PPF interest rates de-regulated…..may be good news now but what about later????

This announcement in the papers today was presented in a “feel good” way. As a result of the deregulation, interest rates on small savings schemes like PPF schemes are expected to rise by as much as 0.5 to 1%. In the recent past, the RBI deregulated savings bank rates as well and again it was expected that the competition amongst banks would push those rates up. These are examples where people will support deregulation because it helps them earn more. What may happen a few years later when the interest rates dip as a result of a different macroeconomic environment may be totally different though!

The opposite of deregulation is of course – government control. Petrol prices are deregulated – which means the prices of petrol can be revised upwards or downwards whenever the oil marketing companies wish to do so. In India, of course, because the government is the majority shareholder in most of these, it continues to remain the final decision maker, even if it doesn’t accept this fact in public. When it comes to diesel prices however, the government is officially the final decision maker and if it fixes a price lower than the cost of production of the fuel, then it has to compensate the oil marketing companies for the difference. This is what builds up the huge subsidies that we see in the petroleum sector.

The experience of Indian consumers unfortunately has always been that prices rise when something is deregulated. Or at least that’s what sticks in their minds. For example, when the prices of many medicines were deregulated, their prices shot through the roof. The government follows the same philosophy here – control the prices of the critical drugs and allow the prices of more routine drugs to be deregulated.

The foreign exchange regime in the country has also been deregulated in a large measure since liberalization began in 1991. FIIs can bring in money to invest and take it when they wish to. As a result of this, the inflow of FI moneyI in India has risen dramatically in the recent few years. One of the results of higher FII inflows into the stock markets is that the availability of dollars in India increases and that makes the rupee appreciate. Just a few years back, the rupee was quoting at 40 to a dollar. In those days, most people (except exporters, whose exports became uncompetitive in dollar terms) felt elated. Traveling abroad was lighter on the pocket. Buying imported things was lighter as well. One could see an improvement in the quality of goods available and everyone thought this was a terrific thing! Today when, because of global jitters and because of waning interest in India, the FIIs are pulling out their monies, the rupee is depreciating rapidly. When the rupee depreciates, all imported items – including fuel – are becoming costlier. Suddenly, people are complaining about the government not doing enough to keep the rupee up!

Essentially, most people are simpletons; not economists. They have a lot of struggle in their lives and are looking for ways to keep their heads above the water. Anything that helps them improve their life is considered good; anything that hurts them is criticized. Also, its human nature to remember the hurt more than the help. When inflation is high, people talk about it all the time. But when inflation is low, people hardly talk about it. For example, the inflation in wheat, rice and pulses even today is less than 5%, but that hardly occupies anyone’s minds. Prices of fruits and veggies are going through the roof, and everyone believes that the world is about to collapse! In the same way, when salary hikes took a hit in 2009, everyone complained. But when salaries kept increasing for the last 20 years at a rapid pace, hardly anyone came out singing peans of joy! This is human nature.

So when – hopefully in the near future – economic conditions improve and when the interest rates comes back to lower levels, all interest rates will fall. Including the interest rates on PPF and on savings deposit – those that have been deregulated now. When that happens, people – especially the old and the retired who survive on interest incomes – will complain. Many media outlets will publicly take up their cause. The opposition will blast the ruling government – whichever it is. Maybe there will be a demand that the government should start regulating interest rates. We shouldn’t be surprised if that happens! This – like I said earlier – is human nature.

Before I end, I cannot but help comment on one point that is often raised with respect to diesel prices. Many people argue that since premium cars and SUVs run on diesel (and now increasingly many smaller cars as well), the subsidy on diesel is going in the wrong hands. This is definitely true when seen from the perspective of the government. Ideally, the one who drives a premium car should pay the market rate for diesel. The subsidy on diesel should be meant only for trucks, agricultural pump-sets and the like. While this is true – and while the sale of diesel cars is rising – what is often not realized by many (including buyers of diesel cars) is that diesel cars cost a lot more than petrol cars in the long run. Buyers have to pay a lot more for diesel cars. This is partly because of higher production costs of diesel engines compared to petrol engines. And also because the government levies higher taxes on diesel cars. What buyers of diesel cars often don’t realize is that by paying more for diesel cars upfront, they are actually losing out a lot. Take this example. Let’s say a car is driven for 1200 kms a month. If it’s a petrol car, its fuel efficiency may be 10 kms/litre; so it consume 120 litres of petrol which costs about 120x72= Rs 8640 per month. If it were a diesel car, the fuel efficiency may be 12 kms/litre; so it would consume only 100 litres of diesel which would cost 100x46 = Rs 4600 per month. So the saving on a diesel car is approximately Rs 4000 per month or Rs 48000 per year. The higher price paid upfront is between Rs 1.2 to 1.5 lacs – so it would take 3-4 years of such savings to recover the higher payment made upfront (leaving aside the interest earnings on the money paid upfront!). Then there is the higher maintainance cost of diesel cars. And the interest lost by paying the higher amount upfront. But none of this matters! We are happy to pay more upfront; but we want the satisfaction of a visible saving every month! This also is human nature.

The fact is that common people (and most journalists!) don’t understand economics. This much is certainly true in what Justice Katju (new and already controversial Chairman, Press Council of India). Most people (and this is true around the world) support governments that “appear” to be doing good for them. They expect their governments to work like magicians. Leaders who are unlucky and have to take tough calls are punished. I am told Obama is in trouble in the US for not being able to create more jobs. Now honestly, it’s not entirely Obama’s fault. Maybe he could create more jobs if he were given a little more time. The world is in turmoil and to hold Obama singularly responsible for that is perhaps wrong. I doubt if another President could have done any better. But it is possible that Obama will be punished when he contests again for his second term. Maybe he won’t get it. Maybe the Republicans will get another chance to govern – at least in Bush’s time, the economy was doing much better!

The real truth is that people want to hear good news. It’s not that they like or dislike deregulation per se. If deregulation of interest rates leads to them getting higher interest income, then it’s a great move. When interest rates start falling, deregulation should be thrown out the window! The only thing that is important is that people must thing that their quality of life is improving. What do people in India feel about that? An honest admission will show that most people are doing much better than 20 years back. Our salaries have risen; availability of consumer goods is at never-before levels; and we now feel confident to take on the world…..