Tag: Reserve Bank of India | Page 6

21 November, 2014

What Arun Jaitley can learn from marketers and real estate agents

Vivek Kaul

I need to confess at the very start that I should have written this column a few days back. But more important things happened and this idea had to take a back seat. Nevertheless, as they say, it’s better late than never.
So, let’s start this column with two examples—one borrowed and one personal. The idea behind both the examples is to illustrate two concepts from behavioural economics—contrast effect and anchoring.
In the book The Paradox of Choice: Why More is Less, Barry Schwartz discusses an example of a high-end catalog seller, who was selling an automatic bread maker for $279. As he writes “Sometime later, the catalog seller began to offer a large capacity, deluxe version for $429. They didn’t sell too many of these expensive bread makers, but sales of the less expensive one almost doubled! With the expensive bread maker serving as anchor, the $279 machine had become a bargain.”
Essentially, there are two things that are happening here. The buyer first gets “anchored” on to high price of the deluxe version of bread maker which is priced at $429. After this the contrast effect takes over. The bread maker priced at $279 seems cheaper than the deluxe version and people end up buying it.
As John Allen Paulos writes in A Mathematician Plays the Stock Market “Most of us suffer from a common psychological failing. We credit and easily become attached to any number we hear. This tendency is called “anchoring effect.””
And once an individual is anchored on to a number, he then tends to compare it with other numbers that are thrown at him. Marketers exploit this very well. As Schwartz points out “When we see outdoor gas grills on the market for $8,000, it seems quite reasonable to buy one for $1,200. When a wristwatch that is no more accurate than one you can buy for $50 sells for $20,000, it seems reasonable to buy one for $2,000. Even if companies sell almost none of their highest-priced models, they can reap enormous benefits from producing such models because they help induce people to buy cheaper ( but still extremely expensive) ones.”
This was the borrowed example. Now let me discuss the personal example. Sometime in May 2006, I was suddenly asked to leave the apartment that I lived in because the landlord had not been paying the society charges for a very long time. And thus started the search for another apartment to rent. Affordable apartments in Central Mumbai tend to be in buildings that are not in best shape.
Given this, real estate agents use a trick where they try and exploit the contrast effect. The first few apartments that they show are in a really bad shape. After having done this they show an apartment which is slightly better than the ones shown earlier, but the rent is significantly higher.
The attractiveness of the apartment shown later is increased significantly by showing a few “run down” apartments earlier.
The idea behind sharing these two examples was to explain the idea of anchoring and contrast effect. I hope both these concepts are clear by now. Now let me move on to real issue that I want to talk about in this column.
On November 18, the finance minister Arun Jaitley said in a speech “Inflation, especially food inflation, has moderated in the last few months and global fuel prices have also come down. Therefore, if RBI, which is a highly professional organisation, in its wisdom decides to bring down the cost of capital, it will give a good fillip to the Indian economy.”
In simple English, Jaitley, as he has often done in the past, was asking the Reserve Bank of India (RBI) to cut the repo rate. Repo rate is the interest rate at which RBI lends to banks. The idea is essentially that at lower interest rates, people will borrow and spend more, and companies will invest and expand. This will lead to faster economic growth. While this sounds good in theory, as I had argued a few days back, it isn’t as simple it is made out to be.
One argument offered by those asking the RBI to cut interest rates is that inflation as measured by the consumer price index has fallen to 5.52% in October 2014. It was at 6.46 % in September 2014 and 10.17% in October 2013.
Nevertheless, is inflation really low? Or are Jaitley and others like him who have been demanding an interest rate cut just becoming victims of anchoring and the contrast effect?
The inflation figure of greater than 10% which had been prevalent over the last few years is anchored into their minds. And in comparison to that an inflation of 5.52% does sound low. Hence, the contrast effect is at work here.
Further, it is worth remembering that this so called low inflation has been prevalent only for a few months. Chances are that food prices might start rising again. The government has forecast that the output of kharif crops will be much lower than last year and this might start pushing food prices upwards all over again. Also, recent data showsthat vegetable and cereal prices have started rising again because of the delayed monsoon.
Central banks of developed countries typically tend to have an inflation target of 2%. In the recent past they have been unable to meet even that number. Large parts of the world might now be heading towards deflationary scenario, where prices will fall.
In October, the consumer price inflation in China stood at 1.6%, well below the targeted 3.5%. Also, in January earlier this year the Report of the Expert Committee to Revise and Strengthen the Monetary Policy Framework set up by RBI had recommended that the Indian central bank should set an inflation target of 4%, with a band of +/- 2 per cent around it .
The committee had said “transition path to the target zone should be graduated to bringing down inﬂation from the current level of 10 per cent to 8 per cent over a period not exceeding the next 12 months and 6 per cent over a period not exceeding the next 24 month period before formally adopting the recommended target of 4 per cent inﬂation with a band of +/- 2 per cent.”
Once, these factors are taken into account, the latest inflation number of 5.52% as measured by the consumer price index, isn’t really low, even though it seems to be low in comparison to the very high inflation that had prevailed earlier. But as explained this is more because of anchoring and the contrast effect at work.
Also, as I had written earlier, more than anything people still haven’t come around to the idea of low inflation, given that inflationary expectations(or the expectations that consumers have of what future inflation is likely to be) continue to remain on the high side.
As per the Reserve Bank of India’s Inflation Expectations Survey of Households: September – 2014, the inflationary expectations over the next three months and one year are at 14.6 percent and 16 percent. In March 2014, the numbers were at 12.9 percent and 15.3 percent. Hence, inflationary expectations have risen since the beginning of this financial year.
If inflationary expectations are to come down, then low inflation needs to be prevail for some time. Just a few months of low inflation is not enough. As RBI governor Raghuram Rajan had said in a speech in February this year “ the best way for the central bank to generate growth in the long run is for it to bring down inflation…Put differently, in order to generate sustainable growth, we have to fight inflation first.”
Rajan is trying to do just that, and it’s best that Jaitley allows him to do that, instead of demanding a cut in interest rates every now and then.

The article appeared originally on www.equitymaster.com on Nov 21, 2014

17 November, 2014

Raghuram Rajan won’t cut interest rates even in Hindi

At a recent function, Raghuram Rajan, the governor of the Reserve Bank of India (RBI), spoke in Hindi. The joke going around in the social media after that was that even in Hindi, Dr Rajan refused to cut the repo rate. Repo rate is the interest rate at which the RBI lends to banks. Nevertheless, four pieces of data that came out last week, will increase the pressure on Rajan to cut the repo rate. These four pieces of data are as follows:

Inflation as measured by the consumer price index fell to 5.52% in October 2014. It was at 6.46 % in September 2014 and 10.17% in October 2013.
Inflation as measured by wholesale price index fell to 1.77%. It was at 2.38 % in September 2014 and 7.24% in October 2013.
The index of industrial production, which is a measure of the industrial activity within the country, grew by 2.5% in September 2014, in comparison to September 2013. The IIP for August 2014 was only 0.4% higher in comparison to August 2013. Interestingly, some economists believe that this marginal recovery in the IIP will not hold for October 2014. The reason for this lies in the fact that indicators of industrial activity like car sales, bank loan growth etc., have slowed down in October 2014.
The bank loan growth for a period of one year ending October 31, 2014, stood at 11.2%. This had stood at 16.4%, for the period of one year ending November 1, 2013. The loan growth year to date stands at 4.6%. It was at 7.6% last year.

These four data points have got the Delhi based economic experts and industry lobbyists brushing up their economic theory again. “It is time that the RBI started to cut interest rates,” we are being told. Chandrajit Banerjee, the director general of the Confederation of Indian Industries, a business lobby said “This provides sufficient room to the RBI to review its prolonged pause in policy rates and move towards policy easing in its forthcoming monetary policy especially as investment and consumption demand are yet to show visible signs of a pick-up.” This was a sentiment echoed by A Didar Singh as well. Singh is the secretary general of Federation of Indian Chambers of Commerce and Industry (FICCI), which is another industry lobby. As he put it “The inflationary expectations are fairly tamed and we see no immediate upside risks with regard to prices. Given that, it is important to reiterate that demand remains subdued. The consumer durables segment reported negative growth for the fourth consecutive month in September. It is imperative that all levers are used to pep up demand.” The idea here is simple. If the RBI cuts the repo rate, banks will cut the interest rates they charge on their loans as well. If that were to happen, people would borrow and spend more, and businesses would borrow and invest more. And this will lead to faster economic growth. Economics 101. QED. Banerjee and Singh are not the only ones asking for an interest rate cut. Sometime back industrialist Anand Mahindra had said that “It might be time for the RBI to think of a rate cut…The need of the hour has changed and its time to start to look to support growth.” Sunil Mittal, chief of Bharti Airtel, also suggested the same when he told CNBC TV 18 that the finance minister Arun Jaitley “had spoken for the nation,” when had asked for an interest rate cut. In an interview to The Times of India in late October Jaitley had said “Currently, interest rates are a disincentive. Now that inflation seems to be stabilizing somewhat, the time seems to have come to moderate the interest rates.” While all this sounds good in theory, things are not as simple as the businessmen and the politicians are making it out to be. It is worth recounting here what Rajan had said in a speech in February 2014: “But what about industrialists who tell us to cut rates? I have yet to meet an industrialist who does not want lower rates, whatever the level of rates.” And what about the politicians? Alan Greenspan, the former chairman of the Federal Reserve of the United States, recounts in his book The Map and the Territory that in his more than 18 years as the Chairman of the Federal Reserve, he did not receive a single request from the US Congress urging the Fed to tighten money supply and thus not run an easy money policy. In simple English, what Greenspan means is that the American politicians always wanted lower interest rates. The Indians ones aren’t much different on that front. Nonetheless, the question is will lower interest rates help in reviving consumption and investment? Let’s tackle the issues one by one. Let’s say an individual wants to buy a car. He borrows Rs 4 lakh to be repaid over a period of five years at a rate of interest of 10.5%. The EMI on this works out to Rs 8,598. Let’s say the RBI cuts the interest rate and as a result the interest rate on the car loan falls to 10%. The EMI now works out to Rs 8,499 or around Rs 100 lower. Now will an individual go out and buy a car because the EMI is Rs 100 lower? Even if interest rates fall by 200 basis points (one basis point is one hundredth of a percentage) to 8.5%, the EMI will come down by only around Rs 400. For two wheeler and consumer durables loans, the differences are even smaller. Hence, suggesting that lower interest rates lead to higher consumption isn’t really correct. The real estate experts think that cutting interest rates will help revive the sector. The basic problem with the real estate sector is that prices have gone totally out of whack and a cut in interest rates is not going to have any significant impact. What about corporate investment? As Rajan had asked in his speech “Will a lower policy interest rate today give him more incentive to invest? We at the RBI think not…We don’t believe the primary factor holding back investment today is high interest rates.” So what is holding back investment? The answers are provided in a recent report titled “Will a rate cut spur investments?Not really“, brought out by Crisil Research. As the report points out “Investment growth, particularly private corporate investment, plummeted in the fiscals 2013 and 2014, despite low real interest rates. During this time, the policy rate in real terms – repo rate minus retail inflation – has been negative, and real lending rates averaged 2.4%. This is significantly lower than the 7.4% seen in the pre-crisis years (2004-2008). Yet investment growth dropped to 0.3%, down from an average 16.2% seen in the pre-crisis years.” The accompanying chart makes for an interesting read.

After 6 years, real repro rate (adjusted for CPI inflation) turns positive

Source: RBI, Central Statistical Office, CRISIL Research Note: Nominal repo rate at the fiscal year-end minus average CPI inflaction , F= Forecast

As Crisil Research points out “During fiscals 2013 and 2014, when investment growth slumped to 0.3% per year, the real repo rate was still minus 2.1%, while the real lending rate was only +2.8%. Only in June 2014, for the first time in six years, did the real repo rate turned mildly positive.” So companies were borrowing and investing at higher “real” interest rates earlier but they are not doing that now. Why is that the case? This is primarily because the expected rate of return on investments has fallen “because of high policy uncertainty, slowing domestic and external demand, and rising input costs driven by persistently elevated inflation.” “The rate of return on investments – as proxied by return on assets (RoA) of around 10,000 non-financial companies as per CMIE Prowess database – have fallen sharply to 2.8% in fiscal 2013 and 2014 from 5.9% in the pre-crisis years,” Crisil Research points out. Moral of the story: Corporates invest when it is profitable to invest, and not simply because interest rates are low. Indeed, the other factors that are likely to revive investment are in the hands of the government and not RBI. Hence, a cut in interest rates is neither going to revive consumer demand nor corporate investments. Having said that, high food inflation has been a big factor behind high inflation. And the RBI really cannot control that. Also, food inflation has come down considerably in the recent past. So why not just cut interest rates? Rajan explained it very well in his February speech where he said “They say the real problem is food inflation, how do you expect to bring it down through the policy rate? The simple answer to such critics is that core CPI inflation, which excludes food and energy, has also been very high, reflecting the high inflation in services. Bringing that down is centrally within the RBI’s ambit.” Further, food prices might start rising again. The government has forecast that the output of kharif crops will be much lower than last year and this might start pushing food prices upwards all over again. Also, recent data showsthat vegetable and cereal prices have started rising again because of the delayed monsoon. To conclude, despite falling inflation, the inflationary expectations (or the expectations that consumers have of what future inflation is likely to be) are on the higher side. As per the Reserve Bank of India’s Inflation Expectations Survey of Households: September – 2014, the inflationary expectations over the next three months and one year are at 14.6 percent and 16 percent. In March 2014, the numbers were at 12.9 percent and 15.3 percent. Hence, inflationary expectations have risen since the beginning of this financial year. And for inflationary expectations to come down, low inflation needs to stay for a considerable period of time. As Rajan said “A more important source of our influence today, therefore, is expectations. If people believe we are serious about inflation, and their expectations of inflation start coming down, inflation will also come down…Sooner or later, the public always understands what the central bank is doing, whether for the good or for the bad. And if the public starts expecting that inflation will stay low, the central bank can cut interest rates significantly, thus encouraging demand and growth.” If inflationary expectations are controlled only then will consumer demand revive and that in turn, will lead to revival of corporate investments as well. Given this, it would be surprising to see Rajan start cutting the repo rate any time soon. The article originally appeared on www.equitymaster.com on Nov 17, 2014

Vivek is a writer who has worked at senior positions with the Daily News and Analysis (DNA) and The Economic Times, in the past. He has just finished writing a trilogy on the history of money and the financial crisis. The series is titled Easy Money. His writing has also appeared in The Times of India, Business Standard, Business Today, The Hindu and The Hindu Business Line.

22 October, 2014

Don’t blame Rajan: It’s time the interest-rate-wallahs stopped punching the RBI

Vivek Kaul

It fashionable these days to criticize the Reserve Bank of India at the drop of a hat. The senior columnist Prem Shankar Jha is the latest person to join this bandwagon. The newest interest-rate-wallah on the block in a column in The Times of India held the RBI responsible for India’s slow economic growth over the last few years. As he writes “[The] Indian economy is not on the road to recovery. The reason is the sustained high interest rate regime of the past four years. Industry has been begging for cuts in the cost of borrowing since March 2011… On August 5, RBI governor Raghuram Rajan surprised the country by announcing that he would not lower interest rates, because at 8% consumer price inflation was still too high.”
I guess Jha must have among the few people surprised by Rajan’s decision given that among those who follow the workings of the Indian central bank closely, almost no one had expected Rajan to cut interest rates.
The premise on which interest-rate-wallahs work is that at lower interest rates people will borrow and spend more, which will lead to economic growth. But the entire premise that low interest rates will lead to a pick up in consumption and hence, higher economic growth, doesn’t really hold. (As I have explained here).
The other big reason offered is that companies can borrow at lower rates of interest. The bigger question that interest-rate-wallahs tend to ignore is how much control does the RBI really have over interest rates that banks pay their depositors and in turn charge their borrowers? Over the last few weeks, banks have cut interest rates on their fixed deposits. The list includes State Bank of India, Punjab National Bank and Central Bank of India. (You can read about here, here and here). The Indus Ind Bank also cut the interest it pays on its savings account to 4.5% from the earlier 5.5% for a daily balance of up to Rs 1 lakh, starting September 1, 2014.
All these cuts in interest rates have happened despite the RBI maintaining the repo rate at 8%. Repo rate is the interest rate at which the RBI lends to banks. So what has changed that has allowed these banks to cut the interest rates at which they borrow?
Let’s look at some numbers. As on October 3, 2014, over a period of one year, the loans given by banks rose by 9.87%. During the same period the deposits raised by banks rose by 11.54%. How was the situation one year back? As on October 4, 2013, over a period of one year, the loans given by banks had risen by 15.18%. During the same period the deposits had grown by 12.9%.
Hence, the rate of loan growth for banks has fallen much faster than the rate at which their deposit growth has fallen. Given this, it is not surprising that banks are cutting fixed deposit rates, given that their rate of loan growth is falling at a much faster rate.
As Henry Hazlitt writes in Economics in One Lesson “Just as the supply and demand for any other commodity are equalized by price, so the supply of demand for capital are equalized by interest rates. The interest rate is merely a special name for the price of loaned capital. It is a price like any other.”
As Hazlitt further points out “If money is kept…in…banks…the banks are eager to lend and invest it. They cannot afford to have idle funds.”
Hence, given that the rate of loan growth is much slower than the rate of deposit growth, it is not surprising that banks are cutting interest rates on their fixed deposits. Given this, the impact that RBI’s repo rate has on interest rates is at best limited. It is more of a broad indicator from the RBI on which way it thinks interest rates are headed.
Further, it also needs to be remembered that financial savings in India have fallen dramatically over the last few years. The latest RBI annual report points out that “the household financial saving rate remained low during 2013-14, increasing only marginally to 7.2 per cent of GDP in 2013-14 from 7.1 per cent of GDP in 2012-13 and 7.0 per cent of GDP in 2011-12…the household financial saving rate [has] dipped sharply from 12 per cent in 2009-10.”
Household financial savings is essentially the money invested by individuals in fixed deposits, small savings scheme, mutual funds, shares, insurance etc. It has come down from 12% of the GDP in 2009-10 to 7.2% in 2013-14. A major reason for the fall has been the high inflation that has prevailed since 2008.
The rate of return on offer on fixed income investments(like fixed deposits, post office savings schemes and various government run provident funds) has been lower than the rate of inflation. This led to people moving their money into investments like gold and real estate, where they expected to earn more. Hence, the money coming into fixed deposits slowed down leading to a situation where banks could not cut interest rates., given that their loan growth continued to be strong.
What also did not help was the fact that the borrowing requirements of the government of India kept growing over the years.
The RBI was not responsible for any of this. The only way to bring down interest rates is by ensuring that inflation continues to remain low in the months and the years to come. If this happens, then money flowing into fixed deposits will improve and that, in turn, will help banks to first cut interest rates they offer on their deposits and then on their loans.
The government needs to play an important part in the efforts to bring down inflation. In fact, it has been working on that front. In a recent research report analysts Abhay Laijawala and Abhishek Saraf of Deutsche Bank Market Research write that the “the government is firmly ‘walking the talk’ on fiscal consolidation” through a spate of “recent administrative moves on curbing food inflation (such as fast liquidation of surplus foodstock, modest single-digit hike in MSPs, an effort to eliminate fruits and vegetables from ambit of APMC etc.)”
To conclude, RBI seems to have become everyone’s favourite punching bag even though its impact on setting interest rates is rather limited. It is time that interest-rate-wallhas like Jha come to terms with this.

The article originally appeared on www.FirstBiz.com on Oct 22, 2014

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

1 October, 2014

As bank loans to real estate companies grow, an average Mumbaikar needs 34 years income to buy a home

Vivek Kaul
The Reserve Bank of India (RBI) releases the sectoral deployment of credit data towards the end of every month. Data released on September 29, 2014, throws up some really interesting numbers.
Between August 23, 2013 and August 22, 2014, the overall lending by banks grew by 10.2% to Rs 5,729,300 crore.
Between August 24, 2012 and August 23, 2013, the overall bank lending had grown by 16.8% to Rs 5,199,100 crore. Hence, the growth in overall bank lending has slowed down considerably over the last one year.
What are the reasons for the same? A reason offered by banks is that the borrowing has slowed down because of the high interest rates that prevail. But interest rates had been high even around the time same time last year. Nevertheless, the overall lending by banks had still grown by 16.8%. So high interest rates cannot be a reason be the only reason for bank lending slowing down considerably.
A more feasible reason is the increase in non-performing loans of banks. As on March 31, 2013, the gross non-performing loans of public sector banks had stood at 3.61% of total loans. In a recent report ICRA points out that the gross non performing loans of public sector banks is expected to rise to the region of 4.4-4.7% of total loans as on March 31, 2015.
This rise in non-performing loans could be a reason behind banks going slow on giving out loans. They don’t want to see more loans go bad, and hence, have decided to go slow on lending. Nevertheless, the slowdown doesn’t seem to have impacted one particular sector and that is, commercial real estate.
Between August 23, 2013 and August 22, 2014, the lending to the sector grew by 17.6%. to Rs 1,59,900 crore. Between August 24, 2012 and August 23, 2013, the lending to the sector had grown at a similar rate of 17.4% to Rs 1,36,000 crore.
So, the question to ask here is why has the lending to commercial real estate continued to grow at the same rate whereas the growth in overall lending has fallen dramatically? This, under a scenario where real estate companies have a huge inventory of unsold homes all over the country. (To read about this in detail click here and here).
There is no straight forward answer to this question. To make a definitive statement on this, one would need the break up of the amount of lending to commercial real estate by public sector banks and private sector banks. It would be interesting to see the growth in lending to this sector by public sector banks.
As I have mentioned in the past most Indian real estate companies are fronts for the ill-gotten wealth of politicians. And a possible explanation for the lending to commercial real estate continuing to grow at the same rate as it had last year can be that politicians have been forcing public sector banks to continue to lend to real estate companies.
This continued lending has helped real estate companies to continue repaying their old loans to banks. This has allowed real estate companies to not cut prices on their unsold homes. If bank loans had not been so forthcoming, the real estate companies would have to sell off their existing inventory to repay their bank loans. And in order to do that they would have to cut prices.
In fact, there is nothing new about this modus operandi. Ajit Dayal, an investment manager and the founder of Quantum Asset Management Company had made a similar point in a column in October 2009: “Banks have used your money[i.e. depositors’ money] to give it as a loan to real estate developers. Their act of giving the loan to real estate developers gives them badly needed cash. The real estate developers no longer need to sell their real estate to get “cash flow” to stay alive. They got the money from the banks.”
These loans have allowed enough leeway to real estate companies to launch more new projects. As an article in The Financial Express points out “With more than a hundred launches, across the top real estate markets in Mumbai, Delhi, Bangalore and Pune, and attractively-priced offerings, it could turn out to be a cracker of a Diwali for developers.”
As mentioned earlier, the fresh loans from banks has allowed real estate companies to not cut prices. This, despite the fact that they have a huge inventory of unsold homes. In fact, a July 2014 report in The Times of India quotes Pankaj Kapoor of property research firm Liases Foras as saying “In Mumbai, the average cost of a flat is Rs 1.2 crore.”
An estimate made by Forbes put the average income of a Mumbaikar at $5900 or around Rs 3.54 lakh (assuming $1 = Rs 60) per year. This means it would need nearly 34 years of annual income (Rs 1.2 crore divided Rs 3.54 lakh) for an average Mumbaikar to buy a home in this city currently. What this tells us very broadly that homes in Mumbai are very expensive. Similar calculations done for other parts of the country are most likely to show similar results, though probably the situation might be a little better in other cities.
Nevertheless, the real estate companies never get tired of giving us other reasons. One favourite reason often offered is that people are not buying homes because interest rates are very high. This reason was offered yesterday as well, after the RBI decided to keep the repo rate at 8%. Repo rate is the rate at which RBI lends to banks.
The Confederation of Real Estate Developers’ Associations of India, a real estate lobby, said in a statement yesterday that it was “disappointed with the status quo on the RBI policy rates and demands a reduction in interest rates to facilitate lowering of entry barrier and spur demand for the real estate sector.”
Well, even if the RBI were to cut interest rates by 50-100 basis points (one basis point is one hundredth of a percentage) how would it help in home sales, is beyond my understanding.
So what is a reasonable home price to annual income ratio? An April 2013 article in Forbes points out that “The price-to-income ratio looks at the total cost/price of a home relative to median annual incomes. Historically, the typical, median home in the U.S. cost 2.6 times as much as the median annual income (so if the median income in an area was $100,000, the median price of a home would typically be about $260,000: $100,000 * 2.6).”
A similar scenario emerges in Great Britain as well. A January 2014 article on www.economicshelp.org points out that “First time buyers in London are seeing house prices at a record 7.5 times average earnings. For the UK as a whole, the ratio of 4.3 is still above long term trends.” In comparison, if it takes 34 years of annual income to buy a home, what it clearly means is that the real estate companies have clearly priced themselves out of the market.
But this is something they really won’t want to believe because now they are used to the high prices that have commanded over the last few years.
The article appeared originally on www.FirstBiz.com on Oct 1, 2014

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

4 June, 2014

SLR cut: A central banker shouldn't jump into bed with his finance minister

Vivek Kaul

Since yesterday there has been a lot of analysis about the Raghuram Rajan led Reserve Bank of India (RBI) cutting the statutory liquidity ratio(SLR) from 23% to 22.5%. Earlier the banks had to maintain 23% of their deposits in government securities. Now they need to maintain only 22.5%, a cut of 50 basis points. One basis point amounts to one hundredth of a percentage.
This cut, the analysts have concluded will lead to bank giving out more loans. The Business Standard estimates that “the cut will free up about Rs 35,000 crore with banks which they can now lend.”
The newspaper does not explain how they arrived at that number. But an educated guess can be made. Currently, the aggregate deposits of scheduled commercial banks in India amounts to Rs 7,855,520 crore. The SLR ratio has been cut by 50 basis points or 0.5%. This amounts to around Rs 39,278 crore (0.5% of Rs Rs 7,855,520 crore) of the total deposits of banks. From this number, the ballpark number of Rs 35,000 crore seems to have been derived.
It is important to make things simple, but not simplistic. The assumption being made here is that now that banks need to invest a lesser amount in government securities, they will do so and prefer to lend more money instead.
But is that really the case? The latest numbers released by the RBI show that scheduled commercial banks had invested nearly 29.27% of their deposits in government securities. This when the SLR had stood at 23%. What does this tell us? It tells us that banks prefer to invest in government securities than lend money.
This is not a recent phenomenon. In late September 2007, when the economic scenario was significantly better than it is now, scheduled commercial banks had nearly 31% of their deposits invested in government securities. In mid May 2012, the number had stood at 30%.
Given this, even though banks are required to maintain only a certain portion of their money in government securities, they have maintained a significantly higher amount over the years. Whether this is lazy banking or the lack of good investment opportunities that only the banks can tell us.
In fact, it is interesting to see how things panned out after the RBI cut the SLR from 24% to 23% on July 31, 2012. As on July 28, 2012, the banks had invested nearly 30.6% of their deposits in government securities. Three days later, the RBI cut the SLR. A little over six months later in early February 2013, the government securities to deposit ratio stood at 30.4%. So, the banks did cut down on their exposure to government securities, but not significantly. In fact, as on July 26, 2013, nearly a year later, the government securities to deposits ratio stood at 30.8%. This was higher than the ratio before the SLR cut.
What this clearly tells us is that a cut in SLR does not necessarily mean that banks will invest less in government securities and lend that money instead.
The RBI of course understands this. If it really wanted to ensure that banks had more money to lend it would have cut the cash reserve ratio (CRR). CRR is the portion of their deposits that banks need to hold with the RBI. It currently stands at 4%.
The RBI does not pay any interest on the money that banks maintain with it to fulfil their CRR obligations. Hence, when the RBI cuts the CRR, banks have an incentive to lend the money that is freed up. The same scenario does not hold in case of an SLR cut because banks get paid interest on the money they invest in government securities.
So that brings us to the question, why did Rajan cut the SLR? My guess on this is that there was pressure on him from the Finance Ministry to show that RBI was serious about “economic growth” and do something that forced banks to lend more. And that something came in the form of an SLR cut. It was his way of telling the government, look you wanted me to do something, I did something. If banks are still not lending, what can I do about it?
In the monetary policy statement Rajan said that there were still “Upside risks” to inflation “in the form of a sub-normal/delayed monsoon on account of possible El Nino effects, geo-political tensions and their impact on fuel prices, and uncertainties surrounding the setting of administered prices.” What this tells us clearly is that Rajan is still not totally convinced that we have seen the last of the high inflation that has prevailed over the years.
What this further tells us is that Rajan continues to be his own man as he was in the past and is unlikely to be weighed in by pressure from the finance ministry. It is important to remember here what economist Stephen D. King writes in When the Money Runs Out “A central banker who jumps into bed with a finance minister too often ends up with a nasty dose of hyperinflation.”Given this, it is important that Rajan stays as independent as he has been since taking over as the RBI governor in September 2013.

The article originally appeared on www.firstbiz.com on June 4, 2014

(Vivek Kaul is a writer. He can be reached at [email protected])