Rational Optimism Amidst Turbulence

Indian economy may be facing more woes than there are civil-servants turned economists in Delhi. Current Account Deficit, Trade Deficit, Fiscal Deficit, Bad Fiscal Policy, Problematic Monetary Policy, Declining Growth in GDP, Corruption, Policy Paralysis, Wasteful Freebies vested in the many ‘rights’, NREGA, Low-productivity, FDI Pull-out, Anaemic Exports, World Slowdown, Troubled Infrastructure Sector, Coming Elections – a good dash of all of the above, and not necessarily in the listed order – maybe contributing to the dark clouds we see hovering over our economy. V Raghunathan pens down an average Indian’s survival guide in the face of the turbulent economic conditions

What should the common man do to survive the low altitude bumpy flight riddled with air-pockets, under low visibility conditions - that fairly describes the current economic turbulence? True, in the long haul, everything will pass, and the sun will rise again, the air-pockets will repair themselves, the visibility would improve and we shall land safely, no doubt, ready to soar yet again. In the long haul! But in the meanwhile, the only clue for you and me, for navigating in these complex economic times is from the dials on the dashboard.

And what the dashboard reveals to us citizens is exactly five dials of the economy: High Inflation, High interest rates, hugely depreciated rupee, falling stock market and high oil prices; add the loss of jobs or increase in employment to the list if you must. With these meters to guide us, how do we steer ourselves through these turbulent times? Here are a few pointers.

High Inflation

The government may think we are innocent kittens and trust it when it tells us that the inflation is still in single digits – WPI (Wholesale Price Index) around 5.8 per cent and CPI (Consumer Price Index) about 9.65 per cent (notice how precariously it is kept this side of the double-digit number!).

So, while readers of James Patterson’s fiction may believe in the 9.65 per cent inflation, the rest of us know that in reality, the inflation is way, way higher. Ask any housewife, who is paying Rs 80 a kilogram for the ubiquitous harimirchi, when not many years ago, it used to be given free by the fist-fulls at the end of a moderate purchase of vegetables. The prices of vegetables ((including staples like potato, onion, et al) and fruits have moved up significantly between last year and this. The good old petrol has gone up from around Rs 65 to around Rs 80 during the same period. The inflation has in fact been so steep that it has significantly hurt the country’s FMCG volumes. But we are told by the Government that the inflation rate is still in single digits and since interest rates on our fixed deposits (FDs) in the banks continue to hover around 9 per cent, the real interest one earns from your FDs is not just zero even if you believe in the inflation figure dished out by the government, but significantly negative. And it turns even more negative after you factor in the fact that nearly a third of the interest income is taxable (if your income exceeds Rs 10 lakh per annum).

As ordinary citizens, we have little shield against the onslaught of such price hike, beyond keeping our eyes open for good bargains from FMCG retailers. When saving becomes increasingly difficult because of rising cost of living, spending some money on discounted FMCG that you really need, may not be a bad alternative! But the real effect of inflation is on erosion of savings as we shall see presently.

High Interest Rates

In general, as inflation goes up, so do interest rates. But as always, life is never without its little tricks. You will find that during inflationary times, the lending rates of banks go up more steeply than their FD rates. So you end up paying much more for home-loans, vehicle loans and personal loans in interest than you earn on your fixed deposits (FDs). What is more, the lending rates also go up far more frequently than the FD interest rates ever do. This is because banks are always clever enough to give you variable rates on their lending (your borrowings), but a fixed rate on their borrowing (your FDs). This means, when you borrow from banks, your interest rate varies with the benchmark rate which is reset every six months by the Reserve Bank of India. This means that during inflationary times like now, the benchmark rate (which is rate at which banks can borrow from the RBI) is continuously revised upwards, say by 0.50 per cent per annum. Since your borrowing rate is pegged to this benchmark, it keeps going up (by more than 0.50 per cent actually). However, as the bank offers you only a fixed rate on your FDs (the bank’s borrowing rate from you), you continue to earn the lower fixed rate, even as the higher inflation continues to erode the value of your savings! Why the RBI does not mandate the banks to give a more symmetric deal to suckers like us is anybody’s guess.

So one thing you should not do at a time like this, if you are worried about preserving the value of your savings, is to park too much of your savings in bank FDs, unless of course you are willing to lose at least a third of the income, if not more, every year. But if not FDs, where else does one save? Debt funds (Mutual Funds that exclusively invest in debt products) could be a better option, the returns on which are taxed much lower at 10 per cent. But make sure the fund has no entry load and has minimal exit load. There are many products in the market with two-year maturity, that are giving a yield of some 8.3 per cent, which translates to a post-tax return of 7.5 per cent, since Mutual Fund returns are taxed only at 10%. This amounts to a pre-tax return of 10.7 per cent of fully taxable debt products like FDs – a much better deal, even if not a goldmine. You may need to make sure that your investment horizon and the maturity of the market-linked debt product coincides. Otherwise, you will be subject to the risk of changes in interest rates. For instance, if the interest rate goes up, the value of your fund will fall. But if you are investing until the maturity of the product, this risk is neutralised. But of course speak to someone investment-savvy (Branch Managers of Banks ARE NOT) and who has your best interest in mind (again, Branch Managers of Banks DO NOT).

Another word of caution: Whatever you do, Do NOT invest in ULIP like “insurance linked savings plans”, particularly of the private insurance companies marketed by their respective banking counterparts. Typically these products involve annual premiums for ten or fifteen years, and the companies lop off the commission for the entire period from your first year’s premium itself. This means, if the annual premium is, say 2 per cent per annum, and it is a fifteen year product, they would deduct 30 per cent of your first year’s premium (often even more) up-front to recover their commission for 15 years! So if you wish to redeem your savings say after four or five years, you are unlikely to even recover your capital contribution in the plan, leave alone expect even a modest return. There are even atrocious products in the market masquerading as insurance-linked savings products, going by such fancy names as “Savings Assurance Plan” with ZERO INSURANCE content in them. So much for the work of yet another of our regulators, IRDA, who allow such products to con unsuspecting public, possibly waiting for yet another ruling from the Supreme Court in public interest!

Depreciating Rupee

With our currency scratching 65 to a dollar and all but staring at Rs 70 in the foreseeable future, even a cup of coffee on that foreign trip is bound to taste bitter.

Moreover, if you are travelling to Europe, your tragedy is not merely that you will be paying nearly Rs 90 for a Euro. You will be purchasing your Euro (or any other currency) via the Dollar. That means you will end up paying twice the commission necessary. This is hardly necessary for a currency like Euro in which we have significant amount of foreign trade. But that is my view. The Central Bank may have its own views. In any case, unless your travels are work related or you can really afford it, it is best to postpone all your foreign travels. In due course, as the economy improves (which it will of course), the rupee will stabilise, your income will be better, your job less threatened and you will be able to make it to that foreign destination anyway! But this may take at least three years is my guess.

And yes, virtually anything imported is going to cost more. So if you simply must buy anything with significant imported components, like a car, an IPad, a smart phone, or some such, buy it sooner rather than later, even at the current rate of the rupee. With all our political uncertainties, it is only likely to slip down further. We may have a competent new Reserve Bank Chief (not that the earlier one was any less – we have always been lucky with our RBI Governors), but it is not the Central Bank’s job to manage the rupee, no matter what the Finance Minister may want us to believe.

As higher foreign education becomes nearly 30 to 40 per cent more expensive, spend another two to three years interning or working in India and postpone your Masters degree. Or explore some good twinning programs to keep the cost as low as possible and bargain hard for scholarships. It works. The Western Universities need Indian students as badly as our students need those universities.

A Limp Stock Market

As the economy gets sluggish, the stock market is bound to reflect that sluggishness, which it is doing of course. But investors in the stock market have a penchant for strange behaviour. When the stock market is over-priced, and reigns at unrealistically high levels, everyone and his cousin rushes to invest in equities. And yet, when the stock market is at a low, and good value for money, it finds few buyers! The truth is: nothing in life – even the future of India – is likely to remain gloomy forever. Human beings are wired to place disproportionate weight upon the present. When the country was growing at 9 per cent, even the experts projected with aplomb the precise calendar year in which India shall overtake the US economy, as if the good times will last forever. Today when things look bad, we shun the stock market as if it shall never recover! The truth is the stock market is very attractively priced just now. As long as you have a dependable broker (if you look around, you will find them), it may not be a bad idea to invest a part of your saving in equities. What percentage of your savings goes into equities may depend on how old you are, whether you are a double income family, your income level, number of children and so forth. But largely, now may be a good time to invest, provided your investment horizon is not one or two years but more like three to five years or even longer.

High Oil Prices

This is indeed a dampener for anyone planning on buying their first car. In any case, India was never ideally a country for big cars, which the Government in its profound – but not surprising – stupidity, with hopelessly crowded cities sans broad enough roads, have encouraged in recent decades. So my simple advice is this: If you were planning to buy a certain car, you will be well advised to go for a size smaller. If you are in the income bracket which is sensitive to oil prices, purchase of SUVs are best postponed. And yes, go back to car-pools, especially when shuttling between home and your child’s school or your office. If you are deliberating between a petrol and diesel vehicle, and your driving is expected to be less than 10,000 km a year, stay with petrol. This is also because petrol vehicles in my opinion reflect truer prices, while diesel vehicles are priced artificially higher because diesel is significantly subsidised. Diesel pricing, being political, is more likely to throw your calculations haywire, when the subsidy on diesel price is removed suddenly.

Employment

If you are unlucky enough to have lost a job, you are best advised to use the time investing in yourself by upgrading your professional skills. There is little profit in sitting and moping over one’s bad luck. Nor does it make sense to advise your child against opting for IT specialisation in engineering, just because today IT sector is laying off people! The fact is your child will be graduating four years later and in four years, industries change completely. It is best to let your ward opt for a career based on interest rather than the job situation today.

These may then be some desirable options to navigate through the turbulent times we are faced with today. But above all, remember: Bad times, like good times are transient. India may give us a lot of reasons to feel gloomy about, but no, end of the world is not nigh! Let us be rationally optimistic!

(The writer is former Professor of Finance at IIM, Ahmedabad, former President of ING Vysya Bank, a popular author and a columnist)