When you move a system from personality-based solutions to rule of law, there is a painful period of readjustment of the old way of doing things to the new. People, institutions and analysts all need to readjust to the new reality. The recent commentary around the Financial Resolution and Deposit Insurance (FRDI) Bill that is up for debate in the winter session of the Indian Parliament has picked up on one section (section 52) of the Bill, ignoring everything else in the 125 pages, and has resulted in panic about the safety of bank deposits if this bill gets passed. I read the Bill over the weekend and this is my understanding of what the aim of the Bill is and what it means for you.
Bank deposits are the one true friend of a middle class Indian and any threat to their safety is terribly upsetting. The government will introduce a new bill in Parliament in the winter session called the Financial Resolution and Deposit Insurance (FRDI) bill. One section of this bill is causing bank depositors to fear for the safety of their money. I read the bill over the weekend and this is my understanding of what the aim of the bill is and what it means for you.
Should you rent or buy a house? Many young families face this decision when they move out of the joint family to be on their own or when they shift to a new city for work. Notice that this is not an invest-or-not question, to which the answer will be very different. This is a should-I-rent-a-house-that-I-will-live-in or should-I-buy-now question. For others already on rent, the family conversation about ‘rent or buy’ comes up each time the math is done on how much rent flows out of the family budget each month. “If we had bought our own house, we’d be owning it soon rather than all this money getting wasted in rent” is something most renting families stress over. I’ve had this conversation at home many years ago; especially when money is tight and the growing family’s needs are many, the rent vs buy decision seems even more crucial. Why not put money down for something you will own rather than down the drain in rent?
If real estate markets were efficient, there should be almost no arbitrage between the decision to rent a house or buy it. The rent and the equated monthly instalment (EMI) would be not all that far away and you would be able to stretch just a bit to compensate for the mortgage cost to turn the rent into an EMI. But real estate markets in India are far from this utopia and follow no rational rules for valuations for residential real estate. At current market prices where the rental yields (annual rent divided by value of property, or the return you get from the asset if you were to rent it out in percentage terms) are just 1-2%, renting is clearly better than buying. Look at it this way— what you can rent for Rs25,000 a month will cost you at least Rs1.2 lakh in EMI in Delhi and Mumbai.
I have a friend who lives well when she earns more and gets into a frugal mode when business is bad. An artist, her income fluctuates, so does her lifestyle. Up when there is more and down when there is less. Her mood, though, is quite delinked from her financial status—always up. Last year, she said she wanted to start systematic investment plans (SIPs). Why? Because everybody around her was starting SIPs, and it seemed a cool thing to do—getting financial security is good, no? Yes, sure, but it has taken her the first 40 something years to get to even talk about financial security. Better late and all that. The first thing I asked her to do was to put down a number that she needed each month to live. It’s very difficult to pin down an average monthly expense for a person who matches expenses to earnings every few months. But the budgeting exercise, which is the building block for most plans, takes on much bigger importance for people with fluctuating incomes. Without knowing what you spend each month, there is no financial plan.
Why Indian households remain in financial behaviour that is ‘regressive’ is a question that has wrinkled the brows of many a policy maker. ‘Regressive’ behaviour is the over-exposure of Indian households to cash, gold and real estate instead of financial assets. This behaviour includes a reliance on the moneylender for debt, rather than the formal financial system, and the use of ex-post borrowings to deal with medical and other emergencies rather than purchasing an insurance contract. With the mandate of the Reserve Bank of India (RBI), the Tarun Ramadorai committee set out to find answers to some of these questions in 2016. While other committees have looked at the same issue of the strange behaviour of Indian households from the supply side and found serious problems in the way formal markets have been set up, the Ramadorai Committee was asked to look at the problem from the demand side and provide solutions to it. In short, the committee found (read the report here: bit.ly/2iC3GKU) that Indian households are indeed globally unique in their financial behaviour. Not only do they rely heavily on gold and real estate, they are under-insured, have very little pension corpus build-up, take home mortgages much later in life than their mature-market counterparts, and walk into retirement still carrying the burden of debt on their heads.
If in the 1950s somebody wrote a future finance story about India, they may not have predicted the market that faces a retail consumer today. Till the 1990s, your savings and investing decisions were dependent on the government. No wonder Indian households chose gold and real estate as saving sumps. The financial sector was a reflection of the overall direction of the economy. Costs were high, service poor in state-owned and run finance. But post 1991, change came suddenly to finance and this column maps some of those changes as India celebrates 70 years of political and 26 years of economic freedom.
A very irate 70-year-old spoke to me sometime back about his bugbear with the inflation stories he was reading in the papers. The inflation numbers had just been announced and the papers had stories about the rising real return on deposits. The stories celebrated the fall of inflation leading to positive real returns. This means that an inflation number of 4% and a deposit rate of 6% gives a ‘real’ return of 2%, as against an inflation number of 8% and deposit rates of 6% giving a negative real return of 2%. People don’t understand that they are better off, said the stories and comments, they just see the lower nominal return and feel poorer even when they are not. “It’s not as if the price of milk or vegetables has come down,” the septuagenarian grumbled. He’s right. The bite of inflation is such that even when inflation numbers go down, it just means that prices are still rising, but not as fast as before. What the commentators forget is that inflation too has a compounding effect. If compound interest on savings makes our money grow faster, the compounding of inflation makes our money buy less and less. For a retired person sitting on a fixed pot of savings and living off its interest, falling rates of inflation also mean falling deposit rates and that means insufficient funds to live on.