Why an increase in tax break won’t make people buy more homes

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Vivek Kaul
It is time of the year when tax saving stories start to make it to the front page of newspapers, as the finance minister gets ready to present the annual budget of the government of India.
Today’s edition of The Hindustan Times has one such a story according to which the “the government is considering hiking the tax deduction limit on home loan interest from the present Rs 1.5 lakh to more than Rs 2 lakh per annum.”
The story goes on to quote an expert to state that this increase in tax deduction will lead to an “increase the demand for housing units and have a multiplier effect on the economy through increased demand for steel, cement and labour.”
This is what we call kite flying of the highest order. Lets try and understand why.
Currently a deduction of upto a maximum of Rs 1.5 lakh is allowed for interest paid on a home loan. At the highest tax level of 30.9% (30% tax + 3% education cess) this means a tax saving of Rs 46,350 (30.9% of Rs 1,50,000).
Now let us say this is increased to Rs 2 lakh. At the highest tax level of 30.9% this would mean a tax saving of Rs 61,800 (30.9% of Rs 2,00,000). This implies an increased tax saving of Rs 15,450 per year (Rs 61,800 minues Rs 45,350) or Rs 1287.5 per month.
So basically what The Hindustan Times story really tells us is that people of this country will buy homes because they will save Rs 1287.5 more every month. But what it does not tell us is the amount of money they will have to spend to get this extra tax saving.
Let me throw more numbers at you. The story points out “The average home loan size has grown from about Rs 17 lakh about three years ago to close to Rs 22 lakh currently.” Let us consider a 20 year home loan of Rs 22 lakh taken at an interest rate of 10% (the actual home loan interest rates might be higher currently though).
The EMI (equated monthly instalment) on this loan would be Rs 21,230.48. Hence to get an extra tax deduction of Rs 1287.5 per month any individual taking a home loan would have to first spend Rs 21,230.48 which is 16.5 times more.
I guess people of India are clearly more intelligent than that. And I don’t see many people doing that.
People don’t buy homes to get a tax deduction. The average middle class Indian buys a home to stay in it. And for that to happen a couple of things need to happen. First and foremost real estate prices need to come down because only then will EMIs become affordable.
As The Hindustan Times story points out that three years back the average home loan size was Rs 17 lakh and now it is Rs 22 lakh. This has happened because home prices have gone up since then.
A home loan of Rs 17 lakh at an interest of 10% for a period of 20 years would mean an EMI of Rs 16,405.37. Hence, EMIs have gone up by around 29.4% in the last three years. And that makes it difficult for individuals looking to buy a home to live in.
The difference between the EMIs on a home loan of Rs 22 lakh and a home loan of Rs 17 lakh is around Rs 4825. This is 3.75 times more than the extra tax saving of Rs 1287.5 that would happen when the tax deduction limit on home loan interest goes upto Rs 2 lakh per year from the current Rs 1.5 lakh.
Also to get a bigger home loan one needs a higher income as well. Hence, an income required to get a Rs 22 lakh home loan is higher than the income required to get a Rs 17 lakh home loan.
So for people to start buying homes to live in real estate prices need to fall from their current atrocious levels. Whether that happens remains to be seen. As my paternal grandfather told me late last evening “roti kapda aur makaan ka daam kabhi nahi girta. (The price of food, clothes and houses never falls).”
The second thing that needs to happen for sales of homes to pick up is a fall in interest rates. At an interest rate of 8%, a 20 year home loan of Rs 22 lakh would imply an EMI of Rs 18,401.68. This would imply a lower EMI of Rs 2828.8 than at the 10% level.
In fact I have made all the calculations at the highest rate of tax of 30%. At lower rates of tax it makes even less sense to buy a home to get an extra tax deduction. Also, the average home loan in cities is obviously higher than the Rs 22 lakh used here. In cities, it is highly unlikely one would be able to buy anything for that kind of home loan value. Hence, the argument holds even greater value for cities where prices are much higher.
To conclude, the real estate market in India has been taken over by speculators looking to put their black money to some use. And currently it is these speculators playing a game of passing the parcel among themselves. Unless that breaks people won’t start buying homes, higher tax deductions notwithstanding.

This article originally appeared on www.firstpost.com on February 4, 2013
(Vivek Kaul is a writer. He can be reached at [email protected]
 

Why interest rates do not follow Newton's third law of motion

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Vivek Kaul
Newspaper editors are great believers in Newton’s third law of motion i.e. every action has an equal and opposite reaction. So if the Reserve Bank of India (RBI) governor Duvvuri Subbarao cut the repo rate by 0.25%, it should immediately translate into banks cutting interest rates on their loans as well. Repo rate is the interest rate at which RBI lends to the banks.
So if you are the kind who still reads newspapers you would have come to the conclusion by reading today’s edition of almost any newspaper that equated monthly instalments(EMIs) on loans are about to take a dip. The logic being that now that the RBI has cut the repo rate and that will lead to banks cutting the interest rates on their various loans as well and passing on the benefits to their current consumers and prospective customers.
Now only if it was as simple as that. Lets try and understand why.
The basic business model of any bank is very simple. It raises money as deposits at a certain rate of interest and then lends it out at a higher rate of interest. The difference in interest rate at which it lends and the interest rate at which it borrows is the money that a bank makes.
So for a bank to be able to cut interest rates on its loans it should first be in a position to cut interest rates on its deposits. Now this is where things get interesting.
The loans of banks (non food lending i.e.) over the last one year (between January 13, 2012 and January 11, 2013, which is the latest data available) have grown by around 15.7%. During the same period the deposit growth of banks has been at 12.8%.
Over the last period of the last six months (i.e. between July 13, 2012 and January 11, 2013) the trend is similar. The lending by banks has grown by 6.8% whereas the deposits have grown by 5.1%.
What this means in simple English is that banks are lending money at a much faster rate than they are able to raise through deposits. Hence, money is tight and banks will need to continue offering high rates of interest on their deposits. Given this, they will have to keep charging higher rates of interest on their loans.
And hence lower EMIs won’t be possible despite the firm belief of newspaper editors in Newton’s Third Law of Motion.
What is interesting is that this trend has been playing out for a while now. In 2011-2012 (i.e. the period between April 1, 2011 and March 31, 2012) bank deposits grew by 13.8% whereas loans grew by 16.3%. In 2010-2011 (i.e. the period between April 1, 2010 and March 31, 2011) the deposits grew by 16.7% whereas loans grew by 23.3%.
The other metric to look at here is the incremental credit deposit ratio. For the period of the last six months this stands at 99.3%. This means that for every Rs 100 that the bank has raised as a deposit in the last six months it has given out Rs 99.3 as a loan.
Now this is a problematic situation to be in. For every Rs 100 raised as a deposit the bank has to maintain a statutory liquidity ratio of 23% i.e. invest Rs 23 in government bonds. Governments bonds are basically bonds issued by the central government to finance its fiscal deficit. Fiscal deficit is the difference between what a government earns and what it spends.
Banks also needs to currently maintain a cash reserve ratio of 4.25% with the RBI i.e. for every Rs 100 raised as a deposit the bank needs to maintain Rs 4.25 with RBI as a deposit. The CRR will come down to 4% from February 9, 2013.
So what does this mean? It means that for every Rs 100 raised as a deposit Rs 27.25 (Rs 23 + Rs 4.25) cannot be given out as a loan. The remaining Rs 72.75 (Rs 100 – Rs 27.25) can be loaned out. Even there the bank needs to maintain some cash in its vaults to pay people who may be withdrawing money from the bank.
So given all this for every Rs 100 that a bank raises as a deposit it can basically loan out around Rs 65-70. But in the last six months the banks have loaned almost every rupee that they have raised as a deposit.
How has that been possible? That has been possible because banks have been withdrawing money that they have invested in government bonds in the previous years and giving that money out as loans.
This is something that may not be possible forever because banks needs to maintain a SLR of 23%. They can’t go below that. As T N Ninan wrote in the Business Standard sometime back “In the last two of these years, the credit growth rate (i.e. the loan growth rate) outpaced that of deposits; as should be obvious, this cannot go on indefinitely. And here’s the thing; nearly 40 per cent of the lower credit growth over the past year has been financed by a drop in banks’ investment in government securities; so a good bit of the money that has been lent has not come from customer deposits. Banks could continue to pull money out of government securities, but if they did that the government would not be able to finance its deficit.”
In this scenario where banks are lending out almost every bit of the money they are raising as deposits it is difficult for them to cut interest rates on their deposits and hence on their loans.
The only way bank interest rates can come down is if the government borrowings come down. And that is only possible if the government is able to manage its burgeoning fiscal deficit. Whether that happens on that your guess is as good as mine.
Meanwhile, newspaper editors will continue to believe in Newton’s third law of motion.

The article originally appeared on www.firstpost.com on January 30, 2013, with a different headline
(Vivek Kaul is a writer. He can be reached at [email protected])

Why the poor are willing to hand over their money to Sahara


Vivek Kaul

Abhijit V Banerjee and Esther Duflo in their book Poor Economics – Rethinking Poverty & the Ways to End It write a very interesting story about a woman they met in the slums of Hyderabad. This woman had borrowed Rs 10,000 from Spandana, a microfinance institution.
As they write “A woman we met in a slum in Hyderabad told us that she had borrowed 10,000 rupees from Spandana and immediately deposited the proceeds of the loan in a savings bank account. Thus, she was paying a 24 percent annual interest rate to Spandana, while earning about 4 percent on her savings account”.
The question of course was why would anyone in their right mind do something like this? Borrow at 24% and invest at 4%? But as the authors found out there was a clear method in the woman’s madness. “When we asked her why this made sense, she explained that her daughter, now sixteen, would need to get married in about two years. That 10,000 rupees was the beginning of her dowry. When we asked why she had not opted to simply put the money she was paying to Spandana for the loan into her savings bank account directly every week, she explained that it was simply not possible: other things would keep coming up…The point as we eventually figured out, is that the obligation to pay what you owe to Spandana – which is well enforced – imposes a discipline that the borrowers might not manage on their own.”
The example brings out a basic point that those with low income find it very difficult to save money and in some cases they even go to the extent of taking a loan and repaying it, rather than saving regularly to build a corpus.
This includes a lot of very small entrepreneurs and people who do odd jobs and make money on a daily basis. Such individuals have to meet their expenses on a daily basis and that leaves very little money to save at the end of the day. Also the chances of the little money they save, being spent are very high. As Abhijit Banerjee told me in an interview I did for the Economic Times “The broader issue is that savings is a huge problem. Cash doesn’t stay. Money in the pillow doesn’t work.”
Hence, as the above example showed it is easier for people to build a savings nest by borrowing and then repaying that loan, rather than by saving regularly.
Another way building a savings nest is by visiting a bank regularly and depositing that money almost on a daily basis. But that is easier said than done. In a number of cases, the small entrepreneur or the person doing odd jobs, figures out what he has made for the day, only by late evening. By the time the banks have closed for the day.
The money saved can easily be spent between the evening and the next morning when the banks open. Also, in the morning the person will have to get back to whatever he does, and may not find time to visit the bank. Banks also do not encourage people depositing small amounts on a daily basis. It pushes up their cost of transacting business.
But what if the bank or a financial institution comes to the person everyday late in the evening, once he is done with his business for the day and knows exactly what he has saved for the day. It also does not throw tantrums about taking on very low amounts.
This is precisely what Subrata Roy’s Sahara group has been doing for years, through its parabankers who number anywhere from six lakh to a million. They go and collect money from homes or work places of people almost on a daily basis.
The Sahara group fulfilled this basic financial need of having to save on a daily basis for those at the bottom of the pyramid (as the management guru CK Prahalad called them). The trouble of course was that there was very little transparency in where this money went. The group has had multiple interests ranging from real estate, films, television, and now even retail. A lot of these businesses are supposedly not doing well.
Over the last few years, both the Reserve Bank of India (RBI) and Securities and Exchange Board of India(Sebi), have cracked down on the money raising schemes of the Sahara group. In a decision today, the Supreme Court of India has directed that the Sahara group refund more around Rs 17,700 crore that it raised through its two unlisted companies between 2008 and 2011. The money was raised from 2.2crore small investors through an instrument known as fully convertible debenture. The money has to be returned in three months.
Sebi had ordered Sahara last year to refund this money with 15% interest. This was because the fund-raising process did not comply with the Sebi rules. Sahara had challenged this, but the Supreme Court upheld Sebi’
The question that arises here is that why has Sahara managed to raise money running into thousands of crores over the last few decades? The answer probably lies in our underdeveloped banking system. In a November 2011 presentation made by the India Brand Equity Foundation ( a trust established by the Ministry of Commerce with the Confederation of Indian Industry (CII) as its associate) throws up some very interesting facts. A few of them are listed below:
– Despite healthy growth over the past few years, the Indian banking sector is relatively underpenetrated.
– Limited banking penetration in India is also evident from low branch per 100,000 adults ratio – – Branch per 100,000 adults ratio in India stands at 747 compared to 1,065 for Brazil and 2,063 for Malaysia
– Of the 600,000 village habitations in India only 5 per cent have a commercial bank branch
– Only 40 per cent of the adult population has bank accounts
What these facts tell us very clearly is that even if a person wants to save it is not very easy for him to save because chances are he does not have a bank account or there is no bank in the vicinity. This is where Sahara comes in. The parabanker comes to the individual on a regular basis and collects his money.
As a Reuters story on Sahara points out “Investors in Sahara’s financial products tend to be from small towns and rural areas where banking penetration is low. “They see Sahara on television everyday as sponsor of the cricket team and that leads them to believe that this is the best company,” said a spokesman for the Investors and Consumers Guidance Cell, a consumer activist group.”
Sahara has built trust over the years by being a highly visible brand. It sponsors the Indian cricket and hockey team. It has television channels and a newspaper as well. Hence people feel safe handing over their money to Sahara.
The irony of this of course is that RBI which has been trying to shut down the money raising activities of Sahara is in a way responsible for its rise, given the low level of banking penetration in the country.
(The article originally appeared on www.firstpost.com on August 31,2012. http://www.firstpost.com/business/why-the-poor-are-willing-to-hand-over-their-money-to-sahara-438276.html)
(Vivek Kaul is a writer and can be reached at [email protected])

Of 9% economic growth and Manmohan’s pipedreams


Vivek Kaul

Shashi Tharoor before he decided to become a politician was an excellent writer of fiction. It is rather sad that he hasn’t written any fiction since he became a politician. A few lines that he wrote in his book Riot: A Love Story I particularly like. “There is not a thing as the wrong place, or the wrong time. We are where we are at the only time we have. Perhaps it’s where we’re meant to be,” wrote Tharoor.
India’s slowing economic growth is a good case in point of Tharoor’s logic. It is where it is, despite what the politicians who run this country have to say, because that’s where it is meant to be.
The Prime Minister Manmohan Singh in his independence-day speech laid the blame for the slowing economic growth in India on account of problems with the global economy as well as bad monsoons within the country. As he said “You are aware that these days the global economy is passing through a difficult phase. The pace of economic growth has come down in all countries of the world. Our country has also been affected by these adverse external conditions. Also, there have been domestic developments which are hindering our economic growth. Last year our GDP grew by 6.5 percent. This year we hope to do a little better…While doing this, we must also control inflation. This would pose some difficulty because of a bad monsoon this year.
So basically what Manmohan Singh was saying that I know the economic growth is slowing down, but don’t blame me or my government for it. Singh like most politicians when trying to explain their bad performance has resorted to what psychologists calls the fundamental attribution bias.
As Vivek Dehejia an economics professor at Carleton University in Ottawa, Canada, told me in a recent interview I did for the Daily News and Analysis (DNA) Fundamentally attribution bias says that we are more likely to attribute to the other person a subjective basis for their behaviour and tend to neglect the situational factors. Looking at our own actions we look more at the situational factors and less at the idiosyncratic individual subjective factors.”
In simple English what this means is that when we are analyzing the performance of others we tend to look at the mistakes that they made rather than the situational factors. On the flip side when we are trying to explain our bad performance we tend to blame the situational factors more than the mistakes that we might have made.
So in Singh’s case he has blamed the global economy and the deficient monsoon for the slowing economic growth. He also blamed his coalition partners. “As far as creating an environment within the country for rapid economic growth is concerned, I believe that we are not being able to achieve this because of a lack of political consensus on many issues,” Singh said.
Each of these reasons highlighted by Singh is a genuine reason but these are not the only reasons because of which economic growth of India is slowing down. A major reason for the slowing down of economic growth is the high interest rates and high inflation that prevails. With interest rates being high it doesn’t make sense for businesses to borrow and expand. It also doesn’t make sense for you and me to take loans and buy homes, cars, motorcycles and other consumer durables.
The question that arises here is that why are banks charging high interest rates on their loans? The primary reason is that they are paying high interest rate on their deposits.
And why are they paying a high interest rate on their deposits? The answer lies in the fact that banks have been giving out more loans than raising deposits. Between December 30, 2011 and July 27, 2012, a period of nearly seven months, banks have given loans worth Rs 4,16,050 crore. During the same period the banks were able to raise deposits worth Rs 3,24,080 crore. This means an incremental credit deposit ratio of a whopping 128.4% i.e. for every Rs 100 raised as deposits, the banks have given out loans of Rs 128.4.
Thus banks have not been able to raise as much deposits as they are giving out loans. The loans are thus being financed out of deposits raised in the past. What this also means is that there is a scarcity of money that can be raised as deposits and hence banks have had to offer higher interest rates than normal to raise this money.
So the question that crops up next is that why there is a scarcity of money that can be raised as deposits? This as I have said more than few times in the past is because the expenditure of the government is much more than its earnings.
The fiscal deficit of the government or the difference between what it earns and what it spends has been going up, over the last few years. For the financial year 2007-2008 the fiscal deficit stood at Rs 1,26,912 crore. It went up to Rs 5,21,980 crore for financial year 2011-2012. In a time frame of five years the fiscal deficit has shot up by nearly 312%. During the same period the income earned by the government has gone up by only 36% to Rs 7,96,740 crore.
This difference is made up for by borrowing. When the borrowing needs of the government go through the roof it obviously leaves very little on the table for the banks and other private institutions to borrow, which in turn means that they have to offer higher interest rates to raise deposits. Once they offer higher interest rates on deposits, they have to charge higher interest rate on loans.
A higher interest rate scenario slows down economic growth as companies borrow less to expand their businesses and individuals also cut down on their loan financed purchases. This impacts businesses and thus slows down economic growth.
The huge increase in fiscal deficit has primarily happened because of the subsidy on food, fertilizer and petroleum. One of the programmes that benefits from the government subsidy is Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA). The scheme guarantees 100 days of work to adults in any rural household. While this is a great short term fix it really is not a long term solution. If creating economic growth was as simple as giving away money to people and asking them to dig holes, every country in the world would have practiced it by now.
As Raghuram Rajan, who is taking over as the next Chief Economic Advisor of the government of India, told me in an interview I did for DNA a couple of years back “The National Rural Employment Guarantee Scheme (NREGS, another name for MGNREGA), if appropriately done it is a short term insurance fix and reduces some of the pressure on the system, which is not a bad thing. But if it comes in the way of the creation of long term capabilities, and if we think NREGS is the answer to the problem of rural stagnation, we have a problem. It’s a short term necessity in some areas. But the longer term fix has to be to open up the rural areas, connect them, education, capacity building, that is the key.
But the Manmohan Singh led United Progressive Alliance seems to be looking at the employment guarantee scheme as a long term solution rather than a short term fix. This has led to burgeoning wage inflation over the last few years in rural areas.
As Ruchir Sharma writes in Breakout Nations – In Pursuit of the Next Economic MiraclesThe wages guaranteed by MGNREGA pushed rural wage inflation up to 15 percent in 2011”.
Also as more money in the hands of rural India chases the same number of goods it has led to increased price inflation as well. Consumer price inflation currently remains over 10%. The most recent wholesale price index inflation number fell to 6.87% for the month of July 2012, from 7.25% in June. But this experts believe is a short term phenomenon and inflation is expected to go up again in the months to come.
As Ruchir Sharma wrote in a column that appeared yesterday in The Times of IndiaFor decades India’s place in the rankings of nations by inflation rates also held steady, somewhere between 78 and 98 out of 180. But over the past couple of years India’s inflation rate is so out of whack that its ranking has fallen to 151. No nation has ever managed to sustain rapid growth for several decades in the face of high inflation. It is no coincidence that India is increasingly an outlier on the fiscal front as well with the combined central and state government deficits now running four times higher than the emerging market average of 2%.” (You can read the complete column here).
So to get economic growth back on track India has to control inflation. The Reserve Bank of India (RBI) has been trying to control inflation by keeping the repo rate, or the rate at which it lends to banks, at a high level. One school of thought is that once the RBI starts cutting the repo rate, interest rates will fall and economic growth will bounce back.
That is specious argument at best. Interest rates are not high because RBI has been keeping the repo rate high. The repo rate at best acts as an indicator. Even if the RBI were to cut the repo rate the question is will it translate into interest rate on loans being cut by banks? I don’t see that happening unless the government clamps down on its borrowing. And that will only happen if it’s able to control the subsidies.
The fiscal deficit for the current financial year 2012-2013 has been estimated at Rs Rs Rs 5,13,590 crore. I wouldn’t be surprised if the number even touches Rs 600,000 crore. The oil subsidy for the year was set at Rs 43,580 crore. This has already been exhausted. Oil prices are on their way up and brent crude as I write this is around $115 per barrel. The government continues to force the oil marketing companies to sell diesel, LPG and kerosene at a loss. The diesel subsidy is likely to continue given that with the bad monsoon farmers are now likely to use diesel generators to pump water to irrigate their fields. With food inflation remaining high the food subsidy is also likely to go up.
The heart of India’s problem is the huge fiscal deficit of the government and its inability to control it. As Sharma points out in Breakout NationsIt was easy enough for India to increase spending in the midst of a global boom, but the spending has continued to rise in the post-crisis period…If the government continues down this path India, may meet the same fate as Brazil in the late 1970s, when excessive government spending set off hyperinflation and crowded out private investment, ending the country’s economic boom.”
These details Manmohan Singh couldn’t have mentioned in his speech. But he tried to project a positive picture by talking about the planning commission laying down measures to ensure a 9% rate of growth. The one measure that the government needs to start with is to cut down the fiscal deficit. And the probability of that happening is as much as my writing having more readers than that of Chetan Bhagat. Hence India’s economic growth is at a level where it is meant to be irrespective for all the explanations that Manmohan Singh gave us and the hope he tried to project in his independence-day speech.
But then you can’t stop people from dreaming in broad daylight. Even Manmohan Singh! As the great Mirza Ghalib who had a couplet for almost every situation in life once said “hui muddat ke ghalib mar gaya par yaad aata hai wo har ek baat par kehna ke yun hota to kya hota?
(The article originally appeared on www.firstpost.com on August 16,2012. http://www.firstpost.com/economy/of-9-economic-growth-and-manmohans-pipedreams-419371.html)
Vivek Kaul is a writer and can be reached at [email protected]

'You can shut the equity market, India would still be doing fine'


Have you ever heard someone call equity a short term investment class? Chances are no. “I have always had this notion for many years that people buy equities because they like to be excited. It’s not just about the returns they make out of it… You can build a case for equities on a three year basis. But long term investing is all rubbish, I have never believed in it,” says Shankar Sharma, vice-chairman & joint managing director, First Global. In this freewheeling
interview he speaks to Vivek Kaul.
Six months into the year, what’s your take on equities now?
Globally markets are looking terrible, particularly emerging markets. Just about every major country you can think of is stalling in terms of growth. And I don’t see how that can ever come back to the go-go years of 2003-2007. The excesses are going to take an incredible amount of time to work their way out. They are not even prepared to work off the excesses, so that’s the other problem.
Why do you say that?
If you look at the pattern in the European elections the incumbents lost because they were trying to push for austerity. And the more leftist parties have come to power. Now leftists are usually the more austere end of the political spectrum. But they have been voted to power, paradoxically, because they are promising less austerity. All the major nations in the world are democracies barring China. And that’s the whole problem. You can’t push through austerity that easily in a democracy, but that is what is really needed. Even China cannot push through austerity because of a powder-keg social situation. And I find it very strange when people criticise India for subsidies and all that. India is far less profligate than many nations including China.
Can you elaborate on that?
Every country has to subsidise, be it farm subsidies in the West or manufacturing subsidies in China, because ultimately whether you are a capitalist or a communist, people are people. They don’t necessarily change their views depending on which political ideology is at the centre. They ultimately want freebies and handouts. In a country like India, they don’t even want handouts they just want subsistence, given the level of poverty. The only thing that you can do with subsidies is to figure out how to control them. But a lot of it is really out of your control. If you have a global inflation in food prices or oil prices you are not increasing the quantum in volume terms of the subsidy. But because of price inflation, the number inflates. So why blame India? I find it absurd that the Financial Times or the Economist are perennially anti-India. They just isolate India and say that it has got wasteful expenditure programmes. A lot of countries hide things. India, unfortunately, is far more transparent in its reporting. It is easy to pick holes when you are transparent. China gives no transparency so people assume that whatever is inside the black box must be okay. That said, I firmly believe the UID program, when fully implemented, will make subsidies go lower by cutting out bogus recipients.
If increased austerity is not a solution, where does that leave us?
Increased austerity, while that is a solution, it is not achievable. If that is not possible what is the solution? You then have a continual stream of increasing debt in one form or the other, keep calling it a variety of names. But you just keep kicking the can down the road for somebody else to deal with it as long as the voter is happy. Given this, I don’t see how you can have any resurgence. Risk appetite is what drives equity markets. Otherwise you and I would be buying bonds all the time. In today’s environment and in the foreseeable future, we are overfed with risk. Where is the appetite to take more risk and go, buy equities?
So are you suggesting that people won’t be buying stocks?
Well you can get pretty good returns in fixed income. Instead of buying emerging-market stocks if you buy bonds of good companies, you can get 6-7% dollar yield, and if you leverage yourself two times or something, you are talking about annual returns of 14-15% dollar returns. You can’t beat that by buying equities, boss! Even if you did beat that by buying equities, let’s say you made 20%, it is not a predictable 20%, which has been my case for a long time against equities. Equities are a western fashion. I have always had this notion for many years that people buy equities because they like to be excited. It’s not just about the returns they make out of it: it is about the whole entertainment quotient attached to stock investing that drives investors. There is 24-hour television. Tickers. Cocktail discussions. Compared with that, bonds are so boring and uncool. Purely financially, shorn of all hype, equities have never been able to build a case for themselves on a ten-year return basis. You can build a case for equities on a three-year basis. But long-term investing is all rubbish, I have never believed in it.
So investing regularly in equities, doing SIPs, buying Ulips, doesn’t make sense?
I don’t buy the whole logic of long-term equity investing because equity investing comes with a huge volatility attached to it. People just say “equities have beaten bonds”. But even in India they have not. Also people never adjust for the volatility of equity returns. So if you make 15% in equity and let’s say, in a country like India, you make 10% in bonds – that’s about what you might have averaged over a 15-20 year period because in the 1990s we had far higher interest rates. Interest rates have now climbed back to that kind of level of 9-10%. Divide that by the standard deviation of the returns and you will never find a good case for equities over a long-term period. So equity is actually a short-term instrument. Anybody who tells you otherwise is really bluffing you. All the fancy graphs and charts are rubbish.
Are they?
Yes. They are all massaged with sort of selective use of data to present a certain picture because it’s a huge industry which feeds off it globally. So you have brokers like us. You have investment bankers. You have distributors. We all feed off this. Ultimately we are a burden on the investor, and a greater burden on society — which is also why I believe that the best days of financial services is behind us: the market simply won’t pay such high costs for such little value added. Whatever little return that the little guy gets is taken away by guys like us. How is the investor ever going to make money, adjusted for volatility, adjusted for the huge cost imposed on him to access the equity markets? It just doesn’t add up. The customer never owns a yacht. And separately, I firmly believe making money in the markets is largely a game of luck. Even the best investors, including Buffet, have a strike rate of no more than 50-60% right calls. Would you entrust your life to a surgeon with that sort of success rate?! You’d be nuts to do that. So why should we revere gurus who do just about as well as a coin-flipper. Which is why I am always mystified why so many fund managers are so arrogant. We mistake luck for competence all the time. Making money requires plain luck. But hanging onto that money is where you require skill. So the way I look at it is that I was lucky that I got 25 good years in this equity investing game thanks to Alan Greenspan who came in the eighties and pumped up the whole global appetite for risk. Those days are gone. I doubt if you are going to see a broad bull market emerging in equities for a while to come.
And this is true for both the developing and the developed world?
If anything it is truer for the developing world because as it is, emerging market investors are more risk-averse than the developed-world investors. We see too much of risk in our day to day lives and so we want security when it comes to our financial investing. Investing in equity is a mindset. That when I am secure, I have got good visibility of my future, be it employment or business or taxes, when all those things are set, then I say okay, now I can take some risk in life. But look across emerging markets, look at Brazil’s history, look at Russia’s history, look at India’s history, look at China’s history, do you think citizens of any of these countries can say I have had a great time for years now? That life has been nice and peaceful? I have a good house with a good job with two kids playing in the lawn with a picket fence? Sorry, boss, that has never happened.
And the developed world is different?
It’s exactly the opposite in the west. Rightly or wrongly, they have been given a lifestyle which was not sustainable, as we now know. But for the period it sustained, it kind of bred a certain amount of risk-taking because life was very secure. The economy was doing well. You had two cars in the garage. You had two cute little kids playing in the lawn. Good community life. Lots of eating places. You were bred to believe that life is going to be good so hence hey, take some risk with your capital.
The government also encouraged risk taking?
The government and Wall Street are in bed in the US. People were forced to invest in equities under the pretext that equities will beat bonds. They did for a while. Nevertheless, if you go back thirty years to 1982, when the last bull market in stocks started in the United States and look at returns since then, bonds have beaten equities. But who does all this math? And Americans are naturally more gullible to hype. But now western investors and individuals are now going to think like us. Last ten years have been bad for them and the next ten years look even worse. Their appetite for risk has further diminished because their picket fences, their houses all got mortgaged. Now they know that it was not an American dream, it was an American nightmare.
At the beginning of the year you said that the stock market in India will do really well…
At the beginning of the year our view was that this would be a breakaway year for India versus the emerging market pack. In terms of nominal returns India is up 13%. Brazil is down 3%. China is down, Russia is also down. The 13% return would not be that notable if everything was up 15% and we were up 25%. But right now, we are in a bear market and in that context, a 13-15% outperformance cannot be scoffed off at.
What about the rupee? Your thesis was that it will appreciate…
Let me explain why I made that argument. We were very bearish on China at the beginning of the year. Obviously when you are bearish on China, you have to be bearish on commodities. When you are bearish on commodities then Russia and Brazil also suffer. In fact, it is my view that Russia, China, Brazil are secular shorts, and so are industrial commodities: we can put multi-year shorts on them. So that’s the easy part of the analysis. The other part is that those weaknesses help India because we are consumers of commodities at the margin. The only fly in the ointment was the rupee. I still maintain that by the end of the year you are going to see a vastly stronger rupee. I believe it will be Rs 44-45 against the dollar. Or if you are going to say that is too optimistic may be Rs 47-48. But I don’t think it’s going to be Rs 60-65 or anything like that. At the beginning of the year our view that oil prices will be sharply lower. That time we were trading at around $105-110 per barrel. Our view was that this year we would see oil prices of around $65-75. So we almost got to $77 per barrel (Nymex). We have bounced back a bit. But that’s okay. Our view still remains that you will see oil prices being vastly lower this year and next year as well, which is again great news for India. Gold imports, which form a large part of the current account deficit, shorn of it, we have a current account deficit of around 1.5% of the GDP or maybe 1%. We imported around $60 billion or so of gold last year. Our call was that people would not be buying as much gold this year as they did last year. And so far the data suggests that gold imports are down sharply.
So there is less appetite for gold?
Yes. In rupee terms the price of gold has actually gone up. So there is far less appetite for gold. I was in Dubai recently which is a big gold trading centre. It has been an absolute massacre there with Indians not buying as much gold as they did last year. Oil and gold being major constituents of the current account deficit our argument was that both of those numbers are going to be better this year than last year. Based on these facts, a 55/$ exchange rate against the dollar is not sustainable in my view. The underlyings have changed. I don’t think the current situation can sustain and the rupee has to strengthen. And strengthen to Rs 44, 45 or 46, somewhere in that continuum, during the course of the year. Imagine what that does to the equity market. That has a big, big effect because then foreign investors sitting in the sidelines start to play catch-up.
Does the fiscal deficit worry you?
It is not the deficit that matters, but the resultant debt that is taken on to finance the deficit. India’s debt to GDP ratio has been superb over the last 8-9 years. Yes, we have got persistent deficits throughout but our debt to GDP ratio was 90-95% in 2003, that’s down to maybe 65% now. So explain that to me? The point is that as long as the deficit fuels growth, that growth fuels tax collections, those tax collections go and give you better revenues, the virtuous cycle of a deficit should result in a better debt to GDP situation. India’s deficit has actually contributed to the lowering of the debt burden on the national exchequer. The interest payments were 50% of the budgetary receipts 7-8 years back. Now they are about 32-33%. So you have basically freed up 17% of the inflows and this the government has diverted to social schemes. And these social schemes end up producing good revenues for a lot of Indian companies. The growth for fast-moving consumer goods, mobile telephony, two wheelers and even Maruti cars, largely comes from semi-urban, semi-rural or even rural India.
What are you trying to suggest?
This growth is coming from social schemes being run by the government. These schemes have pushed more money in the hands of people. They go out and consume more. Because remember that they are marginal people and there is a lot of pent-up desire to consume. So when they get money they don’t actually save it, they consume it. That has driven the bottomlines of all FMCG and rural serving companies. And, interestingly, rural serving companies are high-tax paying companies. Bajaj Auto, Hindustan Lever or ITC pay near-full taxes, if not full taxes. This is a great thing because you are pushing money into the hands of the rural consumer. The rural consumer consumes from companies which are full taxpayers. That boosts government revenues. So if you boost consumption it boosts your overall fiscal situation. It’s a wonderful virtuous cycle — I cannot criticise it at all. What has happened in past two years is not representative. It is only because of the higher oil prices and food prices that the fiscal deficit has gone up.
What is your take on interest rates?
I have been very critical of the Reserve Bank of India’s (RBI) policies in the last two years or so. We were running at 8-8.5% economic growth last year. Growth, particularly in the last two or three years, has been worth its weight in gold. In a global economic boom, an economic growth of 8%, 7% or 9% doesn’t really matter. But when the world is slowing down, in fact growth in large parts of the world has turned negative, to kill that growth by raising the interest rate is inhuman. It is almost like a sin. And they killed it under the very lofty ideal that we will tame inflation by killing growth. But if you have got a matriculation degree, you will understand that India’s inflation has got nothing to do with RBI’s policies. Your inflation is largely international commodity price driven. Your local interest rate policies have got nothing to do with that. We have seen that inflation has remained stubbornly high no matter what Mint Street has done. You should have understood this one commonsensical thing. In fact, growth is the only antidote to inflation in a country like India. When you have economic growth, average salaries and wages, kind of lead that. So if your nominal growth is 15%, you will 10-20% salary and wage hikes – we have seen that in the growth years in India. Then you have more purchasing power left in the hands of the consumer to deal with increased price of dal or milk or chicken or whatever it is. If the wage hikes don’t happen, you are leaving less purchasing power in the hands of people. And wage hikes won’t happen if you have killed economic growth. I would look at it in a completely different way. The RBI has to be pro-growth because they no control of inflation.
So they basically need to cut the repo rate?
They have to.
But will that have an impact? Because ultimately the government is the major borrower in the market right now…
Look, again, this is something that I said last year — that it is very easy to kill growth but to bring it back again is a superhuman task because life is only about momentum. The laws of physics say that you have to put in a lot of effort to get a stalled car going, yaar. But if it was going at a moderate pace, to accelerate is not a big issue. We have killed that whole momentum. And remember that 5-6%, economic growth, in my view, is a disastrous situation for a country like India. You can’t say we are still growing. 8% was good. 9% was great. But 4-5% is almost stalling speed for an economy of our kind. So in my view the car is at a standstill. Now you need to be very aggressive on a variety of fronts be it government policy or monetary policy.
What about the government borrowings?
The government’s job has been made easy by the RBI by slowing down credit growth. There are not many competing borrowers from the same pool of money that the government borrows from. So far, indications are that the government will be able to get what it wants without disturbing the overall borrowing environment substantially. Overall bond yields in India will go sharply lower given the slowdown in credit growth. So in a strange sort of way the government’s ability to borrow has been enhanced by the RBI’s policy of killing growth. I always say that India is a land of Gods. We have 33 crore Gods and Goddesses. They find a way to solve our problems.
So how long is it likely to take for the interest rates to come down?
The interest rate cycle has peaked out. I don’t think we are going to see any hikes for a long time to come. And we should see aggressive cuts in the repo rate this year. Another 150 basis points, I would not rule out. Manmohan Singh might have just put in the ears of Subbarao that it’s about time that you woke up and smelt the coffee. You have no control over inflation. But you have control over growth, at least peripherally. At least do what you can do, instead of chasing after what you can’t do.
Manmohan Singh in his role as a finance minister is being advised by C Rangarajan, Montek Singh Ahulwalia and Kaushik Basu. How do you see that going?
I find that economists don’t do basic maths or basic financial analysis of macro data. Again, to give you the example of the fiscal deficit and I am no economist. All I kept hearing was fiscal deficit, fiscal deficit, fiscal deficit. I asked my economist: screw this number and show me how the debt situation in India has panned out. And when I saw that number, I said: what are people talking about? If your debt to GDP is down by a third, why are people focused on the intermediate number? But none of these economists I ever heard them say that India’s debt to GDP ratio is down. I wrote to all of them, please, for God’s sake, start talking about it. Then I heard Kaushik Basu talk about it. If a fool like me can figure this out, you are doing this macro stuff 24×7. You should have had this as a headline all the time. But did you ever hear of this? Hence I am not really impressed who come from abroad and try to advise us. But be that as it may it is better to have them than an IAS officer doing it. I will take this.
You talked about equity being a short-term investment class. So which stocks should an Indian investor be betting his money right now?
I am optimistic about India within the context of a very troubled global situation. And I do believe that it’s not just about equity markets but as a nation we are destined for greatness. You can shut down the equity markets and India would still be doing what it is supposed to do. But coming from you I find it a little strange…
I have always believed that equity markets are good for intermediaries like us. And I am not cribbing. It’s been good to me. But I have to be honest. I have made a lot of money in this business doesn’t mean all investors have made a lot of money. At least we can be honest about it. But that said, I am optimistic about Indian equities this year. We will do well in a very, very tough year. At the beginning of the year, I thought we will go to an all-time high. I still see the market going up 10-15% from the current levels.
So basically you see the Sensex at around 19,000?
At the beginning of the year, you would have taken it when the Sensex was at 15,000 levels. Again, we have to adjust our sights downwards. A drought angle has come up which I think is a very troublesome situation. And that’s very recent. In light of that I do think we will still do okay, it will definitely not be at the new high situation.
What stocks are you bullish on?
We had been bearish on infrastructure for a very long time, from the top of the market in 2007 till the bottom in December last year. We changed our view in December and January on stocks like L&T, Jaiprakash Industries and IVRCL. Even though the businesses are not, by and large, of good quality — I am not a big believer in buying quality businesses. I don’t believe that any business can remain a quality business for a very long period of time. Everything has a shelf life. Every business looks quality at a given point of time and then people come and arbitrage away the returns. So there are no permanent themes. And we continue to like these stocks. We have liked PSU banks a lot this year, because we see bond yields falling sharply this year.
Aren’t bad loans a huge concern with these banks?
There is a company in Delhi — I won’t name it. This company has been through 3-4 four corporate debt restructurings. It is going to return the loans in the next year or two. If this company can pay back, there is no problem of NPAs, boss. The loans are not bogus loans without any asset backing. There are a lot of assets. At the end of every large project there is something called real estate. All those projects were set up with Rs 5 lakh per acre kind of pricing for land. Prices are now Rs 50 lakh per acre or Rs 1 crore or Rs 1.5 crore per acre. If nothing else, dismantle the damn plant, you will get enough money from the real estate to repay the loans of the public sector banks. So I am not at all concerned on the debt part. If the promoter finds that is going to happen, he will find some money to pay the bank and keep the real estate.
On the same note, do you see Vijay Mallya surviving?
100% he will survive. And Kingfisher must survive, because you can’t only have crap airlines like Jet and British Airways. If God ever wanted to fly on earth, he would have flown Kingfisher.
So he will find the money?
Of course! At worst, if United Spirits gets sold, that’s a stock that can double or triple from here. I am very optimistic about United Spirits. Be it the business or just on the technical factor that if Mallya is unable to repay and his stake is put up for sale, you will find bidders from all over the world converging.
So you are talking about the stock and not Mallya?
Haan to Mallya will find a way to survive. Indian promoters are great survivors. We as a nation are great survivors.
How do you see gold?
I don’t have a strong view on gold. I don’t understand it well enough to make big call on gold, even though I am an Indian. One thing I do know is that our fascination with gold has very strong economic moorings. We should credit Indians for having figured out what is a multi century asset class. Indians have figured out that equities are a fashionable thing meant for the Nariman Points of the world, but for us what has worked for the last 2000 years is what is going to work for the next 2000 years.
What about the paper money system, how do you see that?
I don’t think anything very drastic where the paper money system goes out of the window and we find some other ways to do business with each. Or at least I don’t think it will happen in my life time. But it’s a nice cute notion to keep dreaming about.
At least all the gold bugs keep talking about the collapse of the paper money system…
I know. I don’t think it’s going to happen. But I don’t think that needs to happen for gold to remain fashionable. I don’t think the two things are necessarily correlated. I think just the notion of that happening is good enough to keep gold prices high.
(A slightly smaller version of the interview appeared in the Daily News and Analysis on July 31,2012. http://www.dnaindia.com/money/interview_you-can-shut-the-equity-market-india-would-still-be-doing-fine_1721939)
(Interviewer Kaul is a writer and can be reached at [email protected])