Union Budget 2019 manages the numbers with a few surprises: Business Standard July 5 2019

The Union Budget for financial year 2019–20 (FY20) has used the revised numbers for FY19 as the benchmark as against the accounts, which showed a smaller size of almost Rs 1.5 trillion to almost retain the budgetary numbers for the coming year with a marginal improvement in the fiscal deficit number to 3.3 per cent.

While the speech has focused on the main thrust areas, benefits have been provided to specific sectors like affordable housing and electric vehicles. It has kept most of the tax structures unchanged. Customs rates have been selectively increased and petrol and diesel are to cost more as this is an assured revenue stream for the government.

A major takeaway is the bank recapitalisation (bank recap) amount of Rs 70,000 crore that has been announced. However, this would be through the issuance of securities, which means that once again it will not be a part of the budget but an offering through the recap bonds route. The cost of such an exercise would be witnessed through the interest payments that have to be made over a period of time. The infusion of such capital is welcome, as it will help banks to lend especially so as six of the public sector banks (PSBs) have come out of the prompt and corrective (PCA) framework and would require capital to grow.

The semi guarantee being provided to PSBs for purchasing assets of non-bank finance companies (NBFCs) is a very good step. It sends strong signals that the government considers this sector to be important and that it is willing to support it directly through the Budget. This should help the market, which was getting jittery on account of lack of action here. This could be a precursor to the Reserve Bank of India (RBI) also considering some other windows for lending, which has been a demand from this industry. 

The disinvestment scheme of Rs 1.05 trillion will probably be the highest and will help the government balance the budget, if successful. It also looks like the exchange traded funds (ETF) route will be preferred to drive home the benefit and to this end they have linked this with the ELSS schemes for investors to draw tax benefits.

The budget has been carefully drafted keeping in mind the constraints of commitments made in the interim document in terms of expenditure and the reality of growth trends. Hence, the borrowing programme of the government remains unchanged and hence the market should take heart at this. Also, in the absence of the RBI report on the use of reserves being out, there was limited scope to use the money for further expenditure. Total capex is just around Rs 20,000 more than that in FY19. 

However, there is an upward revision in the GDP growth number to 12 per cent. While this could be assumed to manage the budget numbers, it could also mean that with real growth expected to be no more than 7 per cent as per the Survey, there could be higher inflation of above 4 per cent. In this scenario, the talk of interest rates cuts should be reviewed, as the monsoon progress so far has also been less than satisfactory. 

Lowering rates may not really lead to the push required for growth: Business Standard June 6 2019

With the monetary policy committee (MPC) already indicating in the last two policies that inflation would not be the only factor that would drive the decision on interest rate changes, it is not really a surprise that the Reserve Bank of India (RBI) has gone in for a rate cut, especially after rather disappointing numbers have come out on GDP (gross domestic product) growth in Q4 and unemployment rate. The extent of rate cut was debatable – and settling for 25 basis points (bps) would be something that the market has buffered in. The important question is whether or not this will work?

From the monetary standpoint, a rate cut helps companies and individuals that borrow as it lowers cost of loans provided banks pass it on. Banks would be in a position to lower lending rates in case they can lower the deposit rates. This may not always be feasible, given that growth in deposits has tended to lag that in credit, which had created a virtually permanent liquidity deficit. This, however, has been plugged through the liquidity adjustment facility (LAF), open market operations (OMO) and forex swaps.

Globally, central banks have been seen to be the driving force behind growth when interest rates are lowered as it gets investment going. This is less obtrusive than fiscal stimulus, which has a bearing on the fiscal deficit. A cut in repo sends strong signals to the market that has to, in turn, pick-up the cues. Therefore, the transmission is important. Contrary to the often expressed view that is critical of the transmission mechanism, it has been observed from RBI data on weighted average lending rates (WALR) on new loans has actually moved in consonance with the repo rate. This means that the benefits are flowing to the customer.

It is a different issue that borrowers have to borrow more for investment. If they do not borrow more but take advantage of the lower cost, it helps their profit & loss (P & L), but may not add anything to investment, which appears to be the case today. The problem is more on the demand side. Hence, lowering rates may not really lead to the push required for growth. Consumption has not quite picked up pace, which has also meant that the capacity utilisation rates have not reached the level required for that extra push. Infra investment remains stagnant from the private sector; and the NPA issue combined with the NBFC (non-bank finance companies) challenges has to be sorted out before there is fresh interest shown.

But such a rate cut can have wider ramifications for savings, as presently the problem is also on this front where households are saving less. Also, as there is a significant part of the population that lives on interest income, there could be negative effects on such spending that hence comes back to hurt consumption. This is one reason as to why banks have not been lowering their deposit rates with alacrity.

The accommodative stance indicates that there will be further easing of inflation, which also means that the monsoon will not be perverse nor are there any known fears of fiscal led demand-pull inflation forces. Therefore, inflation will remain benign under 4 per cent and we can expect another 25-50 bps cut in the repo rate during the year.

Interestingly, this also means that the RBI does not see the economy picking up as it has lowered its forecast to 7 per cent from 7.2 per cent. The 0.2 per cent number is not significant but a lower revision means that we may not be seeing too many green shoots this year. It will be another tough year for the economy and the employment-output equation may not change much.

Time for manufacturing-related issues to be addressed with alacrity: Business Standard May 31 2019

The quarterly gross value added (GVA) growth numbers for the last eight times point to an interesting trend. They rose continuously from Q1-FY18 to Q4-FY18 and then declined by Q4-FY19. The high point was Q4-FY18 at 7.9% and the low was at 5.7% in Q4-FY19.

Quite clearly, there is a problem in the economy which is serious because this was a year when nothing went wrong. There was a good monsoon and no disruptive reform. Last year, it was widely believed that the system had adjusted with goods and services tax (GST) and the ghost of demonetisation was behind us. Yet, agriculture has registered a negative growth. This is a concern going ahead, as the monsoon prospects are mixed and given low prices received on corps like pulses, there could be some changes in cropping patterns.

Manufacturing growth has been impacted (3.1%) by lower consumption and investment, which was evidenced by higher buildup of inventory of consumer goods including auto. Clearly, the new government has to work towards reviving manufacturing as it is the sector which creates jobs, which in turn feeds consumption. This also gets reflected in lower job creation

The three positive pictures seen in Q4 have been construction (7.1%), financial services (9.5%) and public administration (10.7%) that tell unique stories. Construction has been spearheaded by the government where the focus on roads and affordable housing has helped to increase production on a sustained basis. The public administration component has witnessed high growth of 10.7% in Q4 over a high base of 15.2%.

This is again the contribution of the central government. The financial sector contribution is striking, because it has been caused by the higher growth in deposits and credit in Q4, which does not reflect the health of the sector nor the crisis in the NBFC segment.

On an annual basis, the growth in GDP at 6.8% is lower than that in FY18 (7.2%) and it would take effort to bring it up in FY20. Once again, it is the same three sectors that have driven growth with electricity also chipping in with 7%. The interesting point here is that the investment rate has increased to cross 29% compared with 28.6%. This is probably a positive sign though given the limited traction witnessed in the private sector may be attributed more to the government. But with investment coming to a standstill in April and May on account of general election, it needs to be seen if this will be taken up by the private sector post July when the Budget is announced.

The problem is essentially in manufacturing, which has to be addressed with alacrity. The consumption cycle has to change and it will happen slowly. Hence, there will be some expectation of a fiscal stimulus this time in the form of tax cuts or higher cash transfers. While the Reserve Bank of India (RBI) can help with rate cuts, experience tells us that investment has not picked up notwithstanding the rate cuts in the past, as the logjam in the banking sector needs to be cleared. Besides with the NBFC sector in a state of flux, an important channel of finance has been impeded. There is need for affirmative action to be taken by the government, more importantly than the RBI.

The NDA returns: Time to introspect policies that did not work: Business Standard May 23 2019

The return of the National Democratic Alliance (NDA) government to power does indicate a couple of things. First, there will be continuity in policy stance, which is good for the country. The second is that some of the economic issues that had taken Centrestage like employment, economic stagnation, falling consumption etc. did not matter in terms of affecting the decision of the electorate. It is not surprising that the Bharatiya janata Party (BJP) campaign this time was not talking about development or the Gujarat model, but other political issues and economic issues focused on the lowest common denominator which struck the right cord.

What does this mean for the economy going forward?

The government can take heart at the overwhelming verdict, as two of the rather brave reforms, which include demonetisation and implementation of the Goods and Services Tax (GST) that apparently had not gone down well with the lower income groups, had not changed their voting patterns. This is in a way a green signal to the government that it can go ahead with strategic reforms in the areas of land and labour without any significant fear of reprisal in terms of possible loss of votes. Ideally, such action in the first two years makes imminent sense as human memory is always short and the disruption caused here will be forgotten by 2024.

The Budget is unlikely to have any serious changes as the government had quite astutely highlighted the farmer scheme of Rs 75,000 crore without upsetting the arithmetic and can hence manage the main budget with minimum tweaking. The focus this time can be more on tax reforms where the direct taxes can be revisited especially for the corporates where so far a lower rate has been offered to smaller companies and not the rest.

The second term for the government will be useful for introspection of policies that did not work as was envisaged earlier. Here, in particular, power sector reforms need to be revisited as this was one area that promised much, but did not deliver as it is always hard to get the states to fall in line when it comes to cutting transmission and distribution (T & D) losses and billing are concerned.

Second, the 'Make in India' campaign needs to be looked at closely to find out where things did not go right. The fact that industrial production (IIP) has stagnated in the last few years is compelling for some firm action. The government should consider choosing specific sectors that can make this theme work rather than focus on 25 odd sectors which makes it more of a text book prescription.

Third, it needs to be accepted that there is a problem on the employment front so that work can begin on creating more jobs. While it is true that there have been low income jobs created in construction or slightly higher level cosmopolitan jobs in e-commerce, the same has not happened in manufacturing or services. This should be addressed carefully especially if labour laws are going to be brought in as there is a major contradiction here.

Fourth, the financial sector has to be made robust and the fact that the banking sector’s non-performing asset (NPA) woes seem to be ending is a good starting point for the government in its second term.

Last, the farm policy approach needs to be made sharper. Here, too, like the ‘Make in India’ campaign, it should be focused on crops or regions sequentially so that it is manageable. This would make it feasible and provide some modicum of stability.

While these ideas are known to the policy makers, having a drop down of priorities for sequential implementation will make it more effective.

US-China trade war escalates: What are the implications for the world ? Business Standard 13th May 2019

The increase in tariffs on Chinese exports to the United States (US) was more or less a foregone conclusion, as President Donald Trump had not minced any words on the volume of imports ($ 200 billion) that would now be taxed at 25 per cent instead of 10 per cent. This is a blow to China, which depends more on US than the latter on this nation. In 2018, the deficit was $ 379 billion and China is the largest trading partner of the US. The products to be affected are machinery, toys, sports goods, furniture, plastics etc.

What are the implications for the world at large? First China can retaliate but the US may not be affected and could look at other countries to fulfil its needs. The main imports from US are aircrafts, machinery and vehicles.

Second, with Chinese goods being taxed at a higher rate in the US, other countries can pitch in and fill the gap. This opens up opportunities for other exporters, including India. The cost advantage, however, will be important as well as the strength of currency or rather weakness to capture this market.

Third, from the point of view of domestic industry in the US that was being outcompeted by cheaper Chinese goods, this would be a good move though the user industries would be at a disadvantage in terms of higher cost.

Fourth, China is likely to get more aggressive with exports and the world should watch out for dumping of goods as it seeks to regain markets. China has intrinsic strength when dealing with countries in Africa and Latin America and can explore deeper here.

Fifth, there is the possibility of China depreciating the currency so as to get the competitive edge which cannot be ruled out. This happened in 2015 as well. The move now will also go along well with the storyline of China slowing down in terms of growth and the Yuan weakening. This, in turn, will have ramifications for other countries as China has enough power to move the currencies. A strong dollar and weak Yuan may not be good news for all countries.

The two economies are likely to be affected in a disparate manner. The US is already on the path of tax cuts to revive its economy and hence may not get impacted in the trade war.China could have more to lose but appears to be prepared with easy domestic policies being pursued to keep investment moving which can counter the 0.5 per cent decline in output conjectured by analysts. The overall impact on global growth may hence not be too significant even as there could be volatility in prices – both commodities and currencies in the extreme case.

Can India take heart from this? Theoretically, in areas like readymade garments, we can push forward but will have to compete with Bangladesh, Vietnam in particular. At the margin, there can be some gains. However, India, too, has been in the radar of the US for unfair trade and the GSP status is already to be withdrawn soon. Given our clout in the world economy, we may have to review our policies and practices.

The repercussions can be more volatility in both commodity prices and currencies as the trade war escalates. While a non-retaliatory situation would make the dollar stronger and pressurize the rupee, the continuation of the war can cause volatility. Global trade will get more volatile and also affect investment flows which are otherwise not part of the deal. This can be more serious.

A Case For And Against GST: Book review Business World 22 June -5 July

Arun Kumar’s book Ground Scorching Tax is a well-articulated treatise on the GST where all concepts are explained in a rudimentary manner

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GST has generally been acknowledged as being an ideal tax system, which has been implemented in a large number of countries and brought several benefits. India, too, embarked on this tax system post demonetisation, which raised the emotive cord as one major constituency -- the SMEs -- was impacted by this new tax regime. The government has been fine tuning the system regularly both in terms of changing the tax rates on various goods and services and also making it easier for the SMEs.

However, when one reads Arun Kumar’s book on the subject, the impression derived is that the GST is an incorrect concept for a complex country. The argument that GST is there everywhere in the world cannot be a justification because countries have adapted this concept to their underlying conditions, which the author feels has not been done in India. While Kumar, an erudite scholar and economist, has written earlier extensively on black money and demonetisation where he convincingly argues that the government was off track, the same cannot be said in this context. Some of his conclusions may be perceived as premature as the system is still evolving, and this has been accepted by the government.

Let us see how he puts forward the case against the GST. The reader will agree with the author that to begin with, we cannot have an efficient tax system, which lowers prices and also increases revenue for the government while addressing black money simultaneously and delivering a high score on doing business. Above all, GDP growth will be higher by 1-2 per cent. In fact, based on the data collected till now, it does look like that after a series of changes in the tax rates, revenue collections have come down. The story on prices is equivocal as it is a mixed result. And most certainly GDP growth shows no sign of being affected though it may be too early to expect it.

The advantage that forward looking economists have when they come to such conclusions is that they can get theoretical without giving timelines. Often it will be close to impossible to separate the incremental growth in an economy due to GST and other direct factors.

Kumar also argues that having multiple rates, which change regularly has created havoc in the system. This is where he talks of the GST not being appropriate in our complex structure. But in defence of the government, it can be said that this was acknowledged upfront when the GST was introduced with the rider that the system would be evolving and such changes would be made to ensure that we get the right fit over a period of time. Otherwise it would be close to impossible to set in motion any new tax system in an economy where as much as 40-50 per cent of the GDP resides in the informal sector.

The author hits the bulls eye when it comes to bringing to fore the plight of the unorganised sector. Kumar writes that the case of GST enhancing efficiency and easing the ‘doing business’ environment is only for big business and comes at the expense of the unorganised sector which gets marginalised in the process. While this argument is true to an extent, the effort is definitely on from the government’s side to assuage this sector with the frequent changes in the structure.

The author has also made a pertinent point on fiscal federalism being impaired by the GST. States have been given constitutional power to levy certain taxes, which has now been changed and this actually puts them in a bind when it comes to enhancing income by raising tax rates as these GST rates are now institutionalised. States surely will find it challenging to raise revenue on goods and services as these rates have been set in the Centre.

Kumar raises the issue of exclusion of certain goods like petrol products, liquor and tobacco. It is true that these have been consciously left out as they bring substantial revenue for the states. But discussion is on to look seriously at petroleum products. Therefore while the author looks at this being ‘opportunistic’, it can be counter argued that we are presently in stage one of the phased rollout of the GST.

Does he provide an alternative? Towards the end, he does offer his suggestion, which is debatable. For instance, first, Kumar believes direct taxes are better than indirect as they fundamentally tax the rich more which is the right way. Here it can be said that direct taxes contribute substantially to overall tax revenue (over 80 per cent). Second, he feels that we should get rid of the input tax credit system and only tax goods and services at the consumption stage. Hence steel will not have a tax rate but only cars and utensils will be taxed. While this sounds good, it will have challenges of mapping every product with the end product and lead to a different set of complexities. Similarly services that are productive should not be taxed like chartered accountants, lawyers, finance but others like tourism and hotels should.

GST, hence, according to the author has several unfulfilled promises, ‘marginalises the marginal’ and does not formalise the economy. Ground Scorching Tax is a well-articulated treatise on the GST where all concepts are explained in a rudimentary manner. While the arguments put forward appear to be one-sided at times, they are well presented. That’s what makes this book a compelling read.

Budget 2019: What you may have missed: Financial Express July 9 2019

Union Budget 2019 India: The Union Budget, presented last week, was unique in the sense of being a follow-up on the Interim Budget, presented earlier this year. There were lots of expectations from the Budget, which may not have necessarily been addressed. But, for sure, there are some points that may have been missed.

First, the speech was long and eloquent, and touched upon all the government priorities. But, as the presentation was made, there was an abrupt end to the speech without touching on the Budget numbers as such, or even the fiscal deficit target. This was a surprise, as normally the finance minister does give these numbers for a better understanding. Arguably, this was deferred to the documents that were uploaded immediately.

Second, one of the reasons for the sudden change in the thrust of the speech may be due to the rather confused state of budgetary numbers. The Interim Budget was based on RE numbers for FY19, which kept the budget size at Rs 24.57 lakh crore. However, the Controller of Accounts had given an update on this based on actual numbers, which were much lower at Rs 23.11 lakh crore.

There was a distinct slippage in revenue of over Rs 1.45 lakh crore, which was made up for by expenditure pruning on capex as well as rollover of subsidy, which was hinted at in the Economic Survey. The Budget now still sticks to the revised number of Rs 24.57 lakh crore as the base, which is significant as all the growth rates that are reckoned will actually be on a lower number than the one used here.

Third, the size of the Budget is now Rs 27.86 lakh crore, compared with the Rs 27.84 lakh crore in the Interim document. Therefore, there has actually been no change in the overall budget allocation compared with the earlier one. This should be indicative that the government did not really do much at the aggregate level, but has moved numbers around within this overall outlay, which is pragmatic as it has worked on fine-tuning various components of the Budget.

Budget 2019 tax proposals futuristic in nature; have a far-reaching impact

Fourth, following from the above, the speech had spoken about the tax benefits given in the Interim Budget when presenting the follow-up Budget, indicating that when viewing the Budget one must look at both of them together rather than independently. Thus, the income tax benefit provided to some sections earlier this year was part of the overall proposals, which is fair enough. Therefore, when evaluating ‘what has’ or ‘has not’ been done, it has to be done in conjunction with the Interim Budget.

Fifth, surprisingly, the Budget still talks of Rs 75,000 crore for PM-KISAN—the cash transfer scheme for farmers. At the time of general elections, the amount was raised to Rs 87,000 crore as it was to cover a wider cross-section of farmers. However, the provision made now is unchanged at Interim Budge level, which means there will be economies here.

Sixth, the fiscal deficit target will be lowered to 3.3% from 3.4% projected in the Interim Budget. This did come as a surprise, given that nothing else has changed. On a closer look, the Budget has actually expanded the denominator by increasing the GDP at current prices at a higher rate of 12% as against 11.5% projected earlier. This is interesting, considering that the Economic Survey spoke of real GDP growth of 7% this year, which now means that inflation will be closer to 5% that is higher than the orbit mentioned by the MPC.

Seventh, the government has spoken of raising debt in global markets, which will be the first time that such a thing is done. This has been received with considerable enthusiasm, as it not only helps the government to raise funds without disturbing domestic liquidity, but also gets in forex that will stay for the period of issue and could come at a lower cost.

But such a move would mean a change in ‘stance’ that has been held so far by the government when commenting on the sovereign rating given by international rating agencies, since India never had sovereign debt. Once we do go in for such an issuance, the challenge will be to change the well-established shibboleths of global rating agencies (which the emerging markets have been voicing for over a decade now) that our rating is no better than just about an investment grade at BBB. In fact, these agencies look deeper than the fiscal deficit ratio of 3.3% and include state debt, PSU debt, off-balance sheet debt, etc, and are harsh on governments for not having labour reforms that are not consistent with domestic policies. Therefore, these will be difficult hills to climb in coming months.

Eighth, the Budget has made some curious changes in the expenditure outlays for various heads compared with the Interim one. Outlays on fertilisers, agriculture, rural development, health, transport and education are higher by a combined amount of around Rs 12-13,000 crore, with a compensatory fall in transfer to states and interest payments. The latter is interesting because this assumes that borrowing costs will be lower (about Rs 5,000 crore) either because the government will borrow cheap from global markets or that interest rates will decline further this year. This is significant because the issuance of bank recap bonds for Rs 70,000 crore will mean an annual outflow of at least Rs 4,200 crore at the rate of 6% per annum.

Ninth, the Budget also has assumed changes in the financing pattern. Interestingly, GST collections are to be lower by almost Rs 1 lakh crore compared with the Interim Budget and will be compensated for by higher excise (Rs 40,000 crore, mainly petrol and diesel to fund it), by customs (Rs 10,000 crore, higher rates on several products) and non-tax revenue (about Rs 41,000 crore) where RBI will be paying around Rs 1.02 lakh crore instead of Rs 0.82 lakh crore (Interim). One may expect interim dividend to be paid by the central bank in FY20, too.

Lastly, there has been no mention of the use of RBI surplus reserves, which may actually turn out to be the emergency cash buffer to be used for balancing the budget as it may be assumed that the RBI committee will arrive at a decision on the use of such funds during the course of the year. However, any such use will have to be done keeping in mind how global rating agencies view the move, especially so if the government plans to use the global route this year.

Budget doesn’t give or take: Free Press Journal 6th July 2019

From the point of view of the individual tax payer, the Budget may come as a disappointment as it was expected that there would be some tax concessions given.

This expectation has been generated on account of the fact that consumption has been growing at a low rate and a tax cut on income would have increased disposable income.

However, the government has been silent on this and instead enumerated the tax benefits that have been provided in the last 5 years including the interim budget. In fact at the higher level the surcharge has been increased.

Two areas where individuals would be better off on the consumption side are housing and vehicles. The Budget has provided for enhanced tax exemption on interest paid on loans for buying a house that comes in the category of affordable housing.

This means that if a person buys a house for less than Rs 45 lakhs and borrows from a bank to finance this purchase, the interest paid will be tax exempt for an additional Rs 1.5 lakhs.

This will be an incentive for sure. It will also benefit the housing industry and to that extent can add to job creation, though may be limited in scope depending on the reaction of the public.

The second is on electric vehicles where loans taken to buy such an article would get a tax break up to Rs 1.5 lakhs. While the immediate response from buyers and sellers may be slow,

it may be expected that in course of time this will work out well for producers and consumers. This can be a simultaneous boost for the auto segment which is facing various challenges that has led to declining growth in sales.

This enthusiasm may be dented by the decision taken to increase excise duty on petrol and diesel by Rs 1 a litre. This is one of the reasons that the government has kept them out of GST as this would otherwise have meant not being able to change the rates on these items.

The fact that demand is inelastic gives that much space to the government to raise rates on these products. Hence even as crude oil prices remain low at less than $ 65/barrel and the currency strengthening to now Rs 68-69/$, revenue collections will increase.

Another disappointment would be no action on the LTCG. While some may say it was overoptimistic to expect such a measure, given that there was a sense that the government may try and assuage the markets, any change in the LTCG on equity and equity funds would have spiked the market. But this has not been done and it may be assumed that it would not be on the agenda for some time.

In terms of expenditure, there is not much change from the Interim Budget proposals with some items moving across to other categories. The ability to spend has also been heavily restricted given that economic growth is not really going to be very much different this year compared with FY19.

However, companies with turnover of less than Rs 400 cr would now face a lower corporate tax rate of 25% instead of 30% which will be a major gain. The Budget does expect corporate taxes to be the main driver of tax income this year with an increase of Rs 95,000 cr expected.

This will be followed by Rs 40,000 cr from income tax. Quite clearly there is an assumption that either the tax base will increase or compliance will be significantly better to drive these numbers.

With the budgetary numbers being largely unchanged, the government’s borrowing programme remains virtually static at Rs 7.1 lkh crore. This is good for the market which would have taken it perversely if the borrowing increased.

However, the government has been indicating that it was committed to lowering the fiscal deficit number to 3% by FY21 and hence was unlikely to stray from the path.

It has bettered the number to 3.3% this year. There is always scepticism on whether the target will be attained. But it must be remembered that the government follows a cash based accounting system where expenditure is reckoned only when it is paid.

By rolling over expenses, the budgetary numbers can be maintained and the expenses deferred. This could always be done again to meet the goals.

Economic survey 2019: Focus on investment and sharpening the edges: Financial express 5th July 2019

When analysing the implications of the Economic Survey it must be understood that it is a detailed view of the economy (where most information is already known) with a view provided independently by the CEA on how things look going ahead. The CEA’s views and ideology get embedded in the document, and as this is the first of Dr Subramanian, is insightful. While there are some prescriptions made, there is no reason to
believe that they will be considered by the government which has to balance the same with political and economic compulsions.

The Survey has pinned hopes on investment to be the driver of the economy through the ‘virtuous cycle route’ and believes that it forges links with consumption, exports, employment, etc. Hence, in a way, a concentrated effort on pushing up investment can achieve the other objectives too.

More importantly, the Survey believes that the worst is over and that there is reason to believe that the cycle will turn around this time. The reason is that capacity utilisation is up, NPAs of banks have peaked and being resolved and therefore both demand and supply conditions are favourable. Therefore, there are signs of green shoots.

The question really is whether these green shoots blossom or not. Presently, the picture on farming does not look comfortable with a delayed monsoon. Industrial output will have to be watched and the base effect can tend to depress numbers in the next few months.

The NBFC crisis is still in progress and while it is localised does still tend to send cautionary waves in the industry. Banks have recognised their NPAs, but would require capital and tread carefully in the coming years. Therefore, a clearer picture will emerge in the next 3-4 months.

The Survey has highlighted four major achievements in the last few years for which the government has to be commended. First is delivery which is very important because it has been the Achilles heel all along where government programmes falter due to inefficient delivery mechanism. Getting technology in for better delivery has been illustrated here in the NREGA.

Second has been infrastructure where relentless focus by the government through direct intervention in roads, railways and urban development has brought about significant improvement in these structures. On the other hand, proactive policies in terms of doing business have opened to the doors for private investment.

The third achievement has been federalism which is the cornerstone of the government development programme. This has actually helped in terms of better flow of funds as well as responsibilities which is finally also reflected in the combined fiscal numbers.

The last has been addressing the issue of corporate exits through the IBC which had been a stumbling block in the way of resolution of corporate insolvency. To this it adds that the removal of policy uncertainty has helped a lot to make things work better.

An interesting revelation is that the traditional MSMEs with less than 100 workers remain dwarfs all through their life and do not actually add to the employment chain or productivity. In fact, they actually destroy jobs as a number of them become non-operational. The suggestion here is to unshackle MSMEs and thereby enable them to grow. In this context all size-based incentives must have a sunset clause of less than ten years with necessary grand-fathering.

Hence, the report does read well and provides a path on what should be done. As the government is already on this road, there will probably be only incremental changes required to hone the system and make it work better.

Calls for reduction of interest rate- here are pros and cons Financial Express July 3 2019

With the elections resulting in a successful return of the NDA government, the focus of attention is now on what will be the stance taken by the MPC? Against the background of not showing a convincing uptick and out of force of habit, there are already calls for reduction of interest rates, with the decibel level being higher for 100-200bps cut. It is, hence, necessary to analyse the pros and cons of reductions in interest rates.

Interest rates have been looked at normally from the corporate lens, and hence the view is these should be lowered to spur investment. Is there a real relationship between the two? Also, as interest rates have a bearing on savings, should this perspective also be looked at? Last, as there tends to be regular comparisons of real interest rates in India with those in the developed world, is there a basis for doing so?

The best indicator of investment is the gross fixed capital formation (GFCF) rate, which is expressed as a percentage of GDP at current prices. The GFCF rate has been declining since 2012-13, from 34.3% to 28.9% in 2018-19. A decline of 5.4 percentage points is significant. During this period, the return on advances for all banks based on RBI data declined from 10.42% in 2011-12 to 8.31% in 2017-18 (the latest year for which data is available)—a decline of 211 points. Therefore, to argue that lowering rates is the panacea for investment can be contested by data.

The disconnection between the two can be explained. First due to over-investment in the pre-2011-12 era following the financial crisis, the stimulus provided on fiscal and monetary sides gave investment a boost. But much of this went into infrastructure, which was afflicted with irregularities in sectors such as coal, iron ore, power, telecom, among others. This led to projects getting stalled, which later got translated into NPAs after some umbrella cover was provided through the CDR route. This led to projects still being in the stalled mode or abandoned. Therefore, private sector interest in investment is limited irrespective of the interest rate regime.

The second reason for low investment is surplus capacity in most industries. Typically, a utilisation rate of around 78-80% is required to push investment. With the rate being stagnant in the 70-73% range on an average, there is limited push here. The latest RBI data shows this has crossed 75%, which is not consistent with the declining IIP rate. Unless this number improves, only then will fresh investment take place.

Now, the way out is really on the demand side for capacity utilisation and on structural issues relating to NPAs and regulation to reignite interest in infrastructure. Under these circumstances, there have been some collateral effects on savings, which have declined during this period.

The ratio of household savings came down from 23.64% in 2011-12 to 17.2% in 2017-18—a fall of 6.4 percentage points. This is significant because bank deposits are today around Rs 125 lakh crore, and another Rs 12 lakh crore are in debt mutual funds. Lowering of rates affects income received, which, in turn, affects spending power and consumption. The average cost of deposits of banks has come down from 6.28% in 2011-12 to 5.02% in 2017-18—a decline of 126bps. Thus, hasty decisions on interest rates can have a negative impact on savings. Curiously, the decline in average return on advances of 211bps was higher than that in cost of deposits of 126bps, but savings rate of households fell at a higher rate!

An interesting takeaway from the accompanying table is the spread between return on advances and cost of deposits has come down from a high of 414bps in 2011-12 to around 330bps in 2017-18, and the benefits have been more to the borrowers than the deposit-holding public.

The other issue on real interest rates does raise a fundamental question. Can we really compare the real interest rate in India with that in a western economy? The interest rate is the cost of capital and should reflect the same. This is what theory says. The cost of capital is the result of demand and supply for funds, and if supply is less as revealed by the higher CAD ex post, then it means the economy is capital-scarce. In such a situation, the interest rate level has to be higher than that in other developed economies. Lowering the interest rate to a level that is not supported by the market can lead to distortions. The table also provides the real interest rates in various countries based on the policy rate adjusted for CPI inflation. As can be seen, the higher ranges of real interest rates are in some of the faster growing economies where there is greater demand for funds. While it can be argued that 3% real interest rate should be 2% or 1.5%, it must be realised that the real rate is looking higher due to low inflation, which is due to supply factors rather than demand. In 2013-14 and 2014-15, CPI inflation was 9.3% and 5.8%, respectively, in which case the real repo rate would have been negative.

The argument on comparing the real repo rate with those in other countries should not be considered in isolation. The low inflation rate that is being witnessed today is due to unusually low farm and fuel prices. The average CPI inflation for industrial workers up to 2017-18 was 8% per annum in the last 10 years, with seven years of above-6% mark. So, rather than looking at current inflation rate for reckoning real rate, an average may be advisable as these rates tend to be quite volatile—at times due to single commodity price effects.

The discussion points to a few conclusions. One, interest rate should be considered looking at both investment and savings, and has to be balanced as it can lead to distortions on the consumption side. Second, lower interest rates are just one factor going into investment decisions, and are not a guarantee for positive response. Third, the global real interest rate comparison misses the point that nations are different, as are their credit markets. Last, even the concept of real rates runs into problems when inflation increases, as the same train of thought can justify significantly higher repo rates when prices of, say, potatoes or onions increases, which can be adverse for future growth.

Book Review: Firefighting The Financial Crisis And Its Lessons: Financial express June 30 2019

The global financial crisis is probably the event that has engendered the maximum number of books and papers, throwing up a lot of facts and interpretations. Therefore, one may ask the question whether we really require another one after almost 11 years. The attraction in reading the book titled Firefighting is that it is like hearing things straight from the horse’s mouth, as the three authors had worked with relevant authorities during this phase and got the system back on its feet. That probably is a novelty when one picks up the book.

However, for those who have read other books on the subject, this one may not have anything very different to add, as most facts, which include the genesis of the crisis and the rescue missions, are well known now. In short, the crisis was all about too much of risk leverage, coupled with excessive short-term financing used for long-term lending, and the migration of risk from the formal banking sector to the shadow banking system, where there was too little regulation.

More importantly, there was no access to the Federal Reserve’s emergency safety net, which made the difference at the end of the day. To top it all, there were too many large firms that were too big to fail and were interconnected. This magnified the problem when it spread fast across the sector. Add to this the opaque mortgage-backed securities, which added to the puzzle, and it was a recipe for disaster if things went wrong. The authors also admit that the regulatory bureaucracy was outdated and fragmented, with no one being responsible for monitoring or even addressing systemic risks.

The authors have pointed out that the main cause of the crisis was ‘maturity transformation’, which meant borrowing short-term and lending long-term. This will ring a bell in our minds in India, as the present NBFC crisis, though not quite widespread but localised, had its genesis in a similar model. Therefore, when the crisis erupted and institutions had been blocked out of the CP market, the crisis just escalated. The CDOs and ABS were the second part of the story. In fact, the other point made about the crisis is that institutions that went down under were technically not regulated by the Federal Reserve, just as is the case with the NBFCs, where there are various regulations followed but no specific regulator. In fact, even capital standards were weak at that time with backward-looking regimes instead of forward ones.

A warning sent out here is that every time there is a boom in any financial segment, regulators need to be extra cautious as it could mean the sowing of the seeds of a bubble that can burst. This is what capitalism is all about and the Schumpeterian concept of creative destruction is a natural process that has to play out periodically, which, in turn, will lead to the transformation where the weak are sieved out and the system emerges stronger. The authors describe in a very incisive manner the meltdown that happened as the virus spread from one institution to the other. In such situations, there is general distrust that is built, and every institution is apprehensive of the other and not willing to deal with them. This is what made life difficult, which finally led to the quantitative easing programme that had the Fed directly buy bonds in the market to provide liquidity as market players were loath to lend to one another.

The authors are upfront in taking on the criticisms that have been levelled on them in terms of using public money to save the capitalists who were the ‘bad men’. Their view is that this was required to save the rest of the system, or the consequences would have been catastrophic. The act of saving the system and using all that was required to ensure it happened has actually helped the economy reach where it is today. The funding provided to institutions like AIG actually paid off, as they returned the money with a premium. Therefore, in retrospect, too, the action taken was judicious.

There is a first-person account of the deliberations and reactions to various institutions going down, including Bear Stearns, Lehman, JP Morgan, Merrill Lynch, Morgan Stanley, etc. But it is presented in a more official manner, unlike some of the first books on the crisis, for instance Too Big to Fail by Andrew Ross Sorkin, which was more exhaustive in documenting the parleys in various meetings. The authors also clear doubts on why Bear Stearns was rescued but not Lehman — it was more because they were not able to get a buyer given the time constraints. So, it was not a case of partiality being shown or a late reaction.

The book does not really get too much into the QE solution and has focused more on the crisis and the reaction of the Fed and the government to the problem. The authors are also clear that the next crisis can never be known from a regulatory perspective but there should be more safeguards built, especially when money is borrowed in the market and hence should be dynamic in nature.

From a regulatory standpoint, they argue that it would be necessary to have a policy on what can be done in such situations so that the playbook is in place. This book is surely a very good refresher with useful insights. The sequencing of the events has been narrated in a succinct manner, which makes the book extremely readable. There are almost 70 pages of graphs in a book of 230 pages, which may not be of much interest to the average reader.

India 2030: How would the Indian economy look like in 10 years? Book review Financial express June 23 2019

India 2030 is a kind of omnibus on the visualisation of experts of how the Indian economy would look like in 2030, and the action points required to be taken for getting us there. Sameer Kochhar, better known for his remarkable work at Skoch, has gotten together 26 essays on various aspects of the economy and presents this volume, which is a very good guide for anyone trying to understand the complexities of the system.

While each of the essays is very well articulated, which can be expected as the authors are of the calibre of Ashima Goyal, Rathin Roy, Tamal Bandyopadhyay, Deepali Pant Joshi, etc, the introductory article by Kochhar in a way sets the tone.

He is generally apolitical when putting forward his views and does not go overboard in eulogising the NDA government or condemning the UPA regime. Three views expressed by him stand out in terms of controversy. The first is regarding demonetisation, where he argues that it helped to bring in digitisation and a cleaner system. He blames the RBI for very unprofessional handling of the transition, however. This is probably where all the defenders of demonetisation go wrong.

Digitisation was never the stated objective when notes were removed from the system. It came in only when it was realised that the stated objectives were not met as an afterthought.

The second is that he blames the RBI for the economy slowdown and in particular points towards Raghuram Rajan for stifling growth by choking interest rates. While critics are entitled to their views, he goes wrong because even the MPC (which has six members) took a similar stance under Urjit Patel. Therefore, to point a finger at Rajan seems out of place. Also, Kochhar misses out that interest rates are not the panacea to growth and is only one enabler.

India 2030 Sameer Kochhar and Rohan Kochhar Skoch Media Private Limited Pp 483, Rs 495

Third is a curious distinction Kochhar brings in when trying to debate the issue of conflict between the RBI and government. Here he supports the government as he draws a distinction between bringing about ‘economic development’ and ‘socio-economic development’. The government was justified in prodding the reluctant RBI to open up the doors. In his opinion the government had a long-term vision of socio-economic development, which is different from that of the RBI, which thinks of just orderly growth. Therefore, Kochhar is not for things like PCA or anything that come in the way of the SMEs. The reader can decide for herself here.

Ashima Goyal and Rana Kapoor are very optimistic about India going beyond the $10-trillion mark by 2030 and do expect GDP growth rates of 8-10% going ahead. Presently it appears to be more like wishful thinking as the economy in the last four years or so has struggled to stay in the region of 7% and even here few are convinced that the economy is really robust, notwithstanding the fact that India still remains the fastest growing economy based on the CSO data.

Tamal Bandyopadhyay discusses NPAs in a critical manner but looks positive again given the progress made so far. As this was written well before the Supreme Court ruling on RBI action relating to IBC, the author may have a different view today post this announcement as the resolution process may slow down.

There are essays on sectors like steel and energy that are useful but the one on start-up’s Rameesh Kailasam is different. This becomes relevant today where the internet has changed the way in which business is done and ‘startups’ based on technology have been widespread with different levels of success. But given that India needs to create jobs and those companies are parsimonious in this respect, individual enterprise holds the clue going forward and the plan drawn up by the author is interesting.

Similarly, there are essays on women empowerment by Deepali Pant Joshi who has been a strong advocate on the subject, and another one by Soma Wadhwa on girl counselling. Here she advocates counselling in school so that girls are aware of career options and can pursue studies that lead to a satisfying career.

Charan Singh’s views on inclusion are incisive as usual and very relevant as growth without taking along the majority of the population is less meaningful. Financial inclusion for sure is a way out, which makes individuals independent and in the long run can actually free the government from other programmes that deal in subsidies or goods.

Co-author Rohan Kochhar has provided a very important prerequisite for the 2030 story to unfold i.e. education. What is missing is school infrastructure and qualified teachers and this is what we need to build if we are to reach there. He brings to the fore the fallacy in our focus on education where an end-to-end solution is required starting with infrastructure that can be used. This has to be supported by the supply of qualified and interested teachers so that children can be taught in a meaningful way.

There is an essay on universal basic income by Rathin Roy who believes this will work for inequality, but clarifies that all that is spoken of is directed transfers and not universal basic income. Indira Rajaraman highlights the importance of investment for growth and minister Nitin Gadkari has a well-written piece on infra financing. These are well-written and comprehensive pieces that place the building blocks for the 2030 scene to emerge. This book is a very good compilation for student as well as novices who read business dailies and watch business channels and would like to clear the clutter in their minds.