Monetary policy transmission in India

In its monetary policy meeting last week, the Reserve Bank of India’s Monetary Policy Committee cut the policy rate – the repo rate – by 25 basis points. This is its third rate cut since December 2018 and it was unanimous. The Committee also unanimously decided to move to an ‘accommodative’ stance indicating further easing down the road. So far, so good.

Transmission from RBI policy rate to the lending rates fo banks remains the big challenge in India. See this article in ‘Business Line’, for example. Some banks have even increased their lending rate since the last RBI policy rate cut!

Everyone – including my friend Gulzar Natarajan – points out that Indian banks have a much higher share of their liabilities in bank deposits. These deposits are fixed in nature. Therefore, interest rates on them are payable at a fixed rate regardless of the movements in the policy rate. Since they cannot come down with cuts in the policy rate, the lending rates too cannot be lowered. Ergo, there is no transmission.

Gulzar even shared a chart with me that showed that Indian banks’ deposits as a % of overall liabilities is higher compared to other developing nations.

But, the truth is that Current and Savings Accounts (CASA) are more than 40% of overall deposits. 41.3% to be precise. The last data point available – in a easy to retrieve manner, that is – is from February 2019. See here.

Current accounts pay no interest and the interest payable on savings accounts is 4% – at the lowest balance between the 11th and the end of the month. That is as low as one can get, in terms of savings account balances. In the first ten days, the balance could be higher due to salary deposits. That is why they are excluded!

Therefore, the argument is somewhat unconvincing. Not untrue but not the total explanation.

The explanation lies in lack of competition with the central bank prescribing a floor for lending rates via its formulaic Marginal Cost of Deposits based Lending Rate (MCLR). I wrote about it in my MINT column last Tuesday.

If one went through the RBI Internal Working Group Report on the MCLR and the previous base rate, published in October 2017, one would realise that these are not MCLR (i.e., not marginal) but that they are also binding floors for lending rates.

Note a key sentence in the report:

One bank included a negative spread under business strategy due to market competition, which was in contravention to regulatory guidelines. (PAGE 47)

Indeed, that should be the case. Banks should have the freedom to take the basic of decisions for a commercial entity – the pricing decision. But, they do not.

India needs genuine competition in lending rates between banks. Neither the owner nor the regulator must intervene. It will also enable the owners to figure out which of them are worthy of further capital infusion, growth and which of them deserve to be merged, consolidated or weeded out.

Of course, the second thing is the Small Savings Interest Rate. Check out the table in page 26 of the said report (Table II.8).

Interest rates offered on bank deposits are lower than that of the interest rates on small savings and these interest incomes are tax-free too. The Government-announced interest rates on these Small Savings Schemes are higher than that of the rates that would be offered if the government sticks to the formula that it promised – linking the interest rate to the 10-year Government bond yield. It has not. On top of it, there are tax benefits.

That is the second (or, even the first) biggest hindrance to transmission. That is why I felt that the usually meticulous Indira Rajaraman quite did not get it right in her column on the topic of transmission. She is right with her conclusion, of course. The multiple strands that link the funding of government budgets (of the States and the Union) to the National Small Savings Fund (NSSF) need to be broken. She is right on that one.

But, more than that, the idea of offering a higher interest rate on a product that is even safer than a bank deposit and with tax benefits is a sure-fire killer of the banking system profitability and of transmission of monetary policy.

Some politically unpopular decisions need to be taken. They will be unpopular in the short-term. But, a government with its back to the wall on the banking system and with such low actual economic growth (more on that in a separate blog post) has to take some decisions and face up to the tradeoffs. There are no costless choices here.

Surjit Bhalla had got this one right. One of the most important decisions ever taken by a FM was taken by Yashwant Sinha when he lowered the interest rate on Small Savings Deposits. That did play a big role – among many other things – in India’s post-2002 economic boom.

Surjit Bhalla had got this one right. One of the most important decisions ever taken by a FM was taken by Yashwant Sinha when he lowered the interest rate on Small Savings Deposits. That did play a big role – among many other things – in India’s post-2002 economic boom.

Employment creation in India

Apparently, Surjit Bhalla and his co-author (Tirthatanmoy Das) have put up a paper on the website of the Economic Advisory Council of the Government of India on job creation in India in 2017. They estimate it to be 22 million jobs. That seems to be on the high side. Commentators have their knives out to attack the estimates. The protagonists and the antagonists are politically motivated. I am yet to read their paper. But, I have seen two critiques. One by Professor R. Nagaraj and the other in Hindustan Times which was supposedly second of a five-part serial on Indian labour market.

Professor Nagaraj analyses the claims of Bhalla and Das in four dimensions. The third dimension is that of generating formal employment estimates from the data provided by the Employee Provident Funds Organisation (EPFO). Prof. Nagaraj’ critique is stale and wrong because of the work of Pulak Ghosh and Soumya Kanti Ghosh had taken them into consideration in coming up with their conservative estimates of formal job creation from EPFO data. They have excluded EPFO enrolment through amnesty. They have excluded those who were above 25 years of age. They have dropped those where even one contribution was missed. I have written about their work here and here. That Prof. Nagaraj rehashes the same critique is a reflection of both sloppiness and bias.

Key sentences in this piece tell me that the authors are offering opinion and not analysis. Pulak Ghosh & Soumya Kanti Ghosh’ estimates based on EPFO were conservative and passed the test of rigour. These authors, when discussing their work, say that Ghosh & Ghosh were criticised. They leave it at that. Criticised by whom? For what? and how rigorously? Were the criticisms correct and reasonable?

That throwaway line dilutes the seriousness with which one should take the entire piece although one cannot and does not rule out political and, otherwise,upward bias in the work of Bhalla +1.

The first part is here (can be safely skipped) and the third part is by Manish Sabharwal. Those who have not read Manish’s articles on Indian labour market before can find them all neatly recapitulated in that piece.

Demonetisation update 38 – pre-dispositions

Prasanna Viswanathan of Swarajya had shared a good article from Economic & Political Weekly (December 30, 2017) on the impact of demonetisation in rural Tamil Nadu. It was a survey based article. What came out well was the fact that people found a way around the cash ban and yet stuck to cash. That came out well. The second thing is that informal networks got strengthened. The authors strangely note that as a failure of the demonetisation exercise. Far from it. The authors of the demonetisation exercise in the government did not wish to disturb social networks in India!

The other thing that came out – the authors mention it twice – is that there was widespread support for demonetisation. That makes us wonder if the inconveniences and difficulties faced by the public are exaggerated by those who were not well disposed towards the government. If it had caused huge hardship to people, the measure could not have remained popular for too long.

The paper is ‘Insights on demonetisation from rural Tamil Nadu’ – understanding social networks and social protection, Economic and Political Weekly, December 30, 2017, Volume 52.

If the authors of the article were not pre-disposed towards judging the demonetisation as a failure, it would have made for a scholarly article. Pre-disposition makes scholars look silly.

You do not have to look far from this FT article by Larry Summers on the American economy for a classic example of pre-disposition or prejudice making for poor scholarship. If my students had written it, they would have scored very low marks indeed. Just one example: for America, a weak currency is not a reflection of its economic weakness at all. Mr. Summers knows it well but mentions it all the same as reflecting economic fragility because he cannot get himself to say something good about the U.S. economy under President Trump.

While on the subject of the U.S. economy, it was amusing to read that President Obama was claiming credit for the improved performance of the economy in 2017. Well, debatable but would he then take the blame for its sluggishness up to 2016 in almost all parameters of the economy?

Coming back to pre-dispositions, we had one on the other side – this time from Surjit Bhalla. He wrote in ‘Indian Express’ that tax buoyancy had picked up in the current financial year 2017-18, despite the demonetisation. Well, he says, it was because of the demonetisation’s impact on black money that tax buoyancy (more like elasticity- % change in tax collection for a % change in GDP) picked up.

This is problematic. GDP growth slowed down in the first three quarters following demonetisation. That does not establish causality but it is reasonable to think that demonetisation had at least a partial impact on economic growth. If, on top of the growth slowdown, there was increased tax collection, then one has to wonder if it was a good or bad thing. Vigorous tax collection in the middle of an economic growth slowdown might have aggravated the slowdown.

So, I am not sure if improved tax buoyancy in the context of an economic growth slowdown that might possibly have been aggravated by demonetisation (if not caused by it) is cause for celebration.

Fanciful, Mr. Bhalla

Mr. Surjit Bhalla concludes his piece (‘An easy win for Hillary Clinton’, IE Nov. 5, 2016)  with these words:

 If it turns out as predicted, the election will likely provide a much-needed boost to those who believe in trade, open borders, and the traditional “American way”. The anti-trade, anti-immigration wave around the Western world will at least be halted, if not reversed, with a large Clinton victory. The recent high court judgment in England (parliament must vote on Brexit) has already provided the basis for the beginning of the retreat of anti-globalisation forces.

It appears that he has plenty of catching up to do with what is going on in the Democratic Party and what has been happening under this administration for the last eight years. For starters, he can visit the website of the National Federation of Independent Businesses and he can read up the references cited in my blog post written in response to the 370 academics who urged Americans to vote against Trump.

The anti-globalisation movement has its origins in the fantastic success of globalisation except that it was not widely shared. Second, the current Democratic Party rising stars are Elizabeth Warren and scores of other anti-free traders.

If the Democratic Party takes the Presidency and the Congress, it will veer too far to the Left of Centre. Ms. Clinton has disavowed the TPP.  Elizabeth Warren drove the resignation of Jon Stumpf of Wells Fargo -correctly so, in this case. But, the truth is that it would be a party of anti-globalisation.

So, what is he talking about?  He has written a fanciful piece as he does, from time to time. The rise of anti-globalisation is, in large measure, due to its success and those who benefitted from its success kept the benefits for themselves and thus imperilled globalisation. They are the reason for the rise of anti-globalisation and it is not going away.

Sorry, Mr. Bhalla. You have your arguments very wrong and, I hope, your prediction too.

Weekend Reading Links – 16.04.2016


A ‘Chinafile’ conversation on the Panama papers and China

A North Korea think tank referred to China as “a vanity-driven nation bowing down to the US” at the cost of losing a precious friendship forged in blood.

This movie has played out elsewhere in the world and in China too again. But, it has returned to China: “Trying to reduce housing inventory by encouraging individuals to increase borrowing is a dangerous experiment.”

Martin Feldstein abandons his critical faculties too and falls for the charms of China.

South China Morning Post reports that Vincent Chan, head of China research at Credit Suisse, is worried about the China economy in the medium-run and long run. How short is his short run?

China’s Xinjiang province signs deals worth USD2.0bn with Pakistan.


UK Government opens probe into Tata Steel ‘fraud’. A rather strange ‘China-like’ response.

Moody’s said rising FDI inflows continue to narrow India’s external financing needs and mitigate the risk of a potential widening of the current account deficit related to weakening remittances.

India could be sitting on a gold mine, and not even know it.

This article in Swarajya believes that India can eliminate poverty but does not mention ‘income’ or ‘employment’.

Surjit Bhalla, citing mainly inflation statistics, argues that NDA-2 is not UPA-3

SEBI publishes new rules requiring transparency from fund houses on how they remunerate their executives and their financial advisors who sell their fund to retail investors.

Bloomberg discusses the potential of Unified Payments Interface in India. Leapfrogging conventional banking with digital technology.

A must-read piece by Tamal Bandyopadhyay on the changing landscape in Indian banking.

India could potentially invest more than 130,000 crores of Rupees in Iran. Are we sure of the numbers?

Royal Bank of Scotland to close its India operations.

Do not let the somewhat overdramatized header dissuade you from reading this piece on the importance of de-risking Indian farming for which the crop insurance scheme unveiled by the government earlier in the year is an important first step. There needs to be a constant and continuous empirical evaluation of the scheme to iron out wrinkles from time to time.

Comprehensive remarks by Indian FM Arun Jaitley on the Indian economy.

A good article (book excerpt) on the role of MIT in IITs.


Prithwis Mukherjee’s lucid article on Blockchain and cryptocurrency

A massive trawl of Northern Hemisphere rainfall data for the last 1,200 years revealed there had been more dramatic wet-dry weather extremes in earlier, cooler centuries before humans set off fossil fuel-driven global warming.

France ‘Up All Night’ protests entered 12th night; started out as a protest against a draft labour bill but extended to other issues.

Accuity is a firm is in the business of selling database to banks of people and entities to avoid. It has more than a million entries.

Market inefficiency and Stephen Curry of Golden State Warriors.

Dan Lyons would rather work for an old-fashioned furniture maker than in a tech. start-up.

Will be useful to know how much (if) Dubai has changed since this article was written in 2009.


Puerto Rico declares bank emergency

Mario Longhi, head of US Steel, blames Europe and US for being complacent towards the threat from China on steel dumping. China says that its overcapacity problems in steel won’t go away soon.

Where they live matters a lot for the poor in the US for their life expectancy. New and interesting research.

A small problem with the acronym for the name Antonin Scalia School of Law at the George Mason University.

An index of confidence among small businesses in America hit a 2-year low.

Financial Markets

In a desperate bid to be listened to or in a case of successful wooing or lobbying, Mark Mobius bats for the inclusion of China A-shares in MSCI Index.

If this FT news story is anything to go by, Blackrock’s Larry Fink gets it, on negative rates.

Woodford Investment Management in the UK would disclose all costs of running its funds, including ‘hidden’ costs. Just six months ago, asset managers were accused of ousting the chief of the Investment Association in the UK because he pushed for greater disclosure of costs and charges to clients. Nor are asset managers willing to discuss executive pay excesses in their own midst.

To succeed in investing, start reading.

Easwar Prasad and Karim Foda are not sure if global recovery would be fleeting and fragile.

This FAQ on negative interest rates in Wall Street Journal (from Feb. 28, 2016) is useful.


Normally, whose fingerprints the police would look for, in a crime scene?

Andy Mukherjee has a great column on Singapore Corporate Boards of Directors

It might be too early to tell, though. Australia new home sales dropped 5.3% in February.

Japan to print additional ¥10,000 bills as more people stash their cash at home

Data vs. perception

This is what Surjit Bhalla wrote some ten days ago, on 28 November 2015

There’s consistent talk that over the last year or so, communal tensions and intolerance have increased. Although data on communal violence doesn’t support this inference, it would be wrong to infer that intolerance in India is not at its peak today, a year after Modi and the BJP assumed power.  [Link]

A day earlier, on November 27, 2015, Pratap Bhanu Mehta had written this:

It is then countered with the false scienticism — look, the number of violent incidents has not risen dramatically, and so forth. As a piece of social science, this can be important. But data often tells yesterday’s story. We forget that averages are not helpful in assessing specific threats and experiences, and there is no data that can capture the suffocation that discourse can produce. [Link]

What both of them – they are researchers/social scientists – fail to appreciate is that it is objectively impossible to prove that the perception was not the manifestation of living inside a self-feeding echo chamber.

In other words, they may be having that perception now. So, what they write may be really what they are feeling and not are faking it. But, it will be impossible to separate, objectively, the causes of the perception.

For example, they cannot say if their perception of fear and insecurity would have been formed even if the media had not spun every attack on the Church as the doing of the ‘mad, intolerant goons of the Hindu Right’.

Ms. Barkha Dutt ‘confessed’ in a town-hall discussion in May 2015 that the media did not do a proper job of its investigations of attacks on the churches before the elections to the Delhi Assembly and that it jumped to conclusions. Here is the link and watch the ‘confession’ at 23:50. Almost all of the attacks on Churches had motives other than intolerance or communal motives. That the retraction or confession was made rather quietly and in a wholly disproportionately insignificant manner relative to the original reports is one point to note and the second is to acknowledge the self-feeding frenzy that it created with people like Julio Ribeiro, Errol D’Souza – just two names that came to my mind – expressing a sense of insecurity as members of ‘minority’ community.

Neither Mr. Bhalla nor Mr. Mehta – or, for that matter, any one  – can say that exaggerated news-reports and articles which were based on those news-reports did not influence their perceptions. It is impossible to prove that their perceptions were independently formed. It is a cognitive impossibility.


Do interest rates matter?

In my post on the Indian data deficit, I had cited the Op.-Ed by Sajjid Chinoy on how the GDP deflator subtracted too much from nominal GDP growth to produce a real GDP growth estimate of 7% (y/y) in India in the Quarter ending June 2015. The piece by Surjit Bhalla in ‘Financial Express’ completes our understanding. It is well worth a read.

Towards the end of the piece, Mr. Bhalla reverts to his familiar slogan of interest rate cuts:

When and how will India see a GDP growth close to its potential of 8-10%? Of course, I mean real GDP growth of 9%, one accompanied by growth in jobs, and economy-wide growth—and not by manna-from-heaven decline in the price of oil. There are no magic wands available, but there is a time-tested policy: Make real policy rates competitive with the rest of the world. And 25 bps will just not do it. It is now over to RBI. [Link]

International evidence is very much against his near-religious belief that interest rates are the only thing that matters.

(1) This quasi-academic note in FT about how Quantitative Easing by the European Central Bank has failed to revive investment spending has two important quotes from corporations who are supposed to benefit from the QE programme and invest:

If the cost of capital reflects the low interest rate environment, then so will the cash flows

The problem in a world of zero interest rates is that it’s very difficult to find projects where you can still earn the WACC within a foreseeable future [Link]

(2) There is a Federal Reserve Board Discussion Paper that the Federal Reserve itself does not seem to have read. It was published in December 2013. The paper is titled, ‘The Insensitivity of Investment to Interest Rates: Evidence from a Survey of CFOs’. [Link]. Their conclusions are profound:

Firms expected to be somewhat more sensitive to interest rate increases than decreases, but for the most part the interest rate increases required to elicit adjustments to investment plans are generally quite large.

… in contrast to steeply declining interest rates, average hurdle rates have remained elevated and quite steady over that period. This seems to corroborate our main finding that investment plans tend to be quite insensitive to interest rates.

Still, the findings from the special questions in the Duke CFO survey about the interest rate sensitivity of investment, together with the evidence on consistently elevated investment hurdle rates in several prior studies, arguably provide some support for the view that investment is not as tightly linked to interest rates as traditional theory would suggest.

Clearly, this explains why QE has done everything else except to boost capital spending and hiring. On the latter, check out this note by the ‘Employment Law Project’ in the United States. U.S. has created low-wages paying jobs and they are losing out to inflation – whatever little there is, in the U.S.

What is fascinating in the Federal Reserve Board discussion paper is the section on hurdle rate. That requires a separate behavioural investigation in itself. Corporations seldom lower their hurdle rate, no matter what happens to interest rates! Well, almost. It does look like that the response of companies to interest rates is rather asymmetric. Much higher interest rates make them raise their hurdle rate and thus can crimp investment spending. But, lower rates do not seem to matter much at all.

If all that low and lower interest rates do is to boost asset prices and causes bubbles, one really wonders about the role of and the need for a centrally planned monetary policy!

Perhaps, low interest rates boost consumption and residential real-estate investment. So, there might still be a case for cutting interest rates in India. But, that is a separate topic for a separate occasion.