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Opinion

Shrinking FD Rates, Expensive Loans and Where to Invest Instead

Podcast-FDs.jpg

 

In this episode, Shray and Deepak discuss the evaporating returns from safe investments such as FDs, what it means for lending, and how should you invest in this new (to India) low interest-rate world.

Show Notes

The issue with safe investments

  • Worldwide Central Banks Instead, they are telling people to go to risky assets, perhaps stocks, perhaps real estate, perhaps anything, run on a business, but use that and that will improve the economy. This has its merits. 
  • The RBI has traditionally been very hawkish….But now they’ve said ‘Listen, whatever happens prices may go up a little bit. I don’t care. I will try to build growth because growth is suffering and suffering a lot because of what is happening with COVID and other reasons. 

Use FDS to Generate Cash and not as an Investment but even then you have some better options

  • But it’s easier to generate cash by doing a Pradhan Mantri Vaya Vandana Yojana, which is PMVVY, operated through LIC. It gives you roughly 7.6% annually. 
  • Senior Citizen Savings scheme operated through the public sector banks, you have, again, 15 lakhs per person, for two people it is 30, only available to senior citizens, 7.4% roughly is the interest rate. 
  • But the RBI floating rate bonds pay 7.15%, floating in the sense they float along with the National Savings Certificate rate, which is 6.8%. You get that plus 35. 

Loans Don’t Reflect this lower interest rate

  • I said, ‘Are you out of your mind?’. Your interests on deposits are down to 4.5%. And you’re charging me 16% for an asset- backed loan. She’s like, ‘okay, that’s what we have. We will cut it down to 15%.

Lack of Competition and Barriers to lower loan rates

  • India needs a better system. We’ve got UPI, we’ve got centralised banking. Why don’t we have centralised collateral?

Ideas for Investing

  • [especially in this environment] it may be useful to park money into risky assets – either a business you run or stocks
  • Find debt that is currently priced at a very rich level. Now, at some point the government debt itself because the government is paying 3% for a 6-month loan but 6.5% percent for a 30-year loan. 

Links


Full Transcript

Shray: Hi everyone, and welcome to Episode 34 of the Capitalmind podcast. First up, apologies, we’re really sorry for the long delay between episodes. But we’ve had a crazy few months. I came down with COVID. And mercifully, it wasn’t too bad. And in between, we looked at the stock markets every now and then. And they seem to have decided that gravity doesn’t exist anymore.

So that’s been keeping us busy as well. So now as we start 2021, we’re aiming to put all this craziness behind us to the extent we can and for us to be more regular and systematic with these podcasts. So, we’re aiming for twice a month. And let’s hope that works out. 

Now, we have a topic today, that’s honestly been the subject of armchair debates and discussions for probably decades now. 

On one hand, you have people who are interested in the safety and predictability of fixed deposits and swear by them. On the other hand, you have the others who talk about the higher returns and tax efficiency of stocks, mutual funds, and the like. And they swear by that. And often there’s really nothing to bridge the gap between these folks. 

But as we start 2021, I feel the armchair debate has taken on a real tenor and, and suddenly, the stakes are much higher. Because as we look at our inflation, and we look at our interest rates, things don’t look so rosy anymore when it comes to fixed deposits. And Deepak, you mentioned in the past that fixed deposits are the biggest, or one of the biggest financial assets in India, right? I thought, this is probably what we should tackle today. So Deepak, welcome.

Deepak: Thanks, Shray. It’s good to start the podcast again. It’s exciting to be here at the end of 2020.

Shray: Yeah, absolutely. Deepak, I’ll start with this excerpt from Raghuram Rajan from his January 2016 ‘Walk the Talk’ interview at Davos. I think this was the start of all that dosa economics thing, but we won’t go down that path. But here’s what he said, ‘Look, earlier you used to get some 9% interest on your fixed deposit whenever this earlier was, but inflation was like 10, or 11%. So honestly, you weren’t doing all that well.

Then in January 2016, he said, ‘Look, now you get only 5.5% on your fixed deposit. But inflation is 4% or something like that. So, you’re actually in a much better place, because you’re making some real interest, some real return on your money, and you should be happier. Even though you’re only optically poorer, you’re actually doing better. Well, now, we have this great article by our analyst Krishna out and we’ll link to it later.

The fixed deposits aren’t really returning all that much. It’s like sub 5%. And when you look at inflation, it seems to be 5% or higher. I mean, this seems to be a problem, right? I mean, how have we gone from having the interest rates working in the right direction, to suddenly things not being so happy anymore?

Deepak: You know, Shray, this is a problem that not just people in India are facing but we are seeing all over the world, is that the governments and the central banks of the day have changed their track. They’ve actually gone down to the level of saying, ‘we don’t think that you can get a lot of money from relatively low-risk instruments. So, you give the government money, which is the safest form of investing your money, by buying a government bond. But we are going to make that as unattractive as possible. 

A single reason for that is when you’ve had a recession of the kind you saw in 2008-2009, or perhaps what you’re seeing with COVID today. The issue is that there’s not enough risk taking and everybody’s cowering in fear, and they want to go to the least risk asset possible. 

So worldwide, the central banks and the governments, together, have decided that they want to give you as low-risk, low-incentive to be risk free as possible. In the West, that means going to zero rates, perhaps negative interest rates, that reflects into things like well, government bonds yielding almost nothing, and European banks charging their customers to keep their money in the bank. 

Instead, they are telling people to go to risky assets, perhaps stocks, perhaps real estate, perhaps anything, run on a business, but use that and that will improve the economy. This has its merits. 

In India, a similar function has started to appear in the sense the RBI has printed a lot of money. The RBI has traditionally been very hawkish. They’ve said, ‘Listen, we’re afraid of inflation. We’re afraid of prices going up’. But now they’ve said ‘Listen, whatever happens prices may go up a little bit. I don’t care. I will try to build growth because growth is suffering and suffering a lot because of what is happening with COVID and other reasons. So, I would rather keep interest rates and prices low.’ 

The interest rates have gone down so much, it’s now at 3.5-4%. But because they’ve made money so easily available in the banking system, banks have said, ‘we’ve cut our rate, we don’t really want your money, we don’t have any great avenues to deploy them at higher rates. So, we’ll reduce our deposit rates and reduce the FD rates.’ 

Inflation remains relatively high because of food but take food away and inflation is still around the 4.5% range. What we are getting now is a much lower rate because governments are trying to push people into riskier assets. And India’s kind of falling into the same kind of curve.

Shray: Well, you know, earlier, the fights between these two groups used to be that the stock market folks and the “sophisticated” investors would fight with the FD types. Now what you’re basically saying, at some level, I know this is a bit of an exaggeration, is everyone is out to get your fixed deposit, particularly wants you to keep it and they’re making it as unattractive as possible.

Deepak: Yes. That said, you have people, who are simply unable to get credit on one side and you have people who are giving credit at these ridiculously low rates, as in the have-nots, the bridge between them has gone to some crazy level. 

Shray: Yeah, well, I think it’s a little more nuanced than that, as you just said, because just as we were sitting to record this, it flashed on the screen, that EPF is going to be at 8.5% for this financial year. In an environment of 5% inflation, that seems astonishingly good, right?

Additionally, you’ve yourself mentioned that instruments like PMVVY and so on are still looking respectable? What’s the deal here? I mean, my FDs are not looking all that great. What do I do now? I mean, who is the government still looking out for in this situation?

Deepak: This is interesting from two perspectives. Where you are now and where you are going to be in the future. Now, anybody who is looking to put some amount of money aside for their parents or if you are retiring yourself, you are going to need a certain amount of money to survive. 

I don’t want to eat out of the money I already have, let it earn that interest. To a large extent, a set of people like a salary. So, we want our money to pay as a salary every month in a way that salary should just take care of the expenses that we have. 

Let’s say your expenses of Rs. 50,000 a month. And if you put in something in a fixed deposit, if that’s what your view was, you’ll get enough to make that 50,000 a month. 

Today, because interest rates have fallen to 4.5-5% on an FD, you’re sitting there saying ‘Listen, if I do 5% on an FD, I will have to put 1.1 crores or something into an FD, to make that Rs. 50,000 a month. 

This is where I say, ‘Listen, there are better avenues as safe or perhaps even safer than FDs that give a higher return’. There are reasons why, but I’ll come to that. But we’ve talked about this in an older post. We’ve said, ‘Listen, do a Pradhan Mantri Vaya Vandana Yojana, which is PMVVY, operated through LIC. It gives you roughly 7.6% annually. 

But it’s limited to, I think, 15 lakhs per person. If you have both your parents are seniors, it applies only to senior citizens. They both get 15 lakh limits, so you can get 30 lakhs into it.  30 lakhs at 7.5% is roughly about 2.2-2.3 lakhs per year, which is roughly Rs. 20,000. So that’s like almost saying the government guarantees you 7.5% and about those rates. Then there’s something called a Senior Citizen Savings scheme operated through the public sector banks, you have, again, 15 lakhs per person, for two people it is 30, only available to senior citizens, 7.4% roughly is the interest rate. 

So here again, you’ve got a semi-government or quasi-government guarantee to the whole thing and you get 7.4% interest. All this is taxable. So, what I’m trying to tell you here also from a tax perspective, but you don’t actually have tax when your only income is up to five lakhs. So, you don’t have to pay any tax. 

Shray: And that’s per person as well. Right? 

Deepak: Yeah. So, if you’re if your parents are spending a lakh a month, you could generate 12 lakhs of income for them, six lakhs per person, without having to deal with any taxation, whatsoever.

Shray: Yeah, because you also get some exemptions and stuff like that. 

Deepak: Some exemptions on fixed deposit, savings bank interest and so on. There’s a bunch of exemptions you can avail, i.e about 6-6.5 lakhs per year is not taxed at all, per person. So, effectively, it means, one lakh a month, for a family of two above 60, is not taxed at all.

So, the highest return you can get in a cash flow instrument; when I say, a cash flow instrument, say like a stock, you know if I invest in a stock, even if it goes up 10% there’s no cash flow until I sell it.

A fixed deposit is a cash flow instrument i.e. whether I like it or not, it is going to pay me that money. The same thing with this PMVVY and SCS; they pay you cash flow whether you like them or not like. You’ve got to pay tax on it, whether you like it or not. 

According to me, you compartmentalise, i.e. save your first 30 lakhs or 15, however the number of people there are above 60. The next 15 or 30 lakhs should go into Senior Citizen Savings scheme. And now we come to what happens after. 

I’m not going to compromise on safety. I want it to be as safe as possible. What’s the next best return I can get for the highest safety available. And there is an RBI bond, an RBI floating rate bond you can only buy this from banks, unfortunately. I wish there were an online site. They create these fantastic products and then you must go to banks to buy them which is such a mess. 

But the RBI floating rate bonds pay 7.15%, floating in the sense they float along with the National Savings Certificate rate, which is 6.8%. You get that plus 35. So, 35 basis points is 0.35% more, i.e 7.15%. When you reset the rate of NSC, the rate will fluctuate (it will go down, most likely).

But what happens over here is that 7.15% is quasi-guaranteed because it is from the RBI and the RBI can print money.

Shray: I mean, when the RBI defaults you’ll have other stuff to worry about right?

Deepak:  So, it’s as safe as it gets. I don’t know why anybody would go to a fixed deposit, because you have these other fantastic avenues. The first 60 lakhs, 30 to 60 lakhs, you can do in those PMVVY or SSC. Subsequently, any amount, there is no limit to the amount as far as I know, goes into RBI Bonds. When you do this, you should have taken care of your cash flow needs.

That means, this is the highest interest rate possible. If you can put 1.5 crores into these instruments, you can generate 1.5×7, i.e about 10.5 lakhs or 11.5 lakhs of income every year. And with two people such income is tax-free. So, it’s almost like saying the first 10-11 lakhs, use instruments like these to generate income. 

Now, why do I say this, i.e., why is it a problem? The answer to that is, when you have these instruments, you have a lock-in. So, SCS is locked in for five years, something locked in for 7 or 10. When you are locked in, you don’t have access to the base capital. 

But a lot of people for whom you’re generating income, the income matters no more than the availability of the corpus. Right? So, you lock the corpus in, there is a penalty for taking some of that money out in various cases. But even that penalty is acceptable, perhaps, if the interest rate that you were receiving is high enough. So, if you’ve generated 1.5 crores. you should pretty much put it here and generate your one lakh per month, as income. 

Now, you might tell me this in the program, I’ve actually got much more. So, the stuff that’s beyond should go to fixed deposit, because now any income that’s generated is pointless to you, it’s just getting taxed. You’re already generating how much we need from the others in the most tax efficient way. 

Shray: And just to emphasise this point, I mean, what you’ve said is if there is a family of two over here, and they’re both senior citizen or above 60, at least, you can very tax efficiently with something to the tune of 1.5 crores produce 1 lakh a month and it’s almost tax free. I think that’s how we calculated it. So that’s like, if I may say, what you can get done with basically no risk, or it’s safer than your bank account.

Deepak: In fact, there are chances you might not be a senior citizen. For example, someone is recently widowed, who has children, who may not be able to work, but has a corpus left behind by her husband, of say 1.5-2 crores left by their husband and that person needs one lakh a month to live, they can still use RBI bonds i.e., 7.14%, but they may not be able to use the Senior Citizens’ Savings scheme. 

But still, this allows them to say, we’ll lock-in this money that’s guaranteed to get this amount. And I can survive on that. Anything beyond, that may require an extra amount to be earned. And this is also why you should have insurance to this extent, that says well, because if I am going to spend a lakh a month, then I must have at least 1.5 crores worth of insurance or assets, at least worth that much.

This ensures that at least that part of the system is taken care of. But what happens beyond this is, you should either take risk, that means, you are now reaching people who can take that risk. Or you can put the money into different kinds of instruments where you don’t get cash flow. 

Now, there are many instruments where you don’t get a cash flow. One of the riskiest would be investing in a business where the cash flow may come and take about five, six years before it comes. You could invest in other people’s businesses, which is in the stock market in the equity fashion, and so on where again they may not do much cash flow, but it’s a great long-term business to hold. 

You may also then invest in debt. Now, investing in debt through mutual funds has a layer of risk. We’ve seen one extremely risky case of Franklin. We’ve also seen risk in terms of asset values going up and down. And today, the least risky of those mutual funds yields just about as much as a fixed deposit, that means 4-4.5 %. The riskiest ones you don’t even want to get into because they’re most risky and you’re like, ‘Okay, I want to avoid those’. 

So, you might want to balance those by saying, ‘Listen, I think a little bit of equity, a little bit of debt, all of these should not generate cash flow for you, because the minute they do they get taxed. And that’s a waste of time for you. It’s not usable. So, clearly, the government has also put us into a position where we must take risk.

Shray: I really wish to point this out, it was one thing when your fixed deposit was getting you returns at par with inflation. You could still say, I don’t understand all this stuff. So at least this will give me what I need. And I’m okay with that. But now you’re saying that is a guaranteed way of getting poorer, pre-tax every year, post tax, perhaps even more so. 

And if you’re like most Capitalmind listeners, you have some assets to worry about. And so, the taxes do matter. It’s almost reaching a state that other than them fulfilling some strategic or short-term purpose, as an asset-class itself, they’re just not looking great.

Deepak: Yeah, if you think about what the government’s worldwide have done, they’ve actually increased asset prices at the expense of everything else, which means your stocks have gone up. But your employment, your job is not giving you a higher return every year. You might not get a wage increase, but your asset prices are going up. That’s because the companies that you’re working for are generating higher profits by not paying you more and therefore prices are going up. 

So, investing in the company you work for is probably better than just working. But it’s also that the focus on asset price inflation has basically become that ‘Listen, we don’t care if assets become a problem. We don’t care if you’re overpaying for a lot of these assets. We just want to ensure that the economy continues.’ And for the economy to continue, the rich get richer, and even the poor, get richer… 

Shray: Or at least we hope so.

Deepak: And perhaps this is their way of saying this is the least politically bad option. 

Shray: Okay. Well, I’m so glad you brought this up. Because I have a problem with this thing. If what you’re saying for this to hold true, I have one issue with the current financial system in India. Why are my loans so expensive still? 

I mean, I think we can share without names. We have repeated distress from people who’ve been dealing with a person whose car is going to be possessed, and we had to help them out just in time. Landlords and other folks who have rented things struggling to refinance and are still paying 9-10 percent on home loans if that’s the right word for it.

I can see my FDs falling but the loans don’t seem to be coming down at anywhere close to it. And that’s a problem, right? 

Deepak: It is. In fact, I got approached for a loan a couple of days back and said, Can I give you a loan again? And I said, What’s the cost? And she said, ‘9% fixed’ 

Now, because I was familiar with this term. I said, ‘What do you mean fixed?’ And what does that mean? ‘No, no, it’s a one-year loan. So, if you take one lakh and you only pay Rs. 9000. I said, that’s not what it is actually, because I’m paying you the loan back, every month. So, what does it effectively mean for me?’ She said ‘16%’. 

I said, ‘Are you out of your mind?’. Your interests on deposits are down to 4.5%. And you’re charging me 16% for an asset- backed loan. She’s like, ‘okay, that’s what we have. We will cut it down to 15%.

Deepak: I am absolutely at the top end of the borrowing curve because I have no loans. If they look back at my credit history, they will be like, ‘Okay, this guy can take a loan. Of course, he can.’ But even for a person like me, they’re offering it at 16%. But the persons you talked about; people who are asking you for money to be able to repay part of their car loans. They have the option of defaulting, telling the person, you take my car and then going and buying a new car on a different loan. 

Shray: And there won’t be red marks (on the credit score)?

Deepak: Unlikely to be right away, at least before the situation becomes bad. You may be able to pull this off to, to some extent. And the point about this is very simple. It’s like the person is not doing this not because he hit a red mark, but it’s because he actually genuinely wants to pay back. And this person may be in such a bad spot, he will beg or borrow to return the money. 

And we’ve seen this in another case where people got these apps which were charging usurious rates. We are telling them it is usurious, but they still want to pay back. We are telling them listen, you can default. This is not fair. There are even people who charge 4% a week, it’s insane. So, you have to default to come down to the negotiating table, and say, I will give you back my principle, but you guys are just taking us for a trip.

And this is also not acceptable, because they’re like, we have a moral obligation [or fear of the system] to return loans. In that environment, why are banks not reducing rates? Banks need to understand that people really do want to be back, and they are genuinely unhappy. And banks must consider the fact that the RBA has cut rates just in order to help these people downstream. 

Banks, on the other hand, are saying, ‘Listen, why do we have to cut rates? Well, why do we have to cut rates. If we fail, you rescue us at the outer extreme. If a person becomes an NPA, in any case, you will come and rescue me or do something like that, to be competitive.

Shray: Shouldn’t there be someone coming in and offering you loans at a couple of percentage points lower and stealing all this business?

Deepak: Look at the same car guy. If he must do this, he goes to the bank and tells them, I will repay my loan because I’m getting a better lower cost loan from somebody else. The bank is going to put barriers to his exit. First, they will say, ‘Oh well, you’ve got to pay a 2% prepayment penalty.’ 

Okay, fine. We’ll pay the 2% penalty. Oh well you will get your papers after three months. 

At this point, the guy is lost because the other bank is not going to wait for him. And according to me, this is where the RBI must really step in and say, ‘Listen, if a guy pays back, in 24 hours, you have to return the collateral as it is or it stands cancelled. 

In fact, I think India needs a better system. We’ve got UPI, we’ve got centralised banking. Why don’t we have centralised collateral? If I have a housing loan, why should my paper sit with the bank? The papers are anyway meaningless because the registrar has documentation of the property. He also knows that you’ve taken a loan against the property. The bank can register at the registrar, it’s electronically registered. You don’t even need documentation. 

But as you hold the primary documentation, if somebody else comes and offers a better rate to me, housing loans anyway cannot charge a prepayment penalty, I should have 24 hours to just click and move. The collateral can automatically move from one back to the other. 

If a loan is paid 100% by depositing money into a certain account, the bank should be forced to close the loan instantly, which means the RBI guidelines should be, the minute the loan was received, the loan is closed, and you have 24 hours to return documents or start the process. 

If the process is dynamic, if the person is willing to collect the documentation from wherever it is or you know, whatever time it takes you to post it, or if there’s another lender involved, the process should start within 24 hours, Okay, 48 hours by the time or after you’ve centre-loaded. 

Once you create this, every bank will compete. Let’s say you’re a person who’s paid his home loan for five years, five years out of 20. So, you’ve paid 25% of the loan, probably about 15 to 20% of your principal. The rest of it is interest and so on.

So now you are a lower risk person to me, because when you needed the loan, it was a one crore loan, you paid 20 lakhs down. It was an 80-lakh loan. You paid 20% of that also. So, it’s about 64-63.4 lakhs that’s remaining? And you’ve got a house which is still worth say one crore because the housing prices haven’t gone up. 

Now me as a lender look at you and say well, if you have a much bigger buffer now, the house is worth one crore. It may fall to 80 lakhs, but his loan amount is only 64 lakhs. So, technically I have a 36% buffer on the value of the house. 

Why am I not coming up to us back and saying listen, whatever interest rate it is that you’re paying, I’ll let you pay 1% less. If you’re paying 8%, I’ll give you 7%. 

I can tell you this for a fact. A lot of people are paying 8 or 9 or 10% today also. And they find it daunting because every bank is saying ‘listen, we have to analyse this whole thing all over again. You need to pay 50,000 rupees upfront fee to do this.’ 

Why are banks doing this? Because this is clean business. I’m getting a loan at 7%. My borrowing costs are down to 4% or 3%, in fact at many banks. And I can have an endless supply of fixed deposits. RBI is printing money like there’s no tomorrow. So why wouldn’t I do this? Why wouldn’t I offer a person 6-6.5% (some people are), but they are not new loans. They are going after the people who currently have loans…

Shray: They refinance… 

Deepak: And if you were able to refinance today, you could instantly reduce the interest costs of a lot of people, I’m telling you, there is about 20 lakh crores in housing loans. If you reduced everybody’s rate by 1%, that’s 20,000 crores of savings you could put into people’s pockets. And accordingly, it’s even more than that. 

You could reduce it by roughly 2-2.5% on loans. And you would get people saving on housing loans, consumer durable loans on car loans, all of whom are very tiny, by the way. I mean, the housing loan is a big mix. You’ve already done that to corporate corporates because they are not stupid…

Shray: They’re aggressive on this…

Deepak: They are going to extract their part of their pie. Why aren’t you doing it to regular people, the retail public gets a better cost loan or lower cost loan. The chances are, they are not going to default because of this moral obligation stuff, which we never factored into lending. The richest default.

Shray: Yeah, I was just going to mention that what you’re saying doesn’t I mean, at least when you look at the news, the biggest defaults and to some extent scams, do seem to be done by the uber wealthy, or at least, the wealthy in almost strategic or ‘I don’t care’ kind of manner.

Deepak: The more money you have, the more education you have, the more likely you know the loopholes of the system. You know, the bank will have to take a haircut, and it’s willing to at some level, so you default. 

The poorest guy, even if he doesn’t have anything, he’s actually afraid of the consequences of default, does not want to, because everybody has their dignity, right? So even the smallest poorest person who has nothing, has his dignity, or her dignity. They don’t want their dignity tarnished, because that’s all they have, it’s a greater percentage of what they have than their money.

So, for them, even if they had to borrow at a very usurious rate, they would want to return the money. That is why farmers, commit suicide, even though they get waivers. The point is that people feel they must. 

In this context, we simply don’t have the financial system. The RBI should promote hundreds of banks like this. Go in and break the monopoly of the large banks. Why is Bank A, the primary lender for everything? It makes no sense whatsoever. Today, new banks must come in….

Shray: You mentioned that IDFC is trying to raise CASA right, and they are giving you 7% or something on their fixed deposit.

Deepak: Why is it that an IDFC offers you 7%, when every other bank is reducing their interest rate? And what is that IDFC can do with its CASA? IDFC is probably seeing the picture and saying, ‘You are not reducing your loan rates. So, I can compete with you at your loan rates. But I can offer my customers 7%, and I will still be okay.’ You on the other hand, the other banks will say, fine, nobody is going to trust IDFC anyway.

Shray: But I was just going to come there. Isn’t there a problem with the customers as well, I mean, the narrative we formed so far is about how banks are not behaving particularly well. But customers also will put the incremental savings with the bigger bank and trust them and take the loan again because it’s from the bigger bank. So, there is a bit of an issue there, as well right?

Deepak: Exactly. Some of it is unnatural. Some of the housing finance companies. They still say, you must come to the branch to close the loan. Why do I have to go to the branch? It’s again a barrier to exit. I will electronically transfer you the money. Just give me back my documents. 

Why do you need to visit your branch and stand in line in a COVID timeframe? I’ll just pay you back the money that I owe you. You should be coming to my house. But no, they force you to and they won’t allow you to close a loan in the last five days of a month. We should not allow this to happen. But we are a society which has promoted ego over brilliance and perhaps authority over responsibility. 

When I say that I mean it. I mean, a person who seems to have authority is more right, than the person who has demonstrated responsibility, which is sad because in this case, the reason why banks can get away with this behaviour is because the largest banks are doing it

If it were a small bank that was doing it and it was the largest bank that opposed it, you would bet your last rupee that RBI would come and hit the bank strongly, right? 

So, if the RBI says, ‘24 hours and no branch visits’. The minute you’ve reached zero balance in your account, the bank is forced to close the loan and make it zero. It must return any collateral to you or start the process of returning it to you within 24 hours.

Make collateral electronic, where you could even have a centralised electronic system for collateral where all liens are communicated to the respective regulatory authorities. So, you could have shares under collateral, you could have real estate under collateral. It’s a simple system where once you pay your loan, that flag of saying this thing has a loan against it, is gone. 

What this will do is make interest rates more viable. It’s like, if I have money, I can only get 4.5%. If I want money, I must pay 16%; that spread needs to come down. In every developed economy, this is the reason why you pay low for say, juice [soft beverages]. There were times when the only two choices you would get were Coke, ThumpsUp and Pepsi. Today, if you go to a supermarket, there are at least 40 different things; there are some, there’s some Indian coconut water or something. 

And the point about this is, the more brands you have, the more competition you have the different price points you can get different things at. And therefore, inflation comes down.

This also applies to the financial system, the more choices you have of finance, the more different meaning interest rate choice perhaps, and more competition you have in this space, the better it is for the man consuming. When the US reduced rates, mortgage rates came down almost instantly. That’s because there’s enough mortgage lenders in competition that say, ‘Listen, if you’re giving a higher rate, I will help this guy refinance at a lower rate, instantly.’

RBI also has some rules also against this. If there is a cost to the person, the person should pay the cost. You can’t roll it into the new loan. I mean, why? If it costs you Rs. 50,000, I will just give him a Rs. 50,000 loan more. Let him refinance it, what’s the big deal? 

You are anyway going to come back hard on me, with some grievance or something. Don’t work with one edge-case, where some genius, somewhere in the corner of the country…

Shray: Was able to boost up the loan thing by refinancing…

Deepak: Yeah, for that edge-case, why do you hurt the entire system? It’s just about authority over responsibility, it’s just that.

Shray: I think it’s interesting, because you have taken this. I have two questions now to sort of, as we near the end of the discussion. The first is, hopefully this is not going to last forever. This sounds like there is an investment opportunity here, right? 

I mean, as a Capitalmind customer, if you look at the landscape today, you see the madness of the stock markets, which may not be madness though. Then you see the fixed deposit and interest rates reflecting the government’s position and the RBI’s money printing, you see a bit of a disconnect with how loans are still not working out the way they should. 

This makes it look as if some things are still yet to correct. There is scope not just in the stock markets, of course, which we talk about, but there is scope, even in the world of debt and interest rates, where there’s money to be made, what’s your take there.

Deepak: Very much. In fact, when you think about it, from the 1980s, in the US, when there was a recession, which is when Volcker came in and increased interest rates. Since then, when we were coming out of that recession, we’ve had falling interest rates for the most part. And then Greenspan came in and he cannot reduce interest rates more. 

So, the way the governments of the world are deciding they will fight recessionary times is to cut interest rates down to make people take more risk. And India will also have to go down that road. At some point, there is no worldwide or widespread inflation. And that’s a caveat. India will see rates coming down. 

Now think about what impacts our inflation. To a certain extent, we’ve financed ourselves, our country itself, through some part of domestic supply and some part of international supply that’s imported. 

For the first time in many years, we’ve only had two or three quarters of continuous current account surpluses. India is not a current account surplus country; India imports, everything – crude, gold, all sorts of things. Despite all of that, we had a current account surplus in the last quarter, which was $15 billion.

Earlier, you used to have a current account deficit which meant we would import stuff, and then that would get financed by FPI, FII, foreign investors. So, the capital account will be surplus, and the current account would be deficit. They would match and RBI’s purchase or sales of the dollar would make up for this whole thing. That was called the balance of accounts. 

And typically, what happens is if you don’t have enough inflows, then the rupee depreciates. And when the rupee depreciates, your imported goods cost more, and inflation goes up. So, now take this whole thing and map it for years forward. 

India’s size is small relatively to the world market in terms of economic impact, but very big in terms of size. So, as we come out of this and grow into this will attract more and more foreign capital. Also, because the foreigners have printed so much of their own currencies, that they want to invest anywhere where they have yield and India has yield, and we are going to get more foreign inflows just because of that. 

If things continue like this, we will not import inflation, but will have foreign inflows coming in as investment, as capital, our current account surplus, which currently is probably more due to the government stopping imports at ports. 

But if you think about it a little bit more, if stopping imports at ports or slowing them down a little bit has caused us to go into a current account surplus, that means we’re not really a mega deficit country, we are at the bottom line. So, it’s possible that because of this border lining in capital flows coming in, the rupee is likely to perhaps appreciate or not depreciate too much, okay? 

The 4% average in depreciation we have seen on a yearly basis since 2000, will probably go down to 1.5-2%. The difference in inflation between India and the rest of the world is probably also going to narrow down to 1% to i.5%. If the world inflates at 1-1.5%, we will inflate to 2.5-3.5%, in general. This also means that interest rates in India are not likely to go up tremendously. 

Also, the factors which I told you about, which is more competition, I think. I scream my head off about it, but there are people trying to make this change, as in, lend to people, with security, without security, against shares, against property, all these things at lower and lower and lower interest rates. 

Eventually, they will succeed and bring down lending rates, and bring down further borrowing rates, which also means that people who are borrowing at a high cost today, some of them who are good, will be able to borrow at a much lower rate tomorrow. Yields will fall. 

Therefore, it may be useful to park money into risky assets. If this will happen eventually, which means the riskiest thing would be starting a business, because you may not need cash flow now, because now you already parked your required cash flow into the RBI thing and all that but when you start a business, the first three years you don’t have any cash flow, you will get cash flow eventually. 

Or you must know other people’s businesses. Other people’s business would be in the stock market, in the private market, however you like it. But the idea is, you don’t need the cash flow, you want the appreciation of the business as it grows up. Both these factors help GDP eventually, because more people want to do this. 

For instance, if you support someone who’s been able to buy a car, to survive, he might eventually get to a point where he can buy two cars and then that would employ more people, get more business going, and so on. 

So, this is two ways. The third way is to find debt that is currently priced at a very rich level. Now, at some point the government debt itself because the government is paying 3% for a 6-month loan but 6.5% percent for a 30-year loan. 

6.5% is a lot. It’s higher than inflation, even if we look at 5% inflation. 6.5% is something that you can buy today and tomorrow if interest rates were to come down, that 6.5% will result in a profit to you of maybe 10.5-11% simply because people tomorrow start expecting lower rates. 

So, the opportunity from an investor’s standpoint is in the risk, not outside of it. 

Shray: You are taking a risk. You are betting on the interest rate cycle. You’re hoping that there’s no mass inflation event worldwide, and that there’s no government default and so on. But there are opportunities there, in particular, on debt that is still not adjusted to what you have said, the likelihood of falling.

Deepak: What you should be careful here is that a high-risk bet is different from credit risk. I mean, it’s like there are some companies where I know they might actually fail. Taking a risk on that is actually very different from taking a risk on a government bond i.e. 20 years ahead.

I know that the government won’t go down. Maybe, they will go down, but I don’t care about that. But let’s say that I was taking a bet between the two, I think I would take that bet that there are some companies that will survive and others more quite likely to survive. But the current lot aren’t currently aren’t getting as much love from the markets as they otherwise will, like companies that lend against gold, which for the most part has been a relatively safe asset. So even if you have extreme inflation, gold prices will continue to remain high. 

Those kinds of companies may offer you a 9% return. That may be your opportunity, where you say I’m going to get 9%, even if this company remains where it is. If things get better, yields on that company will fall from 9% to 7%, in which case my investment of a 100 will become a 120 because that’s the way interest rates work. So, you will get a higher gain on your money than otherwise.

So, I think opportunities also exist in the fact that while rates are down, the reason for those rates coming down has not reached a point where the rates can go down no further, in India. In the west, I would be afraid of taking a stance but in India, lots of scope still applies.

Shray: Let’s end with a parting question, which is a little different from how we started but still tying things together. I do get your point. With FDs not looking so attractive anymore. You are into the business of wanting to have a corpus and wanting to give you some income; you mentioned the way you can do that. 

But as you know, if FDs aren’t the most beloved financial product, and you argued this with people as well. It’s not just retired people who are putting their money into FDs, right? It is also people who are saving money each year; everyone says, from household workers, to executives at IT companies, to well-paid start-up founders; even they are parking their money into FDs, and that doesn’t make sense either. 

So, if you want to make a more generalised recommendation, in this universe, where FDs are just making you poorer, what do you do with your money if you don’t need to generate income from it?

Deepak: Clearly, the answer is, find a way to take a little more risk or move a cash flow product like an FD into a product like a mutual fund, which will give you the same return but is not cash flow. For example, earning 4.5% in a debt mutual fund in the growth mode, is better than earning 4.5% from an FD, when you don’t need the money.

When you don’t need the money, you are getting the money, paying tax on it, and then reinvesting only whatever is on top of it. Which means it’s just a complete waste of money. It’s just paying the government tax, for no reason at all. Whereas, if you invest it in a mutual fund, you’ve got the same 4.5%, okay, let’s say you’ve got 4.4% also; that’s effectively better than moving your money into anything else.

In fact, if you looked at paying tax and you are just afraid of the cash flow, you’d get a tax-free bond – a bond from a public sector company, that’s actually tax free; these were issued between 2010 and 2015. These bonds pay around 4.4% so far and it’s tax free. Effectively, you won’t pay tax on your return, but you can use that money; it’s only 4.5%. 

This is the range of instruments, where you could say, ‘Listen, I don’t want cash flow, but I want relative safety’. So, a government bond fund may be relatively safe, depending on how long your investment with them is, and what kinds of bonds they buy. You want to analyse that. 

The next set is, ‘Listen, if everyone is taking risks. Then maybe, the risky assets are safer than we think.’. Because if we think about it. The West doesn’t allow its stock markets to go down. 

Why don’t they do it? It’s not because they like stock markets. They have forced their citizens to put their money, in their 401Ks, their retirement funds, into stocks. If you let stock markets fall a lot, now you are jeopardising people’s retirements, which is not what you set out to do in the first place, but you don’t want the political damage of that to hurt you. 

So, the governments of the world unite, to ensure that their stock markets don’t fall because it’s a political problem. India will go down the same road at some point of time if everybody were to invest in equities. 

So you are probably safer investing in equities, give or take the 30% fall you see once in a while, which will be this V-curve on the outside, than in depth, because it’s doesn’t matter what the valuations are, because they just don’t want the markets to fall, from whatever level they are at. The old normal, the old norms, don’t apply, because earlier it used to be one set of people who used to be bullish and one set of people who used to be bearish. 

Now, it’s one set of people, plus the government which is bullish. Plus, you are fighting the wrong battle if you are not bullish. At this point, it might make sense to say, ‘Listen, when I am betting, I understand I have this problem with risk. But when I look upon it, the political situation is that risk exists in not taking risks.

Shray: I completely understand what you’re saying. It feels innately wrong, on so many levels. And that is the best way to end 2020 right?  Nothing makes sense anymore. Surely, this can’t be right!

Deepak: But it is, and they are slapping you on the face with it, right? Being in cash is the worst thing you can do right now. So, maybe, interestingly, things will change, over the next few years. And hope I’m able to say this or laugh at myself, three years down the line. But I have a feeling, it’s going to be even more inexplicable than before and we’ll all be muddled up even more because we come from a school anchored to the principles of a past that no longer applies.

[Note: Will Deepak’s statement be prescient or age poorly like this Stocks have reached a permanently high plateau!]

Shray: Well, on that note, Deepak, let’s end 2020 and start 2021. Let’s see how this podcast ages every year, for say, the next three or four years!

Deepak: Yes! Happy new year! everyone and thanks for listening.

Shray: Thanks for listening.

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