What should the common man look forward to? Free Press Journal 26th February 2013

The interest for the common man in the Union Budget is largely to the extent of whether or not we will be better off in terms of tax payments and prices, and whether there are any concessions to be had in terms of financial investments. Fiscal prudence is more of an academic exercise which appeals to the intellectual or critic but may mean less to the man on the street who has to contend with problems of high inflation and is not really directly interested in a more sound fiscal deficit number.

Presently we have had relentless inflation at over 10% per annum (going by the CPI) in the last 2 years. Incomes are not increasing commensurately though stock markets continue to do well. This being the case we as citizens have had less purchasing power while those who also operate in the stock markets have gotten relatively better returns as well as paid lower taxes, as capital gains taxes are favorable in the equity segment.

The government has limited flexibility when it comes to tinkering with tax rates. We are committed to having the Direct Tax Code (DTC) implemented as well introducing the Goods and Services Tax (GST) after the states agree to the compensation formula. Therefore, any changes in the tax rates will have to be within the confines of these two codes.

Two issues are bound to come up for income tax. The first is the tax exemption limit will probably be increased by 10% which will help adjust for inflation. In fact, ideally just like how capital market gains are indexed with inflation based on the CPI so should the tax exemption level. Second, with talk on taxing the rich being the flavour of the season, a surcharge on incomes above a threshold would be on, and the only element of conjecture would be the definition of the super rich. Would it be Rs 20 or Rs 50 Lakhs per annum? The FM will have a final say here.

The excise and customs rates would remain largely unchanged for most goods, and the two areas that could attract attention could be gold and consumer goods for higher customs rates. With the country’s current account deficit being under pressure, it is but natural that gold imports will be discouraged further through duty enhancement. Consumer goods, especially food items could also come under this thought process. Also the service tax would be extended to more services, tough at the margin collections do not increase commensurately as these services are in the unorganized sector and difficult to trace.

The capital market has always been regarded as the barometer of economic success. Governments try hard to woo investors as a robust market means more funds coming in which helps investment and growth. Here there is likely to be some action. There could be a reduction in the STT for non delivery based trades. Further, the RGESS equity scheme would be extended for a longer time period with larger coverage in a bid to get in financial savings which have been dipping in the recent past. This combined with the reintroduction of tax free infrastructure bonds could be realistically expected in this Budget. As financial savings in the country are coming down, the FM may hike the limit for savings in specified instruments including insurance, provident funds, long term deposits etc by Rs 20,000.

The rest of the budget would be more on getting the fiscal arithmetic right. This would mean lowering the fiscal deficit ratio for the year which in turn will have a bearing on the government’s borrowing programme and future course of monetary policy. A lower deficit can be a precursor to the RBI leering rates in the course of the year, which will be beneficial for industry and investment. This will mean further rationalization of expenditure more in the area of subsidies. The fuel subsidy bill will be checked with the decision already taken to price diesel at market levels. With the impending elections in 2014, and the food security hill to be passed this year, food subsidy will be high on the agenda with the silver lining being that the large stock of food with the FCI would provide substantial cover for the first two years even when implementing the programme.

Therefore, in short we should not expect much in the budget. The thrust will be on fiscal discipline with some tax concessions provided on the way to assuage the middle class. Expenditure rationalization which has already commenced will continue, albeit gradually but ensuring all the time that the fiscal numbers look satisfactory.

 

Budget 2013: Fix revenue first, then tighten belt: DNA 26th February 2013

One of the most hyped up issues is the Union budget. Everybody wants something from what was originally a plain financial statement of the government. This has evolved to be expected to be a catalyst for everything that is good for the economy.
Individuals want to pay less income tax and want prices to come down with indirect taxes being reduced. Corporates want the tax rates to come down and expect more leeway to enable investment.
Economists want fiscal prudence to be maintained. Rating agencies want to see progressive reforms as merely stating palatable numbers does not mean that anything will be achieved. Then, there are the elections coming up and prudent politics may dictate that the government should do things like loan waivers or higher outlays on NREGA which others may not approve. Any FM facing these expectations would have a tough job on hand.

The journey through 2012-13 has been challenging. The final numbers may look true, though it has been achieved by forcing disinvestment and cutting ruthlessly expenditures of various ministries which may not be the best way to go about things. Therefore, the starting point is to get the numbers right. The FM should have a budget where growth numbers assumed are realistic — say 6% real GDP growth and 6% inflation to get in nominal growth of 12-12.5%.
Instead of working backwards from expenditure allocation and then revenue projections, the approach should be to fix revenue first and then be uncompromising on expenditure. Just like we had assumed subsidy bill will be 2% of GDP and nothing more, the number once fixed should be sacrosanct.
It will be easy this time on the fuel side as we are now used to having market-linked prices. The task will be on food security where the impact could be on the food subsidy bill. This is where the FM should show resolve during the course of the year and ensure that allocations stop once the limit is reached. There could be warning triggers when 75 and 90% of the amount is reached.
At any rate, for this exercise to be successful, the assumption of growth should be right as it would have a bearing on the resources raised through tax revenue in the form of excise and corporate taxes. Any unrealistic assumptions would mean problems in future.
This done, the next step is to ensure that capital expenditure on projects takes off. Last year around Rs1 lakh crore was to be spent on this purpose. Even if the number is lower, it should be spent for sure so that the government can kickstart the growth process in a limited manner. Typically this gets spent in the infra space and should be expedited so as to have a chain effect on other sectors.
Having populist measures is a necessity and need not be debated. That is so because governments are not corporates and have to spend where no one else does. Governments come to power based on manifestos that promise certain largesse which has to be met.
Besides, everyone gets benefits from the government and this can be seen from the revenue foregone statement of the Budget where the corporates benefit a lot. So why not the common man? The only condition should be that these numbers should not be breached. If this is done, then the budget can be a success.
The budget would definitely make every segment pay a little more in the form of taxes. Corporates would probably have to bear a higher MAT. Richer individuals would probably have a surcharge on their incomes. More services under the net would be a certainty and taxing of transactions in the commodity market may be inevitable in certain areas such as non-farm commodities. Custom duties on gold would be increased further to deter purchase while excise duty rationalisation across some commodities would be in order within the overall framework of GST.
But, quite certainly the FM will have to manage expenditure in a more effective manner. The focus should be on doing things within the limitations of growth which takes place exogenously over which the state has no control. If this is done, half the battle would be won. The FM is astute and probably will follow the same path and draw a balance between political expediency and fiscal prudence.

Interesting banking times ahead : Financial Express 23rd February 2013

The much-awaited norms for awarding new bank licences are out and RBI has been judicious and pragmatic in laying down the criteria. The field is open to anyone with a good track record who can bring in the necessary capital of R500 crore and falls in line with priority sector lending and meet the ‘inclusive banking’ norms of having 25% branches in unbanked areas (population of less than 9,999). Further, they can neither lend nor have investments of any sort to the promoter group—which eschews the concern on whether a business house will direct funds through the bank to its own group. The promoter has to be in for 5 years and go in for a listing within 3 years, and can start with 40% holding, which will be down to 15% after 15 years. Foreign money can come in, but it will be up to 49% to being with.

RBI should be commended for opening the doors and adding caveats to ensure that there is no misuse of the licence and that they operate on a firm footing, which is in line with the objectives of banking in the country. There are really two questions that can be put up for debate. The first is whether this is good enough for private capital to flow in. The second is whether this will change the architecture of banking in the country.
Any entity seeking to enter this field would consider first the preconditions that have to be met. There are two issues here. The first is whether money can be made and the time taken to earn it. The norms laid down are quite tough as the initial capital is high and the commitment to priority sector lending along with the branch location in rural areas can be a dampener. The CASA deposits are attractive, especially for an NBFC waiting to enter the arena. But the restrictions on lending to one’s own group can come in the way, especially so when the promoter group is large and the companies involved are also large and demand credit from the system that cannot be catered to. This can be a dampener for them—especially for conglomerates who have diversified interests.
The second is business prospects. When the first set of new private banks was allowed in the 1990s following the recommendations of the Narasimham Committee, the field was restricted in terms of technology and regulation, which was overcome by the introduction of new banks. They added a new dimension through an array of products for both deposit holders and borrowers, which worked well as can be seen by their position today. Costs were reduced and efficiency norms permeated through the public sector banks, which learnt to compete on an equal footing. While the institution ones dominate the banking space today, the others had gotten assimilated into the system, barring one bank, which continues to do well, belonging to a corporate group. The challenge for the new banks is to bring something new on the table while complying with the RBI norms on inclusive banking. Here, NBFCs converting to banks will have an advantage as they have structures that can be easily put in place and they could take the benefits on the deposits side.
The second macro-based question is whether this will change the landscape of banking? Do we actually need more banks? Currently, banks are well-capitalised and could cater to the requirement of growth in credit of 20% per annum if we are to walk the road of 8%-plus GDP growth. Having more banks will mean more capital coming in. But assuming that there would be no more than 4-5 players to begin with, will R2,000 crore of capital be good enough? Also, can’t the same amount be raised by the existing banks? If the government is not willing to divest in public sector banks, then there will be enough latitude for the new ones. The existing private banks could probably only partly meet the requirement. Therefore, more banks should be good for the system.
But, will it increase the overall reach of the banking system? The answer is a shoulder shrug here as most banks are concentrated in the top 200 centres. The RBI data shows that 74% of deposits and 82% of credit is concentrated within this perimeter. This being the case, more new banks in new rural areas may not serve much purpose, and even if they do, at the incremental level, the amount garnered would not be significant though access could be provided. We already hear complaints of banks that have opened branches that are not viable. In fact, some have also closed down branches on this score. Therefore, will new banks be getting into a rut where we force them to open branches in places that are not viable and have to be closed down subsequently? It is hard to conjecture right now.
Nonetheless, we will see some interesting times ahead. NBFCs will be eager to get out of the ‘NBFC trap’ and move over to banking given the limitations that are there for their own current line of activity. The corporate houses will find this interesting, though blunted by the norm on connected lending. The private banks will feel the heat of competition increasing in the high-banking centres as new players always provide some incentives to customers, which have to be matched. The government has to take a call on capitalising the public sector banks, and we can hope to see considerable divestment, which will be the way to go given the pressure on the fiscal balances to recapitalise these banks. Foreign banks may not be expected to join the fray in any way and would probably tend to follow a wait-and-watch policy before taking a step forward.
Quite clearly, there will be quite a bit of action on this front. As the economy will take time to pick up and grow, the first couple of years would witness more competition, which, in a way, is the right way to go.

Is depreciation different from QE? Financial Express 20th February 2013

G20 meets are usually considered to be jamborees where there is a lot of discussion on how the world economy should behave and how countries should foster growth through consensus. At times, it would not be more than a repetition of the earlier summits. But the recent one had a specific purpose on an aspect that, prima facie, has not really dominated the economic space, but has covertly been playing in the background, i.e. exchange rates. There is growing suspicion that some export-oriented countries may be trying to get out of trouble by depreciating their currencies consciously.

The world economy has been in a downward spiral for quite some time now. The financial crisis had its impact for two years and it was felt that the global economy bounced back as fast as it had crashed. But the sovereign debt crisis has been associated with a deeper crisis involving the credibility of countries, which, in turn, has affected the policies pursued by them.
While trade is not so much as a driver for the Indian economy, though the economy has gained when exports grew by over 20% per annum, being a domestic economy largely, the same does not hold for countries like the US, Germany, Japan, China, etc. The dependence on exports has meant that the exchange rate has a critical role to play in the growth process. One way out is to let the currency fall, which means that exports become cheaper in international markets and this helps domestic industry to expand. However, if this is done deliberately, then it is not considered to be a good sign, as it can provoke similar actions from other countries leading to an exchange rate war. This has understandably become a concern for the G20.
Japan has been the target as the yen has fallen by over 20% since November after Shinzo Abe took over. The economy has been in a slump for quite some time now and yen depreciation would help to revive growth in exports. The dollar has been falling against the euro and this has been unnatural because the euro region is in a crisis situation, and ideally the euro should weaken. But the series of quantitative easing measures by the Federal Reserve have increased liquidity in the economy, thus bringing down the currency which helps exports and hence the country to grow.
In fact, if we look at our own country, we have seen that the rupee has been largely stable in the range of R53-55 to a dollar even though the current account deficit has been increasing. However, the strength has been retained due to capital inflows, which have been enabled by the excess liquidity in global markets due to QE. But this is a natural flow of events that has caused the rupee to remain stable when it should have fallen. But, in a way, we have lost our export competitiveness in global markets, even though these flows have helped to stabilise our balance of payments. The difference here as against the Japanese case is that this process has not been driven by the central bank but has happened under natural conditions.
The euro economies are in a sticky situation. Fiscal prudence has been advocated mainly for the troubled southern nations, but is being pursued by the larger countries too. Germany, in particular, has shown restraint in the past and continues to do so today. This has added to problems of a slowdown. Now, with the euro strengthening due to extraneous conditions, it becomes a double-whammy for an export-oriented country.
Therefore, some countries like Japan and the US have gained while Germany has lost out due to such policies. Japan has been particularly blamed for deliberately letting the yen fall while it has tried to reflate the economy. The fear now is that other nations too may respond with similar policies.
Has this happened before? In the 1930s, when the depressions got deep-rooted, countries tried to drive themselves out of the rut by following policies of competitive depreciation of currency. This came to be called the ‘beggar my neighbour policy’ where each country tried to get out by letting its currency depreciate, thereby pressurising other currencies and jeopardising growth in other nations. In fact, this was further supplemented by protectionist policies internally to block imports of goods and services.
The concern today is quite possible that, if unchecked, we may drift towards this syndrome. It was necessary for the members to take a stance to let the rules of the game be obeyed and that countries not push for conscious depreciation of their currencies.
A point, which however remains unanswered, is that whether in a globalised environment can we separate policies relating to QE that have an impact on various countries with such policies that are induced consciously to push down the currency profiles?
Both the measures such as QE and depreciation are aimed at finally boosting exports through exchange rate impact. Agreed, today India is better off with the QE impact, but in 2007-08, the QE had led to problems of appreciating rupee as well as monetary policy issues concerning excess monetisation. It was also, in a way, one nation getting out of a problem with a policy that created disequilibrium in other countries. If this is acceptable, then can one really blame Japan or China for consciously undervaluing their currency?
There are clearly no answers here, but such issues need to also be juxtaposed so that arguments are not just one-sided. Therefore, global dialogue on exchange rates must also consider such issues as QE so that country responses are analysed in a wider frame.

Let budget planning be more realistic : Financial Express: February 18 2013

This begins with more honest estimates of growth and extends to a tight rein of expenditure

The presentation of this year’s Union Budget will be unique because most analysts have already prejudged the content on grounds of it being the last Budget before the general elections, which will give a tilt to populism. A populist Budget is one that is extravagant in terms of spending while giving benefits through tax breaks, hence putting austerity under jeopardy. Is this a likely scenario?
The answer is that it is unlikely that there will be profligacy in the Budget given that we have a very astute finance minister who has been working hard to rein in the fiscal deficit for FY13. Let us see what all he has done. With tax revenue not rising given low economic conditions, he has cut down on expenditure. There is now some talk that the fiscal deficit number may be closer to 5.1% rather than 5.3%. The disinvestment plan has taken off suddenly and the R30,000 crore target could be met by March. The spectrum sale of R40,000 crore and the subsidy slippage of around R60,000 crore could be problem areas, which are being countered through expenditure cuts. While this is a different way of controlling the fiscal deficit, such a strategy affects growth in the medium term when development expenditure is pruned.
Budgets are basically accounts of the government that have evolved over the years to be the growth-driver through their proposals. Non-development expenditure involves transfer payments that are growth-neutral unlike development expenditure that is Keynesian in spirit. Tax incentives are used more on the supply-side to push up growth while expenditures work directly. If the finance minister actually brings the deficit down to 5.1% this year, it would be a clear compromise on growth. In fact, one of the shortcomings of the efficacy of budgets is that finance ministers tend to cut back on expenditure to control the deficit, which actually affects medium-term growth prospects. Therefore, ideally, expenditure cuts towards the end of the year, though pragmatic, should be eschewed.
The crux of the problem lies in assuming a high growth rate when formulating the Budget. Once we assume a high GDP growth number, which is 14% normally, then tax revenues tend to get exaggerated as excise, customs and corporate tax collections are dependent on this rate. Revenue accrues during the course of the year, but expenditures are incurred in blocks when it involves projects. Also, there is ambivalence over the subsidy bill, which skews conditions. Add to this the inability to get through spectrum sale or disinvestment programmes and there is a crisis-like situation by the end of the year. Budgets always tend to overestimate revenue and underestimate expenditure, which is the starting point of fiscal woes.
Given these issues, what could be a route taken by the finance minister? First, a reasonable GDP growth should be assumed at 12% with 6% growth in GDP and inflation, which looks likely. The cushion of spectrum sale may not be likely and disinvestment should be based on realistic scenarios where a time table should be laid down so that it does not look as if it has been forced on institutions, which is the impression formed today. Ideally, not more than R20,000 crore should be targeted, which have been the highs obtained in FY10 and FY11.
Second, expenditure should be planned with caution. The subsidy bill, which was to be around R1.9 lakh crore, should not be allowed to be surpassed. It must be earmarked for every month and should come to a halt once the level is reached. Also, the number should be realistic—last year, an average crude price of $115/bbl was assumed, yet the target was exceeded. How could this have happened unless the demand was understated? If cash transfers are being planned for PDS, then the food procurement policy of the government has to be made finite. A positive development has been to link diesel prices with the market, which will help control growth in fuel subsidy.
Third, payments under interest subvention (under subsidy), loan waivers (on account of drought) and MGNREGA should be capped with zero flexibility.
Fourth, the allocations made for agriculture, warehousing, land development should be limited to prudence. It should be realised that our approach has been more piece-meal rather than a sustained effort, which ultimately means that we are unable to bring about any real development in these sectors. Also, there are a plethora of schemes where it is a habit to announce outlays without paying much attention to the quality of the service—education, women, healthcare, rural housing, to name a few. Last year, we have an allocation of almost R2.5 lakh crore on various schemes where there is no audit on what reaches the targeted groups while we get only numbers of the number of beneficiaries.
Fifth, as the government has problems garnering resources, it makes sense to get away from recapitalising banks and instead mandate them to raise resources on their own. This will help the banks as well as the market. There can be savings of R15-20,000 crore.
Last, the project expenditure, which was to be around R1 lakh crore, should also be incurred from month one rather than wait till the end and pruned when conditions go awry. This way, budgetary targets will be adhered to.
Today, the government has tended to follow the policy of ‘lazy budgeting’ where no effort is made to rein in non-development expenditure, even as we begin with unrealistic growth numbers. By sticking to the budgeted numbers for expenditure, we can ensure that we get out of this syndrome and yet maximise the efficiency of funds. All this may also mean cutting down on the size of the budget instead of increasing it more out of habit. In fact, for FY13, it was assumed that tax revenue would be 10.7% of GDP as against 10% in FY12. This automatically puts the entire Budget on the edge as it becomes susceptible to slippages.
Quite clearly, our approach to formulating and implementing budgets must change to avoid falling into the deep crevice of lazy budgeting where the exercise by the end of the year is more for an accountant than for an economist.

When all theories collapse...Business Standard 9th February 2013

Countries have to carve their own paths to growth because conventional notions no longer hold

The ideas of economists and political philosophers – both when they are right and when they are wrong – are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually slaves of some defunct economist.”— J M Keynes
Ironically, when we see policy makers struggle to find solutions, this quote strikes us, because none of the theories are working today.

The first defeat is of Keynesianism. When economies are down, Keynes would suggest pump-priming. But two things are happening. The first is that countries are already running high fiscal deficits like the US (seven per cent), the UK (7.9 per cent) and Japan (9.8 per cent). Quite clearly, high deficits have not really helped. Resolution of the fiscal cliff will only add to the pressure of a recession. The problem has been deferred and not yet solved, but either tax enhancing or expenditure cuts mean less of fiscal policy. The second is that the euro zone has to cut down on government expenditure, which means that fiscal austerity is the way forward. The outright monetary transactions (OMT) programme is based on countries sticking to the fiscal austerity path. Clearly, Keynes is forgotten.

The second is that monetary policy also ceases to matter. Interest rates have been lowered to the extent that they cannot go down further. Yet, economic activity has not picked up. Keynesians would call this the liquidity trap when lower rates do not inspire borrowing. The governments have tried to move the money supply curve up through various versions of quantitative easing (QE), going under different names. We had the QE sequels while the European Central Bank used the longer-term refinancing operations (LTRO) and OMT to induce liquidity. Monetarism has not worked, since deleveraging is on and banks do not want to lend.

Third, in this process of downturn in economic activity, a new area that has developed is “Trust Economics”. Both the financial and sovereign debt crises have one underlying commonality — the loss of trust. In the financial crisis, banks stopped dealing with others and even short-term loans became scarce. No one knew how good the counter party was. Money had dried up owing to the fear of toxic assets, as collateralised debt obligations and credit default swaps came to be called. In case of the sovereign debt crisis, countries have stopped trusting one another and banks are holding debt of sovereigns that cannot be serviced.

Fourth, it was always felt that China and India would continue to grow upwards because there was no alternative route. China has slowed down because its basic model is now being questioned. Can an economy grow on the basis of high investments and not consumption? Building flyovers and expressways is one thing, but we need vehicles plying to make it worthwhile, for which incomes have to increase. For India, we spoke of a possible double-digit growth and suddenly high inflation, peculiar to our country, has shattered such illusions. The slump cannot really be attributed to the global slowdown, but we have reached the end of the climb and require a new mindset to move ahead.

Fifth, while the theory of decoupling has been said to be the reason for global growth in the past, it no longer holds. When the financial crisis came in, it affected the US, and Europe was insulated to a large extent. The UK had its shock element in Northern Rock Bank, while it was business as usual for the emerging markets. But now with the euro zone going into a recession and the US stumbling, the export oriented emerging markets are in for a setback. It is not possible to shunt the wagons easily now.

Sixth, a global slowdown, if not a recession, should be bringing down commodity prices. But this is not happening. While metal prices have come down, farm products continue to be volatile, while the oil story is hard to explain. Typically, oil prices should come down once there is a recession in any major economic block. Post financial crisis in 2008-2009, oil slipped down towards the fifties. But this has not been replicated this time. Maybe it is the weak dollar, but we are all paying more for oil.

Seventh, with the euro crisis on, the dollar should have been strengthening. But given the inherent weakness of the US economy, the dollar has been under pressure, thus leading to considerable volatility in the exchange rate. Besides making global markets shaky, it has affected exchange rates across the world.

Eight, on account of exchange rate instability companies have not been able to take advantage of low interest rates in the developed economies. Usually interest rate variations lead to “carry trade” where one borrows in countries with low interest rates and lend where rates are high. Such arbitrage opportunities have gotten reduced through exchange rate risk.

Putting everything together, there appears to be several antithetical economic currents, making it hard to use conventional tools. Conditional monetary resuscitation packages mean governments don’t matter, while the liquidity trap makes central banking challenging. The solution has to be through markets, which are in a confused state. While it is not a 1930s-like situation, the inherent complexities make the recovery process that much more gradual. Owing to strong linkages through globalisation, no country is left out, and the pain is pandemic. Countries have to wean their own ways unlike the 2009 situation where the rebound was as quick as the fall.

Beware, CTT is round the corner : Financial Express February 9th 2013

While markets may be better off if commodity tax is held back, the revenue possibilities make it inevitable

There are at least three compelling reasons for introducing the commodity transaction tax (CTT) this year. The first is that the government requires money, and any amount is welcome as the effort is to look at all options. The second is that if the stock markets are subject to the securities transaction tax (STT), why not the commodity market? The third is that the market is now mature, or has reached whatever level of maturity that is possible given the constraints of absence of movement in policy, and is almost a decade old. In fact, as a corollary, once done, the government can also start looking at the forex derivative market.
The crux of the debate really is how many layers of taxation there should be in any market. There is already a service tax being imposed as well as a capital gains taxes. The rationalisation of the latter led to the creation of STT. The idea was that such a tax makes collection easy and normalises the payment across all participants. Also, it helps to reduce volatility in the market as speculative activity gets more affected and, to this extent, the unwanted ‘noise’ is eliminated. The securities market did not want to have this tax and, when the commodity market started picking up, made an appeal to have the same across this segment too.
The securities market clocks around R1,00,000-1,20,000 crore a day, while the commodity market does around R70,000 crore. The forex derivative market does another R40,000 crore a day. Clearly, such a turnover does, prima facie, show some level of maturity and merits the transaction tax, once it is accepted that we want to tax transactions in any market. The raison d’être is that all transactions that are carried out in the market that are based on an investor-gain motive need to be taxed. Therefore, bank transactions are not taxed, but stock market transactions are. If this is accepted, then one can extend the logic to other segments too.
The mathematics of such a tax is compelling. Of the R70,000 crore being traded on a daily basis, not more than 10% comes from farm products. The rest comes from bullion and energy products, which are non-delivery based. The participation is more from traders rather than hedgers, which strengthens the case for the tax. Also, the standard argument given that futures trading leads to price discovery, which can get thwarted, is countered here by the fact that in crude oil or gold or silver, price discovery takes place on international exchanges and the price at home is simply the international price multiplied by exchange rate plus taxes. If trading volumes come down, this will entail the weeding away of the speculators who are adding ‘noise’ and not substance. Long-term investors would not be affected by such a tax.
In the stock market too, volumes did not really come down with the tax, just like it can be argued that if STT is removed, volumes will increase temporarily but will not sky-rocket, as all stock market activity is based on the state of the economy and not a tax. If the tax is, say, R17 per lakh, as was proposed earlier, with the volumes being more than twice our GDP at close to R200 lakh crore, the government could pick up close to R3,500 crore, which is not bad given that STT was to pick up R5,900 crore this year.
Two issues arise. The first is what about farm products? Should they be taxed? Today, vibrant trade takes place in the oil complex and to a limited extent in chana and some spices. The trading community is well dispersed across traders, brokers, corporates, etc. There is also a suspicion about the role played by speculators in pushing up prices in the case of pulses and cereals earlier that prompted bans and the magnification of prices when there are shortages in narrow commodities such as spices. We have had an expert committee that looked into the linkage between futures trading and spot prices which did find any such relation.
But, this raises an interesting question. If futures trading does not influence spot prices, then what exactly do we mean by price discovery? Therefore, there is an inherent contradiction in such logic because if prices are discovered and efficient, then they should logically impact spot prices. And if they do not, then what could be the purpose of such prices? One may recollect that the main reason from bringing back futures trading was to enable benefits to go to farmers through better prices. Therefore, the basis of futures trading hangs precariously when this rationale has to be balanced with causes for inflation and the quality of trading.
The second is what happens to hedgers in this market? Farmers do not trade, because they have little access. The non-passage of the FCRA means that their participation remains a part of the wish-list of FMC, which has little power to change the rules of the game. Further, there are hedgers such as jewellers and corporates who deal with steel, aluminum, edible oils, etc. Such a tax puts a burden on them. The solution is really to have exemptions for hedgers who already have separate hedge limits with the exchanges as per the rules laid down by the FMC. Therefore, they should get refunds or exemptions. The UID Aadhaar scheme should help to keep farmers out of the ambit of such a tax as and when they come in.
The CTT issue is contentious and there are an equal number of examples of success and failure of such taxes in markets, be it securities or commodities. The same holds for countries with and without such taxes. But the reality is that the government is trying to tap all possible sources of taxation and this market looks juicy enough—especially the non-farm segment. The fact that there is a lot of concern on gold imports could be a factor hastening the introduction of this tax. Hence, while the market would be better off in case CTT is held back for some more time, it may be inevitable.

Not more than 25 bps cut this time : Financial Express 25th January 2013

Just as volatile and unpredictable are stock market movements, so are RBI’s policy actions. On the face of it, we have a simple choice of either lowering rates or leaving them unchanged. Yet, every quote of RBI at different forums has the potential to create expectations, which, in turn, guide GSec yields as well as stock markets. Add to this the FM’s statements on the prerogative of RBI on interest rates, which have their own influence on expectations on the future course of interest rates. What is one to make of such a situation?

The arguments for monetary policy have always been the classic growth versus inflation debate. But this is passé today because we are no longer on this tradeoff as the belief is that low growth is not due to monetary considerations. The discussion board then moved to whether policy affects inflation. Here, too, the core inflation argument fell flat as it has not moved RBI, which still talks of generalised inflation. Logically, given that demand is low, we cannot be having excess demand forces anywhere. The debate then went on to the platform of which inflation rate we are talking of: WPI inflation or CPI inflation. In one of the earlier policies, RBI has emphasised that retail prices are more important as they affect us as consumers.
The portrait in front of us is quite clear. Growth is down or stagnant and there are few signs of it picking up in the near future as there is nothing much happening. Even if rates are lowered, actors will look to the Budget for direction and an entirely different set of issues will surface like GST, DTC, subsidy, etc. Inflation concepts present some ambivalence. WPI inflation is stable at around 7.2% while CPI inflation is high at 10.6%. This unfolds a conundrum for RBI because if it is looking at real interest rates, then it will find that when it adjusts the repo rate with WPI inflation, it is positive, while it is a big negative in case of the CPI. Therefore, RBI can toss the coin and be right either ways.
There are some compelling reasons beyond the clichéd arguments centred on investment and growth for RBI to lower rates. The government has gotten its act together in the last few months with some positive announcements. While some have gone through, others are being debated. The FM has made the right sounds on controlling the deficit next year, and the progressive move on diesel price realignment is heartening. The economy has bottomed out and hopefully will not slide further. Under these conditions, lowering rates will help in creating the right expectations on monetary policy. A 25 bps cut may not be enough to stimulate the economy, which probably has already been buffered by the market, but it will provide some hope that RBI will not be too intransigent. Other rates may not come down, but still such a signal will be good for everyone.
The only strong case for RBI to hold on to its stance is that its target, i.e. inflation, still seems a tough nut to crack. After holding on to this belief for three years now, by lowering rates with unchanged inflation conditions, it would question this basic wisdom of not having done so earlier.
The market, on its part, always keeps hoping that RBI will act and lower interest rates with the belief being that market expectations are self-fulfilling. This is why it has almost been assumed that a 25 bps cut is on. Anything more would come as a surprise and spook the market upwards. This could be a turning point, though admittedly the probability is low.
The other aspect is the CRR. There is shortage of liquidity in the system though it has come under the 1% mark on January 24, which is just one working day before the policy announcement. Besides, RBI has resorted to open market operations in a big way to partly finance the funding requirement of the government borrowing programme, which obviates the need to go in for a CRR cut. Also it has been observed in the past that the CRR is less effective in getting banks to respond through rate cuts, as they are still influenced more by the repo rate than the CRR. Under these conditions, the CRR would remain unchanged this time.
The RBI action this time will be significant because it will give some sense about how RBI is going to behave going ahead this year. RBI has been talking of better fiscal management from the government and has stuck to its stance that interest rates are not solely responsible for low growth in the country. The FM has indicated that next year’s Budget will have a better fiscal number, though the number will finally be open to interpretation as there are differing views on the feasibility of a low fiscal deficit number given the harsh reality of low growth in an election year.
RBI will be tracking the inflation number too, which is higher on the food side rather than manufactured goods. The recent diesel price hike will add to inflation in a small, gradual way and hopefully get absorbed without spiking up prices.
Therefore, one can look forward to a 25 bps cut in interest rates, though it is uncertain whether this is a beginning of a chain of such moves, which will still be dependent on what happens on the 14th of every month when the WPI numbers come in.

Why stock markets have beaten global economic woes: Economic Times 23rd January 2013

Stock markets are supposed to reflect market sentiment. Typically, a buoyant stock market means there are strong proclivities towards growth. But the 2012 picture is quite different going by what has happened around the globe. Global conditions have been weak with uncertain future signals - fiscal cliff, the possible collapse of the Euro zone, stagnation in India and a downturn in China. Experts are only talking of the varying degrees of a slowdown with the 'R' word floating around.

Yet, the stock indices have shown a different trend. In dollar terms, according to The Economist, Indian indices have been up by 24.5% (YoY) from last year, which was probably the most impressive among the larger markets. Turkey, Thailand, Pakistan, Mexico and Egypt scored better while even countries like the US (9.8%) Euro zone (19.8%), Japan (8.5%) and the UK (13.3%) did well.
But stock indices are clearly not reflective of the state of the economies. Why should this be so? Is it a case of irrational exuberance (which would mean that the fall, when it comes, will be sharp) or is there some economic rationale for stocks doing well across markets?
To begin with, other asset classes were under-performers. Looking at commodities, food went up by 1.5%, while metals did slightly better at 3.5%. On the other hand, non-food product prices declined by 6.8% during this period. Gold was better by just 3.6% which is different from what was seen in India, where the domestic price took in the impact of the rupee depreciation as well as higher tariffs to further go up.
Oil was down by 10.9% and, hence, the slowdown in the global economy did not mean a crash-landing of prices which was the case during the financial crisis when prices moved towards the $40/barrel mark. Therefore, commodities were not the flavour of the season.
Global currencies were largely stable during the year which made currency a less attractive investment. The dollar was volatile vis-a-vis the euro given the variety of problems seen in both the US and the Euro zone.
By the end of the year, most currencies strengthened against the dollar - India was an exception as was Indonesia. But, more importantly, with volatility being considerable, carry trade was not preferred as the exchange risk was high. This became popular during the last crisis when rates were reduced by central banks all over.
Fixed income markets were flat. Interest rates remained low thanks to the approach taken by the US Fed, ECB and BoE. Easing of money through different programmes meant there was a lot of money to beTherefore, in this situation, where liquidity was in abundance, money flowed into equities. And this was across all markets. The choice was between holding on to cash or taking a risk in carry trade or buying stocks with fair valuation.
Therefore, it was a rational choice considering that markets ended low in 2011 and valuations were cheap for potential investors. Such flows have spurred markets and sent out contrary growth signals - generally stock markets reflect the strength of the economy, but this link has been severed today.
Typically, when economies are down, stock prices move in the same direction and become cheap for potential investors. As long as they believe that conditions can only improve in future, they would continue to buy, which is what they are doing today.
Quite evidently funds have preferred these markets which are likely to continue to witness such inflows as long as growth is stagnant in the developed world and liberal monetary policies are pursued.
A reversal can be expected only when these underlying conditions change. At that point of time there would be rebalancing of portfolios. Given the way things are moving, 2013 is likely to see a minimum turnaround. Therefore, happy days could be there for some more time. used. Lending was down as there was little trust between banks and borrowers. Nor was there much trust between banks and sovereigns.
Yields on government bonds were at a new low, with policy rates almost touching zero in the US. Real yields on 10-year G-secs were in the negative zone for almost all countries. A positive zone only meant the yield was less than 1%. The exceptions were countries like Brazil and Mexico. So, clearly, government paper was not attractive. The fact that the Euro crisis worsened meant that even the assurance of the safety of instruments was questioned.