Thread by @anshgupta64

Seeing Dosa trend on twitter, got reminded of "Dosanomics" by Raghuram Rajan 😀

In 2016, RBI cut the repo rate to then 5 year low of 6.5%.
Following this, banks also started lowering the interest rate on FDs from 10% to 8%

Many people used FDs as investment vehicles and FD interest was a significant part of a senior citizen’s income. This move was heavily criticised.

Raghuran Rajan explained the reason for the fall in rates using "Dosanomics".

Take example of a senior citizen who earns income only through interest on FDs. In a situation where interest rate offered by banks is at 10% and the inflation rate is at 10%. If the senior citizen invests Rs. 10,000 in FDs he would receive a return of Rs. 1,000 at end of year.

As most Indians, let’s assume the person is a big fan of dosas and plans to only use his money to buy dosas. Dosas cost Rs. 50. With the 10,000 that he has in hand, he will be able to buy 200 dosas.

At the end of the year, dosas will cost Rs. 55. The person claims that with Rs. 1000 interest, he will be able to buy 18 more dosas.

At lower rates when interest rates are 8% and inflation rate is 5.5%, dosas will cost 52.75. He will be able to buy only 15 more dosas.

Rajan explained that people forget that inflation is the secret tax on your wealth. At 10% inflation, even though interest is higher, With 11,000 you will still get only 200 dosas.

[10% inflation and 10% returns]

When dosas cost 52.75, with 10,800, you get 205 dosas. [8% returns and 5.5% inflation].

The purchasing power of your money has in fact gone up!!

The concept that he was trying to explain through Dosa economics was that people will be much better off at 8% rates with 6% inflation as compared to 10% rates and 10% inflation. Better to look at real interest rates i.e. rates with respect to inflation instead of just FD rates