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.