It's Not the Interest Rate, Stupid - Vivek Kaul's Diary
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It's Not the Interest Rate, Stupid

Jun 23, 2016

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This week there has been an overdose on Raghuram Rajan, the governor of the Reserve Bank of India(RBI) and his decision to not take on a second term. I guess some readers haven't liked that. Nonetheless, it is important to discuss his ideas and thoughts, given that this is an opportunity to explain some basic economics, which many people don't seem to understand.

I don't blame them given the surfeit of reading material that is generated these days. I get many WhatsApp forwards with spectacularly illogical conclusions and many people seem to believe in them. One of the theories going around these days is that Rajan did not cut interest rates fast enough, and this impacted both businesses as well as consumers.

I have tried to counter this argument over the last one week in different ways. But given that I have limited access to data, some questions still remained unanswered. Governor Rajan though does not have these limitations. In his latest speech, made in Bangalore, yesterday, he explained in his usual simple style, as to why interest rates weren't slowing down bank lending.

But before we get down to that, I would like to discuss something else.

In one of the many columns written to justify Rajan's decision of not taking on a second term, BJP member and newspaper editor Chandan Mitra, wrote: "Rajan's emphasis on increasing savings fell on deaf ears because the middle class was by now impatient to spend, not save."

The insinuation here is that if Rajan had cut interest rates fast enough, the middle class would have borrowed and spent. This would have reinvigorated the Indian economy. But then the Indian economy grew by 7.6% in 2015-2016. It is fastest growing major economy in the world. So, I really don't what Mitra was cribbing about. Also, Rajan has cut the repo rate by 150 basis points since January 2015.

Rajan in his speech made it clear through data that interest rates hadn't held back bank lending. As he said: "The slowdown in credit growth has been largely because of stress in the public sector banking and not because of high interest rate." Take a look at the following chart.

Chart 1 : Non food credit growth
Chart1 Non Food credit growth

The yellow line shows the overall lending growth of the new generation private sector banks (Axis, HDFC, ICICI, and IndusInd) over the last two years. What this shows very clearly is that the lending growth of new generation private sectors banks has had an upward trend with a few small blips in between.

In contrast the lending growth of public sector banks (the blue line) has slowed down considerably over the last two years. Let's look at the bank lending growth in a little more detail. The following chart shows the bank lending growth to industry over the last two years.

Chart 2 : Credit to industry
Chart 2 Credit to Industry

As can be seen from the above chart, the lending to industry, carried out by the new generation private sector banks has been robust. In fact, in the last one year, it has grown by close to 20%. Hence, the new generation private sector banks have been lending to industry at a very steady pace.

When it comes to public sector banks, the same cannot be said. The lending growth has been falling over the last two years. Now it is in negative territory. In fact, due to this, the overall lending by banks to industry in the last one year was at just 0.1%. The figure was at 5.9% between April 2014 and April 2015. A similar trend can be seen from the following chart when it comes to lending to micro and small enterprises.

Chart 3 : Credit to Micro and Small Enterprise
Chart 3 Credit to Micro & Small Enterprices

This has led many people to believe that high interest rates have slowed down bank lending. As Rajan put it: "The immediate conclusion one should draw is that this is something affecting credit supply from the public sector banks specifically, perhaps it is the lack of bank capital."

But as I have mentioned in the past, both public sector banks as well as private banks, have been happy to lend to the retail sector or what RBI calls personal loans.

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These include home loans, vehicle loans, credit card outstanding, consumer durable loans, loans against shares, bonds and fixed deposits, and what we call personal loans. As I have mentioned in the past, retail loans have grown at a pretty good rate in the last one year.

The retail loans of banks have grown by 19.7% in the last one year. Between April 2014 and April 2015(between April 18, 2014 and April 17, 2015), these loans had grown by 15.7%. Hence, the retail loan growth has clearly picked up over the last one year. What is interesting is that in the last one-year retail loans have formed around 45.6% of the total loans given by banks (i.e. non-food credit). Interestingly, between April 2014 and April 2015, retail loans had formed 32.4% of the total lending.

This is precisely the point that Rajan made in his speech. Take a look at the following chart:

Chart 5 : Personal Loans
Chart 5 Personal Loans

In this graph, the retail ending growth of public sector banks and new generation private sector banks has been plotted. As can be seen, the two curves are almost about to meet. What this tells us is that when it comes to lending to the retail sector, the public sector lending growth is almost as fast as the new generation private sector bank. And given that the public sector banks are lending on a bigger base, they are carrying out a greater amount of absolute lending.

As Rajan put it in his speech: "If we look at personal loan growth (Chart 5), and specifically housing loans (Chart 6), public sector bank loan growth approaches private sector bank growth. The lack of capital therefore cannot be the culprit. Rather than an across-the-board shrinkage of public sector lending, there seems to be a shrinkage in certain areas of high credit exposure, specifically in loans to industry and to small enterprises. The more appropriate conclusion then is that public sector banks were shrinking exposure to infrastructure and industry risk right from early 2014 because of mounting distress on their past loan."

This isn't surprising given that banks are carrying a huge amount of bad loans on lending to industry. As the old Hindi proverb goes: "Doodh ka jala chaach bhi phook-phook kar peeta hai - Once bitten twice shy."

As I have mentioned in the past, in case of the State Bank of India, the gross non-performing ratio (or the bad loans ratio) of retail loans for 2015-2016 was at 0.75% of the total loans given to the retail sector. This came down from 0.93% in 2014-2015.

The bad loans ratio of large corporates has jumped from 0.54% to 6.27%. The bad loans ratio of mid-level corporates has jumped from 9.76% to 17.12%. And the bad loan ratio of small and medium enterprises has remained more or less stable and increased marginally from 7.78% to 7.82%. This is a trend seen across public sector banks. Hence, it isn't surprising that public sector banks do not want to lend to the industry, at this point of time.

Take a look at the following chart, which plots the home loan lending growth of public sector banks and new generation private sector banks.

Chart 6 : Housing Loans
Chart 6 Housing Loans

In this case, the lending growth of public sector banks is as fast as the lending growth of new generation private sector banks.

What all this tells us very clearly is that when it comes to the retail segment, public sector banks are lending as much as they can. This refutes Mitra's point where he said that the middle class isn't borrowing and spending because of high interest rates. If middle class wasn't borrowing and spending, retail lending wouldn't have grown by close to 20%, in the last one year.

In fact, credit card outstanding of banks has grown by 31.2% in the last one year, after growing by 22.9% between April 2014 and April 2015. So, I have really no clue as to what is Mitra talking about. Vehicle loans have grown by 19.7% against 15.4% earlier. Guess, it's time he opened a few excel sheets before just mindlessly commenting on things.

Rajan summarised it the best when he said: "These charts refute another argument made by those who do not look at the evidence - that stress in the corporate world is because of high interest rates. Interest rates set by private banks are usually equal or higher than rates set by public sector banks. Yet their credit growth does not seem to have suffered. The logical conclusion therefore must be that it is not the level of interest rates that is the problem. Instead, stress is because of the loans already on public sector banks balance sheets, and their unwillingness to lend more to those sectors to which they have high exposure."

To conclude, and with due apologies to Bill Clinton, "It's not the interest rate, stupid!"

Vivek Kaul is the Editor of the Diary and The Vivek Kaul Letter. Vivek is a writer who has worked at senior positions with the Daily News and Analysis (DNA) and The Economic Times, in the past. He is the author of the Easy Money trilogy. The latest book in the trilogy Easy Money: The Greatest Ponzi Scheme Ever and How It Is Set to Destroy the Global Financial System was published in March 2015. The books were bestsellers on Amazon. His writing has also appeared in The Times of India, The Hindu, The Hindu Business Line, Business World, Business Today, India Today, Business Standard, Forbes India, Deccan Chronicle, The Asian Age, Mutual Fund Insight, Wealth Insight, Swarajya, Bangalore Mirror among others.

Disclaimer: The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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12 Responses to "It's Not the Interest Rate, Stupid"

Jaychandra B Chapnerkar

Jun 24, 2016

Kudos to Vivek Sir for hitting the nail right on head! There is lot of GIGO (Garbage-IN Garbage-Out) term in computer world which is fitting here for those who write irresponsibly drawing erroneous conclusion and as it get posted many starts believing it. He has explained it lucidly & so clearly that I wonder why many other are not able to understand it, may be all those so called intellectuals have hidden motives & nurture intentions to give bias opinion. Dr Rajan is indeed a great personality and it is sad that he has given in to the criticism of others, who really do not matter when you keep an impartial approach. Indeed India has lost.

Like (1)

jayant gharpure

Jun 23, 2016

To criticise Rajan for credit off take shrinkage is not correct argument. I believe there was enough. Cash with Banks to give credit but there're no takers.
Besides Rajan has not been sacked nor resigned.he is completing his term.Govt is not obliged to offer 2 nd term
I only feel that ha should not have announced his his full 2 months in advance publically

Like (1)

Muthuswamy N

Jun 23, 2016

Lovwly analysis and concludions: I may add a few more:
It is obvious that the public sector banks have erred in their lending in the past by filling forms and obliging politicians and higher-ups rather than finding out the viability. They should therefore correct the system rather than stop or slowing down lending. This they do because of another reason: to follow rules and save their skins and their jobs, probabaly.

Like (1)

sethu

Jun 23, 2016

Again you have explained the point very well;But people determined to not to accept anything other than their biased views and have closed minds will not see the points.

Like (1)

atanu gupta

Jun 23, 2016

Before blamming or commenting any one home work, data anaysis should be done.On what basis Mr Mitra, a Bakt journalist cum politician is blemming Dr Rajan? He is a big stupid.

Like (1)

Avneesh

Jun 23, 2016

It is very true that slowing down interest rate cut is a great way to balance the different challenges that India is facing. Modi is the voice of some industrialists who keep on nudging him for mindless decisions and he keeps on hooking on to their back. When Europea is going through uncertain environment, US is in process of increasing interest rates, it may be a slow process, but it is the path being followed, Indian economy is not out of woods yet. Then what effect would the sudden reduction of interest rate have on our imports. What will be the effect on inflation, what will be the effect on savings of citizens of India. If Modi had given even 5 minutes to this, he would not had exerted pressure on RBI governor for sudden cut in interest rates.

Like (1)

Vishwanth

Jun 23, 2016

Very well written Mr. Vivek kaul! The general news indeed created an impression that the growth was subdued because of non-reduction of interest rates by RBI, but your article summarised the real facts comprehensively! Good job!

Like (1)

Prasad

Jun 23, 2016

Very well explained Vivek.

Like (1)

satish dabholkar

Jun 23, 2016

When every one including econmic channels were discussing lowering of int rate when RBI governr used to declare his quarterly policy.This was happening for last three years.The finance minister was also discussing lowering of Int.rate for fast development.
Now three years are over and then Mr Rajan is awaked and said int rate was not responsible for slowing down the economy.Why he has not said this in the last three years when he used to declare his policy.Then who is stupid?

Like (1)

Rajesh

Jun 23, 2016

Hi Vivek, I am a fan of yours. How simply you put facts forward to your readers is just amazing. A fantastic article which brings out the hollows in the confusion created by various so called think tanks. Keep chugging forward......

Like (1)
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