Ban on 0% EMIs demystified

The RBI has banned 0% EMIs for purchase of consumer durables. 

So what is the reason? This is what the RBI said:

“...in principle, banks should not resort to any practice that would distort the interest rate structure of a product as this vitiates the transparency in pricing mechanism which is very important for the customer to take informed decision,” 

It continues:

The very concept of zero per cent interest is non-existent and fair practice demands that the processing charge and interest charged should be kept uniform product or segment wise, irrespective of the sourcing channel, as such schemes only serve the purpose of exploiting vulnerable customers.

Yes, it is a well-intention, consumer welfare increasing step. Kudos to the RBI. (Not) Everybody knows that there is a hidden cost behind the seductive offer called 0% EMIs. Normally, banks pass interest costs of the purchase amount to the consumer.

But is this the only reason? Well, seems hard to believe! We would get a clear answer if we ask why firms offer 0% EMIs. Firms use various strategies to boost consumer purchase. In a slowdown like this, (not all) firms use 0% EMIs as an aggressive strategy to increase their sales. Hence, it seems that the proper reason of this ban is to reduce sales and thus, inflation. Well, to what extent inflation would decline depends upon it weight on the WPI basket. The weight of consumer durables is 5.8%. The Economic Survey 2012-13 (see figure 4.6, page 86) shows consumer durables inflation is falling from around 11% since August 2011 to around 5.5% as of December 2012. But it is still well above RBI’s preferred zone. It is reported that there is a 34% jump in bank loans for buying consumer durables between July 2012 and July 2013.

Sales of consumer durables also depend upon interest rate and it is highly interset sensitive. So the elevated interest rates helped reduction in consumer durables inflation. May be RBI expected it to decline further and faster. Hence, this ban. This to me appears as a fight against inflation. Well, i mean by this ban RBI tries to reduce debt-financed consumption. Remember that RBI has been fire-fighting to reduce inflation since March 2010. Yet, the success is far is limited. So, this is another instrument used by RBI to bring down inflation.

So what will be the impact?

Durables sales will fall. By how much? We can’t say unless we have data about the share of 0% EMIs sales in total sales. The causalities would be cell phones industry and auto industry.

Was Rajan Unpredictable? A comment on Rajan’s maiden monetary policy statement (MPS)

Finally, the wait is over. So also all the euphoria surrounding Rajan’s first monetary policy statement (MPS). Within two minutes of his speech, the exhalation evaporated. So what sin he committed? To anchor inflationary pressures he has raised the repo rate by 25 basis points. That implies he’s there to kill inflation, defend rupee. In a way he has impeccably taken forward the baton of fighting inflation from his predecessor. Since he has expressed concern for inflation these policy measures should not be a surprise at all! His policies imply that he is serious to raise domestic household saving, thus reducing investment on unproductive yellow metal and he shares the same pain (which poor people bear and in one of his speech Subbarao declared that he is there to represent poor people’s unspoken demands) that his predecessor felt. Rajan may be the new Paul Volcker.

Couple of things stand out from his speech are:

v  His decision to raise the repo rate by 25 basis points is based on high inflation and low household financial saving. Thus, he emphasised the later point warranties an increase in the repo rate.

v  He told the repo rate hike affects only 0.5 per cent of the entire borrowing of the banking system. Stated otherwise, it is not going constraint credit supply and liquidity. This is a very important point which has been missed in the debate and discussion on monetary policy since Governor Subbarao was habituated with rising interest rates.

v  At present interest rate is not consistent with inflation, and also inflationary expectations and suppressed inflation stemming from depreciation.

v  He was unmoved by the Fed’s decision to hold taper off. The justification he offered is that sooner than later the Fed will resume bond purchases. Once it does rupee would feel the pressure again. And suppressed inflation would unfold. Thus, it is better to be prepared by bringing down inflation till then.

v  Finally, he argued that these measures (reducing MSF rate by 75bps, raising the repo rate by 25bps to 7.50% and partial roll back of daily CRR (Cash Reserve Ratio) balances maintained by banks with the RBI from 99 percent to 95 percent) will reduce the cost of bank financing substantially while allowing us to take an appropriately precautionary stance on inflation. In his words, “we must use this time to create a bullet proof national balance sheet and growth agenda, which creates confidence in citizens and investors alike.” It is true that cost will marginally reduce since the MSF has been reduced marginally. It is also true that liquidity will also ease and credit supply would rise.

But the question is: is this enough? It seems the economy is heading towards a long winter. By drastically reducing rates now it should have revived the economy. We must remember that reduced inflation not only resulted from elevated interest rates since 2010 but also significantly from the downturn as it compressed purchasing power.

So, where did the RBI go wrong?

Core inflation is falling. As of July 2013 core inflation excluding food and fuel was 2.8% while WPI headline inflation was 5.8%. Surely CPI is much higher. Both WPI and CPI are above RBI’s comfort zone. The fact that core inflation has reduced implies that demand pressure has also dampened. It is also corroborated by falling manufacturing investment data. RBI is now eying to bring down headline inflation, especially CPI inflation.

He falls in to the trap of Subbarao’s “25 basis points doctrine”. Subbarao was much criticised for his baby-step approach to tame inflation by hiking repo rate marginally every time. It was not enough to kill inflationary expectation. This is why both inflation and inflationary expectation stay high, though responding to RBI’s call lately; with a lag of after 36 months. Given this “very slow” decline in inflation, when will inflation come to below 5%? It may take another 18-24 months, given coming state and general elections. How much cost it has inflicted to the economy?

The growth rate of money supply (M1) has fallen from 18.23% in 2009-10 to 5.85% in 2011-12. Such a drastic reduction in money supply is surely a perfect recipe for an economic disaster. The question is how long he will fight inflation and when will he ease increase rates.

Once inflation reduces to RBI’s tolerable limit, RBI will ease interest rates. Taking account of this fact, and given that very large lag of monetary policy transmission, economy is expected to remain sluggish for next 2 and half years.

Rajan said “the repo rate hike affects 0.5 per cent of the entire borrowing of the banking system”. That means he says repo rate hike does not matter much since it does not constrain credit supply and liquidity much. If he is saying that raising interest repo rate only affects less than 1% of the entire borrowing of the banking system, then why is he hiking interest rate. Anyway it won’t matter much. That means transmission policy is very weak.

Media has already reduced his status from rockstar to rock. Surely, Rajan will not be unfazed by this. But one hopes that he will be unfazed by the coming prolonged slowdown resulting from RBI’s inflation madness. Only time will tell to what extent he will be able to reduce supply-constrained inflation and at what cost.

Why we should have grade inflation data?*

Think of this. You are a HR manager of a reputed company. You want to hire 5 candidates. But you have received 200 applications with their vitas. How would you select? Well, you might conduct a written test and PI or GDPI. But you don’t have time either to check 200 answer sheets (even if it is MCQs) or you do not have patience to conduct interview to all applicants.

In that case it would be prudent to first shortlist a handful of applicants and then conduct written test and PI or GDPI. Again, the question comes: how would you shortlist. On the basis of marks obtained throughout the career? Not a good idea. Why? Of course there are other ways that those HR managers know better than me. Here i will say why career marks are not a good indicator of talent.

Consider this. It may happen that in some places marking/grading is very tight and in some places it is liberal. Students in the liberal region will consistently secure good marks compared to students in the tight region. It does not imply that students in the tight region are bad. Then in that case, it may difficult to shortlist for a vacancy. That is why it is important to create a database of grade inflation. It is available for the US. Through this WE CAN PREPARE A REAL GRADE DATA.

There are other ways to select a candidate.

v  Job-specific qualification and experience

v  Look at her extra-curricular activities, leadership qualities and team learning

v  Flexibility, that is how has been her assignments changing

v  Work Ex

v  How frequently that she has been changing companies, or durability in the job

v  Previous salary

v  Awards and achievements in her academic career and working career

v  Past character reports

So judging on these parameters rather than depending on mindlessly on marks selects the best candidates. What do you think?

*Actually, this is a discussion between a MBA student and me. He asked me how i should select candidates from their vitas. He also mentioned lot of parameters mentioned above. Then, i realized we should prepare a grade inflation data base.

Update
One reason why might have grade inflation is this.
Suppose the examiner has to evaluate 100 papers. She would evaluate properly; implying a student gets marks correctly. No gain no loss for the student. Marks worth effort. Now suppose the examiner has to evaluate 500 papers. She might not give the sufficient time that a proper evaluation of an answer script requires. So, not to get any complains from students she would try to please all students by giving more than what they deserve. As a result the we may see grade inflation. This is also same for TAs.

Why Politicians do big scams?

Why do we see politicians when caught in scams and scandals involve big sums? I have found 4 reasons. If you have any you can suggest.

They consider election expense as an investment. Some borrow (from their own species) to finance election expense and some are sponsored by businessman; some spend from their own wallet.

1.      Since election expense is an investment, they must get inflation- and risk-adjusted return.

2.      Further, they have to make money for the coming election.

3.      Once they are involved in illegal practices, this incentivises them to go for big scams and and (Indian) law encourages it. After all, the punishment is same! You plunder 100 crores or 1 crores, the law treats you the (roughly) same. This is the Principle of Equality! What a fucking joke?

4.      Then, when one politician is involved s/he tries to allocate risk. That is, s/he will try to bring others (big politicians and A-Class officers) in the scam.

Next time when you find a politician is caught red-handed think of these reasons mentioned above.

Update:
After watching the Hindi movie "Andolan", i have to add this point also.

In theses times of coalition politics, politicians are unsure  of whether the Coalition government will survive for the next 5 years. So they charge a hefty risk-premium, that is, to engage themleves directly or indirectly in looting the country.