governance, political economy, institutional development and economic regulation

Archive for the ‘Budget’ Category

Electric subsidy – Haryana’s burden of riches

Khattar

Today we found the grandfatherly chief minister of Haryana Mohan Lal Khattar smiling at us out of a half-page advertisement, paid for by taxpayers, announcing an “unprecedented decision” of his government. From October 1, 2018 onwards, electricity customers consuming less than 500 kilowatt hours per month would pay between 16 to 47 per cent less to their distribution utility. The advertisement proclaims that 4 million consumers in Haryana would benefit.

Cross-subsidy will increase

So who is going to pay for this pre-election bonanza and why is it necessary? In 2017-18 the Haryana Electricity Regulatory Commission (HERC) estimated that the all-in cost of supply to a low tension (LT) consumer – low tension here refers to the voltage of supply and not the potential for aggravation – was Rs 7.25 per kWh. Compare this with the paltry existing tariff which ranges from Rs 2.70 to 5.56 per kWh, increasing progressively up to a monthly consumption of 500 kWh. At no point of consumption, till 500 KWh per month, does the utility recover its cost of supply.

Fiscal red flags may be raised

With the latest bonanza, this loss would further increase. To be sure the HERC can recover some of this loss by charging even more than the cost of supply to other consumers who use more electricity at LT or increasing the tariff for Industry which uses High Tension supply. That has been the strategy all along. But there are problems with continuing the “robbing Peter to pay Paul Robin Hood” approach to finance a utility.

So why have an Electricity Act at all if it is to be flagrantly flouted?

First, the Electricity Act 2003 enjoins regulators and utilities to decrease (not increase) cross-subsidies (meeting the loss from one by over-charging another). This is not just an issue of commercial equity that customers should be charged what it costs to serve them.

Far more important, excessive cross-subsidy can and does severely distort prices and business decisions. Those charged below market rates are prone to wasteful use. Those charged more are prone to steal, game the system (by getting multiple meters) and in the case of industry, become uncompetitive versus other producers in states with more rational tariff policies.

That Haryana’s prices are severely distorted is clear from the fact that the new reduced tariffs (Rs 2 to 4.27 per kWh up to 400 kWh and Rs 4.56 per kWh up to 500 kWh) will not even meet the utility’s cost of power purchase which was Rs 4.13 per kWh last year. Increasing rather than reducing the cross-subsidy and taking it beyond the statutory maximum limit of 20 per cent is ultra vires the objectives of Section 61 of the Electricity Act 2003.

Where are the poor in Haryana and how many are they?

Trump Village unveiled in Haryana

Waiting for goodies – A village in Haryana’s backward district Mewat renames itself as “Trump Village”. 

Second, does the average Haryana electricity consumer need the deep subsidy? The answer is a resounding no. First, the level of poverty in Haryana was one of the lowest in the country at around 11 per cent in 2011 (census data) when the national average was 22 per cent. Since then it has been a high growth economy clocking 11.5 percent per annum in current prices. Poverty in Haryana is low, possibly less than the 3 per cent red flag. Second, the average per capita income is the fifth highest (2014-15) with only Delhi which is part of the contiguous National Capital region and Chandigarh which is Haryana and Punjab’s combined capital ahead of it, along with Goa and Sikkim. Third, it is a 100 per cent electrified state which had 4.1 million electricity customers in 2007. The existing retail tariff subsidizes consumption up to 500 kWh by between 63 to 23 per cent. The new tariffs would increase the subsidy to between 72 to 35 per cent.

Has HERC lost credibility?

Why was the state government in a hurry to announce these new tariffs without any supporting announcement from the regulator? Possibly, this illustrates the current impatience with due process and cynicism around independent regulation. But more likely, this is just one in a series of pre-election bonanzas.

Haryana joins the race to the bottom of the tariff reform ladder

Can Haryana afford to waste money on poorly targeted freebies? The answer is a qualified yes. Haryana’s fiscal stability, as measured by the “revenue deficit (RD)” – the excess of current spending over revenue, is better than its immediate neighbours- Rajasthan and Punjab. Haryana’s RD was high at 2.4 per cent of gross state domestic product (GSDP) in 2015-16. But it is expected to reduce from 1.4 per cent in 2017-18 to 1.2 per cent in 2018-19. The latest subsidy bonanza may, however, upset plans to meet that target.

amrinder khattar

Comparing oranges with oranges, Haryana comes out smelling sweeter than Punjab. The latter state’s RD was 3.1 per cent in 2017-18 and an estimated 2.5 per cent in 2018-19. Rajasthan is an also-ran, with an RD of 2.4 per cent in 2017-18 and 1.9 per cent in 2018-19.

Three other non-contiguous states are worse than Haryana in 2017-18 – Assam, Kerala and Himachal Pradesh. But that still leaves 24 other states doing better than Haryana. That statistic alone should make Haryana’s combative leadership and progressive citizenry stop and re-think their fiscal allocations.

Negative messaging on reform

Even if Haryana has money to spare, subsidising electricity customers is a poorly targeted priority for its resources. It also does not speak well of party discipline and ideology since the Union government ruled by the BJP, as in Haryana, has diligently followed the fiscal stability agenda.

15th Finance Commission should penalise Haryana for poorly targeted fiscal exuberance

Fiscal exuberance in “rich” states just prior to elections needs to be penalised. One hopes the Fifteenth Finance Commission evolves a formula for penalising freebies (political gifts). The judiciary can also bell the cat as it is doing in an environment and human rights. Adding the fiscal review to the overburden of the higher judiciary is a bad option. But we may be heading there if public funds are spent with impunity for partisan benefits.s

Also available at TOI Blog, September 13, 2018 https://blogs.timesofindia.indiatimes.com/opinion-india/haryanas-burden-of-riches/

Jaitley returns as FM

Jaitley returns

Arun Jaitley has returned to take charge as finance minister well before those who care for him would have advised. So what was the haste all about?

The uncharitable view would be that power abhors a vacuum. Politicians and film stars — no wonder the two often overlap — are most vulnerable to the prolonged loss of public face-time. What is most likely, though, is that he returned to his North Block corner office in order to cement his legacy as finance minister through the last and interim budget for 2019-20 of this government.

Chidambaram’s challenge to Jaitley

Chidambram 20142015 interim budget

This is a courageous move, very similar to his taking up Palaniappan Chidambaram’s implicit challenge in his interim and last budget in 2014-15 — a fiscal deficit target of 4.1 per cent of GDP — steeply reduced from 4.6 per cent in the previous year.

Mr Jaitley manfully accepted this unreal target and achieved it, noting in his budget speech: “One fails only when one stops trying”.

Fiscal stability has improved over Mr Jaitley’s tenure. The ambitious target for the current year is 3.3 per cent of GDP. Achieving this is crucially dependent on reduction in subsidies from two per cent of GDP in 2014-15 to 1.4 per cent this year, and a 0.6 per cent of GDP increase in tax collection (7.3 per cent in 2014-15 to 7.9 per cent in 2018-19).

The pressures for fiscal expansion come from the urgency to recapitalise publicly-owned banks; financing infrastructure via public funds in the absence of any appetite for India risk among foreign developers; the narrow base of unimpaired domestic infra developers and finally the compulsions of electoral politics.

Will Jaitley go for an endgame of Fiscal Deficit at 3 % of GDP

Other than achieving this year’s stretch fiscal deficit target, the finance minister needs to ponder on the target for 2018-19. Will he play the “Chidambaram card” and fix it at 3 per cent of GDP? Mr Chidambaram was pretty sure that he would not have to live within his interim budget. The jury is out on whether Mr Jaitley could reasonably assume a similar privilege. But reducing the fiscal deficit by a full percentage point of GDP below what he inherited would be in line with Mr Jaitley’s flair for challenges.

Chasing the UPA I go-go years of high growth

On growth — a sensitive issue for the BJP — Mr Jaitley has thrown a googly. He claimed recently that in trying to copy UPA-1 and chase high growth, both the banks and industry were destabilised through reckless lending and investment. This is a wise move.

It is unlikely that the growth record of UPA-1 (FY 2004-09) at an annual average of eight per cent plus would be achievable till after 2022. The IMF (August 2018 report) expects GDP growth to pick up over the next two years to 7.7 per cent. The “twin balance sheet problem” is likely to take three to five years to resolve, considering that “legal blustering” is a time-honoured mechanism for delaying a decision.

Public Sector Bank accountability and governance reform is key 

The Reserve Bank of India’s Financial Stability Report of June 2018 estimates that Gross Non-Performing Assets will worsen from 11.6 per cent in March 2018 to 12.2 per cent by March 2019. For the 11 worst-performing publicly-owned banks, the GNPAs will worsen from 21 per cent in March 2018 to 22.3 per cent by March 2019. For the six publicly-owned banks which the RBI has barred from fresh lending, the weighted average capital adequacy ratio will fall below the minimum required of nine per cent of loans.

The government has allocated Rs 2.1 trillion for bank recapitalisation, partly by increasing its own borrowings by 0.8 per cent of GDP. Additional borrowing of 0.5 per cent of GDP will be needed in the next fiscal year. Alternative schemes are being implemented like LIC, a publicly-owned insurance company, buying up the bankrupt IDBI Bank and infusing an additional Rs. 90 billion into it. This is mere fire-fighting. Unless bank lending and corporate governance become more market-friendly and transparent, investment levels will hover around the 30 per cent of GDP level — not enough for eight-plus per cent growth.

8 percent plus plus growth needs massive restructuring

Mr Jaitley’s is a nuanced claim. It implies that the growth during UPA-1 was not sustainable. The associated structural reforms to make the banks autonomous of government control; effective oversight of bank lending by the RBI and seeding economic liberalisation into field-level government regulations — labour laws, freedom from “inspector raj”, land regulation and transparent natural resources allocation, were all kicked down the road for successive governments — including the BJP, to manage.

Self goals are expensive

It is good optics to claim the present is hamstrung by the past misdeeds of others. But the BJP also scored some self-goals, most specifically demonetisation and the less than meticulously-planned implementation of Goods and Services Tax (GST)

Demonetisation was effective but cynical politics, which did not pass the “raj dharma” smell test. The GST snafu can be ascribed to the lack of expert skills or a tactical decision to trade off technical rigour against speed of implementation — a perfectly sensible trade-off in India’s fractious democracy.

India’s achilles heel- Twin deficit

India has a long history of carrying a twin deficit. The Fiscal Deficit, because government spends more than it earns annually and borrows, like the rest of us, who borrow to invest. But unlike most of us, it also borrows to fund consumption because we also run a Revenue Deficit. It is “effectively” small  at 0.7 per cent of GDP but typically we should run a revenue surplus to finance at least 20 per cent of our investment.

Our external account (net inflow and outflow of foreign exchange) is in a deficit. We have a Trade Deficit – imports exceed the export of goods and services.  60 per cent of the Trade Deficit is met from the surplus – ie. net inflow of expatriate remittances and foreign income versus outflow of interest on external debt.

What remains uncovered is the Current Account Deficit (CAD). This is met by net inflows of capital – FDI, portfolio investment and loans. The CAD is expected to increase from 1.9 per cent of GDP last year to 2.6 per cent of GDP this year, primarily because of the higher cost of oil imports. But India’s external debt is a moderate 20 per cent of GDP – of this short term external debt is just 9 per  cent, so both refinancing and debt servicing risks are manageable. And the fears of attracting American sanctions by buying oil from Iran have also receded.

The Indian Rupee is freed from its misplaced burden of being an icon of “National Strength”

A gradual rationalisation of the rupee exchange rate since January 2018 have made exports competitive and provide the required protection for domestic production from predatory imports feeding on an overvalued Rupee. The Reserve Bank of India, with its mandate for managing inflation, has kept domestic base interest rates competitive in tandem with trends in “safe havens” to manage the flight of foreign capital. The IMF estimates that the net inflows of foreign investment and portfolio capital increased from $28 billion in 2014-15 to $48 billion last year and anticipate $70 billion this year.

 

Burning his fingers once, while explicitly chasing growth, should not convert the finance minister into a growth wallflower. Rapid economic growth remains fundamental for equity. The trick is to use the lens of sustainable equity while laying our economic foundations. Growth will follow.

Adapted from the authors Opinion Piece in The Asian Age, August 30, 2018 http://www.asianage.com/opinion/columnists/300818/jaitley-returns-as-fm-to-cement-his-legacy.html

Show the middle class some love

middle class

The Indian middle class is a diverse set – professionals, public servants, skilled factory workers, the self-employed in the gig economy and smaller business folk who earn enough for daily needs, educate their children, access healthcare adequately and still have a surplus after consumption. High aspirations are what distinguish them from the hopelessness of the poor and the inherited arrogance of the rich.

Governments delight in extorting the private surplus available with the middle class via tax, purely because it is easier done than unravelling the legal defences and accounting labyrinths which protect the income and wealth of the rich.

The income tax anatomy of the middle class

Budget 2017-18, vicariously defined the middle class as having an annual income between Rs 5 to 50 lakhs. The rich got a surcharge of 10 per cent on top of the marginal top income tax rate of 30 per cent plus an additional cess of 3 per cent, increased subsequently to 4 per cent, for an annual income above Rs 50 lakhs.

A punitive, marginal tax rate of 20 per cent plus cess, on income above Rs 5 lakhs distinguished the middle class from the poor  Annual income up to Rs 2.5 lakhs (around Rs 4000 per head per month for a five member household) is not taxed. This is where being poor ends. Income above this level and till Rs 5 lakhs is taxed at a moderate 5 per cent plus cess. This low-tax, income slab provides a platform for inducting the poor, who are gritty enough to claw themselves into higher incomes levels, into the tax paying habit.

Income tax rates are reasonable

How a tax matrix affects real households is where the rubber meets the road. So how does the government’s tax policy look from the household upwards? Assuming a household of five persons, income per head per month of less than Rs 8,000 or more than Rs 80,000 is either too poor or too rich to qualify for being middle class. This  taxonomy captures the middle class fairly accurately.

GST rates are arbitrary

Problems arise if the impact of the Goods and Services Tax on the lower end of the middle class is computed. The effective tax rates have increased for most items of middle class consumption – branded products, white goods, eating out and holidays in homestays and mid-range hotels. For the large numbers of the middle class who provide services as consultants or on contract in the gig economy, the GST summarily appropriates 18 per cent of the billed revenue if it exceeds Rs 20 lakhs a year. Small suppliers of services do not have the market power to get their corporate customers to bear the tax, even though the latter are legally responsible to pay the GST on receipt of services. Reducing prices to fully or partly absorb the GST is their only choice.

Why is there no standard deduction for costs in services?

There are no standard deductions of costs available for services. Even depreciation on a vehicle is not allowed as a cost.  Oddly small retailers with a turnover of up to Rs 1 crore can claim a standard deduction of 30 per cent for costs. Such glitches are disincentives to declare revenue and completely contrary to the GST dharma of incentivising tax compliance.

Progressivity in GST on services is poorly designed

Oddly the GST is not imposed on the marginal amount of revenue from services exceeding Rs 20 lakh. It applies across the entire revenue. The message it sends is that it is foolish to use banked transactions for revenue from services beyond Rs 20 lakhs annually.  The income effect of such taxation illustrates the absurdity of the structure. The net income, after deducting notional costs of 30 per cent, from an annual billing of Rs 21 lakhs is Rs 17.5 lakhs. The imputed tax imposed by GST on net income is 26 per cent. Add to that income tax of 20 per cent. The post-tax disposable income gets slashed to just Rs 14 lakhs or 54 per cent of gross income. In comparison someone who keeps her billing of services restricted to Rs 20 lakhs pays no GST and therefore has a higher net disposable income of Rs 16 lakh!

Why does cross border supply of services not have a free-of-tax limit?

Arbitrary taxes on turnover are highly discriminatory and inhibit competition. Consider that no GST is payable if services are provided within a State up to Rs 20 lakhs. But all cross border supply to another State attracts GST. In the United States, cross border online supply of services are not taxed, creating a converse unfair advantage for such supply, versus local supply. This was struck down last week by the US Supreme Court. What can possibly be the logic of inhibiting competition by taxing cross border supply below the annual taxable limit of Rs 20 lakhs?

 

Fuzzy economic assumptions on the relative merit of public or private expenditure & savings

By taxing both income and consumption at punitive rates, the government drains the surplus available with the middle class, which could have been used more efficiently for higher consumption – triggering higher production or more savings, leading to more investible funds. We are fuzzy about a fundamental trade-off between being an efficient, rationally-taxed, private sector-led economy — a mantra which every government since Prime Minister P.V. Narasimha Rao’s has sworn by — and a punitively-taxed, state investment led, low efficiency economy — which is what we have become.

It does not help that the tax base remains despairingly low and the same law-abiding citizens and entities get taxed ever more by each succeeding government. The tax base of individual assesses of Income Tax is around 60 million. The tax loophole of agricultural income being tax exempt is a major inhibitor for growing the base significantly. The GST has around 11 million registrants. But tax compliance is said to be a low 70 per cent. The tax buoyancy is coming from bleeding the already compliant.

farm house

Despite extortionist taxes for the middle class, the tax to GDP ratio is stagnant at just below 12 per cent, because of massive evasion and statutory loopholes for avoidance. Inequality is increasing with income and wealth concentrating within the top 1 per cent. Inequality and tax impunity are “dhili” (loose) foundations for building a sharing economy.

This summer, as our political elite relax in the soothing cool of the leafy and shaded Lutyens’ Delhi, spare a thought for the middle class and show them some love. They also vote, you know.

Adapted from the authors opinion piece in The Asian Age, June 30, 2018 http://www.asianage.com/opinion/columnists/300618/its-time-govt-shows-the-middle-class-some-love.html

Follow the money to tackle the fiscal perfect storm

Piyush Goyal 2

Piyush Goyal, the interim finance minister, will need to be a lucky general if he is to overcome the triple challenge of widening trade and fiscal deficits and lacklustre private investment.

Exports – India’s achilles heel

Despite our comparative advantage of cheap, skilled labour and entrepreneurial zeal, export pessimism is endemic — unlike in China. Last year we imported goods worth $460 billion, while exports were just $303 billion, leaving a trade gap of $157 billion. We try and cope with the trade deficit by mimicking the American economy — minus the pull of its global currency. We maintain a strong, stable rupee and high interest rates to encourage inward financial flows of capital to plug the deficit in the external account and protect our foreign reserves.

Our saviors – inward remittances from Indians in the Gulf

Gulf workers

We are blessed that our valiant expatriates in the Gulf states regularly repatriate their foreign earnings to finance their families struggling to survive in India. Net inward remittances — around $70 billion per year — cover around one-half of our trade deficit. The inward flow of foreign direct investment and “hot money” flowing into our equity and debt markets provide the residual foreign exchange for imports.

Aping America’s strategy to manage its external account, is out of context

A chronic trade deficit forces us into economic contortions. One such is high interest rates to generate demand for the rupee, never mind that it permanently disadvantages exports and makes domestic production uncompetitive, versus imports. A new monetary policy announcement is due later this week. If the Reserve Bank of India increases base interest rates, it will be in line with its inflation targeting, rupee strengthening and external account stabilisation objectives.

High interest rates can kill our nascent economic recovery

The consequences for the domestic economy will be harshly adverse. Cheap money and a realistic exchange rate is what drove the Chinese juggernaut for years. Admittedly, it can also create bubbles. But private investment is at risk. The emerging political uncertainty and the yet to be completed corporate insolvency processes — affecting 15 per cent of bank assets — are investment dampners. Higher interest rates could well be the straw that breaks the donkey’s back. Public investment is always a poor substitute for private investment. It comes with the enormous risk of misallocating capital hugely, including for political ends.

A circle of wealth excluding the poor?

Political economy considerations also conspire to maintain the inward financial flows of “hot money”, which boosts stock market valuations. Over the last two months, foreign portfolio investors have sold a net amount of around $3 billion of Indian assets roiling our thin domestic stock and debt markets — eroding the wealth of 40 million equity holders. But it matters little for over 200 million other families, who continue to squirrel away their meagre savings into interest-bearing bank or post office savings accounts, or in gold.

Look beyond tax revenue to fund burgeoning expenditure

HAL

The Central government is constantly walking on a razor’s edge to achieve fiscal deficit targets – which is necessary to avoid stoking inflation. It is a tough call to choose between allowing oil spikes to pass through to consumer prices at the cost of stoking inflation and consumer anger, or to absorb the price increase within the general government finances, at the risk of blowing the fiscal deficit targets. The win-win solution is to find a source of additional non-debt financing, till the full benefits of GST kick in over the next five years. One option is to monetise the public investments made thus far in industrial entities, infrastructure and land.

Find a non-tax source to replace the cushion provided earlier by low oil prices

Ashok

During 2015-18, the government reduced the fiscal deficit by one per cent of GDP because of the availability of additional revenues of Rs 2 trillion from cheap oil. The government should target raising Rs 4 trillion over 2018-20 by monetising public assets, including the sale of equity in public sector undertakings. These capital inflows can help keep the fiscal deficit within three per cent of GDP. This is not easy. Embedded vested interests, which benefit from such investments, would create hurdles. Political capital will have to be spent.

Sell our “crown jewels” and monetise completed publicly financed projects 

NALCO

The disinvestment ministry was notionally empowered last year to discharge a limited mandate with respect to managing government equity in PSUs. But disinvestment remains a programme of simply selling government equity, when the stock market is high, to plug the fiscal hole and keep the fiscal deficit in check. 2017-18 was a landmark year. The government sold equity worth Rs 1 trillion due to very adroit management and with help from deep-pocket publicly-owned entities like ONGC, which bought into HPCL and other institutional investors who generated the demand pull. This was a one-off. The target this year is 20 per cent less at Rs 800 billion.

Air India is a high-profile disinvestment, which can stem the annual loss borne by the government. The 2016-17 loss was Rs 58 billion. Not enough to break the budget but unnecessary, and hence wasteful. No bids were received for it. Blame the flight of international capital to “risk-free” investments. Blame our fragile domestic political environment prior to the general election. But also blame low appetite within the administrative departments to let go of the PSUs that they control.

Don’t mimic the UPA – discipline departments which fight to retain PSU assets 

Air India

It is astonishing how quickly political capital can fade. Prime Minister Narendra Modi’s signature theme was that his writ runs in the Central government. But the foot-dragging in the Air India disinvestment case seems to illustrate that this might have changed. Admittedly, Air India is an iconic brand. For long, you felt you were home once you boarded Air India — remember that familiar smell of curry? Selling it, specially to a foreign investor, is like the British selling Jaguar-Land Rover to the Tata Group. Pragmatic but heart rending. We have yet to become business-like about our crown jewels, as the British have. We sell our assets past their expiry dates and then wonder why we got peanuts.

Focus, diligence and smart choices can make a difference

Success in navigating through this perfect storm will depend on avoiding the bureaucratic gut instinct for “tax terrorism”; monetising public assets in mission mode; monitoring expenditure closely and ensuring fiscal discipline, while absorbing the oil price increase and providing for higher farm gate prices — two politically inescapable imperatives. If the finance minister is lucky, oil prices will subside; America’s tempestuous and unpredictable President will lapse into hubris and the domestic political landscape will change for the better. But don’t wait for it to happen.

Adapted from the authors opinion piece in The Asian Age, June 6, 2018 http://www.asianage.com/opinion/columnists/060618/a-fiscal-storm-looms-dont-wait-for-godot.html

Oil shock: Entry point for reform

POTUS Saudi

The latest oil shock — an increase from $69 (average Indian import price) to $80 per barrel (Brent) this week — is courtesy the American President, Donald Trump, who unilaterally pulled the United States out of the 2015 deal between Iran and the UN’s Permanent Five (US, UK, Russia, France, China) plus Germany. This spooked the global financial markets, which justifiably fear renewed trade sanctions on Iran. Pulling out Iran’s 5 per cent contribution to world oil production has consequences. The nuclear deal which had earlier ended sanctions boosted world supply reducing oil price for India from $84.2 in 2014-15 to $46.2 in 2015-16. New sanctions may reverse the trend.

Who has POTUS benefited?

The gainers are the oil producers. The US President has imposed the supply constraint that Opec finds difficult. Saudi Arabia, Iran’s Sunni bête noir, is in clover. The 42 per cent increase in prices over last year, relieves fiscal stress; is wonderful for the long-awaited listing of Aramaco, its national oil company, and avoids the unpleasantness of having to tax its citizens or reducing their benefits.  Other countries in the Gulf, Venezuela and Russia will also benefit. America’s shale oil producers, for instance, are busily removing the covers on their drills.

Who suffers the collateral economic damage?

The big losers are China and India. For India, higher prices mean a bigger trade deficit and more stress on our foreign exchange reserves. Another outcome is rupee depreciation. Foreign hot money is pulling out to “safe haven” destinations also in expectation of an increase in US interest rates. The hot money bleed made the rupee slide by around six per cent to more than Rs 68 against the US dollar from around Rs 64 earlier. But it is still overvalued and needs to go down to Rs 70.

The risks for India

The oil shock poses two risks for India. First, the fear that it will increase the current account deficit (CAD) — the difference between international receipts and payments, from trade and income flows — beyond the acceptable level of two per cent of GDP.

Second, it poses a conundrum of navigating conflicting objectives — preserve the market-based retail oil price mechanism whilst graduating the price shock for consumers and containing inflation.

Moody had revised India’s credit rating upwards last year. Standard and Poor had not. Enhanced imbalance on the external account and missing the fiscal deficit target for 2018-19 will invite a review of India’s sovereign risk.

How serious is the risk for the CAD – red flagged at max. 2% of GDP 

At $80 a barrel, our additional spend on oil imports could be around $9 billion this fiscal, net of the increased earnings from oil product exports. But the threat to keeping the CAD below the target of two per cent of GDP is over-hyped.

The oil shock has a silver lining. With more robust fiscal balances in the Gulf, investment and jobs will increase for Indian workers, who generously remit all their earnings. Inward remittances, higher than $69 billion last year, will dilute the impact on CAD. More petro-dollars to spend, can boost our exports to the Gulf.

Second, the accompanying six per cent depreciation of the Indian rupee will make our price-sensitive exports much more competitive. Last year exports grew by 12.1 per cent to $300 billion. A three per cent growth in exports this year would generate the additional spend needed on oil imports of $9 billion.

Third, a weaker rupee discourages imports generally. Last year total imports increased by 21 per cent. Making domestic producers more competitive is in India’s interest. The risk of breaching the CAD cap is minimal.

imports

The risk of balooning the fiscal deficit

Transport minister Nitin Gadkari had recently opined that subsidizing oil consumers is not aligned with a market economy. Not quite right,sir. It is in a market economy that the question of subsidy arises – of course subsidy must be tightly targeted, which ours is not.

In an old, Soviet-style economy, there are no subsidies because the government sets the retail price for the production units which it also owns. In our context, this is analogous to directing ONGC to absorb the cost. This is best avoided.

Preserve oil PSU commercial autonomy

Last year, ONGC assisted in achieving the disinvestment target by buying the government’s shareholding in HPCL. Whilst even such nudging to support the government is undesirable. But far worse is to dilute ONGC board’s commercial autonomy for pricing products. More importantly administered pricing distorts markets and discouraged private sector investments and operations – both highly desirable in oil.

Three better options exist : They need professional effort and political capital 

Slash frivolous budget allocations for current year

swaach

Three options present themselves. First, intrusive Budget scrutiny can do the trick. A fiscal “surgical strike” slashing frivolous expenditure, which has crept in, can generate the Rs 0.6 trillion to sanitise consumers from a price increase. This is just six per cent of the Rs 10 trillion, which the Central government spends on schemes without including wages, pensions, interest or capital expenditure.

Pass through the price increase to customers @ 50 paise per litre per month  

Second, it is not desirable to entirely sanitise customers from the oil shock. This will kill the liberalised “marked to market” regime for retail prices of oil products, introduced last year.

It is also environmentally irresponsible not to have a price signal to induce lower consumption of petroleum products and incentivise users to switch to more efficient end-use equipment — cars, motorcycles, water pump and generators. Mr Gadkari is right. A portion of the oil shock should be passed through.

pollution

Invoke the GST style federalized decision mechanism for states to cut VAT equal to the windfall gains for price increase.

But state governments must be cajoled to give up the windfall gain accruing to them because VAT (their tax) is an ad valorem rate and not a specific rate as is Central excise or Customs. TERI, a New Delhi think-tank is modeling a revenue neutral taUse x realignment which would be useful. Government would do well to consult widely rather than go about taking decisions in secret as it tends to do.

Fiscal deficit 2018-19 target of 3.3% of GDP is unreal – last year we were 3.5%

Piyush Goyal

Lastly, Budget 2018-19 projects a fiscal deficit of 3.3 per cent of GDP versus 3.5 per cent in 2017-18. The target is not credible. Capitalisation of stressed public sector banks; agriculture minimum support price revisions; and the new flagship “Ayushman Bharat” medical insurance scheme will surely push the deficit beyond the target. The N.K. Singh committee report on Fiscal Responsibility and Budget Management “blessed” variations in fiscal deficit capped at 4 per cent of GDP. Following this lead can provide an additional Rs 1.3 trillion to the Finance Minister, Piyush Goyal, part of this could be used for absorbing oil price increase. But stoking inflation is a real risk here.

Oil at $100+ soon?

A further increase to the 2011-2014 level of $100+ a barrel is unlikely. Oil producers, like Venezuela, need to cash into the high price. Sanctions on Iran, now seem likely since the POTUS-Kim Jong – peace talks have collapsed and POTUS needs to look muscular.

POTUS

But even if imposed, sanctions will not bite till six months after they are imposed. If oil spikes nevertheless, a temporary adjustment loan, from the IMF, can dilute this external shock, which can otherwise jeopardise our plans for mitigating carbon emissions to meet targets to 2020.

The continued supply of Iranian oil, but denominated in rupees, like the Russian trade earlier, is also possible. The United States may accept such necessary but limited “exceptions” for Iran as a humanitarian response “needed by the Iranian people” to survive.

Economic stress creates reform entry points because the urgency becomes publicly visible. 1991 was an extreme event. The 2018 shock is low intensity in comparison. But it can help to push the needed third generation of reforms — deep fiscal austerity, energy security and PSU autonomy.

Adapted from the author’s opinion piece in The Asian Age, May 25, 2018 http://www.asianage.com/opinion/columnists/250518/oil-shock-entry-point-for-deepening-reform.html

Are Marwaris taking over our heritage monuments?

Red fort

Someone else, better equipped and trained should do this routinely


Somebody needs to fund heritage preservation. Why not the Marwaris and Banias? After all they funded the National Movement for Independence. But try telling India’s die hard, Left Liberal crowd that a person in desperate need of a public toilet, does not care, whether the plaque above it gives credit to a public-sector company or a private entity. An especially abled person, with a yen for travel, couldn’t give two-hoots who paid for the ramp that makes heritage monuments accessible on her wheel chair.

None of this will wash with those who hold public management of “national” monuments and public sector white elephants dear to their heart. They would rather see them collapse, gradually, than hand them over to the private sector for making them user friendly.

Our heritage, our identity

Last year, in September, the government launched, what should have been an innocuous and much needed initiative to seek non-state (private) interest in providing better facilities at our heritage sites in exchange for on-site advertising. This is explicitly not a revenue generating partnership. No additional fee or charge, unless approved specifically by the government, is to be imposed by the non-state partner.

ex-IAS, Minister Alphons, off to a good start

Things moved surprisingly fast after ex-IAS KJ Alphons got elected to the Rajya Sabha from the BJP and joined the government as minister for tourism. Thirty-one entities have been shortlisted to “adopt” 95 monuments and sites across India.

These entities called “Monument Mitra (friends)” are required to prepare a vision document detailing what needs to be done to improve the visitor experience and how they would go about doing it, as a part of their corporate social responsibility (CSR).

The good news is that, this time around the public-sector has been spared the near compulsory burden of footing the bill. Most of the interested entities are private companies except NBCC (India) ltd. – a construction PSU for the Old Fort, New Delhi and the State Bank of India Foundation for the Jantar Mantar complex, New Delhi.

Dalmia Bharat Ltd for the Red Fort

But the selection which grabbed the headlines was the one signed with Dalmia Bharat Limited for the Red Fort in Delhi. Left Liberal sentiment was outraged at this seeming mortgage of India’s iconic heritage fort, to the Dalmia’s – an old Calcutta/Delhi based family business.

It is unclear, why the Dalmias are interested in the project, except to generate goodwill with the government and amongst citizens in their home city. The potential for getting a free Dalmia promo in the national TV reportage of the annual Independence Day spectacle at the Red Fort on August 15, might have also been a motivator.

Keeping art and heritage “aficionados” out of the process, generates suspicion

The vision document or the MOU, spelling out what the company intends to do has not been publicly shared. The Committees reviewing the expressions of interest; the vision documents and approving the MOUs consist only of the relevant government departments, to the exclusion of non-state actors, particularly from the extended arts, architecture and culture community in Delhi.

As expected, exclusion breeds unnecessary suspicion and distrust. The Modi government seems to shy away from the active participation of non- state actors in decision making. The previous government of Sonia Gandhi-Manmohan Singh went overboard in the other direction, possibly to deflect any blame from itself. A healthy balance between the two extremes would help.

The Dalmias – hard nosed businessmen, far from the sensibilities of culture.

Ramkrishna Dalmia, a Marwari from Rohtak, was the founder of the Dalmia group. Thomas Timberg notes in – “The Marwaris” that, like all entrepreneurs of the early 1900s he made his money from speculation in silver and then went on to become one of the three largest Indian industrialists along with Tata and Birla. But unlike the other two groups, the fortunes of the Dalmia’s have waned.

Dalmia Bharat Cement is a listed company with a market cap of just around Rs 220 billion – around one half of the smallest 100 top listed BSE companies. Its CSR focus is on energy conservation, rural development and solar power applications. Providing and managing visitor facilities for a significant historical monument is a significant departure from its main line of business. Of course, that is no reason to dismiss the effort outright. But it does raise doubts about their ability to perform, to satisfaction, even if the intent is genuine.

Not too many private takers for cultural spend

Government argues that corporates are not exactly lining up to spend scarce money on historical monuments. They must make do with those who are interested, even if they will have a steep learning curve. Mechanisms for technical support to the Monument Mitra and oversight of their activities, are being put in place. Cultural czars however, thumb their noses at such amateurish attempts to break into the rarified world of culture, art and heritage architecture.

To be fair to the government, not all selections, have the same problem. The well-known Aga Khan Trust – which restored Humayun’s Tomb in New Delhi, has been selected for the Aga Khan Palace in Pune; The premier hotel chain ITC and a GMR entity (builders of the Delhi airport) have been selected for the Taj Mahal and so on.
Dalmia Bharat Limited – a cement manufacturer and infrastructure developer – is an outlier for the Red Fort. One wonders why the government does not share the rationale on which the decision was made with interested citizens. This would allay fears.

Marwaris

Suspicion of the Bania (India’s mercantile caste) is deeply imbedded in the Indian psyche, possibly anachronistically. Even the Marwaris and Banias might have moved on from the rapacious image that Left Liberals have of them. We shall know soon enough. By Independence Day, August 15, 2018.

Also available at TOI Blogs https://blogs.timesofindia.indiatimes.com/opinion-india/are-marwaris-taking-over-our-national-heritage/

 

 

Union taxes are scraping the bottom

old men

The introduction of a 10 per cent tax on capital gains (with effect from April 1, 2018), accruing from the sale of equity, after holding it for at least one year, has generated a great deal of angst. But it is unconscionable that stock market investors who have earned windfall gains of 30 per cent over the past year should mind paying three percentage points out of that windfall as tax.

The government has gone further and “grandfathered” from the tax all equity-related capital gains accruing till January 31 — the day prior to the Budget 2018-19 proposals being made public. The stock market slid by about six per cent thereafter. Future gains will depend upon better profitability in Indian corporates; the options for alternative risk-free returns in developed markets (US treasuries, for example, which are likely to have higher spreads) and growth in India.

Even wealthy Indians dislike taxes

The new long term capital gains tax is not onerous in the present context. But at the heart of the discontent with it, is a corrosive aversion to pay tax, even by the very wealthy. There are good reasons why we are habitual benders of the rule of law.

To find the reason for this national shame, look no further than our political leaders. The Election Commission turns a Nelson’s eye to the yawning gap between actual election expenditures and the income of parties on the books. The recently introduced Election Bonds are unlikely to bring about a transformative reform.

No crony capitalist wants to be identified while buying these bonds from designated banks. Privacy of information arrangements are easily breached, to ferret out who contributed how much to which party.

Demonetisation did throw up big data on the ownership of cash. But following up on suspected tax evaders is quite another matter. The options of bribing their way out or legally delaying a final decision reduces the incentive to respect the rule of law. We are then back to square one. During the demonetisation of November 2016, 99% of the cash came back into the banking system, because tax evaders innovated, on the fly, to escape the tax net.

No wonder then, that the tax revenue at the Central level is stuck at just below 12 per cent of GDP with an additional 10 per cent in the states and local governments.

scraping bottom

Growth need higher public spends

The conundrum is that higher growth needs higher public spends of around 6-8 per cent of GDP on infrastructure, health and education. India has underinvested in these for decades. The real problem is that tax revenues are difficult to increase with 40 per cent of the population being either poor or vulnerable to fall into poverty.

China innovated best-fit solutions to boost public revenues

China had the same problem. Their solution was to decentralise development decision-making within a broad party line of priorities. Local government and local party offices worked together to monetise government assets — principally land — for private development projects. The proceeds from such monetisation generated the resources to finance infrastructure and increase spending on health and education. Without a doubt, the dynamics of working with the private sector also lined the pockets of party and government officials. But both were held to account if there were failures in achieving development targets.

India too is turning away from template solutions

The good news is that India is changing. Prime Minister Narendra Modi has made chai vendors respectable. Our next Prime Minister may do the same for pakora sellers — much derided today by some, who look down their noses, at anything but formal sector jobs. But Shekhar Shah, director-general of NCAER, a New Delhi economics think tank, cautions that formalisation, China style, can be a double-edged sword.

Formalisation of work and rising inequality

Yes, formalisation does improve work conditions and facilitates production at scale. But formalisation is often linked to capital intensive production, which results in disproportionate benefits to those, with access to capital. Unless managed with great care formalisation takes away from rewarding livelihoods for people in the bottom 40 per cent with traditional or low-level skills. President Kagame of Rwanda — till recently a darling of donors, because of his rapid adoption and implementation of the “doing business” type of performance metrics — runs a spotlessly clean capital, Kigali, with neat markets. But this is at the expense of street vendors who were priced out by the prohibitive cost of a licence.

Innovations in public finance lacking

We need to innovate, to increase government revenue, without trying to copy China. The 15th Finance Commission could be crucial in tweaking the transfer of resources to states and local government in a way which incentivises them to generate more local revenues. That is where a significant contribution to aggregate government taxes can be made, as suggested by the Economic Survey 2018-19.

Every Rs 100 spent from the budget can leverage an equal amount from the private sector.

The mantra for government spending is simple. Big ticket public development spending (both revenue and capital) must generate at least a similar level of private investment as extra-budgetary resources. Funding the premia for providing health insurance to 100 million poor families is one such scheme which can change mindsets and provide the forums for productive collaborations between the Central and state governments and the private sector. There is enough fat hidden away in the 2018-19 Budget to fund the scheme.

The National Health Insurance scheme can lead by using insurance permia to establish private or not-for-profit hospitals  

A ready market already exists — in urban and peri-urban areas, covering around 40 million poor families, as private hospitals are accessible. With an annual premia amount of Rs 20,000 crores, a similar sum as private investment can be leveraged in new healthcare facilities. Insurance companies, which will enjoy the bonanza of publicly-funded premia, will need to work with the healthcare industry to enlarge access to hospital facilities in under-covered areas. Similar state-level health insurance schemes should be allowed to lapse. States should divert their funds instead, to primary care, nutrition and public health.

Government should pull out of being the interface with citizens for service provisioning 

The government must, in a sequenced manner, pull out of the business of direct provisioning of services, except in disaster situations. Central,  state and local governments must learn to use the power of public finance to leverage private capital and management. A big push for outsourcing public services might be the only way to fill the financing gap between aspirations and today’s sordid reality.

Adapted from the author’s opinion piece in Asian Age February 13, 2018 http://www.asianage.com/opinion/columnists/130218/innovate-outsource-to-fund-deliver-services.html

Post-budget stocks – Storm-in-a teacup

bear

Those who live by the stock market must pay for their indiscretions. The stock market slid by 2.7 percent on February 2, 2018 – the day after Budget Day; by an additional 0.88 per cent on Monday, February 5, followed up by a further slide of 1.6% on February 6. in tandem with the global sell-off sparked by crashing US markets.

Its the Bond Market stupid?

Lazy analysis would pin the roil, in India, at the usual open-economy problem of capital flight to safety from small markets making them catch cold when the US sneezes. But a closer look tells a more granular story. Of course hot money will move about in search of higher risk adjusted return. So if the fed fund rate rises in the US to a 3% real return some foreign portfolio investors will move out. But consider that on a 6.5% growth and 4% inflation, the Indian stock market grew at 28% over the last year. There is plenty of room for the let the hot air out and still end up reaping a 8% real return in US$.

Media hysteria around the stock roil is over the top, as usual. Consider, if the stock market slid by 5.3% over three trading days post budget since Feb 2, the value which was lost was value added on since as recent as January 5, 2018 when the SENSEX was at 34154. On Feb 7 the stock market is roughly at the same level. India is high growth story with working markets. There are not many such markets available in the world where 8% returns in US$ are reasonable expectations.

Retail investors will rue their panicked selling

To be sure, panicked retail investors, who have sold their shares are the losers and heavy weight “bears” who drive markets by selling today and buying forward in the hope of buying back the same shares at a lower price, have gained. Note that even their capital gains till March 31, 2018 is free of long term capital gains tax. So bears have scored a double victory – taxless capital gains and re-purchase at a lower price. Brokers are also smiling because they make money of both sales and buys.

For small investors, the lesson is that despite the hype, what happens in the US stock market must not dictate their actions in India. Our markets rise and fall due to a variety of reasons- not just what is happening in the US. There is enough financial fire-power with domestic institutional investors to substitute, a temporary flight of foreign hot money to the US.

Domestic drivers of stock markets 

Stepping back here is an alternative story of why Indian stocks fell post budget.

Will inflation rear its ugly head again?

inflation 2

First, inflation fears arising out of the Budget proposals. The fiscal deficit this year has overshot to 3.50 per cent of the GDP, with no respite likely even next year. Mix this with the possibility of oil prices increasing further and the picture turns toxic.

Oil prices (Brent) started increasing from US$ 46 a barrel in end July 2017. They reached US $60, three months later, in end-October 2017. The high of US $70 came in mid-January 2018 with a subsequent cooling off to US $68 per barrel this week.

Consumer price inflation in India, was at 4.5% in 2016-17. Thereafter, it declined through the first half of 2017-18 but increased to 4.9 per cent in November 2017. But food prices tapered off, so 2017-18 is likely to end, with a similar inflation level as 2016-17.

Note that crude oil price increase during the second half of 2017-18, of around 50 per cent, has not directly fed into Indian inflation because government passes only a marginal proportion of crude price changes to final consumers.
2017-18 was a perfect storm. Growth reduced by at least 1 per cent due to the shocks of demonetization and introduction of the GST. These negatives have abated. Direct tax collection this year is 2.5 per cent higher than budgeted. Next year they are budgeted at 14.4 per cent higher than receipts this year. Receipts from GST next year are budgeted at 54 per cent higher than this year. These positives illustrate that broad fiscal stability around 3.5 per cent of GDP is possible, even if crude oil continues to trade at $70 in 2018-19.

Fiscal policy in 2017-18 has prioritized putting income in the hands of consumers – government pay and pension hikes; pro-poor income support (MGNREGA) and farmer income support at the expense of publicly financed investment in infrastructure. More income with consumers creates aggregate demand for better utilization of the surplus manufacturing capacity. Reviving exports – driven by an uptick in world trade – will also absorb some surplus capacity and create value. Inflation fears are consequently overblown.

Global ques only deepen domestic bearish trends.  

Second, the big bear of multiple increases in the US Fed funds rate, to cool an over-heating domestic US economy, has been looming over developing markets. Last week Bond prices fell, pushing up yields in US and Europe, in anticipation of increases in the fed rate. However, yesterday, bond yields pulled back up.  The signals are unclear. More likely it is domestic drivers which are punishing markets.

India has uncovered financial fire power post the crack down on cash and carry

Third, we have a large community of around 40 million domestic investors in our stock markets. Around Rs 1 trillion flooded stock markets, post demonetization, as the earlier mouth-watering returns in realty and cash and carry trade dried up in January 2017. Savvy intermediation by mutual funds and portfolio management companies facilitated the switch into financial assets by investors.

Churning your portfolio helps your broker more than you

But most investors buy and sell based on trust, led by their share brokers. These market participants are likely to have advised investors to sell and book their capital gains in anticipation of the long-term capital gains tax (10 per cent of capital increase) being imposed on all equity sell trades from April 1, 2018.

This advice is flawed since it ignores provisions, sensibly introduced by the Budget, of “grandfathering” capital gains till February 1, 2018. It makes little sense to sell in a turbulent market, unless you desperately need the money. But who can shake an investor’s faith in their trusted share broker -who incidentally, earns a fee on both the sale and the re-investment in – what else but shares!

Government needs to steer the ship of state steadily- no surprises please

The recent experience with demonetization has not helped. Uncertainty in financial arrangements is crippling and its trauma lingers. Under such circumstances, rumors acquire an undeserved potency, over reason.

Fall out of imposition of dividend distribution tax in FY 2018-19

Fourth, treasury management requirement of mutual funds, particularly for their “dividend based” schemes, could also have prompted a sell off. The budget has proposed a 10% dividend distribution tax on equity mutual fund schemes, to level the tax imposition on capital gains (the basis for investor earnings in growth-oriented schemes) and dividend distribution (the basis for investor income in dividend-oriented schemes). Mutual funds will try and distribute the maximum dividends to their investors, in this fiscal itself, to save them the tax imposition next fiscal. This requires mutual fund to sell equity holdings to generate the cash required.

At the risk of gross simplification, 60 per cent of the sell-off, of around 3.5% of market capitalization till close of February 5, 2018 was due to investor uncertainty about future taxation and the treasury needs of mutual funds. Inflation fears possibly drove 25 per cent of the sell off, whilst global cues were responsible for the residual 15 per cent. The good news is that this sell off is temporary. Stock markets are now back to, where they were just a month ago on January 5, 2017. A mere storm in a tea cup, created by investor exuberance in anticipation of a “please all” budget.

Buying into India’s growth story will recover the tax you pay though growth

lioness

So, hang onto your shares and count your blessings over time. If you hold an equity portfolio of Rs 20 lakhs, an 8 per cent dividend payout of Rs 160,000 will attract a tax of just Rs 16,000 – easily absorbed by postponing purchase of a microwave oven. In the case of additional capital gains, over and above the higher of the purchase price or the market price of the share on February 1, 2018 –-assuming a gain of 15 per cent or Rs 300,000, is just Rs 30,000. Making do with the existing car tyres would do the trick. Anyway, eating out and taking the metro or a taxi are rational and possibly pleasurable substitutes.

Adapted from the authors opinion piece in Indian Express on February 6, 2019 http://indianexpress.com/article/opinion/post-budget-uncertainty-global-cues-drives-market-selloff-5053028/

Tag Cloud

%d bloggers like this: