Monetary Policy: No Penalizing Savers For Borrowers!

Apr 5, 2016

We were not surprised with the poll results when we asked readers if they agree with Ajit Dayal's or Vivek Kaul's views on RBI's 1% rate cut. Almost 56% of the respondents went with Vivek's view that such a sharp cut is not warranted.

The RBI governor stuck to a minimal 0.25% cut in the repo rate in the Monetary Policy review today. Despite all the noise about low inflation and slowing capex, the RBI's policy move reaffirms our view about the central bank's concerns on falling savings rate.

No doubt, we live in a world that favours borrowers over savers. Most central bankers across the global economy measure their success in terms of the liquidity they have added to the system. Most governments run on credit. So it is quite natural for most investors outside India to assume that they are investing in an abnormal world.

Here is what Bill Bonner recently wrote, on what he calls an 'elegant scam', which started on 15th August 1971, with the abolishment of the Gold Standard...

• In a normal, healthy economy, people work, save, invest, and build real wealth one dollar at a time. But today's dollar is different. And the economy is different, too. It runs on credit, not real savings, and builds debt - not wealth.

• Instead of encouraging savings - which is what you need to make progress - it penalizes thrift. Over the past 10 years, U.S. savers have lost nearly $8 trillion, extracted from them by the Fed's ZIRP.

• While savers were punished, borrowers were rewarded.

• Since 1980, the U.S. economy has added about $50 trillion in excess debt - above and beyond the real output that can comfortably sustain it.

• This $50 trillion came not from honest work and saving. Instead, it was conjured up by banks - out of thin air.

• And now, the productive main street economy must pay interest... and principle... on that debt - effectively extracting real wealth from the real economy and sending it to Wall Street and other favored industries.

• The scam is so elegant that not one person in 1,000 understands how it works. We've been studying it for years, and we're still in awe. But the result is obvious: Honest working people struggle to stay in the same place, as real wealth goes to the elite.

RBI's 1% rate cut was not an impossibility but an economic hazard

With corporate borrowing rates in India still in double digits, the 0.25% cut is insufficient to boost earnings. As Ajit Dayal pointed out, a sharp rate cut could be a big boost to the earnings growth potential of Indian companies in the coming years. Thus further rate cuts in 2016 are not impossible.

However, if the real interest rates (rates adjusted for inflation) are to become negative, it would put the bank depositor in a crisis of sorts. And we may see households hoarding cash without investing or spending. Certainly not good symptoms for an economy aiming to grow at one of the fastest rates in the world.

The RBI's action seems to suggest that unlike its peers it is in no mood to penalize savers for the sake of borrowers. The cumulative cut to the benchmark repo rate has been about 1.5% since the start of 2015. The rate itself is currently at its lowest level in the last six years. It is unlikely that the RBI will drop rates any further until the inflation rate drops below 5%, so that real interest rates stay firmly in the positive. A good monsoon could certainly help the RBI do that.

Tanushree Banerjee (Research Analyst), is the editor of Stock Select and, ValuePro Equitymaster's oldest recommendation services. She is also the editor of Equitymaster's most popular newsletter read by over 300,000 subscribers, The 5 Minute WrapUp. Tanushree started her career at Equitymaster covering the banking and financial sector stocks and scrutinising RBI policies. Over the last decade, she developed Equitymaster's research processes that helped us pick out various multibaggers, across all sectors. A firm believer of "safety first" when it comes to investing, Tanushree closely follows the investing philosophies of Warren Buffett, Jeremy Grantham, and Joel Greenblatt.