Recovery : Will it sustain?

Global economy is on a recovery path, led by emerging countries with China and India at the forefront.  This recession was different and so has been the recovery.  Emerging countries like India and China were relatively underleveraged heading into the recession and managed to avoid slipping in negative growth territory.  Last month, India reported IIP (Industrial Production) growth of 16%+, GDP estimates have been revised up to 7.5%+ and jobs are growing in high teens.  Now, the question is if the recovery will sustain. 

• Central banks lag behind the inflation curve - With inflation at 9%+ and food prices up by 20%+, Indian central bank is under strong pressure to increase interest rate.  Markets have already taken that into account, with 10yr Govt Bond yield crossing 8%+ (still implying negative real interest rates).  Monetary policy action is around the corner.  However, central banks are known to be slow in ramping up interest rates as political opposition and recent memories of economic slowdown creates obstacles in decisive action.  We can expect a gradual ramp up in interest rates and with economic growth momentum continuing to build up, we have at least a couple of good years ahead of us.
• Savings rate continue to hover close to 35% - Domestic savings rate in India touched 35%+ a few year ago which was cumulative effect of increase in efficiency of capital deployed by the Government and the private corporate sector.  Increased privatisation of services like telecom, airlines, airports, roads, education and healthcare meant increase in capacity for these services without the Government adding its own inefficiency in capital allocation and implementation.  Historically, India has a incremental capital output ratio of close to 4:1, that is, for 35% savings rate, India can expect to grow at close to 9% over the medium term.
• Increased productivity - Better telecom services, increase in use of IT, penetration of banking services in smaller towns and cities, private investment in road and power and increase in availability of the skilled workforce has resulted in significant increase in productivity across the Indian economy.  Some of the benefits will flow in over the next decade or so, Indian economy will continue to reap the dividend of increased productivity for sometime.
• Diversified economy - India is not dependent on any one sector or industry, even though IT services continue to be an important wealth creator with strong multiplier effect. 

I am therefore not unduly concerned with prospect of increase in interest rates over the next 18 months or so. What's your view, do share in your comments.

Banks Vs Home Loan Borrowers

Indian Banks continue to follow a teaser pricing strategy - offering a low teaser rate for new customers while older customers pay 2-3% more than the rate offered to new customers.  The way it is done by providing a discount to new customers over the floating prime lending rate (PLR), which bank claim is set based on prevailing interest rate environment.

It is always a risk getting locked into one bank's loan because banks levy a charge if you want to transfer loan from one bank to another.  Even though prepayment charges are often low and nil in some case, it is not feasible for everyone to payback the loan first and then seek a new loan from another bank.  Also, once the property has been purchased, the new loan will be denied for policy reasons (Banks offer loans only for new purchases and not refinance existing properties) or may attract higher rate (in case, the reason cited is home repairs).

RBI (Reserve Bank of India) has issued a circular to IBA (Indian Banks Association) to explain the gap between the two rates and IBA today declined to make adjustments for old borrowers.  Moral advice does not seem to be helping, it is probably time for RBI to issue binding regulatory notifications.  One reason teaser rates are low is because of competition.  RBI should introduce competition once a loan has been taken.  This will keep banks on their toes.  For example, IRDA has capped Insurance Policy charges and mandated surrender charges to be zero for policies older than 5 years. This ensures Insurance companies can lose customers if their service levels fall.  RBI can take the cue and mandate the following -

1. All loans more than 3 years old should have zero prepayment charges.
2. Banks cannot levy loan transfer charges after 3 years of loan. Once competition is introduced for the whole life of the loan, banks will be forced to offer good rates for the entire tenure of the loan.
3. Banks cannot offer teaser rates which are more than 1% lower than the existing prime lending rate (PLR) for home loans.

RBI needs to act and act now.