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Archive for the ‘Tax’ Category

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

What the cash crunch foretells

Parliament's winter session

Conspiracy theorists are hard at work to identify the drivers behind the ongoing cash crunch, that has left the automated teller machines (ATMs) in cities and towns across large parts of the country dry. There is much finger pointing between the Reserve Bank of India and the commercial banks, both private and public sector, each accusing the other of being responsible for inefficient operations. It is unusual to see this level of discord, bordering on acrimony, between a regulator and the regulated entities.

Commercial banks bear the brunt of fuzzy policy objectives

The banks allege that the supply of high-value notes has dried up. The Bank Employees Union alleges that a shortage of imported printing ink at the currency press in Nashik could be one reason. Alternatively, this could be a covert attempt by the government to correct a problem dating back to the November 2016 demonetisation — the incomprehensible introduction of a Rs 2,000 note to replace the Rs 1,000 note as a measure to reduce black money. Phasing out the offensive new high-denomination note and stepping up the printing of new Rs 500 and Rs 200 notes instead is a more obvious and welcome blow against black money. The Ministry of Finance says Rs 70,000 crores worth of such “Hi-Value” notes can be printed in just one month. The value of such notes in circulation on March 31, 2017 (the last public data available) was Rs 7.5 Lakh Crore or ten times the value of such notes printable in just one month. So why a shortge ?

RBI waffles with poor communication

The Reserve Bank, unconvincingly, denies that there is any cash crunch and alleges the inefficiency of banks in properly allocating the available cash. Could this be a surgical strike by the banks and ATM service providers who have got unsettled by the criminal investigations into fraud or are upset with the March 2018 decision of the RBI to end the incentives for installing cash recyclers and ATMs for low-value notes? Was it their intention to embarrass the government by engineering a cash crunch to coincide with Prime Minister Narendra Modi’s visits to Sweden and the UK for the Commonwealth Summit? Possible, but far-fetched.

Cash remains king

cash is king

The most plausible reason is that the economy is reverting to its pre-demonetisation levels of cash held by the public of around 12 percent of GDP versus the hugely constrained post-demonetisation level of 9 percent of GDP in end of March 2017. Expectations were exaggerated on two counts. First, that the black economy would permanently be reduced. Second that digital and banked transactions could become uepreferred options. The second has indeed proved true. The use of cash by those who declare their incomes to tax, or even those below the tax levels, has reduced significantly.

But the big stick and carrots embedded in the Goods and Services Tax to incentivise the switch to banked transactions are not widely experienced yet. Systems and reporting compliance are clunky and curiously disadvantage the small, honest entrepreneur. Other small businesses may be unviable with a tax load.

RBI – bitten by the bug to ration currency, & create the “statistical” basis for “digital victory” 

Anecdotal evidence of how cash transactions are done show that post demonetisation, Rs 2000 has replaced the earlier Rs 1000 note as the preferred stock of currency held by high value entities and individuals. Unfortunately, RBI has squeezed the printing of this note. Prior to demonetisation, for every Rs 1000 note available, there were three Rs 500 and three Rs 100 notes. Post demonetisation, for every Rs 2000 note available, there are eight Rs 100 notes but just two Rs 500 notes available. RBI has curiously enlarged the relative supply of the highest value note (which is used mostly for individual stock of currency)  at the expense of having more transaction related currency in Rs 500 notes- possibly hoping that transactions would move to digital rather than remain in cash post demonetisation.

More importantly, not only has the overall quantum of currency, relative to GDP decreased, but even the share of Rs 500 and Rs 2000 notes, by value, in the total stock of currency has decreased, from 86 percent pre-domentisation to 73 percent in end March 2017 – possibly in expectation of individuals banking surplus stocks of money.

The ground reality is that the cash-based supply chain of goods and services is a subset of the demand for cash contributions, related to electoral politics. Highly contested elections are scheduled for mid-May in Karnataka and later this year in several other states. Cash resources will be needed to buy SUVs, print advertisements and motivate the lethargic population to vote.

Election Commission hesitates to adopt T.N. Seshan’s (ex-Chief Election Commissioner 1990-1996) muscular credo on mandate

ECI

Oddly, there is not a peep out of the Election Commission of India (ECI), which is charged with the responsibility of ensuring that election spending remains within the implausibly tight limit of Rs 20 to Rs 28 lakhs per candidate for Assembly elections. The EC has adopted an “end of the pipe” strategy. The intention is to catch the crooks once they show their hands via excess expenditure. A more proactive EC could have recognised the red flags of unusually high cash withdrawals unearthed by the media. It could have directed the Karnataka government to report on the ensuing potential for subversion of the code of conduct and the measures being taken to heighten border vigilance, to clamp down on cross-border transfers of cash. One can imagine former chief election commissioner T.N. Seshan diving through this open door for enhancing the regulatory ambit of the ECI. But today’s election commissioners appear to be content, at least overtly, with a narrower definition of their mandate, strictly as per the law.

RBI – a regulator at odds with its “caged parrot” status 

To speak the truth, the glory days of Indian regulatory institutions are over. Even the RBI, the first to be legislated into existence in 1934, is going through strained times. Demonetisation had spread the apprehension that the RBI was led by the nose from North Block in New Delhi. The extent of wilful defaults in the bad loans of public sector banks, often the consequence of ever-greening of impaired assets and plain fraud, also points a finger at the RBI for exercising inadequate oversight.

RBI governor Urjit Patel had appealed to the government through a public address on March 16 to bring public sector banks into a uniform regulatory arrangement as applicable to private banks. Domestic and international professionals support the broad thrust of a uniform regulatory arrangement for all banks. But the subsequent expose of the yawning deviations in ICICI Bank and Axis Bank from gold-standard board governance have cut the ground from under the governor’s feet.

Public credibility of commercial banks at its nadir

Mutual funds are upbeat about the prospects for equity investment in private banks. But the average person is inclined to quietly diversify away from private banks to the safe haven of public sector banks. Private insurance and healthcare are similarly perceived as being exploitative of the average consumer. It does not help that the Financial Resolution and Deposit Insurance Bill 2017 was worded so ambivalently that it fanned a deep seeded fear of savings deposits being sequestered as equity for resolving bankruptcy. Finance minister Arun Jaitley has been at pains to assure people that deposits up to Rs 1 lakh per account will remain guaranteed. But ministerial assurances provide very little comfort when elections are around the corner.

A common thread across this turbulence is uneven support from the government for beleaguered institutions and the absence of informed participation, quite unlike in the GST Council. RBI governor Patel bravely sat out the storm around the hasty implementation of the questionable policy option of demonetisation. But the Pandora’s box of crony capitalism has taken its toll. These are challenging times. Deeper bench strength, within the government, of trusted fiscal and financial expertise would help.

Adapted from the authors opinion piece in The Asian Age, April 21, 2018 http://www.asianage.com/opinion/columnists/210418/what-the-cash-crunch-foretells.html

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/

FM walks the budget plank gingerly

happy kisan

The Union Budget 2018-19 appears an honest and judicious construct when first viewed on video. Reading the fine print takes some of the shine off, going by precedent. The biggest relief is that there has been no substantive deviation from the path of fiscal discipline. The fiscal deficit for 2017-18 is pegged at 3.5 percent of GDP. This is 0.30 per cent higher than the budgeted estimate for this year.

But it is well within the 0.50 leeway recommended by the N.K. Singh Committee report on Fiscal Responsibility and Budgetary Management. Disruptions caused by GST still linger. Banks need to be recapitalised to expand new credit and public investment pushed because the private sector is still sitting on its funds. The stage seems set for walking through the door opened by the FRBM committee, in the interest of growth and jobs.

More reassurance comes from the fiscal deficit target for 2018-19 set at 3.3 percent of GDP. This re-establishes the declining trend for fiscal deficit towards the magic number of three per cent of GDP, which has eluded us so far.

Marginalised agriculture gets a break 

On the expenditure side, agriculture and rural development take centrestage. This is welcome against the backdrop of agrarian distress and farmer suicides. Ajay Jakhar of the Bharat Krishak Samaj points out that an Indian farmer commits suicide every 40 minutes. No wonder then that Mr Jaitley outlined, in great detail, many of the specific measures proposed to reverse this trend.

One popular, but possibly ineffective step is an assurance that all the crops notified for the kharif cycle will be covered under the minimum support price (MSP) scheme. This means that if market prices fall below the cost of production plus 50 percent as margin for the farmer, the government will stand committed to make good the difference (as is being done in Madhya Pradesh now) or to physically procure the produce.

Ajay Jakhar

But representatives of farmers’ interests are not satisfied. They want the methodology for setting costs should be spelt out in a participative manner to ensure that a meaningful MSP is assured. The downside of an MSP type of production incentive is that it kills innovation and discourages crop diversification away from those covered under MSP. This way of assuring farmer incomes also privileges the traditional “Green Revolution” areas in the North, which unfortunately are not well endowed with the natural resources — water, for example — to sustain intensive modern farming. On the other hand Eastern India, has all of nature’s bounties, but it is too far away from the national capital-oriented policy making we follow. Consider how different things would have been if Lord Hardinge had not decided in 1911 to shift the capital of the British Raj from Calcutta to Delhi.

Agro-products exports to be liberalised – $100 billion potential

Other big-ticket items in agriculture are a more than doubling of the outlay for agro-processing industries to Rs 14 billion and assurances that the export of agri products would be liberalised to boost their exports threefold to their potential of around $100 billion. Corporate tax on income was also reduced from 30 percent to 25 percent for firms with a turnover upto Rs 2.5 billion (US $35 million) benefiting 99 percent of the registered firms in India.

Bamboo the new “green gold”

bamboo2

For the Northeast, a Mission for Bamboo – now recognised as a grass and not a tree to facilitate its commercial cultivation – with an outlay of Rs 13 billion. Two new infrastructure funds — one for fisheries and aquaculture and another for animal husbandry — at a total outlay of Rs 100 billion. Crop credit would increase by 10 per cent to Rs 11 trillion in 2018-19 and lessee farmers would be facilitated to access crop credit from banks — something which they cannot do today and have, instead, to rely on rapacious moneylenders.

The budgetary outlay for rural roads, affordable houses, toilets and electricity extension of Rs 2.4 trillion will leverage five time more funds from other sources and generate work for 10 million people, per the Budget documents.

NamoCare is bigger than ObamaCare – health-equity in motion

Big changes were also announced in healthcare. A new flagship scheme will provide in-hospital medical insurance to 100 million poor families with an insurance cover of Rs 5 lakhs. Compare this with the measly cover now available of Rs 30,000 only under the Rashtriya Swastha Bima Yojana. The outlay on health, education and social protection increases by around 13 per cent over the 2017-18 spend to Rs 1.4 trillion. Simultaneously, the three publicly owned general insurance companies – National Insurance Company United India Insurance Company and Oriental Insurance Company are to merged to create a behemoth conservatively valued at Rs 4 trillion and listed on the stock exchange. Listing would enable the government to progressively hive off equity in them to the public and generate the estimated Rs 1 trillion per year premium to fund this mammoth programme, nick-named NamoCare after ObamaCare of the US. The scale of the ambition embedded in the program is breathtaking. A Rs 5 lakh cover is what even the well-off deem sufficient as health insurance. More importantly it signals that for the government the life of the poor is as valuable, as that of a well off person.

Incentives for generating employment rather than buying machines

The government proposes to extend the existing scheme under which it meets the cost of a contribution of 12 percent per year towards the Employees’ Provident Fund contribution in the medium, small and micro enterprises to all the manufacturing sectors. The idea is to increase the attractiveness of employing young job seekers by reducing their cost to the employer for three years, by which time it is expected the skills they acquire will make their value addition viable on its own.

Infrastructure development – falling short

The highlights for new projects in infrastructure are that 99 smart cities have been selected with an outlay of Rs 2.4 trillion,  against which projects worth around 10 per cent of the outlay are ongoing and projects worth one per cent of the outlay have been completed. The government expects to complete 9,000 km of highways in this year. Bharat Net, the fiber connectivity programme, is also proceeding apace. The Railways will spend Rs 1.48 trillion on capital investments, mostly in new works in 2018-19. Six hundred railway stations are to be upgraded.

The nominal GDP in 2018-19 is estimated to be 11.5 per cent  higher than in the current year. The total expenditure next year is around 10 per cent higher than the estimate for 2017-18 of Rs 22.2 trillion. On the revenue side, the big increase is an estimated increase of 53 per cent (after accounting for the fact that GST was collected only for 11 months in 2017-18) in GST revenues next year by around Rs 2.6 trillion to a level of Rs 7.4 trillion, and a conservatively assessed Rs 20,000 crores from the new capital gains tax of 10 per cent on equity sold after holding it for one year. The huge increase assumed in GST and the undefined budgetary support for “NamoCare” make sticking to the 3.3 fiscal deficit target a bit dodgy in 2018-19.

FM keeps his gun-powder dry and in-reserve

Jaitley budget 2018

But who knows, maybe the finance minister has some artillery hidden up his sleeve.. Disinvestment has been assessed conservatively in 2018-19 at Rs 80,000 crores, against the achievement this year of Rs 1 trillion. The bank recapitalisation support of Rs 80,000 crores is expected to leverage new lending capacity of Rs 5 trillion. One cannot but  feel that some of the expenditure estimates are a bit conservative relative to the ambition embedded in the programmes.

The good news is ending 2018-19 with a higher fiscal deficit but equal to this year’s at 3.5 per cent is no big deal from the view point of fiscal stability, if all of it is pumped into infrastructure and other investments. But for the Narendra Modi government, which takes targets seriously, it would be an unhappy ending.

The blog and the article mistakenly mention the estimated value of a merged insurance behemoth as Rs 400 trillion. The error has now been corrected in the text. I am deeply embarrassed by this snafu. A more reasonable number is Rs 4 trillion. Regrets.

Adapted from the authors article in The Asian Age February 1, 2018 http://www.asianage.com/opinion/oped/020218/fm-walks-the-talk-honestly-and-judiciously-but-very-diffidently.html

Fiscal 2019 -what the tea leaves foretell

Jaitley Adhia

The four years since 2014 have been chock-a-bloc full of fiscal and financial reforms. India needs a rest from such frenetic reforms. It’s time to take a deep breath, consolidate and pull all the loose strings together. One hopes that fiscal 2019 (April 2018 to March 2019) is devoid of breaking news, dull as ditchwater but fulsome in terms of outcomes.

Full marks for restoring fiscal stability

The most successful reform of the Narendra Modi government has been the restoration of fiscal stability. The Union government’s fiscal deficit is down to the targeted 3.2 per cent of GDP this fiscal (2017-2018), from a high of 6.5 per cent in fiscal 2010, post the 2008 financial crisis. The revenue deficit has similarly trended down to 1.9 per cent of GDP. Consumer price inflation has been tamed at sub four per cent. This achievement burnishes the credibility of the government’s fiscal management.

State governments get a bigger share in revenues, now also spend more

Significantly, fiscal discipline was enforced despite a reduction in the net tax resources. The 14th Finance Commission had enlarged the share of state governments, in the divisible pool of Central taxes, to 42 per cent from 32 per cent effective from Fiscal 2015. State government expenditures have consequently increased rapidly.

State governments now collectively spend 87 per cent more than the Union government (Mishra and Singh, NCAER 2017) compared to just six per cent more in 2011. Some of the increase was due the UDAY scheme for restructuring electricity utility by state governments absorbing their debt of around Rs 1.4 trillion, in 2016 and 2017. The collective state government fiscal deficit ballooned from less than two per cent in 2012 to nearly 3.5 per cent of GDP in 2016.

Tax receipts have been stagnant at 11 percent of GDP

Tax receipts have been a traditional fiscal Achilles heel. Union government tax receipts are near stagnant at around 10 to 11 per cent of GDP. State governments additionally collect six to seven per cent of GDP as taxes. But there is a silver lining now. The Goods and Services Tax is likely to disrupt this placid tax regime, because it introduces positive incentives for paying taxes via the tax credit provisions. Honing the multiple GST rates to the specificities of India’s political economy will remain an ongoing exercise. Once the tax revenue stabilises, the government could consider reducing the multiple tax rates, thereby harnessing the efficiency gains of simplification.

Direct tax collection over the first three quarters of 2017 grew at 18.2 per cent over the previous year, versus a target of 15.7 per cent, courtesy the clampdown on cash transactions. India’s direct tax rates are not extortionary. There is little scope to provide tax breaks. In fact, existing tax breaks could be ended, like those for capital gains on equity held for just one year. The stock markets are defying gravity. So, this is a good time to tax capital gains.

A tax on capital gains in equity offers revenue potential

It is nonsense to argue that taxing capital gains on equity is double taxation because corporates already pay tax on income. Yes, taxing dividend distribution is double taxation and wholly unjustified without allowing credit on the corporate tax already paid. But capital gains relate to the market value of a share – which has many more determinants than the book value of the share. Taxing capital gains on equity also aligns with reducing inequality.

But more generally, a consistent rules-based, capital gains regime across asset classes is required. The current tax rate on long-term gains, other than equity, is 20 per cent. Short-term gains are taxed at the applicable income-tax rate. The case for taxing capital gains at a lower rate than income, is sound — it provides an incentive to take risk and invest. Inflation indexation of the capital gains and a common tax rate of say 10 per cent — across asset classes, would be eminently sensible.

We could step up social sector expenses if only private investment built infrastructure

India spends very little on education and health. While throwing money at either is not guaranteed to improve services, low allocations are a serious constraint. More fiscal space could become available for social sector spend, if private investment and management could do the heavy lifting in infrastructure and manufacturing. State-owned enterprises are strewn across transportation, telecommunications, power, coal, oil and gas, steel, metals and other minerals. Nearly all could usefully be privatised and the capital receipts utilised more gainfully in core sovereign areas. But India’s political economy has, for long, enshrined the perks and patronage, derived from public ownership of industries, as the fruits of being in power.

What about the quality of expenditure? Capital expenditure lagged, and revenue expenditure surged during the period 2010-11 to 2014-15. Under the Modi government this trend has reversed. Capital expenditure has increased from a share of 12 per cent till 2014-15 to 14 per cent. Simultaneously, the Central revenue deficit has decreased from 3.1 per cent of GDP in fiscal 2014 to 1.9 per cent in fiscal 2018.

But private investment has dried up from fiscal 2016. Plagued by 14 per cent of stressed loans, banks focused on damage control adversely hitting new lending. The “twin balance sheet problem” of banks and their defaulting borrowers needs faster summary resolution for results.

Solutions must be found for alleviating poverty — one-fifth of our citizens remain poor and another one-fifth are vulnerable to poverty from shocks. Inequality is increasing. This reduces aggregate demand in the economy. Demonetisation and the attack on corruption has subdued consumption and investment, till businesses adjust to the new operational constraints.

80% of the poor live in rural areas – income support can increase demand

There is a general expectation of sops from Budget 2018-19 in view of the impending elections. Finance minister Arun Jaitley is sure to resist this temptation. However, he might be tempted to withdraw subsidy benefits from urban areas, where incomes are higher and employment more easily available. The subsidy burden on food, cooking gas and fertiliser is an unsustainable two per cent of GDP — principally because it is badly targeted and inefficiently spent.

Rural distress and poverty far exceeds that in urban areas. Indeed, entrepreneurial rural folk access urban areas for employment, medical help and higher education. In rural areas, a phased switchover to direct cash transfers for BPL families is required. This will stimulate rural markets, provide flexibility to the beneficiaries and reduce the deadweight loss of high transaction costs.

whale spout

The finance minister is fiscally bound this year, not least because the GST is performing below expectations. He should frankly admit that the economy needs breathing time, before the numerous reform steps deliver results. In the meantime, keep breathing, if you can.

 

 

Adapted from the author’s opinion piece in The Asian Age January 22, 2018 http://www.asianage.com/opinion/columnists/220118/reading-the-tea-leaves-as-fiscal-2019-looms.html

Fiscal 2018-19: Revive shared hopes

shared growth

Normally, the fate of the next fiscal is sealed even before the year begins. Barring windfall gains, the economic engines of value addition are quite stable — business keeps running and salts away its surplus; the government similarly keeps churning out public goods; and individuals — particularly us Indians — keep squirrelling away something for a rainy day, even out of our meagre earnings. But who can predict shocks?

But India is vulnerable

oil 2

India remains very vulnerable to external shocks — changes in the price of oil, the monsoon, the cost of guarding against external aggression, the state of the world economy and domestic events — more specifically elections, as these take away whatever mindspace the politicians have for sustainable development.

Fiscal 2019 will be election fodder

Fiscal 2018-19 is littered with state-level elections followed by the national general election in the first quarter of the next fiscal. Consequently, expect “plug the hole” type of fiscal tactics to be rampant in the government. Borrowing from banks to invest back in them is one such tactic to stick to the targeted fiscal deficit. Borrowing long but promising to liquidate short-term liabilities is another. This is great fiscal accounting. But that’s where it ends.

Growth data just one metric of government performance

There is a world, beyond the fiscal math, in which we all live. Did you feel the change economically in 2014-15 when economic growth jumped from 4.7 per cent in 2013-14 — the last year of the UPA government — to 7.4 per cent — a jump of nearly three percentage points?

Narendra Modi

Yes, our hopes soared with Narendra Modi’s elevating optimism and high energy. Yes, he made us believe in the future. We felt that we had put a large part of our colonial baggage behind us. But at the ground level, nothing much changed because GDP growth data is just that — numbers which are useful for nerds to track policy impacts and take corrective actions. It’s like the speedometer on your car. It can tell you when you rev up or slow down. But it tells you very little about when you will get to your destination. So please don’t tie your dreams to data. Treat it with the caution it deserves.

Ignore rarified metrics – the stock market & growth, focus on your economic reality

Fiscal 2017-18 will end with a real GDP growth of 6.5 per cent, helped by low inflation, versus 7.1 per cent last year. If you didn’t notice the upswing in 2014-15, you are unlikely to be substantially affected by this year’s downtick. Or for that matter by the uptick to seven per cent growth next fiscal, as the “satta market” for growth (if there is one) would predict. The stock market valuations, as measured by the Sensex, rose by 29 per cent over 2017 with just 6.5 per cent growth. Consider also that the market capitalisation of the top 10 family-owned business groups rose by 46 per cent. Clearly, the business biggies don’t live or die by GDP growth data, so why must you? Far better to hone your own tunnel vision of the economy — real stuff which matters to you, and leave growth rates to the genteel debates between the macro policy wonks.

Telescope 2

If you are one of the 20 million students graduating next year, judge the health of the economy from the availability of jobs. For 118 million farmers, who eke out a living on land holdings of less than two hectares, keeping a lookout for the timing and adequacy of the monsoon means much more than GDP growth. For 21 million large and medium farmers, who account for the bulk of the surplus food grain produced after meeting the needs of the family, it’s the government’s minimum support price for your produce, the cost of fertiliser and availability of water and electricity, which will determine your well-being. The point is that each of us has a specific reality which is only loosely tied to the GDP growth data.

Tying our well-being to the GDP growth rate is seeking false comfort when the numbers rise and equally false despair when they fall. The last two fiscals have been costly. Demonetisation in the third quarter of fiscal 2016-17 and implementation of the Goods and Services tax in this fiscal year were both major disrupters for businesses and their employees. But these are behind us now.

Reduce income tax rates at the lower slabs to compensate for tax reform related pain  

Over time, business entities who survived earlier by not paying tax will disappear. They will be substituted by more efficient, possibly scaled-up substitutes. But all that will take time, well beyond the next two fiscal years. Till the efficiency impacts of tax reforms kick in, the government must take steps to insulate citizens from the pain, just as it held state governments harmless — by insuring them against a fall in their tax revenues.

Paytm

Citizens, particularly those who took to digital payments and bank transactions with gusto, find they now pay, not only the GST, but also the income tax (possibly never paid before) of the seller. Direct and indirect tax rates must be reduced to keep household budgets stable, till the efficiency impacts of tax reforms kick in.A fiscal bridge is necessary.

Overshooting the fiscal deficit target is ok to preserve capital outlay

Reforming governments factor in fiscal turbulence. If reform translates into collateral pain for consumers, it is dead in the water. We are battling a perfect storm of reforms — restoring the health of banks; reforming the tax structure to improve compliance while reducing transaction costs and dealing with the additional costs of mitigating climate change. It can’t all be done painlessly.

This pain must be shared. The government must abandon its managerial instinct to stick to the budgeted fiscal deficit target of 3.2 per cent this year — in fact it already has. For the next fiscal, the “glide path” for the fiscal deficit must be kept stable, as advised by the majority opinion in the N.K. Singh Committee on Fiscal Reform. Even at 3.5 per cent, the fiscal deficit will be 15 per cent (0.6 basis points) less than the 4.1 per cent achieved in 2013-14. When the facts change, one must change one’s opinions and tactics. That’s the way to shared growth.

Adapted from the author’s opinion piece in The Asian Age, January 6, 2018 http://www.asianage.com/opinion/columnists/060118/be-flexible-on-reforms-ensure-pain-is-shared.html

Aadhaar – catching crooks & criminals

UIDAI members

The Aadhaar fever started in 2009, when the UPA government was in office. It encountered turbulent times in 2014 when the government changed. But Prime Minister Narendra Modi, a technology enthusiast, was persuaded to look beyond the past at the opportunity it gave to reduce official discretion and corruption, whilst targeting and delivering public services.

Inspirational achievements: Speed, scale, low cost & sustainable institutions

The results have been impressive on three counts — speed, cost and sustainability. First, the system was scaled up at breathtaking speed. Around 15 citizens were digitally registered every second, over seven years, assuming a 60-hour week.  Registering 1.2 billion residents out of around 1.3 billion, in a country spanning 3.3 million sq km is by itself a “never- before” achievement.

Second, unbelievably, this feat was achieved at a nominal cost of Rs 73, a little more than $1, per person. The norm for biometric identification anywhere else has been at least $10 per person. Clearly, frugal Indian innovation was at its best here.

Third, Nandan Nilekani, the single parent of Aadhaar, moved on in early 2014, serially to politics, social impact ventures and today heads Infosys as its non-executive chairman. Small, effective public institutions — UIDAI had a sanctioned staff of just 115 in 2009 — tend to be helmed by charismatic banyan trees — leaders who allow nothing to grow under their horizontally spread branches. But the Unique Identification Authority of India (UIDAI), which he first headed, continues to flourish, which speaks volumes of its sustainable management systems and the quality of successor chairpersons.

Why, then, the angst?

So why then the public angst against Aadhaar? Three reasons come to mind — all of them related not to the technical effectiveness of the system itself but the manner in which it is proposed to be used.

Illegal immigrants are rich political fodder

First comes politics. Illegal immigrants from Bangladesh — between three million to 20 million — along with legal immigrants from Nepal, have acquired voter IDs and ration cards. They are difficult to distinguish from their neighbours. But it has also suited the government politically, till now, to not identify such immigrants. Aadhaar can upset political calculations. Targeting Aadhaar at residents — a more inclusive genre — than citizens was a compromise solution. But the threat remains that this powerful data set will feed into culling voter lists of duplicates or ghosts and weeding out passports wrongly issued to people who were never Indian citizens.

We are all “crooks”

Second is the scale of disruption associated with ending corruption. Consider that 14 per cent of Indians, or 180 million, have a driving licence. But one-third are fake and many more are improperly given to ineligible drivers — a key factor in road fatalities.  290 million Indians have a unique number called PAN, required for filing income-tax. But 80 per cent are not authenticated with the Aadhaar database. This illustrates the poor integrity of the tax database.

Big bang reform catches headlines but induces a push back

Third, managerial ambitions have outrun executive caution in graduating the pushback from those adversely affected. From being a back-office tool, Aadhaar has become a digital shortcut to cull ghosts from the burgeoning food security scheme; weed out manipulations in income-tax submissions; introduce a security check over phone connections or use big data to link bank accounts, phone numbers, vehicles, houses, financial investments with each biometrically identified individual. Aadhaar is the shortcut to dig out our dirty secrets. And no one likes that.

Protection needed against low data integrity at time of issue & poor connectivity for authentication of Aadhar

aadhar center

Section 7 of the Aadhaar Act 2016 specifies that Aadhaar shall not be the sole arbiter of identity for accessing public benefits.  Section 5 makes it obligatory for UIDAI to get those, who lack identity documents — children, women, the specially-abled, senior citizens, workers in the unorganised sector, nomads are mentioned — covered under Aadhaar by other means. The intention is clear. The State must devise methods to include all residents in the database and ensure, till then, that the flow of public benefits to eligible recipients continues uninterrupted. Similarly, the onus for protecting the privacy of the individual is on the State. The government has no option except to align with the law. Indeed, it seems to have already diluted its hard stance on the timeline for the implementation of Aadhaar.

Rolling back or stalling the program a poor option

Two options present themselves for the way forward. First, the government could downsize its ambitions for Aadhaar and allow other modes of identity verification to continue till the availability of Aadhaar becomes universal and, more important, the hardware for authenticating Aadhaar is widely available. This is unlikely, in the short term, till the Bharatnet fibre cables have been laid and are operational in all gram panchayats. Just one-fourth are connected today. But the more real downside here is of a slide into never-ending inertia. This seems alien to the present government’s style.

Prescribe fall-back identity authentications with better oversight over the quality of initial data capture 

AAdhaar alt

The second and better option is to deal with the fears of activists who have petitioned the Supreme Court against linking bank accounts and phones with Aadhaar. With respect to privacy, the fact that the State will be able to trace individuals behind phone conversations or bank accounts seems innocuous. On the contrary, both security and tax revenue considerations point to this being desirable, if not essential.

Better branding: disseminate tax and security advantages of Aadhar widely

The government has advertised the Aadhaar principally as a means to transfer benefits to citizens in a more targeted manner and thereby optimise the public subsidy on such benefits. But this is only part of the story. Aadhaar is a significant tool in increasing tax revenue and bringing criminals to justice. What is in it for those who do not enjoy social security benefits? They must be made aware of how Aadhaar creates a trade off between privacy on the one hand and public finance and security on the other. It must be re-branded as a broad governance tool. It should take a cue from what President Obama said about privacy concerns. No individual right, against the State, is perfect. It must needs bow to the larger public interest.

Theoretically, any information, available with the State, can be misused to violate the privacy of an individual. But surely an income-tax officer using the Aadhaar authentication to check if you have included all your bank accounts in your tax return does not fall in that category. What about a duly authorised police officer who traces the owners of phone numbers talking about crime or a threat to public security? Protocols for tapping phones and accessing details of private bank accounts already exist. The Aadhaar link simply makes it easier and faster to catch crooks and criminals.

recovery ITGovernments rely on their credibility to gain the trust of citizens. Safeguards for individual rights do help. But only for governments that are public-spirited and well-intentioned. Once this is no longer the case, the only recourse is to voice your opinion through your vote, and good luck to you on that.

Adapted form the author’s opinion piece in The Asian Age, December 13, 2017 http://www.asianage.com/opinion/columnists/131217/aadhaar-fever-unveiling-secrets-to-secure-india.html

Moody God of bond markets

bond_mesopotamia_

The international bond market, with an outstanding volume of around $22 trillion, is the final arbiter of a country’s destiny. Bonds, unlike loans, can be traded, or “marked to market”. This makes trustworthy credit ratings, like Moodys’, critical to give pricing signals. Since there is a market, even discards are recycled. Discards are called “junk” bonds. Their outstanding volume is $1.3 trillion. They are traded at insanely high returns up to 12 per cent per annum as compared to AAA-rated bonds, where the yield is just four per cent. India had an investment grade rating of Baa3, which Moodys upgraded, on November 17, to Baa2 (stable outlook).

Rating the sovereign

A sovereign credit rating reflects the country risk. It serves as a “glass ceiling”. Bond issuers from any country can never have a credit rating higher than their country’s rating. India has not issued a sovereign bond overseas thus far. But government-owned companies and private entities access the international bond market. This is one reason why the rating upgrade is welcome.

It is a win-win for India. The upgrade increases the incentive to invest in India. The Reserve Bank must be vigilant to sanitize the potential of such inflows to strengthen an already-overvalued rupee, which is hurting export competitiveness. But our stock market is already inflated in the aftermath of demonetization by the surge of domestic savings, seeking refuge from a dull realty market.  This may dampen the inflow of “hot money”.

Sovereign rankings

The upgrade pulls us ahead of Italy (negative outlook) and level with Uruguay, Colombia, Spain, Bulgaria, the Philippines and Oman. We remain behind Panama, which has a positive outlook and can be upgraded to Baa1 to join Thailand, Mauritius and Slovenia. In the next level (A3) are Mexico, Malaysia, Peru, Latvia, Lithuania, Malta and Iceland. China floats high above at A1 — four rating segments above us.

Unpacking the Moodys rating

The Moody’s rating methodology is complex. First, a country is fitted into one, of three possible levels, for each of the 25 indicators. These are then aggregated into 11 sub-factors using assigned weights. The sub-factors in turn are aggregated into four factors using assigned weights. There is a mechanism to “fine-tune” the final rating using qualitative assessments – this is where confidence-building measures help.

Massaging the numbers

The highest weight — 50 per cent — is for the risk probability of default on interest payment or redemption of the bond. Risk is assumed to increase with higher levels of income inequality and lower scores on the World-Wide Voice and Accountability index (both reflective of political stability); higher reliance on external debt; higher borrowing need relative to revenue; weak banks; imbalance between foreign exchange receipts and expenditures and higher reliance on foreign investment.

Fiscal strength gets a weight of 25 per cent, related to lower nominal and trend line of debt to GDP levels and lower interest payments relative to revenue and to GDP.

Institutional strength has a of weight 12.5 per cent. Countries scoring higher in the World-Wide Government Effectiveness index; the Rule of Law index and the Control of Corruption index get higher marks.

Economic strength has a weight of 12.5 per cent. Higher real growth with lower volatility of GDP; higher nominal and per person national income and a better score on the World Competitiveness Index all ensure higher scores.

Labouring through this long explanation of the methodology becomes rewarding because it points us to a prioritised pathway for improving our credit rating.

Push the right buttons

First, remember that in today’s networked world, not only is it important to do the right thing generally but one must also push the right buttons. Our credit rating depends on our score in the five independent indices, mentioned above, relating to – voice and accountability, rule of law, government effectiveness, control of corruption and competitiveness. The Niti Aayog has demonstrated how our score and rank can be improved in the Doing Business Survey. Similar effort, in these five indices, can directly improve our overall credit rating.

Fastrack four priorities

Second, consider that four initiatives — (1) reducing inequality via direct transfers and NREGA to supplement low incomes; (2) funding investments through tax revenue and domestic private savings via financial inclusion and market development; (3) strengthening the resilience of our banks by shrinking the size and functions of weak banks and recapitalising the strong banks; and (4) increasing export earnings by removing the import bias for a “strong” rupee, can together improve one half of the overall score. These four areas should have a very high priority.

Go easy on piling up debt

Third, stabilising the aggregate public debt to GDP ratio is necessary. This contributes to one-fourth of the aggregate credit score. Moody’s recognises that this ratio shall increase from 68 per cent in 2016-17 to 69 per cent in 2017-18.

headload

It may even be higher, if real GDP growth this year is less than 6.7 per cent. State government debt has increased by Rs 2.7 trillion (1.5 per cent of GDP) due to financial engineering in acquiring 75 per cent of the stressed assets of electricity utilities through UDAY (electricity restructuring) bonds. An additional source of stress is the proposed recapitalisation bonds, particularly if financed from public funds. Financing the capital needs of strong banks through private equity would be far better, even if government equity must be diluted to 26 per cent. At the very least, the market would force adequate internal restructuring. Sharply reducing the revenue expenditure by 10 per cent can bridge the “effective revenue deficit” (0.7 per cent of GDP) and release fiscal space for virtuous allocations. Revenue expenditure — other than interest and capital grants —is budgeted at Rs 11.2 trillion this year.

Diligent nudging will show results

The Moodys’ rating methodology has evolved beyond the pure commercial intent of repaying lenders on time, to assess systemic sustainability and happy citizens.

The ball is now in the government’s court to navigate the tightrope between short-term welfare priorities and medium-term fiscal stability and growth. Political sagacity, restraint and technical wizardry in choosing the right boxes to tick will determine if the finance minister can widen our smile.

Adapted from the authors opinion piece in The Asian Age November 21, 2017 http://www.asianage.com/opinion/columnists/211117/after-the-upgrade-can-fm-widen-our-smile.html

FM Jaitley’s press meet – more lobs than ground strokes

Jaitley lobs

What was Finance Minister, Arun Jaitley’s press conference on Tuesday all about anyway? If the intention was to gain eyeballs, it succeeded. But if it was to allay fears about the Indian economy, it failed. Here is why.

Misguided choice of communication medium

First, the optics were all wrong. The finance minister had just returned from the annual meetings of the International Monetary Fund and the World Bank in Washington. The timing required talking up the economy in a more artful way, drawing on international trends, in rethinking the role of the State in development. Instead, the assembled press corps got drab statistics. The naysayers remain unconvinced that the economy is doing fine. Presenting alternative indicators — other than those already in the public domain — could have helped. For example, the government has reduced risk by conferring residency tax benefits for local administrative offices of multinational companies. Similarly, GST revenue is marginally more than the targets for the first quarter.

Recycled “kosher” ideas for fudging data on the fiscal deficit

Second, the key “announcement” was a proposed outlay of `2.1 trillion for recapitalising public sector banks over two years. This was presented as a “bold” step. But how is it going to be achieved without relaxing the fiscal deficit target of 3.2 per cent of GDP this year and 3 percent next year? The budgeted outlay, for capital support to publicly-owned banks is just Rs 200 billion till FY 2019. Where will the “additional” resources come from? The how and when remains a mystery – though speculation, some of it inspired by the views of Chief Economic Adviser, Arvind Subramanian, abound.

FM Jaitley unhappy at being trapped

The finance ministry has a long, credible tradition of technical expertise. The Prime Minister can get away with making generic promises, as he has done in Gujarat, of a tax amnesty for small business, for past misdeeds. But finance ministers are required to be very precise. They can’t waffle. They must not seem to be led by advice, whispered into their ears, while a press conference is on. This, unfairly, makes the finance minister look feeble, or worse, being led by the nose.

arvind subramanian and jaitley

Mr Jaitley fell squarely into these traps. To his credit, he looked decidedly unhappy and uncomfortable while doing so. It is inconceivable that this media jamboree was his idea. Just back from Washington, where “best fit” fiscal practices are the main discourse, resorting to fuzzy announcements, which create high expectations and uncertainty, is not par for the course.

It’s the politics stupid

So what explains Mr Jaitley going down this route? After all, the Budget is just three months away. The sanctity of placing new budgetary proposals before Parliament, prior to revealing them to the public, is a sound convention. The only explanation is that the press meet was convened to boost the feel-good factor prior to the Himachal Pradesh and Gujarat elections, due over the next two months. Recapitalising banks sounds good. Building infrastructure sounds even better. If this was the intention, Mr Jaitley was right to look uncomfortable. Nothing stops the Union government from doing its job, even as state elections are being held. But a red line must be drawn at presenting significant new fiscal proposals, that are not already embedded in the existing fiscal roadmap.

Stick to your instincts Finance Minister

Mr Jaitley’s instincts remain sound. He will try hard not to breach the fiscal deficit target. He will resist reducing the capital outlay. He must also resist forcing cash-rich, listed publicly-owned companies to subscribe to the special recapitalisation bonds proposed to be floated by public sector banks. Listed, publicly-owned companies must be managed by their boards, and insulated from politics, at least with respect to their investments. Anything else is very unfair for the minority shareholders and the Securities and Exchange Board of India is duty-bound to resist such moves — however bizarre that may sound!

Deepen equity divestment in publicly owned banks & companies

Generating Rs 580 billion by selling-off government equity held in excess of 51 per cent in banks is a good idea for a start. A better idea is to dilute government equity even further to 26 per cent without relinquishing effective control. The government does not need more equity to ensure that the public interest continues to be served. We must resolve the legal obstacles which prevent such dilution of equity.Using disinvestment proceeds to inject public finance into private companies, which create growth and jobs, is a great idea. But doing so via the chosen long route of public sector bank recapitalisation is worrisome. Unless management systems are restructured, politicised loans and NPAs will persist. This cannot be achieved by 2019.

Use equity divestment proceeds to refinance private NBFCs for MSME business

What can be done is to use disinvestment resources to refinance private banks and non-banking finance companies, who in turn finance end-use borrowers, including small and medium enterprises (SME), to scale up operations. The unmet financing needs of SMEs are estimated at Rs 65 billion. But this could be an underestimate, not least because of their widespread use of cash or unbanked transactions. The share of manufacturing SMEs in GDP is seven per cent, or just under 50 per cent of total manufacturing GDP. Their most immediate financing need is to discount their invoices and thereby reduce the 60-to-90-day payment cycle which saps their cash reserves.

Scale up private, boutique, supply-chain finance providers

Private specialised companies offering boutique supply-chain financing already exist. The largest is reputed to be the New Delhi-based Priority Vendors Technologies Pvt Ltd. founded by Kunal Agarwal in 2015 (http://www.priorityvendor.com)But these early entrants tend to finance only the payables and receivables of large, star-rated corporates who buy from, or sell goods and services to, smaller ancillary firms. There are 5,000 large corporates. Compare this with 1.6 million registered SMEs.

We have barely scratched the surface of the potential for supply-chain financing. Saturation levels of financing can alleviate the cash crunch, at the firm level, caused by the GST regime of advance tax payments coupled with the delays, in “matching” tax credits, earned on purchases, before they can be used by firms, to pay taxes.

Jaitley ground strokes

India is replete with good ideas. The finance minister could have unleashed an array of nimble steps, which can lubricate the economy, reduce risk and create jobs. But, by not grounding Tuesday’s press meet around a friendly conversation about the nitty-gritty of unleashing private potential and mitigating the hardships arising out of GST, this opportunity was lost. There will surely be another time. But will we be prepared by then to grasp the tide at its flood?

Adapted from the authors article in The Asian Age, October 26, 2017 http://www.asianage.com/opinion/columnists/261017/wheres-the-big-idea-fm-got-optics-wrong.html

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