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Rajan Makes Happy Almost Everyone by 50 bps cut in Repo Rate , But Senior Citizens Will Be Worst Sufferer in Days to Come
by
Rajesh Goyal
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Surprise Cut of 50 bps: On 29th September 2015, RBI Governor, Raghuram Rajan in a surprise move cut Repo Rate by 50 bps in one go. Thus, in totality in last 9 months (since 1st January 2015), there has been a massive cut of 125 bps in Repo Rate.
Why This Cut? Rajan has hoped that "investment is likely to respond more strongly if there is more certainty about the extent of monetary stimulus in pipeline, even if transmission is slow." Thus, he seems to have preferred frontloading the rate cut on the hopes that CPI inflation will be within 5 % by March 2017 and merely 4% percent by March 2018.
Response To This cut of 50 bps The latest move has triggered all-round praise for Mr Rajan across the corporate sector, young generation, stock market etc etc. There is a sense of happiness across the economy. Instead of taking the baby steps, Raghu seems to have gathered the courage to be bold enough to cut down the rate by 50 basis points, instead of 25 basis points.
Impact of This Rate Cut For last few months, Mr Rajan has been bearing the brunt of the criticism for holding his guns for not cutting the Repo Rate till the inflation issue is under control. Now with this single stroke he has passed the ball back to Finance Minister Arun Jaitley to do his part, and now corporate / industry big-wigs will not be able to call him a growth-spoiler any more. The real question which arises is its likely impact on Indian economy, banks and common man. Will this cut translates into growth of the economy, strengthening of the banks and help the common man. Undoubtedly, there are many doubts about the implications this move will have. (a) We know interest costs constitute only a small proportion of the total costs of production of manufactured goods, as will be vouched by any one who is well conversant with financial analysis. Thus, it is likely that it will have positive impact on the corporate profits and can lead to higher demands and growth provided corporate cut the prices of the manufactured goods. We hope with the Government is also in a mood to help the manufacturing sector. If things go this way, this repo rate cut will show its positive impact and Indian economy and GDP will see upward trend.
(b) This front loading of rate cut can even backfire if the inflation again raises its head. In such a situation, Mr Rajan may have to hastily reverse his decision and Repo Rate may be again raised. However, at present this possibility of reversal of trend is minimal.
(c) One of the sectors which has been vigorously demanding a rate cut has been the Real Estate sector. Having made thousands of crores in the boom period of first decade of this century, they have been stung by the massive pile of inventories of flats. In view of rising NPAs in this sector, banks are now not ready to give them big ticket loans, and they wanted to have circuitous route where Aam Adami will raise Housing Loan and pay them. However, my personal experience and observations do not give me confidence as:-
a. Majority of the real estate builders are in the habit of making big profits by violating all sorts of the norms. b. Inspite of the regular payments by the customers, builders do not complete the projects in time thereby putting the actual buyers (not investors or black money investors) to lot of loss and inconvenience. Some of the common methods these days adopted by these builders to cheat include i. Increase in the FAR area even after they have sold the majority of the inventory. Thus, customers are left with crowded complexes; ii. By tweaking the terms like carpet area, super areas etc. they increase the area of the same flats on paper and charge higher amount from the customers; iii. For delayed payment from customers, they usually pay Rs 5/- per sq ft as penalty, which is approximately 2% interest, whereas any delays on the part of the customers, they charge upto 24% interest, inspite of come of the judgements of consumer courts.; They build additional towers in the same complex thereby changing the whole landscape which was envisaged by the buyers at the time of booking the flat
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All these tactics have led to complete mistrust about the builders but in the absence of any other alternative they keep on falling pray to such shark builders. To revive the real estate sector there is need to curb black money and reduce the prices of the houses and transparency in dealings.
Now this sector will be closely watched. RBI Governor has cautioned them a lot but I feel they are not likely to improve, but will concentrate only on higher profits. Thus, hope of revival real sector sector is limited.
(a) Impact on Banks : This rate cut will have mixed impact on banks. The cut on repo rate will make the funds cheaper for banks but such funds are only a small portion of the total funds made available by banks for loans and advances. There is already sufficient liquidity in the system. The sharp drop in Repo Rates have already led to pressure on banks to transfer this benefit to corporate and retail loans like home loans and vehicle loans. Thus, the interest income from loans and advances of banks is likely to see downward trend with immediate effect. Now banks are left with no alternative but the reduce the deposit rates. Banks have to continue to pay higher rate of interest on existing deposits and it will be only on new / renewed deposits that banks will be able to reduce their interest liabilities. Thus, there will be adverse impact on the NII in the coming quarters. With reduced rate of interest on FDs, depositors will be looking for other avenues such as small savings, mutual funds, which may give better yields and which are mor income tax efficient.
Therefore, banks are likely to be under more stress in the days to come.
(b) CPI vs WPI and its Impact on Senior Citizens :
This is only area of concern which most of the analysts have ignored as they are affected by such changes. Therefore, this issue I would like to discuss in depth. Young generation is happy as they feel that the EMIs on their Home Loans / Car Loans / Personal Loans are like to get reduced.
Interestingly, broadly there are two measures of inflation in India: the Wholesale Price Index (WPI) and the Consumer Price Index (CPI). As the name indicates the WPI measures prices at the wholesale level and CPI at the consumer level. The items included in these Indices are different. Some basic commodities are same, but beyond tthis, the number and types of items included in the WPI and CPI basket differ and so does the weights given to these items. Given that the CPI measures retail prices, it is bound to be higher than the WPI, which measures wholesale prices. This has been the case for a long time now and is not a cause for concern as long as both the indices are moving in the same direction.
However, the divergence between movements of CPI and WPI has baffled even the best observers. On the one hand, a drop in WPI builds a case for a rate cut by the central bank, the still high CPI inflation negates this view. Interestingly, the deflation in the WPI does not bother much the central bank. RBI over the years used the WPI as an indicator to set its monetary policy over the years, but decided to shift to CPI in 2014, following the Urjit Committee recommendations. RBI now believes that the CPI is a better reflection of the cost of living and inflation expectations of people. This seems to true, but in reality CPI too fails to show the true state of affairs as far as the aam aadmi’s household budget goes. The annual rate of inflation in August 2015 as measured by wholesale price index and consumer price index continued to diverge. WPI was negative for the tenth straight month while CPI continued to record an increase. Inflation as measured by CPI was 3.66% in August. WPI was -4.95%.
Now let us discuss how senior citizens will be the most affected. In India, only few senior citizens have pensions which are upgraded regularly. Thus, they are major source of income is paltry pension (if they are eligible for the same) and the interest earning on their life long savings. The newly retiree persons and senior citizens whose FDs are maturing in next one or two years will have to get these deposits at rates which may not exceed 8%. With CPI still ranging high, medical costs going up steeply, senior citizens (specially without any pensions) will be really hit hard in the years to come. They are not likely to benefit from lower EMI as they are not eligible for loans at this age. Government seems to be watching interests of the industry across the country but has no plans to insulate the bad effects on the vulnerable senior citizens of India.
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