The Indian Control and Command State Is Bizarre On Interest Rates: Here Is Why

Ask any Indian politician or bureaucrat: “Which is the most important price in the economy?”Pat they will answer: “The price of onions, because that can make and unmake governments.”Now follow up with: “But economic theory says that interest rates, that is, the price of money, are far more critical.”You shall be greeted with a bemused look which almost says: “Don’t be silly! The interest rate is what the bank pays on my fixed deposits. What is this nonsense about money having a ‘price’? Money is the price I pay to buy an onion, right? So how can money have its own price?”That, my dear reader, is a conundrum bedevilling the Indian state. For over four decades after Independence, our governments controlled the interest rate as a political tool. In fact, until it was decontrolled in the 90s, everything was mandated by sarkaari firman (fiat): the interest rate on your savings accounts, fixed deposits, provident fund, car finance, business loans, everything was set by the government.Perhaps that is why, even to this day, almost every pillar of the Indian State – from the legislature, executive, judiciary, and even media – fails to treat it like a market variable, like any price that should be competitively decided in a well-regulated market. Unfortunately, this national amnesia has been particularly piquant over the past few weeks.Types of Investors for Whom FD Matters Despite Low Interest RatesWhy This Obsession With ‘Interest On Interest’?A rather bizarre case is being heard in India’s venerable Supreme Court. The ‘problem’ began when the Reserve Bank of India (RBI) allowed a blanket moratorium on interest payments for about six months. It was an exigent call, with the noble intention of rescuing strapped debtors whose businesses and incomes had collapsed because of COVID-19.If such a critical relief had not been given, people would have run out of cash, defaulted, and gotten bankrupt on a massive, pervasive scale – thereby crippling the economy, perhaps irretrievably.As with any emergency, it was assumed that once things became normal, the ‘moratorium-ed’ amounts would be sensibly recovered. So it was natural to think that a deferred interest payout would simply get added to the outstanding loan – just as an example, if I rolled over an interest payment of Rs 10,000 on a loan of Rs 100,000, my ‘new loan’ would automatically become Rs 110,000. And once the moratorium ended, I would work out a fresh repayment schedule on the enhanced loan, that is, on Rs 110,000. Simple. It would be the age-old principle of ‘interest compounding’ at work, albeit in a negative sense, on the person paying the interest and not earning it.But nobody had bargained for what followed.Reduction in Interest Rates on Small Savings Heartless: CongressA bunch of petitioners began raising hell. They virtually accused banks of being usurious and exploitative. “How can they charge interest on interest?” – they asked shrilly. Many sane voices tried to make them see reason:This is not ‘interest on interest’ – it’s a levy on unpaid interest, which is the same as an interest charged on any other outstanding; andWhat if you were a lender/depositor, and not a borrower? If the bank missed paying an interest instalment to you, wouldn’t you ask for additional compensation? Isn’t that the principle of compounding? So, if you have a right to ask for this on your income, why don’t you have an obligation to pay the same on your loan; andSpare a thought for the guy who did not avail of the concession but paid his interest on time through the COVID-19 moratorium. Why should he be penalised for discipline and honesty?The answers were so obvious, so black and white, so open-and-shut, so incontrovertibly in favour of the age-old principle of ‘compounding’, that the petition should have been thrown out of the venerable Supreme Court on Day One.But a lot of us were astounded: India’s Supreme Court not only accepted the petition, but every judicial observation is pointing towards the court’s sympathy for the borrowers! Worse, it is almost ignoring the fate of simple, unassuming, voice-less depositors. It just boggles my mind that the mighty Indian State – executive, judiciary, and media – are spending countless hours on an utterly vacuous and undefendable argument, while a million other pressing issues are in abeyance. Somethings (tut tut) just happen in India!Dear EPFO, You Can’t Force Us To Part With Our Money & Not DeliverIn ‘New India’, You May Have to Pay, Not Earn, ‘Interest On Income’Now, if you thought this impending ‘interest on interest’ fiasco is the only instance of economic illiteracy, do brace for a rough ride. Here are three more extant debates that are similarly illogical:Under the GST dispensation, the central government had guaranteed revenues to the states. Now, the Modi government is honestly acknowledging that it is falling short of Rs 2.35 lakh crore to keep that promise. But proclaiming that COVID-19 is a dislocation caused by an ‘Act of God’ (which is a legal defence in ordinary contracts), it has thrown in the towel – ‘we can’t pay you’, it’s saying with stubborn guilt. Instead, ‘please borrow directly from the market and recoup the principal from a later cess’. But wait. The interest on these loans would still have to be paid by the states. This is bizarre, perhaps the only instance in the world where an entity is being asked to pay, not earn, interest on its legitimate income (!!). It also underscores how ignorant our State apparatus is about the logic of interest rates, the most crucial macro-economic variable.Bleeding heart advocates will clobber me, but there’s an equally bizarre ring in the call to pay a guaranteed 8.5 percent on Employees’ Provident Fund (EPF) deposits, even though the fund has made stinging losses on its equity exposure of Rs 1 lakh crore. While I commiserate with depositors whose money has been so incompetently managed, there is no economic logic in demanding 250 basis points above the ‘risk-less’ benchmark of 6 percent (that is, the current 10-year treasury rate).Finally, that incredibly bizarre (yes, once again) Supreme Court order to include interest on financial instruments – which is clearly a ‘non-operating income’ – while calculating the license-able Adjusted Gross Revenue (AGR) of telecom companies. See how perverse this is – a company which uses more equity, and therefore keeps higher cash surpluses on its balance sheet, is required to pay a higher license fees than the one which gorges on debt while keeping a thinner equity base. Bizarre! Somethings (tut tut) happen only in India.So, I rest my case. The Indian State has a blind spot. It fails to understand that the interest rate is not a political tool, but the most critical price in a competitive setting. That’s why it stumbles and fumbles around creating a genuine market economy.

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Why India’s ‘Control + Command’ State is Bizarre on Interest Rates

The Indian State has a blind spot; it fails to understand that ‘interest rate’ is not a political tool: Raghav Bahl

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Topics: Reserve Bank of India Loan Interest rates