Interest rate reduction?
Raghuram Rajan is an intelligent man and has a lot of integrity. He stays firm on what he says.
The whole of the industry, finance ministry, why even the PMO might want a interest rate reduction. I agree, we need to reduce interest rates. Let us take the case of a 60 year old man dependent on interest income alone. Currently i guess he gets a -3% real return on bank deposit. He earns about 7% post tax and the inflation applicable to him is about 10% (applicable inflation rate means include auto fare, eating out, clothes, gifts, medicines etc. nothing to do with WPI).
Do you realize that if he has only Rs. 50,00,000 and assuming he is spending about Rs. 300,000 he will exhaust his capital by his age of 72?
Which means if he lives till the age of 85…he will need about Rs. 1.25 crores…and obviously about 3 crores if he lives till the age of 95.
Now throw in a rate reduction…and make the -ve return to about 4%…i.e. the gap between the interest income to inflation gap..it means he will need a greater corpus.
From my experience of dealing with people, if interest rates go down, PEOPLE actually try to save more. The other thing that they do is to SPEND LESS. I am sure RR understands this. This is EXACTLY OPPOSITE of what Economics taught us. Behavioral finance is more important in Economics than pure economics.
RR knows what he is doing. And by holding interest rates at this level he is making sure that the senior citizen is protected.
IN a country where there is NOTHING that the government does for the Senior citizen at least protecting his REAL INTEREST is a huge necessity. Imagine if you had retired in the year 2000 in the US depending on interest income from CDs. You have been ‘s…d’ beyond shape.
Thank you RR. Some of us trust your judgement. Do what you think is right.
Prashanth
Is there a good explanation for why inflation is so high in India?
ajayrajaram
LOL
Raghuram Rajan is always thinking all the time and making sure all the senior citizens (incl the author) protected. Yeah right!.
meanwhile the govt is introducing bills to curtail RBI governor’s powers on interest rates.. LOL
HAIL CAESAR
sandeep
Prasanth, i doubt if Subra’s explanation with good enough for you,
but yes , may be Subra can write a blog post on inflation, or he may searh through his old posts and give a link to something he has written before.
🙂
Prashanth
Ajayrajaram, this is perhaps Subra’s way of explaining that interest rates have to be above inflation rate.
In a free market, I presume interest rates will float to above inflation rate through market forces, otherwise it makes no sense to lend money.
In a situation where the RBI sets the rate, it is it’s responsibility to ensure that this is maintained and the interest rates need to track inflation. Otherwise, it is subsidizing one over the other. Such attempts, end badly as it seems to have in India.
Sethuraman
Prashanth
Ajayrajaram knows everything..as a habit he posts something..should I have said posting is his addiction? Not sure where all he posts, but on Subramoney he must be the largest poster of comments. Till now not one has made sense.
Ramakant
I partially agree with the point made by Subra here. But while one needs to be sensitive to senior citizens country’s growth prospects cannot be hurt in the name of savers.
By keeping interest rates high on one pretext or other, growth is being hurt which would create jobs. If we dont create enough jobs for youth today, they will not have money to save during their old age.
While I may agree with Rajan that there are big corporates who misuse low interest rates, there are also many small businessmen who take loans for their day to day business. Low interest rates will help these small businessmen too.
Rajan needs to be sensitive to needs of small businessmen too who have been worst hit by UPA regime. While Rajan is a very intelligent Governor, agreeing with him on every action he takes or every statement he makes without counter arguments doesnt make sense.
Ramakant
Morever from inflation point of view, high interest rates can only affect core inflation which is very low. CPI inflation today is due to stuff like food prices which cannot be controlled by keeping interest rates high.
In a country where there are more than 30% people below the poverty line, with inflation under control job oriented growth should be way ahead. Keeping interest rates high on one pretext or other will take its toll on economy, growth & jobs.
Prashanth
The problem has been that high inflation hurts the common man too. Perhaps more severely than low growth. And, there is no good explanation of why inflation is high.
Pursuing growth, without inflation in control results in the growth sputtering after an initial burst.
PRAKASH
Let RBI Governor do his job.However, govtt. can increase taxable limit for senior citizen to at least Rs 5 lac.so the effect of the lowering of inflation,rate cut will be reduced little.Even shri.Subramanian Swami, MP HAS WRITTEN LETTER to our PM that no income tax to be levied to middle class.Even tax limit on bank FD INTEREST is Rs 10000/-,when it was fixed? similarly, Company FDs Rs5000/- Why there is no revision in these amounts?With overall increase in cost it difficult to live peacefully.
Krish
I really doubt whether RR is holding the rates to protect senior Cs. This article contradicts the popular theory that economic growth would be achieved through lower interest rates. Atleast this is what Fed and ECB rationale for keeping the lower interest rates is understood.
With lower interest rates, people would go for homes, cars, bikes, gadgets, jewellary and what not. That is why RE players are lobbying hard to get the lower rates.
Why RR is not lowering, definitely not a special love for Seniors. It is because most of the FIIs money is locked in debt funds and some of the capital would move away to other EMs which would then weaken our currency in addition to spur in inflation which would hurt economy in the long run.
He is playing it safe at the moment and trying to balance both ways.
Akhil Khanna
The problem with interest rates reduction in India is that there are more savers than borrowers and their spending power will be reduced thus feeding the current economic slowdown.
Moreover reducing interest rates will encourage outflow of funds, thereby weakening the INR and making our imports expensive. This will again lead to higher inflation, RBI tightening its monetary policy and increasing interest rates.
Reducing interest rates is not going to encourage people to borrow and buy more houses or cars just because their EMIs have reduced slightly.
So in a country like India reducing interest rates is unlikely to have the effect the industry is hoping for.
Sendhil
There is definitely heavy pressure on Rajan and RBI to reduce the Repo Rate. However if they are still holding on to the rates then I am sure they have their reasons. Rajan is one of the most highly qualified persons in the world of Economics and Politicians and Businessman trying to lobby hard might frustrate him to quit resulting in a big and irreparable loss to India (He can get a cool job anywhere in the world for his intellect). All our arguments on rate cut or not is based on certain known factors published in the press and there are definitely a lot of nuances that goes behind the decision.
VK
I don’t think senior citizens looks at the interest rates to decide whether or not to cut back on their spending and jack up the savings. They are more or less in this mode already.
It’s the youngsters who might sway more with the interest rate movements – throw in the ~0% and a huge population would be showing off their latest iGadget, the fancy new two-wheeler HDs, membership to various gyms/clubs/…The traditional economic theory would be validated or refuted depending on the demographic under study!
ajayrajaram
@Krish :
You have hit the nail smack bang right on the middle of its head
nice to see a beacon of light amid turbulent seas of ignoramus 😉
LuckyOye
Nice crisp article on how lower interest rates can/and does in fact reduce general public spending and hence reduces aggregate demand (People who want more growth, please take note!).
Also, reducing the interest rates to increase consumption thru borrowing is a joke! At best, you are pulling forward demand (the car you purchased this year thru financing WON’T be purchased 2 years hence, when you could have purchased it with cash). Also, the money you pay as INTEREST further reduces your PURCHASING CAPACITY for OTHER GOODS. The combined effect is that this CRATERS FUTURE aggregate DEMAND. In a steady population economy, that is a total disaster (think Japan/Europe, and now USA).
Central Bank Interest rates should be a pure function of National Inflation, period. It should necessarily be greater than core inflation, not adjusted (hedonistic) inflation, which is insensitive to real personal expenses.
I join the author in supporting RR, may his tribe increase! And to jokers who advocate ZIRP (like VK above), please explain WHO will LEND you the money to buy your latest iGadget at 0%? (please, no offence meant, I did have a good laugh at your comment, hence!)
Ramakant
I am quite sure that many people who’re advocating here to Rajan to not cut rates have never done any kind of business in their lives.
Go and check with many small businesses across India and you will find how tight the liquidity situation is. Small businesses are not able to make payments for goods they have bought for 1-2 yrs due to real slowdown in economy. They are stuck up paying high interest rates for loans they have taken for working capital. The worst affected people of UPA policies were these small buisnessmen who are real people who deliver real growth & jobs to majority of Indians. If learned people here think fall in interest rates will not help these small businessmen they are living in their own cuckoo land far away from ground realities.
Indian small businesses have all these years been working based on Jugaad and no Harvard/Stanford educated economists can change that just by making statements in the conferences. It was unfortunate to hear Rajan ridicule the so called Indian Jugaad way of doing business.
Prabu Raja
First thing, RR is on leave from his Distinguished service professor in Chicago Booth school of business: http://www.chicagobooth.edu/faculty/directory/r/raghuram-g-rajan, and he doesn’t really have any real need to worry about losing his Gov. of RBI job.
He’s so clear as a crystal when he says that the stability is more important when we reduce interest rates. He’s all for reducing it, but he just doesn’t want to do a dance of decrease/increase along with inflation. Unfortunately, that’s the exact item dance number we, the bollywood fed India wants!