FinMin’s Economic Survey is fine with teaser home loan products

Indian Ministry  of Finance (MoF) tabled Economic Survey in 2010-11 on Friday (25-Feb-11). The survey is an annual update by MoF on Indian economy just ahead of its budget.

Much of the document is just a repeat on various updates on Indian economy we get from various sources – RBI, PM’s Economic Advisory Council, IMF and various private sector sources. Still, it is a nice decent read.

However, Just like we saw in previous survey, this year’s survey has two interesting chapters. First is titled – Micro-Foundations of Macroeconomic Developement and second is Human Development, Equity and Environment. The first chapter talks about some microeconomic aspects which could help improve macro performance. Second chapter shows details our socio-economic profile which is really worrisome. I will just cover both the chapters in brief.

Micro-Foundations of Macroeconomic Developement is a strange report. It gives some interesting insights on some issues but disappoints on others.

Some interesting insights first:

  • Indians still keep a lot of money in cash – 42% of rural savings in cash. Via financial inclusion this money will come into the formal system leading to increase in circulation and inflation. (Friedman’s golden rule   MV = PY) This has been the experience worldwide as well. This does not imply undoing financial inclusion but be aware of the reality
  • Another inflation pressure will come from India becoming globally integrated. This is because of purchasing power parity (PPP) principle. In poor countries PPP is low and then declines with growing economy. India’s PPP is 2.9 as of now and is expected to decline to 1.5 levels going forward. With this decline, some pressure on inflation will be there. It expects inflation to be higher by 2% based on this change. This implies inflation to be around 5% in next decade given our growth potential. This means relooking at policies for inflation management as sudden spikes could push inflation much higher as we saw in 2010-11:

This implies that, other policies remaining unchanged, we will have an average annual inflation of nearly 5 per cent during the next decade or so of the rapid growth that is widely expected to occur in India. This suggests the need to revisit some of our standard policies for managing inflation, and also underlines the need to ensure that India’s growth is inclusive and that we have better designed systems for providing basic security to the vulnerable.

  • Allow competition in production and marketing of agri commodities. Competition Act 2002 should allow new players to come into agriculture markets to work on the huge arbitrage in India’s agriculture markets. This will make the market more efficient
  • Even if we adopt best practices of few states with respect to bureaucracy, our doing business rankings will come down from 134 to 79. We don’t just need to look at foreign countries for best practices. We have some good examples within the country alone
  • Social Trust is as important to economic development. Economies in which people people show higher interpersonal trust grow faster. As a modern economy depends on contracts it is important that people trust and honor these contracts. Long term contracts like home loans etc still requires government enforcement but for short-term contracts this trust is important.  You can’t bring policemen/lawyers for these short term contracts and hence this honesty is important.

For India to develop faster and do better as an economy, it is therefore important to foster the culture of honesty and  trustworthiness. Thanks to the fact of this social prerequisite of economic development remaining unrecognized for a very long time, this has not received adequate attention in the scientific literature. Fortunately, a large body of recent economics research has been stressing the importance of these social and cultural factors. While it is true that we do not as yet have a hard science of how to develop these cultural qualities in a population, we know that even the mere understanding of the importance of certain qualities for promoting the economic development of a group of people, helps nurture these qualities in people.

After all, people have learnt not to smoke in a crowded room even when not smoking is not in their self-interest simply because they have come to understand that this is not in their collective interest. These good values are then further  supported in society through mechanisms of social stigma, which help bring individual and social interests into alignment. So once we recognize that honesty, integrity, and trustworthiness are not just good moral qualities in themselves but qualities which, when imbibed by a society, lead to economic progress and human development, people will have a tendency to acquire these qualities; and that should help build a more tolerant and progressive society.

With Greece case study we know how this trust thing is so important. Greeks just did not trust anybody. Well, in India’s case things are not as bad. But we also have little trust in government officials,  don’t want to pay  taxes, black income is huge part of our economy and so on.

Disappointing points:

  • Teaser Loans: This is pretty disappointing. I can still understand FinMin being fine with teaser loans but naming a particular  bank is a strict no. You just can’t do that in an official document. And that too a public sector bank. It calls these teaser loan products as terraced loans. SBI offered two such products which were very successful. It says most takers  were first time home buyers. Really? It is so easy to show yourself as a first time home buyer. One keeps buying homes in the names of family members/friends…Then it says the products were successful for two reasons:

First, despite having the shape of repayment associated with conventional teaser loans in the US, these loans in India were not given to subprime borrowers. In the case of Easy advantage Home Loans, a borrower’s repayment capacity and hence eligibility was worked out under the presumption that the person would have to payfrom the beginning what she would actually have to pay from the fourth year onwards. Second, there was a lot of effort made to keep the contracts transparent so that the borrowers knew exactly what they were getting into.

It is too early to say whether the buyers were subprime or not. It is all a matter of business cycle. Once the cycle reversed in US, did we realise that most of them were sub-prime borrowers. And all this mention of repayment capacity and transparent contracts, less said the better. When the crisis has shown that even the best are financially illiterate we are again expecting too much from the know-how of the borrowers. And again it is a matter of cycle. If it reverses, repayment capability suddenly become incapability.

The survey realises this but still gives the credit to bankers’ prudence:

Given what behavioural economics has taught us, we know that this may not always be adequate, that a borrower’s nod does not always mean that the borrower has fully comprehended what it is that he or she is getting into. However, especially the decision not to make these products available to the sub-prime borrowers but instead to expand the choice available to borrowers with an assured capacity to replay played a major role. The fact that this enabled many new home buyers to enter this market speaks well of the inclusiveness of the scheme, even though the subprime segment was deliberately left out.

This is what enabled India’s mortgage market to remain stable even as such markets in industrialized countries faltered. The basic lesson is clear. In general, it is worthwhile giving banks and financial institutions the freedom to introduce new products and thereby expand the options available to consumers and firms. This can enhance entrepreneurship and enable ordinary citizens to achieve a higher standard of living than would otherwise have been possible. The importantrestriction should be that banks and even NBFCs should be discouraged from lending to categories of borrowers who are clearly not in a position to takeon such debt burdens. As far as restrictions on the types of products go, these should be used minimally and with judiciousness.

Well well well. Didn’t we hear these statements before the subprime crisis as well from US officials as well? These simple home loans were like a bonanza for most. Most got to convert much of their black income into white using these easy home loan facilities.   One just has to go the real estate market to understand what is going on.  Poor/corrupt real market + easy finance is a deadly combination. Worst is nothing really happens if things go wrong as we learnt in this crisis. The genuine buyers, which are a few feel the punch.

Another issue is this stance is contrarian to the stance by RBI.  In many previous posts (this, this, this and this) this blog has pointed RBI’s averseness to the product and its recent moves to prevent banks to offer this product. Different perceptions are welcome and bound to happen in a democracy, but this whole idea of giving home loans on attractive initial low interest rates has been such a  problem in this crisis. Why disagree on what is has just been learnt recently?

  • Economic Power of Government (EPG): Here the document says EPG of Indian government has increased in the world. It develops an index to measure the same:

The index of government economic power (IGEP) endeavours to capture the ability of a government to project itself in the international sphere. There is also a normative content to this. Since the index shows the extent of charge a government has,it also can be used to determine how much say the Government should have in multilateral fora. The index is composed of four variables: government revenues, foreign currency reserves, export of goods  and services, and human capital. These variables broadly capture a Government’s ability to raise resources, its creditworthiness and credibility in international financial markets, its influence on global economic activity, and its representational strength, that is how much of the global economy, including global manpower, it can claim to represent.

Based on this India ranks 5th higher from its ranking of 10 in 2000. It adds  changes in index represents what is happening in global economic prospects  as well and there seems to be a correlation between this index and GDP growth..

Pretty surprising really. At a time when the state of governance  is at such lows (if not hit the depth), the document talks about  the international image. So instead of worrying about this lack of social trust (raised above) and dismal state of governance, we are actually saying all is well. We should also have a governance perception index of the citizens to understand this paradox better.

Overall, it was a mixed experience reading this statement. The highlight again is on how well we are doing and the micro issues we need to sort out. The idea is to just get those high growth numbers without really bothering about how it is to be achieved. The ends seem to be mattering more than the means. If it distorts markets further, be it.

This is something which Michale Spence highlighted working for growth commission – it is not growth which matters. It is a means to end that matter to people….

I will cover the social inequalities chapter in next post..


3 Responses to “FinMin’s Economic Survey is fine with teaser home loan products”

  1. State of India’s social development indicators… « Mostly Economics Says:

    […] Mostly Economics This blog covers research work in Economics with focus on India « FinMin’s Economic Survey is fine with teaser home loan products […]

  2. Adhil Shetty Says:

    Great article! But I guess a teaser home loan carry attractive interest rates and discount offers during the initial phase of the loan. After a specified time period, they relapse back to the then prevailing interest rates.

  3. The Bribery game: Changing incentives of the bribe giver and taker « Mostly Economics Says:

    […] This is what he had also mentioned in Chapter 2 of Eco Survey: […]

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