Rupee gains as zebra stripes at the end of the world

Let’s start with BeyondBrics this week who reported a study released by Lloyds TSB International about global housing prices which places India at the top of the list as far as rise in house prices are concerned. Prices in India grew 284% in the last decade while Russia was second with a 209% price rise.

If anything, this number will seem low if you live in any of the major cities, and one of the three big reasons cited for these high prices is the red tape that plagues land acquisition and permits to build houses.

On a related note, Financial Express had an editorial last week that cited a CMIE study which said that 8 out of the top 20 projects that were shelved last year were due to land acquisition problems.

The Rupee gained by a massive 119 paise today and that was triggered by a draft on GAAR released on thursday that was a lot better than the original version. While you shouldn’t make much out of a one day move, it does point to the direction that fixing underlying problems with the economy and not tinkering with things like NRE interest rates or debt limit are what will solve the current problems.

On the question of the Rupee – Jamal Mecklai talks about a range of 47 – 57 for the Rupee this year.

The Economist has an interesting chart which shows how much of a currency can be bought in a dollar.

Random Roger comments on some articles that spell gloom and doom and makes the small but important point that end of the world has always been a bestseller.

Finally, the question that’s been on your mind all week long – why does a zebra have stripes?

Enjoy your weekend!

Reader Stories: Mr. Chari’s Approach to Managing Money

One of the things that I find most incredible and interesting about blogging is how different people use OneMint, and I’m always keen to hear if someone has anything to say about how they have used the site.

I find that listening to these stories is the best motivation to continue writing, and the range of readers and the way they use OneMint truly amazes me.

Mr. Chari is one such reader who I exchanged emails  a couple of weeks ago, and he shared his approach to manage money, and how he has benefited from the site.

He graciously gave me far more credit than I deserve as is evident by most of his ideas that I never wrote about,  and looking at his detailed emails, I thought they will make a good post as there are some very good takeaways here.

Thank you Mr. Chari for your time, and here are some of his thoughts that he shared with me (edited).

1. I had to invest my father’s money which was quite an amount in tax free bonds, but after your article comparing tax free bond returns to SBI fixed deposit, I found putting the money in cumulative fixed deposits proved to be more profitable he being a senior citizen. As for me who is in 30% bracket, I invested in tax free bonds.
2. Your blog on infrastructure bonds also proved useful in choosing the AMC for investment.

3. I also invest in gold ETFs as well as the scheme by Tanishq where you can invest for 2 years monthly with any fixed amount and book your gold. You can choose any day of the month whereby I track gold rates and book on the day it has fallen.
4. I advise my office to deduct an average sum of income tax monthly. I know that at the end of the year it will fall short because we are given DA every six months being a government employee. So I opened a recurring deposit account of 10,000 per month for one year in bank. I get the interest plus the capital so I save quite an amount. The interest takes care of balance income tax and the principal is partly invested and partly spend for festivals.
5. I also regularly invest in 5 equity, 1 hybrid and 2 debt funds irrespective of the market fluctuations for the last 8 years. I am on a handsome profit.

Whenever DA goes up I try to take one additional SIP in the existing scheme only. I do not get chance to make any additional investment because I am already booked and have no surpluses except for some emergencies. But I do stick to what I have and all of them are deducted through ECS from my bank for long periods so nothing for me to worry.  In 2008 and 2009 I have seen my funds have gone negative to the extent of 66% but I still stuck to my investments due to which I am well off now. I stopped tracking them but invested through SIP’s thinking I am getting more number of units and whenever market goes up it will benefit me. It is a game of patience, that’s all.

6. Till one and a half years ago I was very jittery when investing in direct equity. I have tried retaining good stocks for quite a long time but it is still in a loss. I am more comfortable with MF’s so religiously invest in it. May be I need to develop more confidence at 59.

7. The last is the same as in your recent article on unnecessary purchases. I reward my children and my wife for not doing so. So the reward is proving to be cheaper than the unnecessary purchases. For the kind of salary I get the savings are around 48%.savings being slightly higher because of frugal living and low needs in a small place as Raipur. I know I am not perfect but even at this late stage I am taking up whichever is beneficial. I don’t know how you would react to such small things. These small things are definitely helping my colleagues and students in their life which I believe is more richer.

I felt that these were some great ideas and once again, I’m really thankful to Mr. Chari for sharing his thoughts. I’m really keen to hear comments on this one, so please post any thoughts that you may have!


Introduction to liquid funds

Liquid funds are getting increasingly popular these days because of the high interest rates, safety, and tax advantage that they offer.

Liquid funds invest in treasury bills, government securities, call money, repo and reverse repos and other such instruments that are quite safe in nature and have a short maturity. This means that they are good for parking that part of your money that you would have otherwise put in a bank savings account.

There are a large number of liquid funds available in India and to give you an indication of the returns they have generated in the past few years, I took the returns of 3 funds that were rated high, medium and low for the long term by Value Research.

You can see those returns in this chart.

Sample Liquid Fund Returns in India
Sample Liquid Fund Returns in India

As you can see, last year has been particularly good for liquid funds, and that is beginning to show in the fund inflows as well. ET reports that during the month of May 2012, liquid funds had the largest inflow of funds in any category and got over Rs. 25,000 crores.

Liquid Fund Tax Benefits

Liquid funds are taxed long term capital gains at 10% without indexation and 20% with indexation. The short term capital gains are charged at the marginal tax rate of the investor and the dividend distribution tax is charged at 25% but that’s in the hands of the fund house and not the investor, so the returns that you see in the chart above have taken care of that.

In general, liquid funds do not have exit loads, and the ones that I checked showed this to be true, however I’m not sure that this is true across each and every liquid fund that exists in India.

Liquid Funds versus Savings Account

It used to be that liquid funds were a lot better than savings accounts because their returns were higher than savings account interest rates and they were taxed at a lower rate than the savings account interest income.

While this is still true, two things have reduced their advantage in recent times.

The first one is that savings bank rates have been liberalized and you can get 6% or so in a savings bank account now, and secondly, bank fixed deposits for short periods like 3 months can now give you as much as 8.25%, and you can always move some part of your emergency funds to these short term deposits especially when a lot of these can be opened electronically and don’t have a penalty when you break them.

I feel that liquid funds definitely have a place in your portfolio if you are in the higher tax bracket but you can’t focus too much on it because the absolute difference that you get by investing in a liquid fund versus a savings bank account shouldn’t be a lot. If it is a lot, then you have to ask yourself where else you can invest this money for a longer duration to get better returns.

This post was from the Suggest a Topic page

ICICI Prudential US Equity Bluechip Fund Review

ICICI Prudential has launched a new mutual fund called the ICICI Prudential US Equity Bluechip Fund which will invest in stocks of American companies, and I think this is just the second fund after Motilal Oswal’s NASDAQ 100 ETF that allows Indians to get exposure to US equities using a fund vehicle.

A look at the chart of the Motilal Oswal’s NASDAQ 100 ETF’s performance overlapped with the performance of NASDAQ itself helps drive home a very important point that you must keep in mind before investing in any fund that invests in the American market.

NASDAQ versus Motilal N100
NASDAQ versus Motilal N100

The big thing that you see from this chart is that even though the NASDAQ only grew 7.4%, the index fund based on that grew a whopping 37.8%!

Most of these gains are due to the currency rate movements and Rupee’s depreciation in the recent past has really helped this fund show the kind of returns that it has. Kapil Visht has done an analysis of Motilal Oswal’s NASDAQ fund to show the relationship between Rupee movement and fund performance and that is worth a read as well.

Simply put, if the fund had 100 crores in INR and the USDINR rate is Rs. 50, you can buy USD 2 crore or 20 million dollars worth of shares. But when the same rate moves to 57, and you sell those 20 million dollars worth of shares you get 114 crores in Rupees.  You can use the rupees crores to million dollars calculator that I developed some time ago to see how this works.

This is an important point that you need to consider because it is not quite intuitive how big of a difference these currency rate movements can make, and you might feel that over a longer period they may not make a difference, but at least so far that hasn’t been true, and I think that’s going to continue for some time to come due to the Rupee volatility that we have seen in the past couple of years.

PP commented earlier in the day what would happen if the Rupee were to appreciate which it eventually will and I would say that there is no guarantee that the Rupee will or should appreciate and you can’t take that for granted. For people who remember 39 Rupees to a Dollar, they thought that it would go back to 39 once it hit 45, but it hit 50 instead and I’m sure there were a lot of people who thought this would go back to 45 but look where we are today.

However, if the Rupee were to rebound and American market were to remain flat or go down then you will make losses on your investment.

You can see this simply based on the above example where you have 20 million dollars worth of shares, and instead of selling it now, you hold them for a year when the Rupee rebounds to 45. In this situation your 20 million will just be able to buy 900 million rupees or 90 crore rupees and you will be left with a loss of 10%.

Now, the offer document does say that they are going to try and employ currency hedging but it doesn’t go into a lot of detail so you will have to wait and see what this really means and see how it actually plays out.

Now let’s look at some other aspects of this fund.

ICICI Prudential US Equity Bluechip Fund Is An Actively Managed Fund

This is an active fund and not an index fund, the benchmark is the S&P 500 and the fund will buy stocks only in companies that are listed in NYSE or NASDAQ. In their review of the ICICI Pru US Equity Bluechip Fund, Business Line says that the fund will invest in 20 – 25 stocks and I think that was mentioned at the press conference.

This is not a fund of fund

The good aspect of the fund is that it will invest directly in equities so there won’t be any double fees. There have been some international funds that have been fund of funds so this is also an important thing to keep in mind.

Expense Ratio

The expense ratio that’s mentioned in the fund document is 2.5% and this is pretty high, it remains to be seen whether they actually charge this much but 2.5% is a bit high for any fund.

Open and Close Dates and SIP Amounts

The NFO opened on June 18 2012 and will close on July 2 2012, and the minimum application for NFO is Rs. 5,000 and then for the SIP the minimum amount is Rs. 1,000. Regular readers know however that there is no benefit of investing in the NFO of a mutual fund.


This is an interesting product and and it is good that fund houses are coming up with funds that invest directly in American markets but the expenses seem to be high and it’s a lot better to have a passive index fund that’s low cost than an active fund with higher cost.

In two or three years there will be plenty of funds in this category and then perhaps you will have lower cost options but till then if you wanted to take exposure to the US markets then this is a viable option along with the Motilal Oswal NASDAQ fund.

This post was from the Suggest a Topic page.

Rupee lows, Tax Deductions and Jobs Lessons

The bad news today was the Rupee sliding to another all time low and The Hindu has a small article on the steps that the RBI is taking to halt this slide.

The RBI’s first step though is quite weird and I don’t think it does anything at all. Deepak Shenoy has a detailed post on why this is so.

Bemoneyaware has a great article on Chapter VI A of the Income Tax Act. This act contains the various deductions that you get like the 80C or the 80D deduction, and this is a great article to see all of that in one place.

Fred Wilson talks about the art of important work, of making a ruckus and of inventing the future

BBC has a short article on India unblocking The Pirate Bay.

All Things Digital has this great interview with Larry Ellison and Ed Catmull about the lessons that can be learned from Steve Jobs’s life and what makes this interview so fascinating is that the two of them constantly repeat that you just can’t become like Steve Jobs or just can’t copy him.

This is a great interview.


Finally, The Atlantic has this interesting article on why crowded coffee shops fire up your creativity.

Enjoy your weekend!

Home Loan Basics in India

The topic of home loans has appeared a few times in comments now, and in this post I’ll cover some things that I have learned about home loans over the years.

Home loans are disbursed based on the evaluation of property price

When you approach a bank to give you a loan for a house, they have it assessed through their own appraisers and this is an important criteria in how much loan you can get against the property.

While I’m not familiar with the methodology for this, there are some old apartments and houses whose assessed value is a lot lower than the actual market price so it is impossible to get a loan on them that could actually enable a buyer to buy the property.

Property valuation doesn’t include stamp duty or other charges

When you buy a house you need to pay stamp duty and other registration charges and this can be a big sum in its own right.

These charges include stamp duty, VAT, service tax, and registration charges, and can go as high as 10% of the total cost you have to bear.

It used to be that banks could include stamp duty and registration charges in the property value and then disburse the loan based on that but RBI stopped that practice earlier this year in order to discourage down speculation in real estate.

You can take up to 80% of the house value as a loan

If the house you plan to buy is over Rs. 20 lakhs, then the bank can only give you a maximum of 80% of the value as home loan. This limit goes up to 90% if the house is assessed at less than Rs. 20 lakhs, but I don’t think there are many of those around these days.

This is another measure mandated by the RBI to curb speculation in the real estate market.

Home loan can be on a fixed or floating rate

A fixed interest rate doesn’t change throughout the tenure of the loan, while a floating rate changes with market rates.

In general, fixed rates are slightly higher than floating rates, but most of the loans disbursed today are floating rates and not fixed rates.

Floating rates are different from teaser rates that used to be offered by banks till some time ago.

Teaser rates referred to home loans that banks gave at an initial interest rate that was much lower than what they should have actually been charging. So, they would just charge you 8% in the first year, and then that would go to 9% in the second year, and then climb to 11% from the third year onwards that made a big difference on your EMI.

This was something else that was stopped by RBI in order to stop banks from enticing people into taking loans that they couldn’t afford and get into a US style housing problem.

Current Home Loan Interest Rates

Current home loan interest rates are hovering at about 10.75% and you should expect to pay about this much if you are in the market for a home loan today.

No Prepayment Penalty

In the beginning of your home loan payments – you are paying more of interest than the principal itself so in general it is a good idea to bring down the principal by prepayment as far as possible.

What’s good for you as a borrower is not good for the bank as a lender and to discourage prepayment they used to levy a penalty on any such amounts. Now RBI has asked banks to stop charging prepayment penalties as well, and that’s a good thing for borrowers who can now prepay loan principal if they want to.

Tax Benefit of Home Loans

Home loan repayment has two components – principal and interest, and both of these are treated differently for calculating tax benefits.

The principal part is covered under Section 80C and the interest part is covered under Section 24L.

Briefly, the limit for tax benefit on principal repayment is Rs. 1 lakh under Section 80C and is clubbed with other instruments you may have bought for tax benefit under that section and the limit for interest repayment is Rs. 1,50,000 and that’s not clubbed with anything else. You can read these two posts for more details on the tax aspect of this. (Section 24L and Section 80C)

These are the key things that came to my mind while thinking about home loans in India, and if you want to add or point out something then please do leave a comment!

This post is from the Suggest a Topic page.

Introduction to HUFs

This post is written by Shiv Kukreja

The Hindu Undivided Family (HUF) structure is a very effective way to save tax and a lot of people are eligible to create HUFs but somehow there is very little awareness about it.

I think that’s because most of us don’t know how easy it is to create an HUF. In fact, it is as easy as getting married. I would say it might be difficult for somebody to get married but it is very easy to create an HUF.

An HUF is automatically constituted the moment a person gets married and completes seven pheras around the holy fire and they get married.

That means a Hindu male needs to do nothing to get an HUF created but to get married to a Hindu female. It is one marriage gift that all Hindus get from the government or Hindu Law. It is not necessary to have children to create HUF.

Sikhs, Jains and Buddhists can also create an HUF under the Income Tax Act even though they are not governed by the Hindu law.

What is an HUF?

An HUF is a separate and a distinct tax entity. The income of an HUF can be assessed in the hands of the HUF alone and not in the hands of any of its members. The senior most member of the family who manages the affairs of the family is called the Karta. Minimum two people (at least one male member) are required for the HUF to come into an existence.

A coparcener is a member of the HUF, who by birth acquires an interest in the joint property of the family, whether inherited or otherwise acquired by the family.

Coparceners have a right to claim partition of the HUF. Other members of the family cannot ask for a partition of the HUF and have no right to claim a share in the family property. Coparceners consist of a Karta and his lineal descendants within the following four degrees:

  • 1st Degree: Holder of the ancestral property for the first time – Karta
  • 2nd Degree: Son(s) and Daughter(s) of the Karta
  • 3rd Degree: Grandson(s) of the Karta
  • 4th Degree: Great Grandson(s) of the Karta

A daughter, after her marriage, would remain a coparcener in her father’s HUF and at the same time, can become a member in her husband’s HUF. In the event of the death of the Karta and in the absence of any male member, two females can continue to run the HUF and the senior female can take over as the Karta. A son can create his own HUF while remaining a coparcener in his father’s HUF.

Capital Infusion: Here comes the most difficult part for someone to start the HUF operating – generating capital for the HUF.

One should not contribute his own personal assets or funds into the HUF as any income generated from these assets or from its investment will be clubbed into Individual’s personal income under Section 64 (2) of the Income Tax Act and hence taxed accordingly.

But there is a way out – one can transfer his personal assets or funds into the HUF if the income generated from these assets or from its investment results in a tax free income (like tax free bonds) and hence there is no scope of any tax liability due to clubbing of taxable income.

This tax free income can then be reinvested to earn even taxable income and eventually all of the income would fall out of the clubbing provisions.

Gifts or inheritances meant for the benefit of all the members of a family should be diverted specifically to the HUF. HUFs are liable to pay tax if the value of the gifts taken from the strangers exceeds Rs. 50,000. Though there is a limit for an HUF to take gifts from the strangers, gifts of a higher value can be taken from the relatives, who are not the members of the HUF.

Here is the list of people who fall in the category of relatives:

  • Karta’s Wife
  • Brother(s) or Sister(s) of the Karta
  • Brother-in-law or Sister-in-law of the Karta
  • Immediate Uncle(s) or Aunt(s) of the Karta
  • Immediate Uncle-in-law or Aunt-in-law of the Karta
  • Lineal ascendant or descendent of the Karta or Karta’s wife

A father can also gift money to his son’s HUF but need to specify in the gift deed that the gift has been made to the son’s HUF and not to the son as an individual. Ancestral property can be an asset of the HUF and an income earned on this property can be classified as the income of the HUF. If any of these ancestral properties are sold, the money received on such a sale should be transferred to the HUF.

How to get started with the HUF?

Once there are two eligible family members ready to operate an HUF, the first thing to do is to apply for a PAN card in the name of the HUF and have a separate bank account opened.

For a PAN application, an affidavit by the Karta stating the name, father’s name and address of all the coparceners on the date of the application is considered sufficient as the document proof of identity of the HUF. Also, the identity and address proof of the karta will be treated as the address proof of the HUF.

Then start seeking for gifts or inheritances from relatives or strangers, keep on infusing your own capital, transfer family’s assets/properties to the HUF and do all the possible things that you can keeping in mind the clubbing of income provisions.

Here is a link that contains a sample HUF deed.

Sections/Provisions under which HUFs can claim Deduction/Exemptions and Save Tax

As already mentioned, an HUF is a separate and a distinct tax entity and just like any other Resident Individual assessee, it also enjoys a basic tax exemption of Rs. 2,00,000. All other tax slabs are also exactly same as for an Individual. Here is a useful link from Bemoneyaware that shows the TDS rates for Individuals and HUFs.

Section 80C: HUFs can claim tax exemption under Section 80C by investing money in ELSS, ULIPs, traditional insurance plans, NSC or 5 year Bank FD with a scheduled bank. Principal repayment on a housing loan taken by the HUF can also be claimed under this section. HUFs are not allowed to invest in PPF anymore.

Section 80D: Members of the HUF can take a family floater policy and make the HUF pay for its premium and enjoy the tax benefit too.

Section 80DD: If any dependant member of the HUF is normally disabled (not less than 40% disabled) and the HUF makes an expenditure for the medical treatment, training and rehabilitation of that disabled member, then the HUF can claim a deduction of Rs. 50K under this section. If the condition is of a severe disability (equal to or more than 80%) then the HUF can claim a deduction of Rs. 100,000.

Section 80TTA: Interest earned on the money deposited in the savings bank account up to Rs. 10,000 p.a. is exempt for an HUF also.

Section 24 (b): Interest on Housing Loan: If an HUF takes a loan for buying out a residential property, it can claim a deduction of Rs. 150,000 in respect of Interest on Housing Loan.

30% Standard Deduction on a Rented Property: An HUF can claim a standard deduction of 30% from the rental income it earns by letting out a property.

Capital Gains on a House Property: Tax on Capital Gains made by selling a house property can be saved if the HUF invests the proceeds into buying another property within two years from the sale of the said property. The money can also be invested in Capital Gain bonds offered by REC and NHAI with a lock-in period of 3 years. The interest income on these bonds would be considered a taxable income of the HUF.

The table below shows how the income of an individual in the 30% tax bracket can be split between two entities to lower the final tax outgo:

Introduction to HUF
Introduction to HUF

Some Other Important Points

  • Karta can be paid a reasonable salary for his services of managing day to day affairs of the HUF. The salary will be considered his personal income but at the same time it is deductible as an expense from the books of the HUF.
  • Only one member or coparcener cannot form an HUF. There have to be at least two members and at least one male member.
  • HUF can keep its normal functioning even with two females after the death of its sole male member.
  • The Hindu Succession (Amendment) Act 2005 has given equal rights to male and female in the matters of inheritance as a result of which a daughter now also acquires the status of a coparcener.
  • An HUF cannot become partner in a firm but a Karta can.

These were some important aspects when it comes to creating an HUF and everyone, who is eligible to create an HUF and pays taxes, should strongly consider this option as it is a very efficient and good way to save tax.

India’s $10 billion pledge to IMF: Facts and Fiction

It’s not often that I discover breaking news through my Facebook feed, but that happened today with the news of India’s $10 billion pledge to IMF going viral and people taking some pretty extreme positions in the comments to each other’s posts.

The press release from IMF about this is fairly detailed and let me present two quotes from Ms. Lagarde  that I think are the most important to consider when you’re trying to figure out what to make of this news.

Here is the first quote (emphasis mine):

“We warmly welcome pledges by our members to increase IMF resources by over $430 billion, almost doubling our lending capacity. This signals the strong resolve of the international community to secure global financial stability and put the world economic recovery on a sounder footing. These resources are being made available for crisis prevention and resolution and to meet the potential financing needs of all IMF members. They will be drawn only if they are needed, and if drawn, will be refunded with interest.

So, you see, the impression that some people have got (and I was part of this group initially) that India is just giving away $10 billion is wrong. It is an interest bearing loan, and is not a donation at all.

I think the problem is that most newspapers reported this as “aid” and that word usually connotes some kind of donation or charity, but as you can see this is not aid in the same sense that most people think about it. You don’t expect to be paid back with interest if you donate money to charity.

Now, to the second quote (emphasis mine).

“These resources are being made available for crisis prevention and resolution and to meet the potential financing needs of all IMF members. They will be drawn only if they are needed as a second line of defense after resources already available from quota and the existing New Arrangements to Borrow are substantially used. If drawn, they will be repaid with interest. The IMF is committed to assuring our members’ interests and resources are safeguarded.”

This means that they have to first use up money from the quota and something called the “New Arrangement to Borrow” and only then can they go to this additional funding.

India is part of the quota but is it part of the new arrangement to borrow? Those details are present in this page, and you will be surprised to learn that India’s name figures there and the number is not small either at $8.74 billion. If you’re worried about the $10 billion, you should be more worried about this $8.74 billion because this will get used up prior to the 10 billion.

I think looking at these two quotes help a great deal in getting a clear picture on the announcement that’s made today.

Almost 3 years ago, Dr. Manmohan Singh had said that India is ready to contribute to IMF based on its quota (I had blogged about it then) and this is an extension of that to the extent that India wants to have a greater say in the workings of the IMF along with other emerging economies and these type of steps will help it get that larger say. India’s current voting right is 2.34% and that’s up from the 1.89% that it had 3 years ago.

It is also notable that India is not alone in pledging this money, and here is a chart that shows other countries who have pledged as much or more than India in order to boost IMF’s resources. (Data Source)

Countries that have pledged USD 10 billion or more to IMF
Countries that have pledged USD 10 billion or more to IMF

India was lucky to get IMF support in 1991, not only because of the money that came from IMF but also because of the conditions that came with it as they truly helped usher in the first round of liberalization, and the present generation owes their higher standard of living in a large part to that first wave of liberalization.

It’s only natural then that India plays its part to support the IMF today when the world is even more inter-connected, especially when it is in the form of loans that will eventually be repaid along with interest.

Fitch Lowers India’s Outlook to Negative

S&P lowered India’s credit rating outlook to negative back in April, and now Fitch has also come out and done that. Everything that was said during S&P’s statement has been repeated now, and while nothing new, they serve as a reminder of all the things that are going downhill currently.

Fitch did mention some positives as well, and here are the positives and negatives from the Fitch release.


  • High domestic savings which lower the need to borrow from abroad.
  • The government is able to issue debt on a relatively low cost in INR which means it doesn’t need to borrow in a foreign currency and worry about a sovereign default.
  • Net external debt is low and the forex reserves provide a cushion against any external shock.
  • A big pool of educated workforce and innovative private services sector.


  • High central government deficit
  • Slow growth and high inflation
  • Corruption
  • Inadequate reforms
  • Forex reserves have fallen 11% since August 2011
  • Government debt stood at 66% of GDP whereas BBB median was 39%

The government reaction has been quite different from what it was to the S&P announcement, this time they say that Fitch has ignored the latest data. How they react to the announcement however is fairly irrelevant, what they do to improve the situation is important, and in any case Fitch hasn’t said anything with respect to government action that the RBI hasn’t said already (except of course corruption) and all this has been repeated endless times already.

It is quite likely that the rating itself will be lowered by both S&P and Fitch in the next year if things go on this trajectory and nothing is done on the policy front.


Thoughts on RBI’s Mid Quarter Monetary Policy Review

RBI surprised a lot of people by keeping the Repo rate unchanged, and after the terribly slow GDP growth last quarter I thought the central bank will decrease the rates to help boost the economy. But they didn’t do that and judging the by the reaction of markets and industry players, this was a big disappointment for everyone.

The thing about market reaction though is that it is such a fickle and short term thing that you can’t rely on it for anything, so the market going down because RBI not cutting rates doesn’t mean anything at all.

In fact if you recall what happened three months ago in April, you will see that the RBI then surprised everyone by reducing the rates by 50 bps whereas everyone expected them to only reduce by 25 bps and to that extent – what’s the big deal if they keep the rate unchanged now?

Repo Rate Apr 09 to Jun 12
Repo Rate Apr 09 to Jun 12

Getting to the review statement itself, it is quite interesting and strong worded (like the last time) and is a clear signal to the government that the RBI has done its part but the government needs to do its part as well if there is any hope of the revival of the economy.
Last time, they mentioned the current account deficit very specifically and called it unsustainable, and this time too they referred to the current account deficit and honed in on the oil subsidy part of it. Here is the relevant excerpt.

Also, in the absence of pass-through from international crude oil prices to domestic prices, the consumption of petroleum products remains strong distorting price signals and preventing the much needed adjustment in aggregate demand. The consequent subsidy burden on the Government is crowding out public investment at a time when reviving investment, both public and private, is a critical imperative. The widening current account deficit (CAD), despite the slowdown in growth, is symptomatic of demand-supply imbalances and a pointer to the urgent need to resolve the supply bottlenecks.

What this means is that since people don’t pay market prices for oil products, especially diesel, the demand for these products don’t come down when the international price goes up. The demand doesn’t go down because the domestic prices are kept the same using government subsidies and this means that the government runs a bigger deficit than they would have if they had allowed the market to determine prices. When they run larger deficits, they have to finance those deficits by borrowing in the market, and that increases interest rates and doesn’t leave room for private players to borrow.

Here are three other notable things from the statement.

Role of interest rates in slowing growth is relatively small

They emphasize that while high interest rates may be affecting growth, they are a small part of the equation and other factors such as fiscal consolidation by the government and helping ease the supply bottlenecks are much bigger factors than interest rates.

Rupee depreciation to help exporters

An interesting thing in the statement and I think this is the first that anyone has talked about it in this context is that the Rupee depreciation will make exporters competitive and this should help exporters grow and boost GDP in the time to come. I think this implies that they expect the Rupee to be in the current range for some time to come, and don’t think it’s going below 50 any time soon. This is just my guess though.

Inflation is still high

They talk about both the WPI and CPI and how it indicates that though inflation is not at the scary levels we saw in 2011, there is no definite downtrend and lowering rates risks letting inflation go up even more in the future.

Recurring Themes

Inflation, and especially inflation led by protein rich foods which is a sort of a structural change has figured in RBI statements time and again, and they’ve emphasized that unless you take care of the supply side using policy measures you can’t bring this under control just by tinkering with rates.

They talked about this yet again, but nothing has been done on the policy front to address this.

The concern about current account deficit has also been voiced earlier and the specific focus on oil subsidies shows that that’s an area of concern as well and since diesel prices are a big contributor to those subsidies, something needs to be done in that regard.

I’m obviously not knowledgeable enough to say whether RBI’s decision is good or bad, but I’m fairly certain that you can’t get back to the earlier growth trajectory just by lowering interest rates.

You need action on multiple fronts and good domestic economic policies that are the domain of the government to get back to those days.