‘Non Obvious Mega Trends’ (Book Review): The times they are a-changin’: Financial Express 28th March 2021

 The thought that we should be forward-looking is more than a philosophical advice for an individual and holds for companies too. We have seen how several companies were not able to predict the future of their businesses and hence had multitude problems when change came. Rohit Bhargava, the author of Non-Obvious Trends, talks on the same lines in this book on how enterprise should be able to predict these changes, if not be the agent of transformation, so that one remains in business.

This is not easy, as one needs to understand what the final customer wants and how she adapts to these new products or services. Also, technology, which is simultaneously a blessing and challenge, has to be handled with delicacy. One would never have thought that it is possible to have a holiday without going to a hotel and this is where the homestay concept caught on. We all know that e-commerce has caught on, but this is not just a deal between the individual and an e-commerce platform, as the final product is being dispatched through the supplier who has to create structures to maintain business.

Bhargava, who has been the author of the signature Non-Obvious Trend Report for over 10 years, talks of 10 mega trends that will transform the way we work and live. There are also caveats everywhere that point to what we should watch out for. For example, we all are more conscious of the environment and what appeared to be a fad today is a real fear as we see what ecological damage can do to our lives. The recent tragedy in Chamoli in Uttarakhand just reinforces this thought process as people are more cognisant of how we produce and deliver goods and services. Therefore, sustainability has caught on, as there is a palpable fear that those companies or products which pollute the environment will not just affect future generations but also us in our lifespan.

Corporates are hence more cognisant of how they do business as their customers are more discerning.

Another mega trend that we can associate with is the ‘plethora of data’ that is now available for doing not just analysis, but also has the potential to influence us. The recent controversy on how social media was tracked to find our preferences, which were then fed by political parties, is not just American but is present everywhere. Hence the question is where does your privacy end and how do we control the misuse of such data?

Interestingly, the author points out that gone are the days when we left feedback on hotels or restaurants or even an Uber ride. Just like how we leave our view behind, the same is done by the supplier of the good to the extent that misbehaviour with a taxi operator multiple times can have us blocked from using the services forever. We have seen this happening already for something like air travel where airlines bar people who misbehave from travelling. The same can happen with other services as technology transcends all frontiers. Hence while technology has eased our lives, we need to know we are being tracked every moment and such information has potential of being misused.

In fact, an interesting point raised by the author is that since our attention span is coming down thanks to this new-age technology where we look for immediate gratification, media has been exploiting the same by filling our vision with so-called breaking news which can be meaningless but works to make it addictive so that we view the channel, thus garnering advertising revenue for the channel. This is something we all can identify with given the recent developments in the media space in India.

Another mega trend that is emerging is the concept of ungendering, which is moving away from stereotypes. This is actually necessary as several products that are designed are for men and women have to adjust and the most glaring example is cars, where the height and leg space have not really kept women in mind as the target is men. It holds for other products and services too and this is changing quite fast. This starts from the children’s toys range where products are meant specifically for boys or girls. Here, too, mindsets are changing because often genders do what they were traditionally told to do.

At the individual level, too, there has been growth in individualism where we all work towards projecting an identity which gets buttressed on social media where we get judged. This influences the way people see and judge us. Therefore, even this micro trend is important when companies do their research that goes into future planning.

Bhargava also tells us about the attributes required for spotting such trends. We need to have a particular type of mindset that can be developed if we do not have these qualities that go into making this framework. As a reader, you can pose these questions to oneself. Are you observant? Are you curious? Can you be fickle in the sense of being able to move on? Are you thoughtful? Can you craft beautiful ideas? We need to cultivate these traits or rather trends in our way of thinking before we can look outside and be successful in picking up what is required to build a successful business idea.

Non Obvious Mega Trends

Rohit Bhargava
Ideapress
Pp 258, Rs 599

Loan moratoriums: SC decision to go back to normal is significant: Free Press Journal 27 March 2021

 The problem with any affirmative action taken by Central banks is that they work very well to the extent that it is difficult to roll back the measures. This was the case with the moratorium and therefore the Supreme Court decision to go back to normal is significant. This only supports the RBI thought process, which was that even after the moratorium ended, the large companies which had problems on debt servicing could go to the banks and look for a one-time restructuring package.

Small-time borrowers, with loans of less than Rs 2 lakh were anyway not to be charged interest on interest and those who paid on time were compensated by the government. The SMEs had a running restructuring scheme even before the pandemic for the ones under pressure while the standard assets that faced problems during the pandemic were provided an emergency line of credit with government guarantee. Therefore, the government and RBI took care of credit-related issues for the last one year.

However, companies were still hoping for an extension of the moratorium and the court has only provided support to all borrowers on the interest on interest, which will not be charged. This is fair because when funds move from the deposit holder to the borrower via the bank it is a zero-sum game. The question which now arises is that if there is no more moratorium being provided, will the NPA level go up now?

The NPA level was around 7.5 per cent in September and according to the RBI’s FSR, could go up to 13.5 per cent in a baseline stress scenario by September 2021. Such an estimate would have taken into account the final ruling on non-extension of the moratorium and the consequent impact on companies’ ability to service their debt. Presently, it is hard to conjecture whether this scenario will materialise but for sure the 7.5 per cent number will spike and most likely reach double-digit levels in March as banks begin to recognise these assets as NPAs provided they are not serviced. Several companies which had the ability to pay have been holding back, hoping for further relief.

Therefore, the March numbers of banks will be important as they would have to recognise these assets and a true picture would be obtained. However, it must be mentioned here that several assets have been restructured, especially in the SME segment and this will be a sore point at a later point of time when they have to be serviced. This can be a worry in the future, though not a concern today.

Banks have to start making provisions for these NPAs in case they have not done it so far. Some banks have averred that they had already made these provisions, in which case there will not be major issues. However, those which have not done so will find their P & L dented to this extent and in this context, it would be interesting to see how the banks which have come out from the PCA (prompt corrective action) framework will fare. The financial results of the banks for the fourth quarter will be quite illuminative of the depth of this problem.

While rising NPAs and provisions will lower profits for sure, some of the PSBs will have to seek capital as the net worth gets affected. This would not have been an issue but for the fact that the government seeks to privatise two PSBs which would almost certainly not be a part of the group which has witnessed mergers in the last couple of years. These standalone banks will be the ones to be looked at closely by the markets.

Last, the future of credit will hinge on the final outcome of the asset quality on the financials. The demand for credit will pick up for certain in FY22 and this is where the support from banks will be required. The debt market is a segment that is for all practical purposes open only to the higher rated companies and as companies which are lower down in the pecking order look for funds, banks should be willing to lend. This is important because anecdotal evidence shows that banks are less willing to lend when NPAs increase, as they tend to cherry-pick their customers.

It happened when the AQR was on, which led to escalation in the NPA ratios. This will be a concern for policy makers as funding will be a driving force for growth this year. The RBI can keep rates lower by providing liquidity to the system, which can affect the cost of funds, but for sure, cannot influence the willingness to lend.

Why are PSB staff wary? Financial Express 23rd March 2021

 

From their perspective, once government-owned banks are privatised, there is nothing to stop the staff from being rationalised through VRS programmes, which, as seen in some of the leading private sector banks, has always been a compulsory separation. Even when RBI enables bank mergers, terms and pay are protected for only a fixed period of time, which can be no more than three years.

It is often stated that the government should not be in commercial business and hence privatisation of public sector entities has now become a part of the reforms package. While this is a strong argument, the corollary should be that the government should not be relied upon to bring about growth through spending, which is the forte of the private sector. However, in India, it is assumed that the government should be the driver of capex and all discussions on the Budget are not on the social but commercial aspect.

But when we talk of privatising banks, there is an issue of ideology. Nationalisation of banks was to serve a social purpose that will never be taken up by the private banks that work on the RoNW (Return on Net Worth) concept, howsoever warped it may be. Hence the decision of the government to privatise two public sector banks is a very bold move which lays the roadmap for a series of such measures. If ideology has really changed today, logically all PSBs should be prepared for this metamorphosis.

It is still a guessing game as to which banks will be privatised. There is the merger of several banks already in progress, and while balance sheets have been combined, there is still work in progress when it comes to reorganisation. Therefore, the candidates are more likely to be outside this fold of big banks. Quite clearly, there are two reasons for doing this:

First, these banks are relatively less strong compared to the merged banks, which is good to begin with as an experiment as the same template can be used for other sales.

Second, the government does not want to support them with continuous capital infusion. A lot of money has already been infused by the government either directly through the Budget or the recapitalisation bonds route.

Intuitively, if these banks are less strong, they will not be able to raise money in the capital market as the valuation would be really low. Therefore, the government would be looking at either getting in another bank (private or foreign) to buy these banks or have some PE funds dig into them. One can guess that this will not be a case of another public sector behemoth buying them, which would not really mean privatisation as was the case with the last such sale of a PSB. But such an action also cannot be ruled out that gets in the disinvestment proceeds for the government and also helps to maintain a status-quo position.

Now why should a bank be interested in buying a PSB? All PSBs have solid infrastructure and expertise in the banking business and hence an acquisition provides a large platform to the buyer. There are branches, technology, ATMs spread across the country, and skill-sets etc which come readymade. Therefore, any foreign bank, for example, which wants to scale up in India, will find this offer very attractive. In fact, the problem with PSBs has been not that decisions are not right, but often that they are forced from above. Loan melas, phone banking, shamiana banking are all euphemisms used to explain how loans have been given. Hence letting go of government control fully should ideally make any bank efficient and, therefore, should be welcomed.

In fact, curiously, if taken to the logical end of privatising all PSBs, the entity to be affected the most will be the government as these banks have been used to carry out political agendas since 1969, which will not be possible now. Banking is commercial business; at the end of the day; banks make money on deposit holders’ money and not on share capital. While inclusive banking is mandatory according to RBI guidelines, often social programmes like Jan Dhan, affordable housing, loan waivers, MUDRA loans, etc, may not stand the test of commercial viability, but have to still be undertaken by PSBs.

Therefore, the move to sell them fully is audacious if carried to all banks, as they would then be functioning just like the private banks with independent governance structures. This also means that all appointments of Board members and management will be based on factors other than government diktat. And this is just what critics have been arguing for!

But why are bankers complaining? Here there is a problem for sure because the Unions are cognisant of what happens when bank mergers take place, or any bank buys another one. All acquisitions are based on creating the notional value for shareholders, which often means that there will be a serious look at the cost structure and given that the employee cost is the dominant one, rationalisation is a genuine threat. For PSBs, wage cost was around 60% of operating expenses in FY20, while the same for private banks or foreign banks was 37-38%.

Hence, the fear is palpable. The government has assured the staff that their jobs would be protected, which is assuring.

However, from the bankers’ perspective, once privatised, there is nothing to stop the staff from being rationalised through VRS programmes, which, as seen in some of the leading private sector banks, has always been a compulsory separation. Even when RBI enables bank mergers, terms and pay are protected only for a fixed period of time, which can be no more than three years. To assuage such fears, a way out would be to give a written guarantee to all staff that their tenures and scales are protected till retirement. This, however, may not be acceptable to the buyer of the bank. The fact is that when people choose a public sector job over a private sector one, there is a tradeoff between security and pay, which should be respected.

This would be the right time for the government to also create such templates for privatisation so that there is a smooth transition as PSBs are sequentially privatised. One can assume that this would be the long-term plan for the government or else selling just two banks would send different signals. Also, it is assumed that this privatisation will not be in baby steps where the government keeps selling only part of its stake to begin with while retaining majority control. That would only be kicking the can.

While the size of the banks that are to be privatised would tend to be relatively smaller, the creation of such models should be easier. The bigger questions would remain as to which banks would like to acquire these PSBs. As the government has shown a lot of urgency in implementing all the policies announced in the Atmanirbhar Bharat package, it may be expected that these two exercises would be completed within the financial year 2021-22. The amounts involved may not be very large in the overall scheme of Rs 1.75 lakh crore. The year 2020-21 was exceptional and hence the three very big-ticket disinvestments could not proceed. There is hence a greater push from the Budget side on meeting these targets.

On TV

 CNBC on 25th March 2021

https://www.cnbctv18.com/videos/india/report-says-indias-middle-class-worst-hit-by-covid-experts-list-ways-to-bridge-the-income-gap-8723781.htm

etnow on 21st March

https://www.timesnownews.com/business-economy/economy/article/india-revival-mission-green-shots-evident-in-the-economy-but-challenges-lie-ahead/735359

Will the new DFI boost infra funding? Business Line March 23, 2021

 

Its success will hinge on, among others, the cost of raising funds, returns for investors and efficient project appraisal

The creation of a new DFI (development finance institution) is now real with the government starting the process with zest. It is still not certain whether it will be a new institution or whether it will involve merging an existing institution. The government will put in ₹20,000 crore of capital and the DFI will be able to raise and finance projects over ₹3 lakh crore. The idea is great.

Now let us put the concept in perspective. There were DFIs in the past which chose to get converted to universal banks, which simply meant that they became commercial banks through reverse mergers with their existing commercial banks. This was not because commercial banking was more attractive but on account of the DFI model not being sustainable.

DFIs used to get concessional finance from government and multilateral institutions, which was used for term finance. This helped create assets in the manufacturing and infrastructure space. But the concession window ceased to operate following the reforms of 1992. The DFIs from then on had to borrow from the market and pay, at times, even around15 per cent for funds; therefore, the cost for the borrower had to be higher.

A decision was hence taken that they become commercial banks where the cost of funds those days was less than 10 per cent as demand deposits (share of 10 per cent in deposits) came free, savings deposits with share of 25 per cent came at 4 per cent and the term deposit costs varied with the interest rate environment.

Now it is a time to roll back the clock and have a DFI created by the government to begin with, which can gradually be divested to 26 per cent level at the appropriate time. This may sound a bit antithetical to the view taken, at the same time, on privatising two public sector banks (PSBs) on grounds of the government not having the right to be in business. The only explanation is that the private sector is not in a position to invest such an amount for infra funding and hence the government has to step in. A bit of déjà vu here because even nationalisation was based on a similar sentiment.

The government has assured that the DFI will be run by professionals which should be comforting, as all decisions would be based on commercial judgment. It would be interesting to see if the Banks Board Bureau (BBB) would be involved again with the appointments, in which case it could mean facing the same challenges which came in the way of selection of bank personnel. BBB has members appointed by the government who then select the management personnel of public sector banks. But this will probably be a secondary issue given that there’s need for such an institution and the government is taking a giant step by putting in ₹20,000 crore.

Where will the leverage come from? Will private investors be willing to put in money in a new DFI which is owned by the government? It will depend on the kind of return that can be earned. As the borrowers will be in infra which will be able to start earning money to repay debt with a lag of 3-4 years, the waiting period will be long. Are investors willing to wait?

Also, can the DFI give a return of, say, 10 per cent on capital? These ballpark numbers are important because there are alternative investment opportunities for financial investors which yield quick returns. Foreign investors will find comfort in government ownership but have to get the confidence of getting a return after a lag before putting in money. Else, it may end up as being an institution which gets its funding from other public sector financial institutions which the government is looking to privatise or disinvest. This will create some ideological challenges when getting funding for a new DFI.

The other issue is cost of raising funds. In the absence of tax incentives interest on bonds issued by the DFI will find few takers. Tax-free bonds have been used successfully in the past and should be offered again to get household savings into the fold. Ideally, an interest rate of 7-8 per cent would be attractive enough. Anything lower would be unfavourable for investors as debt funds typically give 7-9 per cent with capital gains tax rate of 10 per cent without indexation.

Should banks be allowed to participate in any way? Ideally no, as the DFI has to create a model which runs without the support of banks as it will be doing what banks are not able to do in an efficient manner. Allowing SLR status to these bonds will make banks subscribe to these safe bonds.

Contours of DFI

The business-related issues that have to agreed upon are the contours of the DFI. First, the DFI should do direct lending for projects which will require the creation of an expansive pool of professionals at all levels. Project appraisal of infra projects requires a different mindset. Second, the business of refinance should also be part of the mandate and here the decision has to be taken on the composition of the portfolio between direct finance and refinance. It should not be one which does only refinance, which is what some of the other institutions did when they were set up to finance infrastructure.

Third, the DFI should be in a position to provide enhancements for loans given by other institutions which will be in the form of a contingent liability. Here too limits should be put on the risk that can be taken as such guarantees or enhancements improve the credit rating of the borrowing entity.

Fourth, the DFI can also take on the role of a market maker in the bond market as part of its treasury operations which will be required to address mismatches in maturity and returns. It can take a lead role in the development of the CDS (credit default swap) market.

Therefore, exciting times are ahead with the formation of the new DFI, which should provide much-needed boost to funding infrastructure.

From INcremental to expotential: Book Review: Financial Express: 21st March 2021

 In the present age it is accepted that innovations cannot be just incremental because they do not work. The scale has to be exponential. This is what Vivek Wadhwa, Ismail Amla and Alex Salkever talk about in their book, From Incremental to Exponential.

This is another guide as to how companies should proceed to remain relevant and in any such narrative the examples of Kodak and Sears are mandatory. These companies never saw change coming and did not alter their business plans, becoming irrelevant. Willingness, adaptation and speed are the ingredients here.

Normally one links technology-based innovation with startups as this is where all the good stories are told. But large existing companies also have the power to bring about innovation by leveraging technology. This is where they give the example of Amazon and its expansion. Starting with being a bookstore it now sells everything. The use of technology to link buyers and sellers has made the conventional concept of retailing quite outdated.

The concept of Amazon Prime where one pays an annual fee and gets purchases delivered free of cost was a novel innovation which brought in billions of dollars in sales as all shoppers opted for this scheme and then kept buying more on this site to realise this cost. All other pay channels and entertainment models are extensions of the mantra of innovation using technology. Therefore, existing companies too should learn to innovate in a big way.

While this sounds reasonable that every company should be adopting this course of action given that access to AI and ML is open to each one of us, why is it that it is not universal? Ideally if everyone followed suit there would be gains from everyone and there would be only winners. Here is where the authors point out are the eight deadly sins which keep companies back.

Innovation is not just confined to the private sector that runs for profit but also the government, which can innovate and save money as it is not in the business of making profit.

This is another ‘how to’ book and may not tell anything new considering that there are several publications on the subject with similar examples. But reading it is useful as it drives home the message.

Need to make cryptocurrency illegal: An ‘official cryptocurrency’ can create confusion & unease amongst citizens: Financial Express: 15th March 2021

 

The fight against black money is still on and tax data does not show that there has been encouraging success in this area. Under these conditions, it is best to keep away from cryptocurrencies and illegalise the same.

With the Bitcoin touching the $50,000 mark, the cryptocurrency concept is back on the discussion table. A cryptocurrency is an anonymous currency created using blockchain technology, and it can be used for buying goods or as an investment. Investors like this concept as cryptocurrencies operate without any regulation. Hence no one has seen the inventor of the Bitcoin, even though a name is associated with it. In addition, the belief is that governments and central banks don’t do the right thing with currencies and hence it makes sense to invest in cryptocurrencies. If this is the raison d’etre of having such currencies, the irony is that its value is denoted in dollars, which anyway is accepted as the major anchor currency across the world. Those who invest in the Bitcoin hope the value goes up and that they can exchange it for dollars and become rich. This is the crazy thing about cryptocurrencies.

Cryptocurrencies should not be allowed for sure because of the anonymity concept. India has embarked on a drive against black money, and demonetisation was an aggressive, though failed, move to control its growth. Tax authorities are hammering away at all the sides of the door to stop leakages. There is already a lot of round-tripping in foreign investment with Indians comfortably channelling their dollars through foreign portfolio investments (FPIs) which are registered in tax havens and SEBI is fighting to plug these leakages. In such a situation, having private players put their money in cryptocurrencies is not acceptable.

With this being the backbone of the ideology, the position here is that cryptocurrencies should not be allowed, and, as a corollary, should be made criminal unless all transactions are revealed in tax declarations. Why?

First, people who invest in a cryptocurrency cannot be traced and hence the entire effort at audit trail disappears. The charm of being anonymous is counter to the government’s drive to get citizens reveal the last rupee in their savings bank account! Are the originators/investors of such currencies prepared for this?

Second, drug money can easily be channelled into cryptocurrencies without a trace. Such cartels are already using substitutes such as foreign currency and gold for these transactions. Cryptocurrency makes it easier as it is technology-based without any formal transfer of currency.

Third, if people invest more here, the overall financial savings in the country will fall which can be used for productive purposes. This follows from the fact that India has moved towards lowering interest rates to ensure easy borrowing, much to the chagrin of savers, who today are venturing out to the stock market and enhancing their risk. Cryptocurrencies would be another tempting option especially so as one would not be traced, and taxes need not be paid.

Fourth, investing in a cryptocurrency is like doing the same on a fictitious base. While it is true that there are over 4,000 cryptocurrencies in the world, most do not have players and the Bitcoin is the leader in every way with no real competition. This is so because there has to be acceptance for any such currency to flourish. The enticement to make money has evidently led several Satoshis to start their own currency, which, fortunately, have not gained traction as this would have created chaos in currency markets. Even products such as gold or diamonds get value from scarcity (and more importantly people accept the high value, unlike the humble product called water which is more precious but has little value) and are tangible and accepted by all because there are owners of the metals. Cryptocurrencies are created out of thin air and the roulette table is set in motion.

Fifth, allowing unknown currencies denudes the power of the central bank. Just think of RBI increasing interest rates to curb demand, but people use the Bitcoin to support their demand without the knowledge of the central bank.

Sixth, if cryptocurrencies are used as a medium of exchange, it rubbishes the concept of a currency. Today, Indians have to use rupees and cannot use forex, which has to be surrendered to the central bank or else violate FEMA regulations. In such a situation, a cryptocurrency will be a parallel currency, which is not acceptable. In the US, there are several establishments that accept the Bitcoin.

Last, if cryptocurrencies are used just as an investment option (assuming we don’t mind people anonymously holding it without letting tax authorities know about their wealth), we should also allow betting on cricket matches where at least there is physical money being transacted.

There are very strong reasons, hence, for not allowing the use of cryptocurrencies. In fact, all such transactions should be made illegal and a criminal offence. If at all it is permitted, there has to be a 100% audit trail, which, then, probably will defeat the purpose of holding such a currency. The government is already fighting a battle on the social media that has been interpreted as being misused in the context of the legal provisions that are there. Allowing a parallel currency system is, therefore, antithetical, besides being a danger.

RBI has spoken about considering an official Indian digital currency. This is complicated because a government or a central bank cannot be having a rupee and also a cryptocurrency given that there has been expansive progress made in digitisation. Digital transactions have caught on which are denominated in rupees and this supports the growth taking place in the country. More digital transactions obviate the need to use banks and adding another cryptocurrency in parallel will not serve much purpose. In fact, it can create confusion. Besides, the essence of a cryptocurrency is to have a paradoxically limited but unending stream of coins being generated—while the sum is fixed, the amount available disproportionately falls with every passing period. This helps to give value for scarcity. A central bank floating a cryptocurrency cannot use this ideal when facilitating transactions in an economy.

The fight against black money is still on and tax data does not show that there has been encouraging success in this area. Under these conditions, it is best to keep away from cryptocurrencies and illegalise the same. An official cryptocurrency, too, is not warranted as it can create a lot of confusion and unease amongst citizens

Panel discussion : IMC seminar on government policy and commodity markets: 11th March 2021

 https://www.youtube.com/watch?v=bivB2Nph5lQ

TV Show

 on CNBC to discuss state of states on 9th March 2021

https://www.cnbctv18.com/videos/economy/four-large-states-report-revenue-deficit-budgets-experts-weigh-in-impact-8546251.htm

Will Petrol prices ever come down? 6th March 2021 Free Press Journal

 One fallout of the lockdown was that the revenues of the government were affected, as lower economic activity impacted income and spending. The response of the government was to focus on fuel products for additional revenue, as these were out of the purview of the GST. This meant increasing the taxes at both the Central and state levels, leading to abnormal prices of the final products. While the justification is that these products are used by the rich, the argument is specious, as it affects everyone’s daily commute and also adds to the cost of all goods which tend to be transported by vehicles that use diesel. Hence, the impact is quite comprehensive.

Absurd retail prices

The absurdity of the retail prices can be gauged from the fact that the global price of crude oil has been relatively stable, at $60/barrel. But governments have relentlessly increased the excise rate (Centre) and VAT (states) to garner higher revenue as, practically speaking, demand is inelastic to price -- as with social distancing, it is prudent for most people to use their own vehicles where feasible. The table above gives the break-up of prices of petrol and diesel as provided by the IOCL for February 16 in Delhi.

Prices vary across states and cities, depending on the VAT rates imposed. Hence, Mumbai has a petrol price approaching Rs 100/litre due to the VAT factor. Excise is constant across the country, being imposed as specific duty by the Centre.

In FY18 and FY19, crude oil averaged $57/ barrel and $70/ barrel respectively. Yet, the price of petrol was averaging Rs 69 and Rs 75/ litre respectively. Interestingly, the cost to the dealer was marginally lower, at Rs 31.39/ litre. The difference in this cost today can be attributed to the movement in crude oil price, as well as the exchange rate. But the remainder of the increase in price is purely in the government domain. In FY18, excise was around Rs 20/ litre, while VAT was Rs 15 in Delhi. One can hence get an idea of how heavily taxed these two products are.

High duties

Why does the government impose such high duties? In FY20, the Centre got as much as Rs 2.2 lakh crore and states Rs 2 lakh crore from excise and VAT. If other charges like customs/IGST/royalty etc. are added, the governments got around Rs 5.1 lakh crore from petro-products, with the Centre getting Rs 2.87 lakh crore. This is around 12-14 per cent of total tax revenue for the Centre. The advantage here is that these products have been kept outside the purview of GST, which provides flexibility.

Fuel products have a distinct inflationary impact and are today being driven by the government, and not the price of crude oil. In the WPI, fuel products have a weight of almost 8 per cent, with petrol and diesel having a weight of 4.7 per cent. Intuitively, it can be seen that with 10 per cent increase in price, the inflationary impact will be 0.8 per cent. in the last few months, the price of petrol has increased by over 20 per cent, which means that 1.6 per cent is the increase in WPI due to this factor. The impact will tell on the index in future too, as the benefit of last year’s base wanes.

In case of the CPI, the weights are smaller but have a pernicious impact, as they have a strong, indirect impact on the prices of other goods and services. The direct weight of petrol and diesel, along with lubricants, is 2.4 per cent, while taxi commute has a weight of 0.57 per cent. Therefore, the weight is approximately 3 per cent in the index. The impact on other goods is sharper, as has already been witnessed with the cost of horticulture products, grains, travel, recreation, tourism, being affected, as also finished goods, as producers hike their prices to buffer in the transportation costs.

No let-up

Until the pandemic set in, it was generally believed that the government would ensure that the price of petrol remained less than Rs 90/ litre. However, with crude price climbing to $60/ barrel, it was expected that the government would relax the duty rate, which was not done. It is expected that the price of crude will move up by at least 10 per cent this year, as the world economy revives -- some upward movement has already been witnessed in this market. This can see the dealer price rising by Rs 3-3.50/ litre, which if not matched with a reduction in duty can send the price to well beyond Rs 100/ litre. This is a probable scenario which will add to inflation, for sure.

A call has to be taken by the government on these tax rates, as the inflation impact will have a bearing on future monetary policy decisions. Presently, the MPC is not looking at inflation, as the focus is growth. But at some point of time, it will have to revert to the mandated inflation targeting, which will be influenced by fuel prices. This should be kept in mind.

Ten questions for the MPC to consider: Business Line 9th march 2021

 

As Monetary Policy Committee ponders on the inflation band, choice of indicators such as CPI/WPI and headline/core need a relook

The RBI appears to be satisfied with the contours of the Monetary Policy Committee as they stand today. However, given that there is talk of what the MPC should be targeting in future, the doors are open for discussion. Here we can pose some questions.

First, are we targeting only inflation? This is important because different Governors have expressed diverse views on the subject. While the legislative mandate speaks of only inflation targeting, it has been expanded to cover growth too especially last year. Therefore, it makes sense to also include a growth objective as perspectives of the same are expressed in the deliberations and the final MPC statement.

Second, which index do we look at? Here, there has always been debate on whether the CPI is better compared to the WPI. Let us look at the logic of inflation targeting. If inflation is very high, then it is necessary for rates to be increased so that excess demand-pull forces are reduced, and inflation tempered.

Here, the assumption is that inflation is being caused by demand going ahead of supply. Also, it is implicit that this growth in demand is being driven by business borrowing money and investing. By raising interest rates this is curbed.

Let us look at the reverse situation. If inflation is low, there is reason to lower rates so that businesses borrow and invest more. This leads to higher growth. Intuitively lowering of rates is growth accretive while raising rates is inflation curbing. In both the situations the premise is that interest rates affect borrowing decisions. The CPI is a consumer-based index and has 46 per cent weight given to food items, 10.1 per cent to housing, 6.8 per cent to fuel and lighting, 8.6 per cent to transport and communication, 5.9 per cent to health, 4.5 per cent to education, etc.

None of these components is based on leverage and hence repo rate action will not affect this index. Individuals do not use leverage to finance these purchases (except through credit cards which are anyway just 1 per cent of total credit).

Therefore, the assumption is that rates will affect business decisions and not inflation. But, then, if this is so, we should be looking at the WPI as that is a production index which assigns a weight of 64 per cent to manufactured products.

But don’t the two indices move the same way? The answer is: not always. The CPI is driven more by food products, as was seen in FY21, and guided more by supply shocks over which interest rates have no impact.

Thus, the third question. Should we be looking only at headline inflation or also core inflation? This is important as the MPC statement is always eloquent on the latter as it often emphasises how core inflation is low even though headline is high because of high food prices. As there is a bias towards growth and hence low borrowing costs, the decision to not increase rates even when inflation is high assumes that it is the food component that has gone awry and hence is not a monetary concern.

Fourth, another issue that comes up in discussions post the announcement of the policy is the concept of real inflation. Often it is explained that real interest rates are very high because inflation is low and the repo rate is high. Is this important? Here it should be pointed out that inflation is always cumulative and hence over five years of, say, 4 per cent inflation, the cost of living has actually gone up by 22 per cent, while the interest rate refers to a point of time. Therefore, a call has to be taken on whether real interest rates make any sense or should it be ignored.

This is important because it leads to the fifth question of whether one should be looking at the returns for savers. They get affected by cumulative inflation and can never understand how their deposits are earning just 5 per cent when food inflation is very high and the repo rate very low.

The question is: Why is it when inflation rises, interest rates are never increased? Savings are important because if they do not increase, ex post will lead to a current account deficit which is what macroeconomics says is the difference between savings and investment.

The sixth question is that when we specify a band, what is one to make of it? A band of 2 per cent over a benchmark of 4 per cent today is treated differently by the MPC. When the inflation path moves downwards along the range, rates have been lowered, but when they go up towards 6 per cent, they have not been touched.

The MPC must consider at what stage does the committee change rates in either direction. While 2 per cent and 6 per cent are well defined, the action taken between these limits is still open to interpretation.

The seventh question is what does an “accommodative stance” mean? Does it mean that rates will not be increased or that liquidity will be provided when required? This is another open question as it has been an addendum of all the last few policies.

The eighth is, what should be the inflation target given that we opt for CPI? Interestingly, before the MPC started its first meeting in October 2016, the average inflation rate in the preceding four years was 7.5 per cent and, yet, 4 per cent was chosen. For all the eight years (excluding FY21) the average has been 5.8 per cent. Even the CPI for industrial workers had averaged 8 per cent in the earlier four years and 6.5 per cent for eight years ending FY20. Therefore, a number of 5 per cent looks more reasonable in the Indian context. To this one can add 2 per cent band on either side which is a deviation of 40 per cent.

The ninth question is whether there should be six meetings or should we revert to the earlier system of two policies — the so-called busy and slack seasons. This is so because every policy makes projections of the future which become susceptible to substantial changes.

Last, the three-day meeting concept can be reconsidered as the perimeter for discussion is fixed and there are limits for debating numbers which are on the table. This can reduce the market noise as players start conjecturing action possibilities from Day 1.

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