Why RBI is not printing more money to pay off all the loan of World Bank and IMF?

June 12, 2014

This post is not my work. It’s Copy-pasted from Quora. The original Post is here.

A very simple and ordinary question (actually this question is far more serious than it looks in first glance) was asked. Here is the question-

Question – Reserve Bank of India (RBI): Why can’t Indian government pay world bank loan by just printing money?

RBI can print as much money as it wants. Why can’t it print enough money to pay off all the loan that has to be paid to World Bank?
And here starts the answer given by Mr. Akshat Agarwal.
Answer – Let us say you are a farmer and you have mango plantation (keeping in line with the season’s favorite  :P). You do hard labor and work day and night and grow 100 kg mangoes every year.

Now, one cannot live his life eating only mangoes, And since mango is a good seasonal fruit, good for health, and not to mention utterly delicious, there would be others who’d happily trade their farm products, say wheat, for some of your mangoes. Realizing this, you decide to exchange your mangoes for other products. You tell about it to your friend who has wheat farms. Incidentally, he happens to be a mango lover like me and together you develop a rate of exchange, with mutual understanding of course in this example, say, 5 kg mangoes for 10 kg of wheat. You give him 10 kg mangoes and get 20 kg wheat for your family, which you assume should suffice for 6 months. You do the same thing with your other friends as well in exchange for pulses, rice, vegetables etc.

Now, past 6 months comes winter, and your supplies have started to diminish. Moreover, you do not have any mangoes to offer in exchange for wheat and other commodities. But without the commodities you wont survive for next six months. Now what should, or rather, what could you trade in exchange for wheat?

You find a solution. You go to your best friend who trusts you a lot, and you promise to give him 5 kg of mangoes next summer for 10 kg of wheat right now. He thinks about it for a while. There are of course things to be concerned here. What if you refuse to give him mangoes later? What if the mangoes you give him aren’t good quality? What if next year is a drought and there are no mangoes?

Let us say for the sake of simplicity here that your friend here thinks about it but on goodwill and years of friendship, he trusts you and agrees. Similarly, you go to your other friends, gain their confidence and promise them some mangoes next summer for providing you with supplies right now. Now, what you have done here is that you have developed a trading system wherein you trade items and commodities for other items and commodities. And the trading currency is none other than the “items and commodities“.

But now, since you are trading with so many different people at different time, it is getting difficult for you to keep track of how much mangoes you owe to whom. So what you do is that you start handing over promissory notes to the people you trade with, with your sign on it and the amount of mangoes you owe them. So next summer, whenever you have mangoes harvested, people come to you, show you the promissory note with your sign on it, and take the mangoes.

But there is a problem with this system: you are promising X kg of mangoes which you have not harvested yet, i.e., which do not exist. Similarly you would have supplied mangoes to someone for a certain commodity he’ll have in future but doesn’t have it now. And then there is always a risk factor, i.e., next year maybe a dry one and you may not have enough mangoes to trade.

Realizing this, you are worried now. You need a damage control. You consult this with your trusted friend and ask him how to avoid possible damage. Now this friend of yours is quite a trader himself and has traveled many cities and traded with many people. He tells you not to worry about it and that he’ll let you on a little secret. He explains it to you how people will need mango no matter what: after all it is a seasonal fruit and very delicious. Now if there is less growth of mangoes next year, then he can ask to negotiate exchange rates in his favor, i.e., more commodities for same amount of mangoes. Simply put, due to scarcity, his mangoes will become costly.

You get it a little bit, but you are still confused. You wonder how will you negotiate rates when you do not know how much mangoes you are going to harvest next year; how can you negotiate when there is uncertainty? Your friend smiles, and tells you that you can. He suggests you to issue only a certain value of promissory notes, lets say  1000, and then do the trading with these notes after declaring their new meaning to the traders. These 1000 notes will represent 100% of your harvest, no mater how much you harvest. So if there is a guy with your promissory notes valuing to 100, he”ll have 10% of your harvest next summer, no matter how much you harvest. He can also decide to not exchange it for mangoes next year when there is a drought, and wait for next to next year hoping for more amount of mangoes then. Lets call your promissory notes as Mango Currency (MC)

All goes good and the mangoes, being good quality and sweeter than its competitors, are valued more. People want to buy mangoes from you even if they have to pay more. This means the value of MC gets more, only a few people can afford it. The very lower class, who wants to eat mangoes but cannot get hold of MC due to its high value is suffering. This also causes you loss in business since people are now holding MC instead of trading it for mangoes since the value is increasing. Since mangoes are not being traded, they are rotting in the collecting compound with very less people to buy them, causing you huge loss. You now need to keep the value of MC in check so that people do not hold up to it.

You go to your friend again and consult him on how to keep value of MC in check. He tells you to simply issue more promissory notes. Since the total sum of promissory notes is equal to 100 % of your harvest, if you issue 1000 more promissory notes in addition to the initial 1000 that you’ve had, the value of MC would be halved. 100 MC that was 10% of the harvest would now only be 5% of your harvest. (This is also how RBI keeps the value of Rupee under check, else Economic activity of country would go down)

Now you have developed a good trade system and also know how to keep the value of MC under check by regulating the supply of promissory notes. Now you decide to expand your business. You go to your best friend who deals in wheat and has currency WC (Wheat Currency). He is already doing very good in business and has surplus money. You tell him about your plans to expand our business and your requirement of more money for expansion purpose. He listens to you and agrees to lend you some money at certain interest rate: he already has enough money and extra money sitting at home isn’t earning him anything, so lending it to you for certain interest seems a good deal.

You borrow 500 WC from him. Now WC is quite strong in market. So much that 500 WC costs around 1000 MC (how much % of wheat harvest it represents doesn’t matter).

Now, you use up all the WC for expansion but suffer heavy losses. All the WC went down into the drain. You bought some stuff from it and have it still, but it is not bringing you any revenue and nobody is ready to buy it back. You are now left with only a few MC (remember, your currency is also floating in the market; you have maybe 1200 MC at hand). To pay back 500 WC, you need 1000 MC. But if you give 1000 MC right now, your remaining business will not be able to sustain itself with only 200 MC at disposal and you’ll eventually end up bankrupt.

You now think about possible way out. You plan to issue 2000 MC more, exchange 1000 MC for WC and return the loan. But if you issue more MC, the value of MC will be halved. Moreover, you can not think of cheating because the value of various currencies is now checked by Association of Auditors and you need to report any more printing of currency to them before it can be floated in the market, and all the currencies are numbered to keep the authenticity in check

Basically, you are now left with only one option: to try to get your act together and grow your business back to what it was, and then further more to get enough MC with sufficient value, to be able to return the loan amount.

Now in the above scenario, lets replace you with our country India, and replace mangoes you harvest with the economic activity that takes place in country; and replace your promissory notes, valuing to 100% of your harvest, to 100% of the economic activity in the country.

Now, back to your questionWhat happens when RBI prints more money to pay off bank loans? You should be able to guess it. More the money printed, lesser the value of currency. Money flowing in the country is nothing but standardized promissory notes issued by RBI. They are equivalent to the total economic activity of the country. If the economic activity does not increase in proportion to the money printed by RBI, the value of Indian Rupee will go down.

And obviously, value of MC will go down with respect to promissory notes issued by other people for other commodities. So when value of Rupee goes down, it does w.r.t other currencies, USD being one of them.

Its not difficult to guess that loans provided by World Bank are in USD. If money is printed to pay off the loan, value of Rupee goes down, which means you need more Indian Rupee to buy USD. As you can see, you can not repay the loan unless youactually have the money, over and above what you ‘ll need to run the country.

So my dear blog readers, What’s your take on this answer? Please update me with your comments.

 


Claiming money from a deceased person’s Bank account

February 23, 2014

This post is a real life example and solution provided in a discussion in our Facebook group discussion. The original query was, how to claim money from bank account if the depositor has died andnomination has not been registered.

https://www.facebook.com/groups/asanideasforwealth/permalink/598389263565304/

Now interestingly an offshoot query was also posted in the group based upon the above discussion and below is the same.

https://www.facebook.com/groups/asanideasforwealth/permalink/598439230226974/

 

Please feel free to post your queries, views, comments, suggestions on the above discussions.


Base Rate v/s Bank Prime Lending Rate

August 14, 2013

Many a times people are not aware of Base rate & Bank Prime Lending Rate while deciding their loan. What do these rates mean? What is it’s impact on their personal loan? Which is good or bad from the two? In this article I’m trying to differentiate between the two rates.

What is Base rate (BR)?

Base rate is the interest rate below which a bank operating in India can not provide loan unless any specific instruction is given by RBI or Govt. of India. It’s the minimum rate of Interest allowed to charge from the borrowers of the bank.

What is Bank Prime Lending Rate (BPLR)?

BPLR is the rate at which, a Bank is willing to lend to it’s most trustworthy, low risk customer. However often banks lend at rates far below this BPLR. For example, most home loan rates are at sub-BPLR levels. Some large corporates also get loans at rates substantially lower than BPLR. For all banks, BR will be much lower than their BPLR.

The Pain of BPLR?

Earlier almost all banks were adopting a common practice of increasing the BPLR when the over all interest rates in the economy are inching up but when the reverse was happening e.g. interest rates were coming down, the reduction in BPLR was either not done at all or not regularly. Instead of reducing the BPLR, the banks were ready to offer a higher spread (difference from BPLR) to it’s new customers (Mainly home loan customers). this was creating a lot of pain & unfair disadvantage to old customers as their loans were running on higher rates due to lower spread from BPLR & thus were not getting the benefit of low interest rates. To control these malpractices of banks, RBI came forward for the rescue of helpless home loan customers.

RBI Introduced Base Rate & made it compulsory for all banks to offer all new loans to be linked to Base  Rate from 1st July 2010. Also to save old customers, the conversion from BPLR to Base Rate was allowed free of cost. RBI gave free hand to each bank to calculate & declare it’s own BR but it was a more transparent number than BPLR.

How often can a bank change its BR?

A bank can change its BR every quarter, and also during the quarter.

What does it mean for corporate borrowers?

Under the BPLR system, large corporates who enjoyed rates as low as 4-6% will be hit since from July 1 no bank can lend at rates below BR. However, there is a chance that some corporates, with low-risk profile, would get a lower rate under the new system as under the BR regime banks are expected to take into consideration the risk levels of the borrower.

What does it mean for retail customers?

The impact could be an increase or decrease of 25 basis points (100 basis points = 1%) compared to the current rate of interest they are enjoying. However, existing customers will not be impacted by this change.

What does it mean for the banks?

Banks’ net interest margin will be unaffected.

Can a customer move from the BPLR to BR regime before the expiry of the current BPLR-linked loan tenure?

Yes, RBI has mandated clearly that all old customers should be given the choice to move/switch to BR linking of their loans if they so desire. For customers, a shift before the expiry of the tenure of the existing loan will make sense only if the BR-linked interest rate is lower than the BPLR-linked rate.

Although here is one interesting thing, housing finance companies like HDFC, LICHFC, Indiabulls, Dewan etc. are still charging BPLR linked rates as these are governed by National Housing Bank & not by RBI. So in case you have taken your loan from one such housing finance company & not from a bank, this Base rate thing is not applicable to you.

 

So what are your views on this article? Please feel free to share your views, queries in the comment section below.