Lower Interest Rates Good for Govt, Banks and Corporates, Not for Average Indian

The new monetary policy committee which met for the first time over the last two days has decided to keep the repo rate unmoved at 4%. Monetary policy committee is a committee which decides on the repo rate of the Reserve Bank of India (RBI). Repo rate is the interest rate at which RBI lends to banks and is expected to set the broad direction for interest rates in the overall economy.

The RBI has been trying to drive down the interest rates in the economy since January 2019. In January 2019, the repo rate was at 6.5%. Since then it has been cut by 250 basis points and is now at 4%. One basis point is one hundredth of a percentage.
This has had some impact in driving down fixed deposit interest rates of banks. Take a look at the following chart.

The Crash


Source: ICICI Securities, October 3, 2020.

From the peak they achieved between March and June 2019, fixed deposit interest rates have fallen by 170 to 220 basis points.
This in an environment where the inflation has been going up. In March 2019, inflation as measured by the consumer price index was at 2.9%. It had jumped slightly to 3.2% by June 2019. In August 2020, the latest data available for inflation as measured by the consumer price index, had jumped to 6.6%. Meanwhile, fixed deposit rates which were around 7-8%, are largely in the range of 4-6% now (of course, there are outliers to this).

Hence, inflation is greater than interest rates on fixed deposits, meaning the purchasing power of the money invested in fixed deposits is actually coming down.

In fact, interest rate on savings bank accounts, which in some cases was as high as 6-7%, has also come down. Take a look at the following chart.

Another crash


Source: ICICI Securities, October 3, 2020.

Savings bank accounts now offer anywhere between 2.5-3%.

The fall in interest rates is not just because of the RBI cutting the repo rate. A bulk of this fall has happened post the covid breakout. Banks haven’t lent money post covid.

Between March 27 and September 25, the outstanding non-food credit of banks has fallen by 1.1% or Rs 1.1 lakh crore to Rs 102 lakh crore. This means that people and firms have been repaying their loans and net-net in the first six months of this financial year, banks haven’t given a single rupee of a fresh loan.

Banks give loans to Food Corporation of India and other state procurement agencies to buy rice and wheat directly from the farmers. Once these loans are subtracted from overall lending by banks, what remains is non-food credit.

During the same period, the deposits of banks have risen by 5.1% or Rs 6.97 lakh crore to Rs 142.6 lakh crore. With people saving more, it clearly shows that the psychology of a recession is in place.

Banks have not been lending while their deposit base has been expanding at a rapid pace. The point being that banks are able to pay an interest on their deposits because they give out loans and charge a higher rate of interest on the loans than they pay on their deposits.

When this mechanism breaks down to some extent, as it has currently, banks need to cut interest rates on their deposits, given that they are not earning much on the newer deposits. This is bound to happen and accordingly, interest rates on fixed deposits have fallen.

While the supply of deposits has gone up, the demand for them in the form of loans, hasn’t. This has led to the price of deposits, which is the interest paid on them, falling.

But there is one more reason why interest rates have fallen. There is excess money floating around in the financial system. The RBI has printed money and pumped it into the financial system by buying bonds from financial institutions.

This excess money has also helped in driving down interest rates. While banks haven’t been able to lend at all in the first six months of the year, the government borrowing has gone through the roof. As the debt manager of the government, the RBI has printed and pumped money into the financial system to drive down the returns on government bond, in the process allowing the government to borrow at lower interest rates. Take a look at the following chart, which plots the returns (or yields) on 10-year bonds of the Indian government.

Going down

Source: Investing.com

The yield on a government bond is the return an investor can earn if he continues to own the bond until maturity. The above chart clearly shows that as the government has borrowed more and more through the year, the interest rate at which it has been able to borrow money has come down, thanks to the RBI and its money printing.

Of course, with banks not lending on the whole, they are happy lending to the government. In fact, in his speech today, the RBI governor Shaktikanta Das said that the central bank planned to print and pump another Rs 1 lakh crore into the financial system in the days to come.

With more money expected to enter the financial system the 10-year government bond yield fell from 6.02% yesterday (October 8) to 5.94% today (October 9), a fall of 8 basis points during the course of the day.

The monetary policy committee also decided to keep the “accommodative stance as long as necessary”, with only one member opposing it. In simple English this means that the RBI will keep driving down interest rates as long as necessary “at least during the current financial year and into the next financial year – to revive growth on a durable basis and mitigate the impact of COVID-19 on the economy.”

The assumption here is that as interest rates fall people will borrow and spend more and corporations will borrow and expand more. This will help the economy grow, jobs will be created and incomes will grow. While, this sounds good in theory, it doesn’t really play out exactly like that, at least not in an Indian context.

Let’s take a look at this pointwise.

1) A bulk of deposits in Indian banks are deposited by individuals. In 2017-18, the latest data for which a breakdown is available, individuals held around 55% of deposits in banks by value. This had stood at 45% in 2009-10 and has been constantly rising. Hence, it is safe to say that in 2020-21, the proportion of bank deposits held by individuals will clearly be more than 55%.

When interest rates on deposits (both savings and fixed deposits) go down individuals get hurt the most. There are senior citizens whose regular expenditure is met through interest on these deposits. When a deposit paying 8% matures and has to be reinvested at 5.5%, it creates a problem. Either the family has to cut down on consumption or start spending some of their capital (the money invested in the fixed deposit).

This also disturbs many people who use fixed deposits as a form of long-term saving. The vagaries of the stock market are not meant for everyone. Also, in the last decade returns from investing in stocks haven’t really been great.

2) When interest rates go down, the families referred to above cut down on consumption and do not increase it, as is expected with lower interest rates. This may not sound right to many people who are just used to economists, analysts, bureaucrats, corporates and fund managers, mouthing, lower interest rates leading to an increase in consumption all the time. But there is a significant section of people whose consumption does get hurt by lower interest rates.

3) It’s not just about bank interest rates going down. Returns on provident fund/pension funds which hold government bonds for long time periods until maturity and post office schemes (despite being higher than banks), also come down in the process.

4) Also, no corporate is going to invest just because interest rates are low right now. Corporates invest and expand when they see a future consumption potential. This is currently missing. Also, banks lending to industry peaked at 22.43% of the GDP in 2012-13. It fell to 14.28% of the GDP in 2019-20. During the period, interest rates have gone up and down, but corporate lending as a proportion of the GDP has continued to fall. So clearly increased borrowing by corporates is not just about interest rates.

But corporates love to constantly talk about high interest rates as a reason not to invest. This is just a way of driving down interest on their current debt.

As former RBI governor Urjit Patel writes in Overdraft:

“Sowing disorder by confusing issues is a tried-and-trusted, distressingly often successful routine by which stakeholders, official and private, plant the seeds of policy/regulation reversal in India.”

One can understand interest rates going down in an environment like the current one, but there is a flip side to it as well, which one doesn’t hear the experts talk about at all. Also, anyone has barely mentioned the excess liquidity in the financial system, which currently stands at Rs 3.9 lakh crore. Why is that? Let’s look at this pointwise.

1)  The equity fund managers love it because with interest rates going down further, many investors will end up investing money in stocks despite very high price to earnings ratio that currently prevails. The price to earnings ratio of the Nifty 50 index currently is at 34.7. This is a kind of level that has never been seen before.

But with post tax real returns from fixed deposits (after adjusting for inflation) in negative territory, many investors continue to bet on stocks, despite the lack of earnings growth.

2) The debt fund managers love it because interest rates and bond prices are negatively related. When interest rates come down, bond yields come down and this leads to bond prices going up. This means that the debt funds managed by these fund managers see capital gains and their overall returns go up. Hence, debt fund managers love lower interest rates.

3) Banks invest a large proportion of the deposits they gather into government bonds. When bond yields fall, bond prices go up. This leads to a higher profit for banks. This in an environment where banks aren’t lending. Hence, bankers love lower interest rates.

4) Corporates love lower interest rates at all points of time, irrespective of whether they want to borrow or not. I don’t think this needs to be explained.

5) The government loves low interest rates because it can borrow at lower rates. Second, with the stock market going up, it can sell a positive narrative. If the economy is doing so badly, why is the stock market doing well?

6) This leaves economists. Economists love lower interest rates because the textbooks they read, said so.

The question is do lower interest rates or interest rates make a difference when it comes to borrowing by an average Indian? Let’s take a look at non-housing retail borrowing from banks over the years. In 2007-08 it stood at 5.34% of the gross domestic product (GDP). In 2019-2020, it stood at an all-time high of 5.97% of GDP.

In a period of 12 years, non-housing retail borrowing from banks, has barely moved. What it tells us to some extent is that the idea of taking on a loan to buy something (other than a house), is still alien to many Indians.

So, the idea that interest rates falling leading to increased retail borrowing is a little shaky in the Indian context.

To conclude, today the RBI governor Shaktikanta Das gave a speech which was more than 4,000 words long. In this speech, the phrase fixed deposit interest rate did not appear even once.

A whole generation of savers is getting screwed (for the lack of a better word) and the RBI Governor doesn’t even bother mentioning it in his speech. The RBI seems to be constantly worried about the interest rate at which the government borrows.

A central bank which only bats for the government, corporates and bond market investors, is always and anywhere a bad idea.

Shaktikanta Das’ RBI is at the top of this bad idea.

 

The ‘GULZAR’ Principle of Investing for Regular Income and Safe Returns

Summary: There is no real way of earning a regular and a safe income that is enough to meet the monthly expenses.

The headline was a clickbait. But now that I have your attention, let me explain the logic behind it.

The title song of the 1979 Hindi film Gol Maal was written by the lyricist Gulzar (Honestly, calling him just a lyricist is doing his talent a great disservice. Other than being a lyricist, he has written screenplays and dialogues for a huge number of Hindi films. He is a poet and a short story writer. He is also a translator of repute. Oh, and he has also directed a whole host of Hindi movies as well as a few TV serials along the way. Also, for the millennials, Hrishikesh Mukherjee made Gol Maal, much before Rohit Shetty started using the title for everything he could possibly think of).

Now getting back to the point I was trying to make. In the title song of Gol Maal there is a line which goes: “paisa kamane ke liye bhi paisa chahiye,” essentially meaning, in order to earn money, you first need money. And that is what I am going to write about today.

In the twenty months, as the economy has gone downhill, people have been getting in touch with me on email and the social media, with a very basic financial query. The numbers were small first but post-covid this has turned into a deluge. The question being asked is how a reasonable monthly income can be generated from savings, without taking any risk, in a safe way.

The answer to this question has become very important as people have lost their jobs or seen their salaries being slashed and incomes falling. What does not help is the fact that the post-tax return from bank fixed deposits are now largely in the range of 4-5%. The inflation as measured by the consumer price index is close to 7%.

Before I try answering this question, it is important to understand why interest rates on bank fixed deposits have fallen. The simple answer to this lies in the fact that there is too much money floating around in the financial system, with the banks not knowing possibly what to do with it.

Between March 27 and July 31, a period of little over four months, the non-food credit given by banks has contracted by Rs 1.32 lakh crore or around 1.3%. The banks give loans to the Food Corporation of India (FCI) and other state procurement agencies to primarily buy rice and wheat directly from the farmers at the minimum support price declared by the government. Once these loans are deducted from the overall loans given by banks, what remains is non-food credit.

What does non-food credit contracting tells us? It tells us on the whole borrowers have been repaying loans and at the same time not taking on enough new loans. It also tells us that banks are reluctant to lend. Further, as we shall see, there has been a huge surge in fixed deposits with banks, as people have increased their savings in the aftermath of the spread of the covid-19 pandemic. Banks will take time to lend all this money out.

Between March 27 and July 31, the total deposits of banks have gone up by Rs 5.95 lakh crore or 4.4%. In an environment, where the non-food credit of banks has contracted whereas deposits have jumped big-time, it is but natural that interest rates on fixed deposits have fallen. In fact, the weighted average term deposit interest rate or simply put average fixed deposit interest rate has fallen from 6.45% in February to 6% in June, the latest data available. Now that we are in August, the interest rates may have possibly fallen even more.

In fact, there is nothing new about interest rates on fixed deposits falling, this has been going on for close to eight years now. Having said that, interest rates shouldn’t be looked at in isolation, it is important to compare them with the prevailing rate of inflation. Take a look at the following chart. It plots the average interest rate on fixed deposits during the course of a year, along with inflation as measured by the consumer price index. The difference between the two is referred to as the real rate of return on fixed deposits.

Interest v/s Inflation


Source: Reserve Bank of India.

What does the above chart tell us? Between 2014-15 and 2018-19, there was a healthy difference between the average interest paid on fixed deposits and inflation. (Of course, this is without taking tax on fixed deposit interest into account, else, the difference would have been lower).

These were the years when first Dr Raghuram Rajan and then Dr Urjit Patel were at the helm at the Reserve Bank of India. In 2019-20, the real return on fixed deposits narrowed to 1.6%. Shaktikanta Das took over as RBI Governor in December 2018.

Let’s take a look at the real return on fixed deposits month wise since December 2018, the month when Das took over as RBI Governor. The real return on fixed deposits as explained earlier is the average interest rate on fixed deposits minus the prevailing rate of inflation.

Crash in real returns


Source: Author calculations on data from the Reserve Bank of India.

This chart is as clear as anything can get. The real rate of return on fixed deposits has simply collapsed since end of 2018. This has happened as the interest rate on fixed deposits has fallen and inflation has gone up.

The interest rate on fixed deposits has fallen primarily because the rate of loan growth for banks has crashed over this period. This we can see from the following chart.

Loan growth crash


Source: Reserve Bank of India.

The above chart clearly tells us that the loan growth of banks has crashed since December 2018. In fact, for the week ended July 31, it stood at just 5.4%. Given this, the Indian economy was slowing down even before covid-19 pandemic struck.

Hence, as economic growth has slowed down, the loan growth of banks has slowed down and this has led to fixed deposit interest rates coming down as well. The point being that in economics everything is linked.

Of course, there is more to this than just the economy slowing down. Since February,  like the rest of the central banks, the RBI has printed and pumped money into the financial system to drive down interest rates, in the hope of getting businesses and people to borrow more.

Also, with collapse in tax revenues, the government will have to borrow more this year, in order to keep its expenditure going. Hence, it likes the idea of borrowing more at lower interest rates. The RBI goes along with this because among other things it also acts as the debt manager of the government.

The problem is that India’s economic crisis has grown worse since the covid pandemic hit the world, leading to a lot of individuals losing their jobs or facing salary cuts. Small businesses have been majorly hit and incomes have come down dramatically.

In this environment, people are now looking to generate some sort of a regular income from their savings. Of course, most them want to do this in a risk free way. As one gentleman recently asked me: “I am currently not employed after having worked in the corporate sector for 10 years. My request to you is to honestly guide me on how and where to invest to earn steady income especially when the fixed deposit interest rates have fallen so low.”

The first thing I can clearly say is that the gentleman believes that there is a solution to his problem. He believes that it is possible to generate a good steady income despite fixed deposit interest rates having fallen.

I see this belief among many people. My guess is, it stems from the fact that way too many personal finance publications believe in offering solutions to everything. I mean, why will a reader read you, if at the end of it you say something like there aren’t really any solutions to this problem that you might have. At least, that’s how their thinking operates. Also, they need advertisers. And advertisers love solutions to everything, even when none really exist.

In June 2020, the average rate of interest on a fixed deposit was 6%. Once we take income tax into account, the rate of return would be much lower. Of course, there are banks out there which are offering a rate of interest of 7% or more. Nevertheless, these banks are perceived to be among the riskier ones. So, the question is are you willing to take on more risk, for a 1-1.5% higher return? If yes, then these investments are for you.

While, we live in an era where no bank is going to go bust, they can and have been put under a moratorium or periods under which only a limited amount of money can be withdrawn from them. And money that can’t be spent when it is needed, is essentially useless. Hence, if you do end up putting money in a bank which offers a 1-1.5% higher return, do remember not to put all your money into it.

There are corporate fixed deposits which offer a slightly higher return but again they don’t have the same safety as a bank does.

If you are senior citizen, you can look at the Senior Citizens Savings Scheme. But that comes with the pain of dealing with the post office.

Debt mutual funds as many people have found out over the last one year, come with their own share of risks. They were marketed to be as safe as fixed deposits, but they weren’t anywhere close. Also, irrespective of what financial planners and wealth managers might say, debt mutual funds are fairly complicated products, which I am sure most people selling them don’t understand. And that’s why they are able to sell them in the first place.

A lot of individuals in the last few months have turned towards investing in stocks. The logic is that the stock market has rallied from its March low. On March 23, the BSE Sensex, India’s premier stock market index was at 25,981 points. Yesterday, August 26, it closed at 39,074 points, a jump of over 50% in a period of a little over five months. This rally has been driven by a few stocks and if you had invested in the right stocks, you would have ended up with good gains by now.

While, one can’t question this logic, but what one needs to remember is that on January 12, the Sensex was at 41,965 points. From there to March 23, it fell by 38% in a little over two months. The point being the stock market can fall as fast or even faster than it can rise. Also, do remember this basic point that a 50% fall can wipe off a 100% gain. (A 38% fall would have written off a 61% gain).

Hence, the larger point here as I mentioned in this piece I wrote a few days back is, just because an investor takes a higher risk by investing in stocks, it doesn’t mean he will always end up with higher returns, precisely the reason the word ‘risk’ is used in the first place. And by the way, the 10-year return on stocks (including dividends) is less than 9% per year.

So, the question is what should a person looking for a regular and safe income, actually do? As helpless as it might sound, there aren’t many options going around beyond the humble fixed deposit, especially for people who aren’t senior citizens. The trouble is the fixed deposit interest rates are at very low levels.

If you need to generate a monthly income of Rs 20,000 at 6% per year, this needs an investment of Rs 40 lakh.

The moral of the story here being that if you want to generate a regular safe income which is enough to meet your monthly needs, you need to invest more money. Or as Gulzar wrote in Gol Maal: “paisa kamane ke liye bhi paisa chahiye.” I would like to call this the Gulzar principle of investing for a regular income and safe returns.

Also, there are corollaries to this. These are very difficult times. Hence, there is a good chance of individuals ending up in a situation where they might have to spend their savings (rather than just the return on savings) to keep meeting expenditure.

Let’s take the example of a middle-class household with monthly expenses of Rs 50,000. In order to generate this income through a fixed deposit, an investment of Rs 1 crore is needed. Of course, the chances of a middle-class household with expenses of Rs 50,000 per month having savings of a crore, are rather minimal. In this scenario, they will have to resort to spending their savings. Given this, as I keep saying, the return of capital is much more important now than the return on capital.

In the short run, the only way to generate a good regular and safe income is find a job or any other source of income by selling the skills that one has (Like I write. I can do that for a media house or do it individually). In the long run, the next time you see interest rates of 8-9% available on fixed deposits or any other safe investment, invest in these assets and lock in the high returns for as long as possible.

While, this might not sound much like a solution but that is the long and the short of it.

The RISK of RISK of Investing in Stocks, which OPIUM Managers Don’t Talk About

Summary: Just because you have taken on a risk by investing in stocks, doesn’t mean high returns are going to materialise.


The only function of economic forecasting is to make astrology look respectable –
John Kenneth Galbraith.

It was sometime in October-November 2010. I had just joined a weekly personal finance newspaper, which for reasons I did not understand and for reasons above my paygrade, was to be run out of Delhi.

During the course of one editorial meeting, we had to decide what sort of return would systematic investment plans (SIPs) into equity mutual funds generate over the next decade. This was necessary as a part of a regular feature to be published in the newspaper, which would help a featured family come up with an investment-savings plan.

It was assumed that SIPs into equity mutual funds would generate 15% per year return. I protested against the assumption saying that 15% per year return was way too high but was overruled by the Delhi bosses.

At that point of time it had almost become fashionable to say that the stock market generates 15% return per year in the long term (In fact, there are people who still believe in this myth, which I shall write about in detail in the time to come).

Getting back to the point. We are now in 2020. 10 years have gone by. As I pointed out in a piece yesterday, the SIP returns on index funds have been rather subdued over the last decade. The average per year return over the last decade in case of the three Nifty index funds I checked was slightly over 9% (around 9.17% to be very precise). Index funds are funds which have a mandate to invest money in stocks that make up a stock market index, in the same proportion that they do.

The per year return of a little over 9% was nowhere near the assumed 15% per year return. Let’s say an individual had invested Rs 10,000 per month religiously through the SIP route for ten years. On this if he had earned a return of 15% per year, the value of his portfolio at the end of 10 years would be Rs 27.5 lakh.

If the return was 9.2% instead as it actually turned out to be, the value would be around Rs 19.6 lakh or around 29% lower. If the individual was saving towards a certain goal, he would end up way short. But that’s the rather obvious point here.

The question is how did the market narrative of stocks giving 15% return in the long-term come about? The first time I heard this 15% argument being made with a lot of confidence by marketmen was sometime in late 2006 or perhaps early 2007.

This, after the Indian economy had grown by greater than 9% in real terms for three consecutive years, 2004 to 2006. The zeitgeist or the spirit of the times that prevailed was that come what may India will now grow by at least 8% in real terms. Add an inflation of 5-6% on top of that and we will grow at 13-14% in nominal terms, year on year.

Assuming that the earnings of companies which are a part of India’s premier stock market indices would grow a tad faster than the nominal growth, we arrived at 15-16% year on year growth in earnings.

This would be reflected in stock prices growing by 15-16% per year as well. From here came the assumption, the stock market growing at 15% in the long-term. There is a lot more to this assumption including Sensex returns from 1979 on, but I will leave that for another day. For the time being knowing this much is fine.

In fact, over the years, I have seen this logic being offered by people who make their money in the stock market by managing other people’s money or OPM or even better OPIUM, with great conviction. These tend to include fund managers, analysts, traders, salespeople etc. (Oh, if you still didn’t get it, OPM and OPIUM sound the same. Rather childish, but good fun nonetheless). Those in the business of managing OPIUM really believe that stocks give 15% per year return over the long-term (I even wrote a piece on this titled Why Economic Growth Cannot Be Created on an Excel Sheet. You can read it here).

The trouble is that this assumption has turned out to be all wrong. The earnings growth has been nowhere near what the OPIUM managers have been projecting. This is reflected in the 10-year return on stocks, which as of August 20, 2020, stood at 8.7% per year (based on the Nifty 50 Total Return Index, which takes dividends paid by companies into account as well, unlike the normal index).

The funny thing is that the stock market has delivered a return of just 8.7% per year over the last decade, despite the valuations being at all time high levels. The price to earnings ratio of stocks that comprise the Nifty 50 index is around 32 these days. This basically means that for every rupee of earnings for these stocks, the investors are ready to pay thirty-two rupees as price. As I pointed out yesterday, such high valuation has never been seen before.

And despite such a high valuation the decadal per year return on stocks on an average is less than 9% per year. This is the irony of it all. It also makes me wonder why investors think that the stock market is doing well. Yes, it has done well in comparison to where it was in late March 2020, but clearly not otherwise.

Of course, when the OPIUM managers talk about 15-16% return per year from stocks over the long-term, they also highlight the fact that for higher return a higher risk needs to be taken on by the investor. The higher risk is the risk of investing in stocks for the long-term.

But what they don’t talk about is the fact that just because you are taking the risk of investing in stocks for the long-term, doesn’t mean that higher returns are going to materialise. I would like to call this, the risk of risk of investing in stocks, something which most OPIUM managers don’t seem to talk about.

The question is why does this happen? The answer lies in the fact that OPIUM managers are in the business of driving up assets under management for the firms that they work for. More the money that gets invested in a fund, the higher the fee earned by the firm to manage that money. And in this business of soliciting money, you need to sound confident.

The moment you start getting into nuance about high risk not guaranteeing high returns, you start losing the average prospective investor. Hence, the projection of confidence that the prospective investor is looking out for, leads to simplistic one-line market narratives like stocks will definitely give a 15% per year return, over a decade. Such narratives are easier to sell.

In a world full of complex uncertainties, the prospective investors are looking for certainty and those in the business of managing OPIUM can’t consistently project confidence to tackle the complex uncertainties, unless they believe in stocks giving 15% per year return in the long-term, themselves. This is the con of confidence which fools people on both sides.

The trouble is such narratives hurt. As  economists John Kay and Mervyn King write in Radical Uncertainty – Decision Making For an Unknowable Future: “Markets narratives are occasionally ‘dishonest and manipulative’, but normal people make honest use of narratives to understand their environment and guide decisions under radical uncertainty.” (King and Kay’s book is a terrific read though not a breezy one. Highly recommended).

This is not to say that one should not invest in stocks and invest all our money in bank fixed deposits. Not at all.

All I am trying to say is that just because you have taken on the risk of investing in stocks, doesn’t mean higher returns are going to materialise and which is why it’s called risk in the first place. So, you might end up short on the corpus you were trying to build (assuming you are trying to do this in a systematic way).This is something that needs to be kept in mind while investing in stocks either directly or indirectly through mutual funds. This is the risk of risk of investing in stocks. While all mutual fund ads have a disclaimer at the end saying that mutual fund investments are subject to market risk, nobody really explains to the investor what exactly this market risk is.

The economist Allison Schrager makes this point in the context of saving for retirement in her brilliant book An Economist Walks into a Brothel—And Other Unexpected Places to Understand Risk. The conventional wisdom is that when it comes to saving for retirement it makes immense sense to build up as large a retirement corpus as possible and then spend it at the rate of, say 4%, per year, after retirement.

The problem with this strategy is that 4% per year isn’t really a fixed amount. It depends on the retirement corpus one has been able to build up in the first place. And that in turn depends on how the stock market has been doing. As Schrager writes: “That’s where the strategy goes wrong.”

One way of getting around this problem is that in the years approaching retirement you take your money out of stocks and invest it in fixed income investments, everything from bonds to fixed deposits. This mitigates the risk to some extent but not totally.

What if the stock market is not doing well in the years before retirement? What do you do then? Do you continue staying invested in the stock market in the hope that it recovers, and you build a better corpus? What if it doesn’t?

That’s the risk of it all. At the cost of repeating just because you have invested in stocks and taken on a higher risk doesn’t mean higher returns are automatically going to materialise.

To conclude, it is important that as a stock market investor you realise this, irrespective of whether the OPIUM managers communicate this or not.

Stay safe and enjoy the weekend.

Will see you now on Monday (or perhaps Tuesday, depending on what my brain throws up over the weekend).

Disclaimer: This article is meant for educational purposes only.  

Why the Bihar poll matters for stock markets: A BJP win will allow stockbrokers to sell ‘ache din’ again

 


narendra_modi
The assembly elections in the state of Bihar are scheduled to happen across five phases between October 12, 2015, and November 7, 2015. The constituents of the stock market are closely following the run up to these elections like they had followed the run up to the Lok Sabha elections last year.

While the stock market following the Lok Sabha elections is but natural, why is it following the run up to the assembly elections in Bihar? Bihar is the poorest state in India as measured by the per capita income. Data released by the Ministry of Statistics and Programme Implementation shows that for 2014-2015, the per capita income of the state was Rs 36,143. This was the lowest among the states and union-territories, which had declared their per capita income when the data was published in July earlier this year.

During 2013-2014, the per capita income of the state was at Rs 31,199, the lowest among all states and union-territories. The state of Uttar Pradesh came in second from the bottom at Rs 36,250. This when the per capita income of Bihar has grown at greater than 15% in each of the last three financial year’s.

Data from the India Brand Equity Foundation points out that the per capita income of the state is around 43% of the Indian per capita income. The gross domestic product (GDP) of the state is around 3.25% of the Indian GDP, even though the state has more than 8% of India’s population.

The installed power capacity of the state is 2759.8 MW, which is around 1% of the total capacity in India. Over and above this, given the many years of lawlessness and the lack of electricity that the state has faced, it barely has an industry.

Data from the ministry of finance shows that the state has 26 public private partnership projects. This is less than 2% of the 1409 projects all across India. The India Brand Equity Foundation points out that the “total FDI for Bihar and Jharkhand combined during the period from April 2000 to May 2015 stood at US$ 59 million.” On this my guess is that even this miniscule amount would have gone more to Jharkhand than Bihar.

The state barely contributes to the Indian GDP, has virtually no industry and almost no FDI is going into the state. In this scenario why is the stock market worried about Bihar? As Shankar Sharma, Vice Chairman and Managing Director of First Global recently told Business Standard: “Bihar election is important from the context of whether the Modi government still enjoys popular mandate or not.”

And how will that help the stock market? A win in Bihar for the Bhartiya Janata Party(BJP) led coalition will allow the stock brokers to sell the Narendra Modi “ache din aane waale hain” story all over again to foreign investors as well as Indian investors.

As Philip Tetlock and Dan Gardner write in Superforecasting—The Art and Science of Forecasting: “The one undeniable talent that talking heads have is their skill at telling a compelling story with conviction, and that is enough.”

Stock market investors love a good story and Narendra Modi in control is a compelling story that can ‘still’ be sold with some conviction by stock brokers. What works for it is the fact that it has already been sold once between September 2013 and May 2014, in the run up to the last Lok Sabha elections. The BSE Sensex ran up 33% between September 2013 and May 26, 2014, when Narendra Modi was sworn in as the prime minister of the country.

This was purely a sentiment based rally based around a compelling story that was well sold. The stock brokers are hoping to repeat this in the time to come. The trouble is that unlike the last Lok Sabha election this election remains too close to call. Hence, up until now, various opinion polls have swung both ways. Some have suggested that the BJP led alliance will win, whereas others have suggested that Lalu Prasad Yadav + Nitish Kumar + Congress (or the Grand Alliance) will win. Let’s see which way things swing.

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

The column originally appeared on Firstpost on Oct 6, 2015

What business news channels have in common with Chacha Chaudhary


Chacha_Chaudhary_with_his_dog_Raaket
I normally don’t watch business news channels given that I find them quite flaky and get put off by their lack of depth. Nevertheless, these days with nothing better to do while having lunch, I sometimes do end up watching these channels discussing the vagaries and the volatility of the stock market.

And one of the things I have noticed is that the anchors as well as the stock market experts who offer their opinion on these channels speak with a lot of conviction and confidence. They appear to be in control of things. They appear to know what is happening, when the world around them is probably going crazy. We never hear them use words like probably, maybe or phrases like I don’t know. Further, they seem to have this uncanny ability to understand and explain something just as it has started to unravel. Their story telling abilities are simply terrific.

The uncanny ability of these anchors and experts to explain things at the speed of thought reminds me of a thought bubble in the Chacha Chaudhary comics, which used to say: “Chacha Chaudhary ka dimaag computer se bhi zyada tez chalta hai (Chacha Chaudhary’s mind works faster than a computer).These anchors and experts are perhaps the Chacha Chaudharies of this day and age.

How is such speed possible? If the anchors and experts are so much in control and seem to have so much insight with such clarity, why are they not making money out of it? Why are they offering their advice for free on TV?

As the British economist John Kay writes in his new book Other People’s Money—Masters of the Universe or the Servants of the People?: “We deal with radical uncertainty through storytelling, by constructing narratives…The reality of market behaviour…relies on conviction narratives – stories that traders tell themselves, and reinforce in conversation with each other. Such narratives are the means by which we cope with radical uncertainty – the unknown unknowns that characterise… business and securities markets.”

The anchors and the experts appearing on business news television are in the business of telling us stories, which offer an explanation for why the market moved the way it did on a particular day. These days the most offered explanation is that economic jitters in China caused the stock market to fall. But this explanation is always offered after the stock market has fallen. No anchor or market expert ever says: “The stock market will fall today because there is economic trouble in China”.

As Kay writes: “The ‘explanations’ provided…by…market commentators…are little more than rationalisation of the noise generated by…market volatility.” And given this, it is worth asking that how useful is it for investors to listen to these explanations and make investment decisions after that.

Bob Swarup calls this phenomenon the illusion of explanation. He defines the term in his book Money Mania as: “Believing erroneously that your arguments…explain events.”

Further, how is it that the anchors and the market experts have an explanation for everything that happens in the stock market? And what is even more surprising is how they are able to come up with explanations so quickly. As John Allen Paulos writes in A Mathematician Plays the Stock Market: “Commentators…provide a neat post hoc explanation for every rally, every sell-off, and everything in between…Because so much information is available—business pages, companies’ annual reports, earnings expectations, alleged scandals, on-lines sites and commentary—something insightful can always be said.”

Over and above this there are many data releases which can also be used to come up with explanations. These data releases include inflation as measured by the consumer price index and the wholesale price index, index of industrial production, export and imports numbers, bank credit growth, and so on. And if all this does not fit into a convincing narrative you can always blame the Reserve Bank of India for not cutting interest rates.

Investing in specific stocks is not easy as it is made out to be by business news television. In fact, what anchors and market experts specialise in is making things simplistic rather than simple, given that they have limited time at disposal to say what they want to say. In this situation, where everything has to be said in thirty seconds to a minute, it is hardly surprising that things ultimately become simplistic. And this is clearly not good from an investor point of view.

What works for these anchors and experts is the fact that while coming up with explanations and predictions, their past record is not available for examination.

As Jason Zweig writes in Your Money and Your Brain: “Whenever some analyst brags on TV about making a good call, remember that pigs will fly before he will broadcast a full list of his past predictions, including the bloopers. Without that complete record of his market calls, there’s no way for you to tell whether he knows what he’s talking about.” This is a very important point that needs to be kept in mind when listening to anchors as well as experts on television.

Also, it is worth remembering here that which way a stock market will go is impossible to predict regularly on a day to day basis.  Nassim Nicholas Taleb in his book The Black Swan—The Impact of the Highly Probable lists a certain category of experts who tend to be…not experts. In this list he includes economists, financial forecasters, finance professors and personal financial advisers.

As he writes: “Simply, things that move, and therefore require knowledge, do not usually have experts, while things that don’t move seem to have some experts. In others words, professions that deal with the future and base their studies on the nonrepeatable past have an expert problem…I am not saying that no one who deals with the future provides any valuable information…but rather that those who provide no tangible added value are generally dealing with the future.” Given this, the stock market experts clearly have an expert problem.

Hence, the next time you switch on your television to try and understand what is happening in the stock market, do remember all that has been pointed out above.

Happy investing!

The column originally appeared on The Daily Reckoning on September 25, 2015