The economics of petrol pricing: Financial Express 27th Feb 2021

 he increase in petrol price has come when the economy is turning a corner and inflation is coming down. Government revenues have also started reverting to normal. The argument for higher levies on petrol and diesel, which could have been justified when the crude oil price was low and consumption declined sharply, is not really strong now.

As usual, there is a discussion on what should be done to ease the prices. The Centre feels that the states should lower their taxes, which is an ad valorem levy. The states feel that the Centre has more legroom as it has already converted taxes into cess, which need not be shared with them. The Centre has pointed to the increasing crude price and made a plea to OPEC to expand output to lower prices.

There are four components to this price: the cost to the dealer, which includes the crude oil price and other processing charges, excise duty charged on per unit basis by the Centre, a dealer commission to the fuel station and a VAT imposed by the state. VAT rates vary across states—being outside the GST ambit—and accounts for a rather wide variation in prices across regions.

This break-up in price can be traced back over the last three years.

The cost to the dealer has three parts: crude oil price in global markets, exchange rate and refining costs, with the first two exogenously determined. As can be seen, this price has varied based on these factors, but has been in the lower range since mid-2019. When the crude oil price was around $65/bbl, the cost went towards Rs 41/litre. But, at present, the crude oil price of around $60/bbl has an associated cost of Rs 32.90, which is comparable to the cost in November 2017 and the two points in 2019. Hence, the argument that the price is high because of global crude oil prices is not convincing.

The excise rate, levied on a per-unit basis, has been in the range of Rs 18-20 for 2018, 2019 and the first half of 2020. In June 2020, the rate was increased by around 65% as consumption had fallen sharply due to the lockdown. The lower crude oil price, hence, did not result in a major gain for consumers as the retail price was maintained at Rs 71-72/litre. Our policy has been that whenever the global price of crude comes down, the government ramps up its revenue collections, giving minimal relief to consumers.

The commission on fuel products has been virtually static, which means that petrol dealers make money only when volumes of sales increase as their income is agnostic to the crude oil price as well as duties paid.

The state contribution to this price rise is interesting. For 2017, the effective VAT rate for Delhi was 27% and remained the same till November 2019. It rose to only 30% in 2020-21. Therefore, the NCT did not increase the rate significantly, but as the tax was on a higher base given the way it is reckoned, there was an automatic gain. Delhi, however, has a low VAT rate. For states where the price is closer to `100/litre, the effective VAT is upwards of 42%.

Now, there can be strong arguments for both the Centre and states to rationalise their taxes. If excise is reduced and the states do not automatically increase their VAT rates, the state part of the price would come down less than proportionately, and the consumer can pay a lower price. On the other hand, if the crude oil price goes up sharply and the tax rates are not changed, the Centre would not benefit while states would gain on the VAT collection as the taxable base rises.

Quite clearly, the economics behind the petrol price determination is complex as the tax rules are very different, being out of the GST framework. For the present, it does look like the government on both sides will remain mostly intransigent in their tax view, which will change only in case the crude oil price increases sharply.

GDP numbers: Positive surprise for third quarter but negative for FY21? Business Standard 26th Feb 2021

 The CSO keeps the suspense alive on growth forecasts by coming with a second advance estimate in February after the first was released in January. The January forecast is based on extrapolations of data known till November or December for most variables while the second estimate is based on more of the realized data. Given that corporate performance has been good for the third quarter and that these numbers enter the calculations for several sectors, these estimates capture the picture in a better manner. Simultaneously there are the Q3 numbers which are provided which are more significant this time as several indicators showed that the economy had turned the corner.

The picture emerging is definitely satisfactory as growth for the year or rather degrowth is better than what was projected at -7.2% with value added now to degrow by 6.5%. The problem has been on the tax collection front as well as higher subsidies which has now caused GDP growth to fall by 8% as against -7.5% projected earlier. This is a result of taxes falling and subsidies increasing (with a new recognition of FCI loans). The improvement in growth rates or rather degrowth rates has been across most sectors relative to the earlier estimate.

The Q3 growth numbers have contributed to this improvement in numbers as GDP has improved to 0.4% for GDP and 1% for GVA. This is a big positive as negative growth was expected this quarter. The number is also significant as it shows that we are now out of the technical recession which is defined as two successive quarters of negative growth. Also, as most sectors have started moving back to a normal growth path in Q4 there will be some acceleration here for sure. Manufacturing, construction and finance groups registered positive growth besides agriculture and electricity.

Two areas of concern have been consumption and investment and here the Q3 growth numbers are more pertinent. Consumption and investment growth have been marginally higher. Therefore the spending witnessed in the festival season does find its reflection here. However, given that private investment is down the improvement in the gross fixed capital formation rate from 27.5% to 27.7% may be attributed to government capex. For the year however, it continues to be moving downwards from 28.8% to 26.7%. Quite clearly this has to be the focus area next year.

The GDP forecasts do indicate that we are on the right path and in the absence of any serious localized lockdowns can be expected to accelerate with time. Q4 growth would be steadier for sure and there will be an upside to the 1% growth in GVA witnessed in Q3. A lot will depend again on corporate performance in this quarter as these numbers enter the computation for sectors such as manufacturing, trade, transport, communication, hotels, etc. An interesting point here is that while manufacturing sector in terms of GVA would be moving in the positive direction, the same for the physical production as depicted by the IIP would be trailing.

But this does set the tone for higher growth numbers in FY22 which will be coming on a negative base and a double-digit growth rate is what can be expected.

GDP Q3 numbers on NDTV

 https://www.ndtv.com/video/business/news/gdp-growth-india-exits-recession-with-0-4-quarterly-growth-577110

Privatisation this time, not disinvestment: Financial Express Feb 23 2021

 

The path towards total privatisation does involve breaking ideological shibboleths that have been built since Independence. At the same time, is it necessary for the government to actually sell stake to get private ethics in PSUs? Can’t the same be done by simply changing the rules of governance? This may also be worth considering

Is there a difference between privatisation and disinvestment? Disinvestment is a purely an Indian term that connotes what it means. The government sells shares of companies so that it supports the Budget. The tone of privatisation is different as it means that the government is keen to get out of certain sectors that are not strategic and where the belief is that it has no right to be there. By selling its stake to below 50%, the ownership passes, and the company works like any other private sector enterprise and the government need no longer worry about it. This makes a lot of sense, and as the finance minister spoke of the concept during the Atmanirbhar series, it does appear that the government is keen on moving out of some companies.

But a question here is whether making a company privately-run is better than keeping it where it is? If one looks at the private corporate sector, the performance is not always very good if one moves away from the top 100 companies. First, most of the non-farm NPAs reside in the private sector. Data on this is not provided by RBI post 2017, but at that time the share of public sector in NPAs was just around 3%. Second, most failures are in the private sector. On both these points it can be counter-argued that some PSUs would have closed down due to similar failure but are afloat because of government support. True, this is valid, especially if one sees PSBs where some of them may have folded up just like the private ones which had to be merged with others.

Third, the private sector does not create jobs, which was a mandate of the public sector. In fact, there is a distinct dislike for creating jobs as technology takes over, ostensibly due to rigid labour laws. Hence, by privatising such units, unemployment will increase as the flab is reduced. Fourth, in the last five years the share of the private corporate sector in gross fixed capital formation had fallen from 26.1% to 23.4%, if IPR is excluded. If included, it would go up from 32% to 35.3%. Clearly, there is intellectual capital generated, though fixed asset is more in the domain of households (individuals and small enterprises) and the government. Hence, it is not very unequivocal as to which model works better from a macro point of view.

There is, however, a strong argument that the private sector has delivered very high value in the market and hence qualifies to take over PSUs. But this holds for some PSUs too. In fact, the Nifty has around eight PSUs that are also favourites of the market.

Now, when we go for privatisation, we have so far followed the disinvestment route where the government sells generally a part of its stake in the market. The modalities are quite well known. At times, one PSU buys into another so that the public ownership remains. Instead of the profits and reserves being transferred directly to the government, it is done through this sale. The other way out is to actually sell fully to the private sector, where there are examples of VSNL or Modern Foods. Otherwise, there is some market sale where individuals can also buy the equity through IPOs. The latest is through the ETF route where the public buys these units which are used to buy shares of PSUs.

The new mode of disinvestment will be privatisation where there are strategic sales taking place. Here the government needs to clearly state that all these sales will lead to its share coming down to below 50% in five years’ time to assure the investors. Will we hear this for all such cases or will it be a case of the government showing intention but still holding the reins? This becomes critical especially so as the government has announced sale of PSBs and insurance companies in the life and general segments.

This is interesting because, traditionally, government-backed insurance companies have been the investor of last resort in all disinvestment plans. Once the stake goes below 50%, the government loses this freedom and has to look elsewhere. The same holds for banks which are used to carry out political agenda of the reigning government.

Shamiana banking, which is the norm today, does not hold for private banks. We cannot have banks being forced to lend to any sector beyond the RBI stipulations once the stake goes below 49%. Therefore, it stands to reason that privatisation in the BFSI space is more likely to be partial stake only and the ‘private’ part will probably not happen in the next decade or so. The government has to be very clear on these issues before going below 50% stake.

To really make PSUs being privatised work, ideally, the entire unit needs to be sold to a single player who can manage the company. Selling to diverse stakeholders like HNIs, FPIs, mutual funds, public will still not add focus to the management. Ideally, an existing airline company buying the state-owned carrier makes sense as there is proven expertise in the field. Even a promoter group that is seeking diversification can extend its claim for such a purchase if the track-record is good. A criteria matrix can be drawn for this purpose where there are qualifications for a buyer.

Having such guidelines in place just helps to fine-tune the process of privatisation in a seamless manner so that all the cards are on the table. The choice of companies is always a challenge because the well-performing ones probably do not need to be privatised, while the loss-making ones would have less value for potential investors. Interestingly, PSUs outside the banking area have contributed to around `40,000-60,000 crore of dividend to the government on an annual basis, and selling off the stake can give one-time revenue but plug the annuity-like flows.

Also, often PSUs are told to invest in machinery to boost capex, which will not be possible once privatised. We have had cases of one OMC buying stake in another to meet the disinvestment target. This again will not be possible. Therefore, the path towards total privatisation involves breaking ideological shibboleths that have been built since Independence.

A rather curious thought that often comes up in this debate is whether it is necessary for the government to actually sell stake to get the private ethic in the organisation? Cannot the same be done by simply changing the rules of governance where the government does not have a say in appointments (which are normally considered as being favours given to the concerned persons) and policies pursued? Creating appointment panels of accepted private sector luminaries to select the top management of PSU staff can actually achieve the same without selling stake. This may also be worth considering.

The changing face of monetary intervention: Business Line 22nd Feb 2021

 https://www.thehindubusinessline.com/opinion/the-changing-face-of-monetary-intervention/article33895997.ece

Beyond Covid’s Shadow review: Group of luminaries examine the pandemic’s economic and social impact: Financial express 21st Feb 2021

 

A A group of luminaries come together with their diverse voices to examine the pandemic’s economic and social impact

Baru has his say in his essay, where he openly says that the lockdown was draconian, as it affected people’s lives and the economy.

When one picks up the book, Beyond Covid’s Shadow, it is a bit of a disappointment as one realises that it’s not written by Sanjaya Baru but edited by him. Baru is well known as an erudite journalist who puts his fingers on the right spots. However, he makes up for his absence, or very limited presence (as he has an article in this volume), by getting some of the best-known luminaries to write essays on the subject. Hence, there is some compensation.

How does he choose the writers? It is a mélange of experts on all sides of the establishment, with the ubiquitous economists on the edge to give expression to different views. Baru has his say in his essay, where he openly says that the lockdown was draconian, as it affected people’s lives and the economy. There is a piece by Subramanian Swamy, which may not find too many supporters, as he advances his pet theories on keeping a fixed exchange rate of Rs 50 per dollar and the lending rate at 9%. There is some logic, albeit not convincing at all, especially when he says that we should print more notes to finance infrastructure and not bother about the fiscal deficit. Clearly, this kind of system does not work any longer.

The essays could get a bit repetitive, as the authors talk a lot about the movements of economic variables during the lockdown period. As they come independently from different experts, this is understandable, but the reader could get caught in a plethora of data points all pointing to the downslide. After a point, one can skip these tables and graphs. Also, it is generally accepted by most authors that the economy was already on the downslide before the pandemic and, hence, one has to look at addressing the long-standing issues and go beyond just the pandemic effect, which is just another shock. Arvind Virmani, for example, gives 12 solutions in different areas, including duty rates.

But some of the ideas emanating from some of the pieces stand out, which can be used by our policymakers. Bibek Debroy, for instance, talks of his preference for expenditure over tax cuts, as he believes that the multiplier effects are larger and more effective. He also speaks of monetisation of assets, which has already found utterance in the FY22 Budget. Such expenditures also help in creating jobs, which is very important. Haseeb Drabu has an interesting piece on federalism, which makes a lot of sense in the current context of the unlock process. We have been concentrating a lot on vertical federalism, which is what is guaranteed by the Constitution. However, what is more relevant is the lateral federalism concept, where states need to be talking to one another and cooperating to bring about the best solutions. If one looks at the way in which the unlock process worked, this idea will resonate, as the states had their own laws and tried to protect their interests even if it meant being at the cost of others.

Rama Bijapurkar has a pointed essay where she rightly points out that we need to distinguish between the small business, which makes the real India, and big business. Most of the accolades that we have achieved, even in terms of being one of the largest economies in the world, have been due to the latter and not the former. We need to concentrate on the former, as this is where there are jobs to be created and, for this, we need to make them strong.

Meghand Desai’s piece is quite provocative, as he shows how it is not just economists who get their forecasts wrong, but also scientists who are generally more precise with their models. His contention is that they were never able to get right the role of herd immunity or even the lockdown concept on the spread of the virus. While this was a shock which no one expected even this fraternity was not able to precisely say how the spread could be prevented or slowed down. Interestingly, he gives an idea to economists that whenever they build models to explain things, a factor that has to be considered is distance, as it affects the future of several industries. This is something which will surely get embedded in models in the future.

There are fairly comprehensive and optimistic scenarios given by Amitabh Kant and Rajiv Kumar, which could be taken as the official view, as they explain how the government had its policies in place, keeping the short-term requirements and medium-term reforms in mind. Therefore, there are refresher courses on what Aatmanirbhar stood for by the latter in an essay written with Ajit Pai. If one juxtaposes this with the views of Omkar Goswami, there is a contrasting picture obtained, as he feels that it would not be right to compare these policies with the package of 1991 and to do so would be hyperbole. He is sure that one cannot be optimistic of the future and uncertainty prevails more than hope.

Hence, this book makes very interesting reading, putting together diverse views. It may be hard to take a call on whether Covid was tackled the right way and if there is hope of a recovery soon. Everyone agrees that jobs, small enterprises (Nageswaran), decentralisation (Jagannathan), women empowerment (AV Jose), etc, are areas where more work needs to be done. There is also convergence on what has to be done in the future, though there is difference of opinion on whether we are on the right track and whether enough has been done to attain this objective.

Madan Sabnavis is chief economist, CARE Ratings

Book info: Beyond Covid’s Shadow: Mapping India’s Economic Resurgence

Edited by Sanjaya Baru

Rupa

Pp 321, Rs 595

In media

 on ET Now 19th Feb 2021

subject of fuel inflaiton

https://www.youtube.com/watch?v=2lsKxSCz0zE

Growth will trend upwards in 2021. But it will need to be interpreted with caution : Indian Express 22nd February 2021

 A common thread that runs through the Economic Survey, the Union budget, and the RBI credit policy, one which is also held by India Inc., is that the economy is on the recovery path. This, in a way, is quite natural as the two quarters of negative growth in GDP were brought about by the closure of the economy, which was drastic in the first quarter and constrained in the second. However, post October, green shoots have been observed by policymakers, which combined with the strong policy support, justifies the feeling that the worst is behind us.

The third-quarter GDP numbers would be out by the end of this month and are expected to be marginally negative or even positive. The clinching factor here would be corporate profitability, which has been positive for the quarter. This is critical, as these numbers are used in the calculation of value-added, which is part of GDP estimation. Hence, a contraction in industrial production will not reflect in a contraction in manufacturing gross value added due to profits being positive. This is conceptual. The fourth quarter will register a positive growth rate, and as a consequence, the contraction for the full year will be between 7.5-8 per cent. From hereon, it will be only an upward movement. This is a reasonable assumption to make as most sectors have been witnessing closer to normal activity even in areas such as hotels, tourism, aviation, and media, which were probably more affected by the lockdown than manufacturing.

The contraction sets the pace for growth in 2021-22 which is now going to be critical as it is the foundation for the fructification of the budget revenue targets. It is believed that there will be double-digit growth in real GDP this year. This is being interpreted by analysts as being a V-shaped recovery and that happy days are back. True, statistically growth will be high and this will give the sense of a boom. This holds in all countries which have gone through a recession in 2020.

But consider this: GDP in 2019-20 was Rs 146 lakh crore, which has come down to Rs 134 lakh crore in 2020-21. Hence, a 10 per cent growth will take the Indian economy to Rs 147 lakh crore — when compared to Rs 145 lakh crore, this reflects modest growth. Therefore, expectations should be tempered when we talk of growth next year. Does this mean that it will be a mediocre performance? Probably not, as there will be a revival in economic activity on all ends which will probably bear fruit in 2022-23 — FY 2021-22 will be a year of consolidation.

Let us look at the policy architecture. The government has brought in a cogent policy framework right from the time of the Atmanirbhar announcements, culminating in the budget. There is a focus on infrastructure as well as providing incentives to investment through the Production Linked Incentive (PLI) scheme. Real estate, power and construction saw several policy reforms last year. There is a strong capex push by the government and the fact that the government is talking of a fiscal deficit ratio of 4.5 per cent by 2025-26 means that there will more action taken here.

The RBI has promised to continue accommodative policies, which sends a signal of managing liquidity notwithstanding the large borrowing programme of the government of Rs 12.8 lakh crore. We can expect more open market operations, and long-term repo operations during the year to ensure that interest rates remain stable. However, there will be concern around state government borrowings too, which will exert pressure on the availability of funds, considering that private sector demand has been lacklustre so far this year and will certainly pick up. Hence, there will be more central bank intervention in the market to ensure that funds are available.

Inflation is a concern as global commodity prices have already started going up and this has led to core inflation rising. In India, too, we have seen that the price of petrol and diesel is rising sharply. And with the government unwilling to relent on taxes, higher fuel inflation has the potential to upset inflation projections. Given that the monsoon has been good in the last four years, there is a possibility of an adverse season this time which can affect food prices. As such, it has been noticed that there are price shocks for vegetables, especially onions, every year, which have the potential to push up food inflation. Add to this rising manufactured goods inflation witnessed of late, and there is a possibility of inflation rising above the MPC’s tolerance levels. This will be something to watch out for.

What else will be crucial going ahead? Growth has to be driven by two engines — consumption and investment — this was our Achilles heel probably even before the pandemic set in. Consumption growth has been affected by the absence of commensurate job creation, which has come in the way of income growth. Good monsoons have normally been associated with high rural demand which feeds to the festival demand. This did not happen in 2018, 2019 and 2020. Hence, for growth to take place, consumption growth has to be real and rapid. This is unlikely too soon as consumption is dependent on job creation. Jobs get created when growth is high and hence there is circular reasoning here. Income has been affected in 2020 due to the pandemic which has led to job losses as well as salary cuts. This has affected the sustainability of the pent-up demand seen in October and November.

The second engine is investment which has lagged with gross fixed capital formation falling to a low of 24.2 per cent in 2019-20 from 34.3 per cent in 2011-12. This has to be reversed. This will be a challenge because post the non-performing loan problem, the demand for such projects has slowed down and banks have been wary of lending for infrastructure. There is also surplus capacity in industry with the capacity utilisation rate being 63.3 per cent in the second quarter of 2020-21. Therefore, private investment will rise only gradually and the onus is on governments to manage their targets: Both the Centre and states have to ensure that the wheels are moving. Private investment will follow, but at a slower pace and realistically speaking, will fire more in 2022-23 rather than 2021-22.

Therefore, the year 2021-22 will be one of cautious optimism. Growth will trend upwards, but it has to be interpreted with caution, keeping a check on the consumption meter, while pushing the investment pedal and keeping one foot firmly on the brake, or rather inflation.

On television/other media

 https://www.timesnownews.com/videos/times-now/specials/what-are-the-top-priorities-of-union-budget-2021-budget-revival-mission-2021-round-table/87365

a pre-budget discussion in Jan 2021

https://www.youtube.com/watch?v=j-bJyHG3UCY

Sound of Money: Santosh Sirur has a disucssion on budget and credit policy.

https://www.youtube.com/watch?v=DPkjch6pNMk

on ET Now 19th Jan 

No laughing matter: Why India Inc needs to recognise power of humour, levity: BOok review in Financial Express Feb 14 2021

 

 a little bit of humour can go a long way in building better relations in the workplace too

It is true that almost everyone loves humour and a relaxed environment is always welcome. The same can hold in the workplace too, and if there is a buy-in on the same, organisations can work better. In fact, inter-personal relations are a very important aspect in a working environment and humour and levity just add a zing to it. This is what Jennifer Aaker and Naomi Bagdonas talk about in their book, Humour, Seriously: Why Humour Is A Superpower At Work And In Life.

They use a lot of science and strategy to put forth their arguments in this rather interesting book. There are numerous examples given which talk about how humour or levity can be exercised in an organisation. It is not that one has to make others laugh, but getting people to relax, especially if there is communication between seniors and juniors, can make the workplace better. Small little things like the CEO talking to the staff on non-office subjects can improve comfort level, which leads to efficiency when put together. This can be a useful tip for all CEOs where a small thing can make a big difference.

We have heard of various leaders who break the ice by always starting off with something in a light manner, which can be a song or a joke. Richard Branson is known for his sense of the dramatic. Some of his serious offsites held on fancy islands actually gave people a day to chill out so that they were fresh for official meetings. But such an exercise also creates a sense of levity as people get to interact with one another before the serious discussions and are able to cross barriers that may have otherwise existed. Here the authors warn that such things should not be predictable, or they lose their essence. For example, it is not a great idea to say that you are telling a joke and fail to live up to the promise.

The authors warn also of the proper and not so proper things to say and the remedial action to be taken when there are faux pas made.

It is also true, argue the authors, that most CEOs prefer to hire people with a sense of humour as it is perceived that funny employees do a better job. It makes people confident and strengthens relationships and boosts resilience in difficult times. Therefore, organisations must try to build a spirit of levity while making sure that it does not come in the way of work. In India, too, it is seen that the new-age companies, which started off in the IT space and now cover all the startups and younger organisations, have an informal culture which breaks barriers and creates a lighter working environment. We have heard of such cultures in advertising even in the Seventies and Eighties where age and hierarchy does not matter when there are professional interactions. Levity just makes things easier for all concerned.

The authors talk of four basic issues in this context. The first is how humour enhances creativity and problem solving. It encourages a kind of mental gymnastics that reveal connections and patterns which we could have missed. Second, it can be used to influence and motivate others. It has hence a percolation effect, especially when it starts from the top and spreads through the organisation.

Third it builds bonds and defuses tensions in tough times. This is not to say that we should be laughing all the time, but building trustful relations in an informal working culture fosters a different kind of resilience for bad times. Last it creates a culture where colleagues feel safe and joyful. It widens our perspectives and makes us feel psychologically safe and creates fertile ground for creativity to thrive.

Now being funny involves some degrees of exaggeration and spontaneity. These may not be inherent in our persona and may have to be cultivated, as all do not have this knack. This can happen in the language we use and often bosses who are self-deprecating strike the right notes with their colleagues.

Now humour helps to set the tone not just in an organisation but also in diplomacy, and here the authors do show that issues will remain unsolved even the USA and Russia can have lighter moments when negotiating, which makes the exercise of disagreement friendlier. The example of Madeline Albright is given where she was able to break the ice with humour even though she had the reputation of being the toughest and most uncompromising negotiator.

Further, as such a culture starts from the top the onus is really on the leaders to set the tone. How do they do so without compromising their authority? This is not easy because colleagues need to know who the boss is and ensure that rules are followed, and business objectives are met. They give examples of Warren Buffet, who is known to be self-deprecating, which makes his colleagues feel at ease while at the same time they know that they have to deliver. For example, forgiving errors with a touch of humour conveys the message that there is a fault without being critical. This is a way of not scaring employees.

This is clearly a book for leaders or those aspiring to be at the top. It always starts at the top and once established, can flow through the veins of the organisation quite swiftly. Indian CEOs need to take cues from this book. We have read about those at the top ruling by spreading fear and threats. Eccentricities have varied from being abusive to throwing papers and asking people to resign. Aaker and Bagdonas show that there are better ways of running a company for sure.

Humour, Seriously: Why Humour Is A Superpower At Work And In Life

Jennifer Aaker & Naomi Bagdonas
Penguin Random House
Pp 257, Rs 699

G-Secs: Retail investors may not prefer government bond: Financial Express 11th Feb 2021

 Bonds for the common man’ is the new message from the Reserve Bank of India (RBI) in its latest credit policy. This step by the central bank, it is believed, will help bring household savings into the Government Security (G-Sec) market and, hence, contribute to the supply of funds required for the government borrowing programme. Also, it gives more G-Sec market exposure to the retail segment. Will this work?

The success of any debt instrument, in the real world, rests on simplicity. When a deposit is made, it is known that it is for a period of three years with a return of 5.5%. If the holder wants to redeem before the maturity date, there is a penalty that can be paid, but the bank will repay the principal. The matrix is well known. The product is simple and hence straightforward.

Let us look at a corporate bond which is bought in the market. The individual sees the return which can be, say, 8% for an ‘AA’ rated bond. There is some doubt on whether the safety is assured, but if the rating is understood, one can go ahead with the purchase. If the person wants to sell the same, it can be tough as it may not be listed, and even if it is, there will be a price that may not be the same as the face value. The price varies depending on the environment and hence is inferior to a bank deposit in terms of certainty. Therefore, if not held to maturity, there is a risk of exit.

Now, the G-Sec market is slightly different. There are securities issued with nomenclature like the 5.77% 2030 bond which talks of the interest paid on face value of Rs 100. There is also the 5.85% 2030 bond. The yields on both of these are different, even though tenures are the same, i.e. 10-year bonds. For the 5.77% bond, the price is Rs 97.76 with an implicit yield of 6.08%. For the 5.85% bond, the price is Rs 98.60 with an implicit yield of 6.04%. What is the investor to make of it when entering the market?

If it is held till 2030, the investor will get the coupon rate on the investment every year. However, there would be several other similar sounding names with different yields. The problem is compounded when it has to be sold in the market. It can be done, provided there is trading taking place. Typically, in the secondary market, there are around 90 government securities that are listed. There are few that are traded in a vibrant manner. And these would be the benchmark securities for 5, 10, 15 years generally. Typically, two-thirds of the trades are in the 10-year G-Secs, which are the current benchmark. Another 20% is in the benchmarks for five years and 15 years. The rest really don’t matter. The problem comes to the fore even for these benchmarks in the t+1 year when the security becomes illiquid completely, as it now has with tenure of one less year.

Hence, the 5.77% benchmark for 10 years loses its importance once a new benchmark is announced and trading gets diluted and disappears after a full year passes. Therefore, exiting from this market is a big problem. The mindset, hence, must be that the retail holder will keep the security till maturity.

Now, look at the returns. The government offers the RBI bond for seven years with variable returns, which give a return of, say, 7.15% today, as it is 35 bps above the National Savings Certificate (NSC) rate. There are NSCs that give 6.8% for five years, and the senior citizen schemes that yield 7.4% for five years. The 6.05% yield on 10-year paper or 5.8% for five years is not even attractive compared to other government offerings, though they score over Fixed Deposits (FDs). But FD rates can increase over the next 5-10 years, while the G-Sec bond would be fixed at the yield of, say, 6.05%.

The curious part of these yields is that they are driven mainly by the monetary policy action that goes beyond the repo rate. Changes in the repo rate can drive deposit rates down as well as other savings instruments. But RBI being assigned the role of banker to the government has also led to the central bank continuously monitoring the liquidity situation to ensure that the government borrows at low rates. This will always keep yields down. Now, the small savings returns are linked to these yields and are kept slightly higher. The government bond scheme goes 35 bps above the small savings rates. Hence, unless one is out to trade in G-Secs, the nominal returns are not attractive. And retailers cannot trade as most of the securities are illiquid.

This is one reason why retail investors prefer to use the mutual funds route to get into the debt market. The gilt funds of different durations are ideal for retail investors as they have the fund manager taking decisions of handling the portfolio of the fund by changing the composition periodically depending on the objective of the fund. The same holds for corporate bonds where the mutual funds route is appropriate.

Therefore, while RBI’s decision to open up the market to retail investors is in the right spirit, the response will be indifference for these reasons. Issuance of special bonds for specific purposes with face value of Rs 100 and an interest rate of, say, 7% for five years will be easy to sell with the investor knowing that these are government commitments. Further, there has to be an exit option if there are no tax benefits for making them attractive. But the regular debt programme of the government may not find market-savvy investors that are in a position to discern the subtle nuances of the pricing of such paper and the exit options.

There will definitely be a good appetite for such simple products as households are wary of the very low interest rates offered by banks on deposits. The government can consider issuing bonds for roads or railways as part of the Rs 12 lakh crore programme to retail investors with a simple payoff matrix. Tax-free bonds have resonated very well with the investors, so too would these issuances. There is scope to think differently when planning to get convergence between retail investors and the government borrowing through these special bonds. The conventional G-Sec platform will not work.

Inflation, Budget and its implications: RBI's two guiding forces on rates: Business Standard 5th Feb 2021

 The guiding forces for Friday’s monetary policy committee (MPC) decision were twofold. The first was inflation, which has been trending downwards and likely to also be lower in January. Was this sufficient a trigger for lowering rates considering that the base effect will get weaker in February and March? The second was the Budget and its implications. The indication given was that government borrowing would be higher for fiscal 2020-21 (FY21), for which the Reserve Bank of India (RBI) has already provided the schedule for next two months. FY22 will also involve heavy borrowing by the centre and states, which would also have to be provided for. The G-Sec yield had moved up post announcement of the Budget with the 10-year paper being above 6 per cent.

Against this background, the MPC has chosen to maintain a status quo position both on rates and stance, which is comforting. The accommodative stance means that as of now chances of raising interest rates can be ruled out and gives comfort to the markets. This will still keep the market guessing of the next step in the April policy when the new financial year commences, where private sector demand for credit will also be buoyant. The tone, however, is that growth will still continue to be the primary driving factor in the coming year, even as the Committee keeps close watch on inflation.

The gross domestic forecast (GDP) forecast for next year is 10.5 per cent, which is within the range of the consensus forecasts with the government also looking at a number of 11 per cent. This is indicative of pick-up in bank credit, too, in the coming year. Interestingly, the inflation forecasts are pointing to a decline from 5.2 per cent in March 2021 quarter (Q4) to 5-5.2 per cent in H1-FY22 and 4.3 per cent in Q3. This hence supports the accommodative stance to be taken.

The other signals expected from the policy related to the rollback of measures announced during the pandemic. The two areas of interest are the cash reserve ratio (CRR) cut, which was to be till March 31, 2021 and the other to the series of liquidity enhancing measures which were very gradually rolled back in the last couple of policies, especially those on long-term refinancing option (LTRO) being redeemed earlier.

On liquidity, there is assurance that it will be provided in adequate quantities and that the market perception of a rollback was not founded on any strong basis. Therefore, we can expect further such action from RBI to also fully facilitate government borrowing in FY22. In fact, the RBI has stated that the CRR will be lowered in two phases on March 27 and May 22, which in effect, will open the doors for other liquidity enhancing measures by the RBI. This is something which the market will be watching for.

On the measures for the financial system extension of TLTRO to NBFC through the on-tap route is significant as this was a long-standing demand. NBFCs provide a very important last mile connectivity to the borrower. This will be useful for this segment and help in channeling of funds to the final beneficiaries. This is also a segment that required support given the developments in the last couple of years.

An interesting measure is to give retail access directly to the market. While it is quite unique the participation will depend on understanding of how these bonds work and also the ability to operate in the secondary market successfully. This has been a problem in the corporate bond market too, and hence the structures would be keenly awaited.

Quite clearly the tone has been set for the next year, which will be stable to a large extent, unless there is a serious economic shock.

Union Budget FY22 not as fiscally expansionary as believed initially: Financial Express 8th Feb 2021

 Indian Union Budget 2021-22: Budget speeches are all about presentation, and hence the market movement following Budget FY22 unveiling on February 1 was a vindication of the positive vibes that were sent by the government. Words uttered are often taken at face value, and the market has cheered Budget FY22 all the way, as have all CXOs who have concluded that this is a Budget that shows the way with an aggressive stimulus through expenditure. Forty-eight hours after the announcement of the Budget, the Sensex had gained over 3,000 points. Hopefully, this fraternity should not have any complaints for the next 365 days on policy.

The characteristic of all Budget speeches is that they convey what has to be said in the best possible manner. Therefore, there are references made to the policies under Atmanirbhar series announced last year, a new set of reforms, outlays which will happen anywhere between two and six years; at times, FY22 (BE) figures are compared with FY21 (BE) numbers, and, on other occasions, it is compared with FY21 (RE). Sometimes, it is FY21 (RE) over FY21 (BE). Budget speeches also drift into poetry to, probably to lighten the environment or underscore the gravitas of a point. There is a clubbing of allocations, under modified new headings which add to the ‘wow’ factor. Hence, it is this author’s belief that, to really understand the Budget, one must take the time to digest the numbers by going through the Budget documents (downloadable from the Budget website) to get a more thorough understanding. This can take some time, but is more useful for making sense of a Budget’s import.

Has the Budget provided a stimulus? In terms of fiscal deficit—it is 6.8% of GDP—it sounds big, seems to involve lots of borrowing and, thereby, connotes a lot of spending. The fact that the timeline for reaching 4.5% fiscal deficit has been extended to FY26 means that we can expect significant deficit figures for the next few years, which clearly signals continued fiscal expansion. However, if we look at the size of the Budget FY22 and compare it with FY21(RE), the numbers appear to be broadly similar. In fact, if interest payments, which are now Rs 8 lakh crore are excluded, the expenditure for FY22, at Rs 26.71 lakh crore, will be lower than that for FY21 (RE), which stood at Rs 27.57 lakh crore. In a way, this does not really seem like expansion of spending.

Now, GDP growth has been taken to be lower than what the Economic Survey had presented, which means a conservative approach has been taken, pegging it at 14.4% rather than 15.4%. Therefore, real growth could be lower than 11%. Does this matter? It does for the Budget because the GDP in nominal terms was to be Rs 225 lakh crore in FY21 (BE) while, for FY22, it would be Rs 223 lakh crore. However, the tax to GDP ratio would be coming down from 10.8% to 9.8%. While tax collections from corporate, income and GST would be higher than that in FY21(RE) they would be lower than the budgeted numbers for last year. The same also holds for non-tax revenue, which is normally heavily dependent on RBI-surplus transfers and spectrum income. Income from ‘communications’ is estimated lower, at Rs 63,000 crore vs Rs 1.33 lakh crore targeted last year.

Either the Budget has been very conservative or has assumed that growth in FY22 will not really be buoyant. One conclusion is that the fiscal deficit number is more likely driven by revenue not growing at the desired rate and expenditure being at same level as FY21 (RE). Hence, a high fiscal deficit number may not necessarily mean more spending as revenue could be the contributing factor.

One major reason for euphoria was health spending. While the Rs 2.23 lakh crore number is higher than Rs 94,000 crore, the heading is ‘health and well-being’; the second part thereof relates largely to water & sanitation. The health ministry actually sees a dip in spending from Rs 78,806 crore in FY21 (RE) to Rs 71,269 crore in FY22 (BE). Around Rs 98,000 crore of the Rs 2.23 lakh crore headline number in the Budget speech is in the water & sanitation bucket, spread over multiple years, while there is an allocation of Rs 35,000 crore for Covid-19 vaccination.

Further, there has been some other economising in the Budget, which does not stand out and requires a close look to become apparent. The PM-Kisan scheme had lower outflows, of Rs 65,000 crore, last year as against a budgeted number of Rs 75,000 crore, which is being retained in FY22. This means that fewer people will have access to this scheme—108 million instead of 125 million. NREGA spending was up by around Rs 50,000 crore last year over the budgeted number, but has been reduced to Rs 73,000 crore. Hence, in a way, there has been some rollback of relief to the targeted sections, ostensibly because it is believed that this hand-holding may not be required as the economy chugs along.

There are some bits that will only become clear when the ministry officials give clarifications—the creation of a new DFI, for instance. This, in a way, could moderate expectations. The DFI announcement was a big one, but, it now appears that the new institution will either take over or be merged with an existing one (likely IIFCL). Therefore, it would be capitalising an existing structure and not necessarily creating a new one. The same holds for the bad bank, which, the financial services secretary has clarified that it will not be owned or funded by the government and will have to be created by the banks. This takes the fizz out because ARCs in the past have not quite worked out, because of the mismatch in expectations between buyers and sellers. Buyers want the lowest price and the sellers (the banks) the highest. There weren’t too many deals struck and the realisation rate was low, at around 20-25%, as against IBC’s 43-45%. The basic fear of PSBs was to sell at a low price and later get questioned. If the ARC were a government body, the willingness to sell at a lower price would be higher. Therefore, we may be getting back to the original state of slow decision-making.

The other big proposals relate to asset monetisation and disinvestment, which is now being called privatisation to signal a change in ideology. The first part will have more to do with the PSUs which sell assets through the InVits or Reits routes. That is outside the budget. If NHAI monetises a road, the money will go the entity. Disinvestment would be in the Budget, and it can be merry times provided the market has the appetite . Will there be fatigue at some stage, given all PSUs don’t fare well in the market? To begin with, there will be a burst of money, but towards the end of the year it will be interesting to see how things work out. More important, to get the right valuation, the market has to continue with enthusiasm and the Sensex has to move towards the next level—even 50,000 may not be enough!

Some tax benefits have been given to InvITs and REITs. But, will investors be assured that this will hold in future? This is the problem with continuously changing tax structures. Let us look at the taxation of interest on EPF savings of above Rs 2.5 lakh a year. The amount that is put in EPF is mandatory as dictated by the government. What was tax-free is now being taxed on grounds that it is the rich who benefit from this remaining tax-free. It is true for irrational sums being put in the EPF, but typically a person who reaches the Rs 2.5 lakh threshold is on the road to retirement and hence sees all future plans going awry. This has been a major problem with the tax rules over the last six year. One can never plan for retirement. Debt funds suddenly had the carpet pulled under their feet with respect to LTCG taxation as the tenure got extended to three years.

Then, it was time for equity gains being taxed. Those who sought dividend for future planning (which is actually inefficient when investing in mutual funds compared with growth schemes) suddenly find this component being taxed. The uncertainty in tax structures can be very unsettling and hence any tax benefit can be assumed to hold just for a year. This approach should be reconsidered.

While there have been no overt tax changes, the ideology of tinkering with rates every year and justifying that such tinkering affects the rich is something that needs a relook as it is this class which pays the highest taxes!