The year 1996-97. You wanted to gift a scooter to your son. You went to an authorised dealer to book your son’s favourite model. The booking was taken with an assurance that delivery would be made within two years.
Same day you visited anotherauthorised dealer to book a car for yourself where too the dealer assured you that the delivery would be made in about two years. You paid the booking amount and left. In fact, you were not surprised that the delivery was taking so much time; it was quite normal then.
That’s not all. You went to your bank to seek a loan for your car and the lender charged you 18% interest for a four-year repayment tenure. You also had taken a home loan and the housing loan company had charged you 16% to 18% per annum, draining most of your income. Remember, the fixed deposit rate then was in the range of 12% to 14% p.a. across banks.
Changed scenario
Cut to the present day. You can get delivery of a scooter or a car across the counter just like you buy a tablet from the chemist. The home loan rate of interest and for all types of secured loans is about 8% to 9%.
What happened in these 20 years? Why the delivery of a two-wheeler / four-wheeler is available off the shelf when the same was not available even after waiting for two years two decades ago?
The answer for the above question is simple – interest rates. Imagine you are a businessman running an automobile company or a cement company where most of the capital has to be sourced from a financial institution as part of the debt capital and if the rate at which you are being sanctioned a loan is at 18% would you be motivated to borrow and expand your business?
Motivation
When the borrowing becomes expensive naturally there would be lesser motivation to invest in a business and that’s why most companies were not able to expand or improve their capacity of production. Even as a borrower it may not motivate you (an individual) to borrow at such interest rates that puts pressure on your income.
There could be other reasons as well such as poor technological development, low liquidity (money supply in the system) besides interest rates (two decades ago), but the damage high interest rates would inflict is much higher compared to other problems.
From 14% fixed deposit rates during 1995-97 to sub-7% in present times and from 18% rate of interest on loans to sub-9% now is all part of the development India has witnessed in these two decades. As and when the interest rates started to head south, the country’s growth turned north. And the price a common man has to pay for the growth of the economy is to sacrifice on the income on fixed deposits that leads to cheaper loans; if you are getting 12% on your fixed deposit you cannot expect loan rates to be 8%. It is a double-edged sword.
What should be understood is that, going forward the interest rates (on deposits and on loans) could be even lower, sub-4% in the coming years, and one has to prepare and equip for such situations. Twenty years ago no one would have imagined that the fixed deposit rates would be at these levels because there were no tools or adequate information to assess the future economic conditions that would lead to understand where the interest rates would head.
Let’s take a situation to understand the vagaries of interest rates better. Karthik is a 27-year-old management graduate working for a private company as a manager for the last two years. His monthly salary is ₹ 50,000 and he had always dreamt of owning a house and drive his own car. He realised that a two-bedroom house would cost him about ₹ 50 lakh and he could take a loan of ₹ 40 lakh at 80% of the apartment value.
Practical?
At 8.50% rate of interest for 20 years his EMI would be ₹ 35,000. And for a car loan of ₹ 5 lakh for 5 years at 9% rate of interest his monthly commitment would be ₹ 10,000. He has to pay ₹ 45,000 every month out of his income of Rs.50,000. Is this practical for this young man? A young man who lives in the U.S., Europe, Singapore or Japan can get a loan at below 3%.
India is a work-in-progress country which aims to become a developed nation in the years to come and the price that one has to pay for this coveted crown is lower interest rate. More production capabilities by entrepreneurs leads to higher employment (by way of business expansion by existing entrepreneurs and setting up of new businesses by budding entrepreneurs) and low inflation and low interest rates would put more money in the pockets of the people that leads to higher consumption and production and these two components (production and consumption) are the ingredients for a successful economy.
Right products
The moral of the story for those who are in their 20s and 30s today is that if it is beneficial to take loans at cheaper rates they have to pay the price of lower returns on fixed deposits. Yes, it pinches to get low interest on fixed income products (deposits and other secured instruments) but what about loans? The solution for this is to understand how to achieve higher returns on the savings and choose right products to invest across various instruments available.
There are tools and calculators besides adequate information and rationale to understand the dynamics of interest rates and plenty of financial products to choose from.
Besides other factors the growth of an economy largely depends on the rate at which interest rates are ruling and that’s the reality.
