegged to the dollar. The Thai baht, was pegged to the US dollar with one dollar being equal to 25 Thai baht. The Philippines peso was pegged at 25 pesos to the dollar. The Malaysian ringgit was pegged at 2.5 ringgits per dollar and so was the Indonesian rupiah, which was pegged at 2030 rupiah to a dollar.
The central banks of these countries ensured that there currencies continued to remain pegged. In case the market suddenly had a surfeit of baht, and the baht started to lose value against the dollar, the Thai central bank started to buy baht and sell dollars. In a situation where the market had a surfeit of dollars and the baht started to appreciate against the dollar, the Thai central bank intervened and started to buy dollars and sell baht. This ensured that the value of the baht against the dollar remained fixed.
But when the South East Asian crisis started, investors started to exit these countries lock, stock and barrel. So if an investor sold out of the Thai stock exchange he was paid in Thai baht. When he had to repatriate this money abroad he needed to convert these baht to dollars. So suddenly the foreign exchange market had a surfeit of Thai baht. In the normal scheme of things, the value of the baht would have fallen against the dollar. But the baht was pegged to the dollar. So as a logical step the Thai central bank started to sell dollars and buy baht, in order to ensure that one dollar continued to be worth 25 Thai baht.
In May 1997, the finance minister of Thailand was fired. The new finance minister made a secret visit to the central bank and realised that the country had more or less run out of dollars trying to defend the dollar-baht exchange rate. The bank had run through nearly $33billion of foreign exchange reserves trying to defend the exchange rate.
On July 2, 1997, Thailand decided to stop supporting the baht and let it fall. It was estimated that the baht would fall by around 15%, but instead by the end of July it had already fallen by 20% to 30 baht a dollar. A year later the exchange rate was down to 41 baht to a dollar. And within two weeks of Thailand setting the baht free, others followed. The Philippines peso’s peg with the dollar broke on July 14. The peg of the Indonesian rupiah and the Malaysian ringgit also broke the same day.
A year later the Indonesian rupiah was at 14,150 to a dollar. It had been at 2380 to a dollar. The Malaysian ringgit was at 4.1 to a dollar, down from 2.5. And Philippines peso was at 42 to a dollar against 26.3 a year earlier
That is the problem with trying to defend the exchange rate. It needs an unlimited amount of dollars, which no country in the world other than the United States (and to a certain extent China which has nearly $3.3 trillion foreign exchange reserves) has. And only the Federal Reserve of United States, the American central bank can print dollars. No other central bank can do that.
A similar situation is playing out in India right now. Foreign investors are looking to exit the country. They have sold off more than $5 billion worth of bonds since late May. They have also sold off stocks worth $1.39 billion in June, after buying stocks worth $4 billion in May. These investors are now trying to convert there rupees into dollars, and that has led to the rupee rapidly depreciating against the dollar.
The RBI tried to halt this fall by intervening in the foreign exchange market and selling dollars. But as the South East Asian experience tells us, obsessing with a certain target against the dollar is not a great idea.
So given that the RBI has got it right by not obsessing with the target of Rs 60 to a dollar. But the trouble is that a weaker rupee will have several negative consequences in the days to come (This is discussed in detail here).
First and foremost will be higher inflation as India will pay more for imported products. Oil will become expensive in rupee terms. If the government passes on the increase in price to the end consumer, then it will lead to higher prices or inflation. If it does not pass on the increase in prices to the end consumer then the government will run a higher fiscal deficit as its expenditure will go up. Fiscal deficit is the difference between what a government earns and what it spends. It will also mean that the government will have to borrow more to finance its expenditure and that in turn will mean that the high interest rate scenario will continue.
India imports a lot of coal which is used for the production of power. With the rupee losing value against the dollar the cost of importing coal will go 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 again will add to inflation.
Companies which had borrowed in dollars and have not insured themselves against the fall of the rupee, will have to pay more. Economist Arvind Subramanian points out in the Business Standard that there will be “a decline in the profitability of all those enterprises that have borrowed heavily in foreign currency and have not insured themselves against a rupee decline (“unhedged borrowing”).”
This cost “will manifest itself in reduced investment by these companies and hence lower aggregate growth; it will also manifest itself (eventually) in a worsened fiscal situation because the government will have to support these companies directly or the banks that have lent to them,” writes Subramanian.
The broader point is that India is screwed both ways irrespective of whether RBI defends the rupee or not.
The article originally appeared on www.firstpost.com on June 26, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)
RBI
Of Subbarao, inflation, gold and Saradha scam
Central bank governors rarely indulge in any plain speak. You have to always read between the lines to understand what they are really saying. They never say what they mean. And they never mean what they say.
But D Subbrarao, the governor of the Reserve Bank of India, indulged in some plain speaking on Wednesday and questioned the logic of the Mamata Banerjee government in West Bengal setting up a Rs 500 crore relief fund to compensate the losses of those people who had invested in deposits raised by the Saradha Group in West Bengal.
A part of this relief fund will be funded by a 10% tax on cigarettes and the rest of the money will be raised through other sources. “If you go back to the West Bengal Saradha scheme, the Chief Minister said ‘I will levy additional taxes on cigarettes and some other things to compensate the people who have lost money’ … Is it fair?” Subbarao asked.
Why should people who smoke fund those whose money has gone up in smoke, is a reasonable question to ask. It is like robbing Peter to pay Paul.
Subbarao also dwelled into why Ponzi schemes like Saradha have become fairly popular. “The reason it (the Ponzi schemes) is happening because ordinary people… the low income people are not sufficiently aware of where they can put their money. They don’t have enough avenues to put their money. They can’t get into the banks like we all do. They face both formal and informal barriers…So they fall prey to these fraudulent schemes,” Subbarao explained.
This is an explanation similar to the one his deputy K C Chakrabarty had come up with a few days back when he said: “The need of the hour is to ensure that our unbanked population gains access to formal sources of finance, their reliance on informal channels and on the shadow banking system subsides and, in the process, consumer exploitation is curbed.”
This is a very one-dimensional explanation of why Ponzi schemes have become so popular in India in the last few years. Ponzi scheme is a fraudulent investment scheme where the money being brought in by newer investors is used to pay off older investors. The scheme offers high returns and it keeps running till the money being brought in by the newer investors is greater than the money needed to pay off the older investors whose investment is up for redemption. The moment this breaks, the scheme collapses.
This writer has explained in the past that lack of a bank in their neighbourhood is not a reason good enough to explain why people invest money in Ponzi schemes. Many of the Ponzi schemes over the last few years have been very popular in urban as well as semi-urban areas, where there are enough number of banks going around. At the same time some of the Ponzi schemes have even needed bank accounts to ensure participate. So saying that people invest in Ponzi schemes because there are not enough banks going around, is not good enough. There are other bigger factors at work.
Ponzi schemes have become a big menace in India over the last few years. There numbers have gone up many times over. While there is no hard data to support the claim, but there is enough anecdotal evidence going around. Be it Speak Asia or Stock Guru or MMM India or Emu Ponzi schemes etc, there has been endless list of Ponzi schemes hitting the market.
This has also been a period of high inflation where interest offered on fixed deposits and postal savings deposits, has been very low or even negative once it is adjusted for inflation. There are other reasons as well why people find fixed deposits and postal savings deposits unattractive.
As Ila Patnaik wrote in a recent column in The Indian Express “Even those who have access often find it unattractive. Interest rates paid to depositors have been pushed down through years of policies of administered interest rates and lack of competition in banking. Regulatory requirements for priority sector lending and holding of government bonds have further resulted in lower returns. The result is low or negative real interest rates for depositors.”
It has been an era where bank fixed deposits have offered around 9% interest before tax when the inflation has been at 10% or more. The returns from post office savings deposits have been even lower than bank fixed deposits. Hence, in the strictest sense of the term, money deposited in banks or post office, has essentially been a losing proposition, given the high inflationary scenario that has prevailed.
And not surprisingly in this situation people have been looking at other investment avenues where there is a prospect of making higher returns. Gold has been one such investment avenue. As the Economic Survey released by the government in late February this year pointed out “Gold imports are positively correlated with inflation. High inflation reduces the return on other financial instruments… This observation, in line with global trends, is easily explained by the declining real returns on the gamut of financial instruments available to the investor and soaring ones on gold (23.7 per cent annual average return between April 2007 – March 2012 versus 7.3 per cent return on Nifty and 8.2 per cent on savings deposits).”
So money came into gold because there was a prospect of earning a high real return instead of bank and post office deposits where the individual would have actually lost money after adjusting for high inflation.
A similar explanation can be offered for people investing their hard earned money in Ponzi schemes like Saradha. They were looking for a higher return which helped them at least beat the rate of inflation. And this is where Ponzi schemes like Saradha came in. These schemes offered deposits which promised higher returns than bank or post office deposits.
As an article in the Business Standard pointed out “Sen(in reference to Sudipta Sen who ran Saradha) offered fixed deposits, recurring deposits and monthly income schemes. The returns promised were handsome. In fixed deposits, for instance, Sen promised to multiply the principal 1.5 times in two-and-a-half years, 2.5 times in 5 years and 4 times in 7 years. High-value depositors were told they would get a free trip to “Singapur”.”
In case of Saradha, the credibility it had built through its media empire as well as being seen closely aligned to the ruling Trinamool Congress, also helped. The deposits being raised may have even been seen as very safe, by those investing.
The other thing that has happened over the last few years is that household savings have come down. In 2009-2010 (i.e. the period between April 1, 2009 and March 31, 2010), savings stood at 25.2% of the gross domestic product (GDP). In 2011-2012 (i.e. the period between April 1, 2011 and March 31, 2012) the savings had fallen by nearly three percentage points to 22.3% of the GDP.
This has primarily happened because of high inflation which has pushed up expenditure as a proportion of total income. But incomes haven’t gone up at the same pace. And this has led to a fall in savings.
Given that savings of people have come down, there might be a temptation to invest them in avenues where they thought a higher return could be earned so as to ensure that investment goals continue to be on track, even with a lesser amount of savings being invested. This might have increased people’s appetite for taking on investment risk.
Hence, high inflation may have had a big role to play in people investing their money in Ponzi schemes. And we all know who is to be blamed for that.
Inflation has had Subbarao worried for a while now. “There is an important constituency in the country that is hurt by inflation. Their voice also needs to be heard. It is the responsibility of public policy institutions like the Reserve Bank to go out of our way and listen to silent voices,” the RBI governor said on Wednesday.
To conclude, it is very easy to argue that more Ponzi schemes spread because people people lack access to basic banking. But the reality is a little more complicated than that. As they say, truth is often stranger than fiction.
The article originally appeared on www.firstpost.com on May 9,2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)
Dear KC Chakrabarty, here’s the real reason why people invest in Ponzi shemes
Vivek Kaul
A standard explanation that seems to be emerging about why Ponzi schemes keep occurring in different parts of the country is that India does not have enough banks. And this lack of banks leads people to invest in fraudulent Ponzi schemes.
A Ponzi scheme is a fraudulent investment scheme in which the illusion of high returns is created by taking money being brought in by new investors and passing it on to old investors whose investments are falling due and need to be redeemed.
K C Chakrabarty, the deputy governor, is the latest individual who has jumped onto the more banks equals fewer Ponzi schemes, bandwagon. “The fact that people have to rely on such entities for their saving needs indicates a failure on the part of the formal financial system to reach out to such groups and earn their trust and confidence through a transparent and responsive customer service regime,” Chakrabarty said yesterday.
“The need of the hour is to ensure that our unbanked population gains access to formal sources of finance, their reliance on informal channels and on the shadow banking system subsides and, in the process, consumer exploitation is curbed,” he added.
So what Chakrabarty is effectively saying is that only if people had a bank in their neighbourhood they would have stayed away from a Ponzi scheme like Saradha. While it simple to come to this conclusion which sounds quite logical, the truth is not as simple as it is being made out to be.
Lets consider a few Ponzi schemes that have done the rounds lately. MMM India which promises to double the investment every month, needs prospective investors to have bank accounts. So here is a Ponzi scheme which is using what Chakrabarty calls the ‘formal financial system’ to flourish.
Before that there was the Speak Asia Ponzi scheme. In this scheme investors needed to fill online surveys. Anyone who has access to internet in India is most likely to have access to a bank account as well. So people who invested in Speak Asia, did so because they wanted to not because they had no banks in their locality.
Then there are Ponzi schemes which involve investments in gold coins. People who can buy gold coins won’t have access to a bank account?
Or lets take the case of Emu Ponzi schemes which had become fairly popular in parts of Tamil Nadu. The pioneer among these schemes was Susi Emu Farms. It promised a return of at least Rs 1.44 lakh within two years, after an initial investment of Rs 1.5 lakh had been made. This was the model followed by nearly 100 odd emu Ponzi schemes that popped up after the success of Susi.
Again anyone who has Rs 1.5 lakh to invest in a Ponzi scheme will not have access to a bank? That is rather difficult to believe. As Dhirendra Kumar of Value Research puts it in a recent column“Could it be that all those people who put money into Saradha wouldn’t have done so if they had a bank in their neighbourhood? Very unlikely. A lot of the deposits seem to have come from towns where there would have been banks. Moreover, almost every ponzi scheme that has come to light in the last few years has actually flourished in towns and cities. The investors who fell for StockGuru or the Emu farms or other schemes all had access to legitimate alternatives.”
So what is it that gets people to put their hard earned money into Ponzi schemes rather than deposit it into banks? The simple answer is ‘greed’. We all want high returns from the investments we make. And Ponzi schemes typically offer significantly higher rates of return than other investment options that are available at any point of time.
Having said that ‘higher returns’ are not the only reason that lures people into Ponzi schemes. There are other factors at work, which along with the lure of higher returns, ends up making a deadly cocktail.
Typically people do not like handing over money to someone they do not know. In small towns, people end up investing money into a Ponzi scheme through an agent they happen to know. So even though they have no clue about the company they are investing in, they feel they are doing the right thing because they know the agent.
In the case of Saradha, agents of Peerless General Finance and Investment were used to collect money. Peerless had a good reputation among the people of West Bengal, having been in the business of collecting small savings since 1932. This helped Saradha establish the trust that it needed to, during its initial days of operation.
As a report in The Indian Express points out “The selection of agents, a crucial link in the chain, was done very carefully by Saradha. Those picked were generally ones who wielded influence in their locality and in whom people had confidence.”
What also helps is the fact that agents are paid reasonably high commissions, leading to a higher level of motivation and thus better service. The agents typically come to homes of prospective investors to get them to invest money. So clearly there is better service on offer unlike a bank. There is very little need for documentation ( PAN No, Address proof etc not required) as well, unlike is the case with a bank.
Let us briefly go back to the more banks fewer Ponzi schemes argument. As the Indian Express report cited earlier states “One important reason for chit funds mushrooming(they are really not chit funds, but Ponzi schemes) in West Bengal is the absence of easy access to banks and other financial institutions. According to an estimate of the state Finance Department, of the 37,000 villages in the state, nearly 27,767 have no bank branch.”
While villages may not have access to a bank, they do have access to post offices. And India Post runs many small savings schemes, in which people can deposit money. But in West Bengal people seemed to have stayed away from these schemes. A report published in December 2012, in The Hindu Business Line quotes Gautam Deb, a former housing minister as saying “small savings and post office collections in West Bengal during the April-October 2012 period were merely Rs 194 crore, against the targeted amount of Rs 8,370 crore.”
So why did people stay away from the post office schemes and get into Ponzi schemes? For one the returns offered on Ponzi schemes were significantly higher. The second reason obviously is the significantly better level of service that Ponzi schemes offer with agents getting higher commissions.
In fact, there are no commissions on offer for selling post office savings schemes. As Kumar points out in his column “The post office offers excellent schemes with a huge reach in rural and semi-urban areas but can it compete on sales and marketing? In fact, when the government eliminated commissions on PPF and other deposits in post offices in 2011, it effectively eliminated whatever little sales muscle there was.”
The formal financial system thus finds it very difficult to compete with unscrupulous operators like Saradha. It is not easy for it to offer higher commissions as and when it wants to simply because it has got rules and regulations to follow. As Kumar puts it “They (i.e. the Ponzi schemes) spend much more on sales commissions, on offices, keeping politicians happy and getting media coverage because they can just dip into the deposited money for all these expenses. Therefore, even if legitimate financial services are available passively, they won’t be able to compete.”
Another reason why the people of West Bengal fell for Saradha was the fact that the Ponzi scheme came to be very closely associated with Trinamool Congress, the party that rules the state. The ‘formal financial system’ cannot afford to do anything like that.
When we take all these reasons into account it is safe to say that the more banks fewer Ponzi schemes argument doesn’t really work. Even if more banks are established, the banks will not be able to compete with the level of service and commissions that Ponzi schemes can offer. Hence, it is very important that unscrupulous operators who are caught running Ponzi schemes are punished and justice is delivered as soon as possible. This will ensure that anyone who wants to start a Ponzi scheme will think twice before he acts. And that is the best way to protect people from Ponzi schemes.
The article originally appeared on www.firstpost.com on May 3, 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)
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)