Should Interest Rates in India go down to Zero

I am not much a fan of Macro Economic Analysis and yet Macro fascinates me more than a lot of equity factors do. Understanding Macro to me is a way to design models that can benefit from the broader philosophy to understand and implement at the micro level.

I have had some fascinating discussions revolving interest rates  in the past and my view was that India with no social safety net could not afford negative interest rates. When I say negative, I mean less than Inflation and not the negative we see in Europe or Japan currently.

There was some bias given that most of my father’s money sits safely in a fixed deposit allowing him to lead a comfortable life without the need to take risks. Why should he take such risks at his age. That reasoning remains but I think that he is a small minority vs the large majority who cannot afford such luxuries.

On one hand, I doubt India can have the kind of safety net that the West has been used to – Quality Public Healthcare, Quality Public Education, unemployment benefits among others. That requires the kind of money that we don’t have and may not have for the forthcoming future.

India is capital starved. Ask any Entrepreneur and he shall say his biggest worry is access to capital that doesn’t require a hand and a foot to be exchanged. While RBI reserve rates are in single digits for a long time, in the real world, the cheapest finance you can get is 13 to 15% for personal loans and 18% at to an atrociously high 60% in the private markets depending on your urgency and credit assessment by the lender (and let me not even go to the Daily Interest Loans where you just don’t want to annualize the same).

The high level of interest is a boon to the middle class and above while a curse to those who don’t have enough capital. The high interest rates has meant that if you are comfortable, you are better off working for someone than starting a business and providing jobs for others.

While in India, there is a certain stigma attached to failure, the cost of failing in a business can many a time end up with losing everything one owns including one’s home. Not an acceptable cost.

If you were to look at Budget 2020, the biggest share of the pie in terms of expenses for the Government of India is Interest. This takes away 18% of the total income and is a bit less than the total sum the government spends on Subsidies and Central Sector Schemes. 

A low interest rate is beneficial for Industry and enables Job creation. In the new world we face post Corona, Jobs will be harder to get given that a lot of business will be stressed and saving it will require firing employees rather than adding more.

Cutting down on Interest Rates would allow the government to save a bundle. This can come at a cost of FII’s not wishing to invest in Government Treasuries. But even today, Foreigners hold just 3.7 per cent of the almost Rs 60 trillion ($835 billion) of sovereign bonds issued by India, and the government has set a 6 percent limit on foreign ownership. Once this crisis started, FIIs have gone out in droves even though the interest rate differential is now even larger.

Borrowing by Private Companies tends to get shadowed over by Borrowings by the Government. This means that other than the bluest of the blue chips, the cost of capital for even mid and small sized firms are nowhere close to where they should be. They are not Junk and yet treated as Junk.

With no Junk or Distressed Bond markets, small businesses are forced to accept the high interest rates of the Bank – why are they high – well, because the bank’s inefficiencies can be easily passed along to borrowers who aren’t easily welcomed elsewhere.

The coronavirus impact is not going away the moment a vaccine is in the cards. When it comes to trade, I strongly believe that there is going to be large scale reorganization and a fresh look by the West at outsourcing as a whole. Unless the government wishes the next generation to be a Ninja, we need radical steps that deviate from the past.

 As I was writing this, a new podcast came out. Is worth hearing to understand how logic in Monetary Policies have been turned on its head by the US, Europe and Japan. 

James Montier on Fear and Investment

Financial Repression seems like a negative word, but the time I think has come to accept the same for a better future for the majority who don’t have idle savings that can help them cruise through life.

I could be very very wrong. Would love to know and learn. Please do share your views either in the comments section here or the #fixed-income channel on Slack.