Taking aim at retail inflation is a very complex challenge for RBI: Mint 24th July 2023

 

Inflation refers to the percentage change in prices. That’s what the text book says. But the way we look at this number varies across countries, and also changes with the purpose. Inflation is the target for central banks and there is a lot of focus on this number all through the year, especially when high.

Interpretation is hard because it involves a lot of subjectivity. Hence, one tends to look at the headline number. This becomes a good anchor for central banks. But often the peg is driven by components which may not be influenced by monetary policy. The first that comes to mind is food, as interest rates cannot affect their prices under normal conditions. People rarely borrow to buy food. Higher interest costs can push up costs for manufacturers of food items, which could add to inflation, but that is a different thing.

What central bankers talk a lot about is core inflation, as it is more sensitive to interest-rate movements. This is the non-food-non-fuel component. This concept, though widely used, has been debated in the Indian context because one may not be using leverage to pay rent or buy cosmetics or a cinema ticket. We may borrow for healthcare or education, but then cost is rarely a limiting factor for their demand. Besides, in India, the use of credit cards is still not high, accounting for just 1.5% of total credit. This is unlike the US, whose citizens live on credit and respond to rate changes. Then there are other inflation concepts such as ‘core-core’, which excludes petrol and diesel products, and the ‘super core’, which takes rent out of it too. These are creations of economists who use them in different contexts.

India’s headline inflation numbers came down in May but increased in June. However, core inflation has come down and held steady at 5.1%. Is one to be happy about it? One cannot be sure. The Reserve Bank of India’s (RBI) central target is 4% headline inflation. It was less than 4% in 2017-18 and 2018-19. In 2019-20, it was at 4.8%. But then the storyline changed, with inflation twice going above RBI’s 6% upper tolerance limit, while it was at 5.5% in 2021-22. This suggested that earlier low readings were more a result of chance, as India has traditionally had inflation above 5%. With inflation now high again, comfort is being drawn from the fact that it is less than 6%. This also means that June’s inflation at 4.8% is acceptable.

But using the economist’s wand, the number of 4.8% in June or 4.3% in May can be tweaked. Food inflation was a challenge in both months, with cereals, pulses, milk, spices and prepared meals witnessing high inflation. But a sharp fall in oils-and-fats inflation (-16% in May and -18% in June) brought down headline inflation, as the category has a 3.6% weight in the index. If this is excluded, inflation would be closer to 6% and RBI is aware of that.

Inflation numbers are also influenced by base effects. In the case of tomatoes, for example, for which market prices have crossed ₹200 per kg in some parts of Mumbai. But with a weight of around 0.6%, they have shown negative inflation for the last three months, with the latest being -35% in June. This reads odd, but it is a statistical reality, as the base was high last year, which has given us such a counter-intuitive outcome.

Using inflation numbers for policymaking is a challenge due to base effects and the spikes or troughs caused by single commodities. The RBI’s mandate is to target the consumer price index (CPI) headline number, which can be too capricious. Using core can be a way out. Currently, it features in explanations but isn’t used to anchor the target. Prior to the CPI, the wholesale price index (WPI) was used as a target. The rationale was that the WPI is influenced by interest rates as it is a producers’ price index. These are the conundrums we face in choosing an inflation target for India.

Interestingly, what goes into the index is also important. Often, we tend to compare US inflation and the policy action of the Federal Reserve with that of RBI. But our indices are different. The CPI in the US is impacted more by the Fed rate because of high household leverage. Here a comparison with the components is also quite insightful.

In India, the food basket has a weight of 45.9% in CPI at the all-India level. For the US, it is just 13.4%. The decisive component in the US index is housing, with a weight of 34.5%, while for India, that is much lower at 10.1%. This can also be associated with the mortgage industry, which is huge in the US, while this segment in India has come into focus only recently. In the US, services dominate the CPI index with a collective weight of 58.2%, and transport, recreation, education and medical prices together account for 20.2% of the index. In our index, these form under 10%. The weight of garments-related products is higher in India at 5.6% than in the US, where it is 2.6%.

Thus, even if we compare the CPIs of different countries, the factors driving them are different as the components vary to reflect the consumption patterns of respective societies. As another example, when we talk of how easing global commodity prices can soothe inflation, it may have little effect if these retail prices are not market-set.

All this means that inflation targeting is complex and central banks have to monitor and target the relevant components to make policy work effectively.

Hi! You're reading a

 

Lessons from the field : Cricketer Faf Du Plessis’ autobiography could well be a guide for corporate leaders: Financial Express 23rd July 2023

 Just think of this situation in a company. A new CEO follows the policy of talking to the senior management team to ask what they would do if they were the CEO and what would they like to have to ensure their teams work better. Sounds utopic? Yes, this rarely happens in the corporate world where CEOs assume they know the best. But this is a strange unintended message that leaders can take when they read cricketer Faf Du Plessis’ autobiography.

Faf Du Plessis has been a regular in successive IPL tournaments, being a part of the Chennai franchise for long and now captain of the Bangalore team. He is known to be an effective captain who can bat very well, opening the innings and also scoring fast.

Du Plessis pens a very honest autobiography, which is rare given that in sports it is hard for anyone to admit that they ever did anything wrong. But he is forthright and talks of the ‘zipgate’ and ‘mint gate’ controversies where he was involved. He does not say that he did not do anything wrong but admits that he did rub the ball against the zip of his trousers and applied saliva laden with mint on the ball to provide the shine for a reverse swing. This is done by all cricketers, but obviously those who get caught are the ones who make the headlines. His Christian upbringing brought in a lot of criticism from his family for which he was apologetic. We do not hear something like this from our cricketers even when they are pulled up by foreign referees for supposed wrongdoing. We always tend to attribute it to biases towards India, which is now common. That’s why Du Plessis’ narrative stands out.

What strikes the reader the most about his story is the way the South African team has always had to work hard to keep together. Coming out from the racism that typified the country, sports has been used as an equaliser, which has worked to an extent. He highlights the quota system in the team where the selectors guide the composition and hence the best may not always find place in the final squad. This is to maintain political and social harmony.

Du Plessis writes a lot on team building, through which it was ensured that there is a sense of belonging for all players. He writes about how even other captains followed the approach of keeping the team spirit alive by having constant conversations with players. Newcomers are made to feel a part of the team and made to speak in team meetings so that they shared a common purpose. Perhaps he was reminded how he felt let down and humiliated when his hero Darryl Cullinan abused him and asked him not to sit by his side when he was new to the team. Do these things happen in the Indian team? One never knows.

Du Plessis takes us through his upbringing and his fascination for the game since childhood. Playing for the Proteas team was the ultimate dream, and he takes genuine pride in finally reaching the stage of captaining the side. Interestingly, he was a schoolmate of another big star, AB de Villiers, and there was some kind of rivalry between the two. He has great admiration for Graham Smith, who was too big to emulate but was responsible for bringing the team to the big league. The other people who he believes were the leading lights include Hashim Amla who was well respected. AB de Villiers was a superstar who everyone would try to emulate, while everyone agreed that Dale Steyn was the best fast bowler in the world.

Blank vertical book template.

Du Plessis has a chapter devoted to the CSK experience, which is quite significant. He admires the owners of the franchise for firmly believing in family values and holding on to them even when it came to team selection. Failure is not shunned and players who are not in form are not left out but persevered with. It was similar to the theme followed by the South African team when the coach and selectors did not ask Du Plessis to drop out when he was not scoring runs. He also points out that the approach of MS Dhoni to captaincy is very different from what happens in South Africa. He was used to having constant team meetings during the match and even before and after the game. He is impressed by Dhoni who does not follow this approach but once on field has everything under control and organised everyone to do what they have to do. This style, alien to the author, has impressed him considerably.

The book can easily pass the test of being one on leadership which is worth pursuing even in the corporate world, while being a must for all sports where teams are involved. As people differ in various fields and backgrounds, it requires a true leader to create a sense of team spirit to deliver on the aspirations and goals of the entity. This may be something that the Indian cricket team should follow, if not already being done, given that there is a lot of talent waiting to be expressed thanks to the IPL.

As a book coming from a cricketer, it is enjoyable and extremely refreshing in content. It is written with honesty and is not pretentious. That makes it an even more compelling read.

Faf Through Fire: An Autobiography

Faf Du Plessis

Penguin Random House

Pp 384, Rs499

Is It Irrational Exuberance Again In The Markets?

The term irrational expectations is quite clichéd and often associated with stock markets. The Sensex has been reaching higher levels progressively and the question asked is whether this is ‘real’. Stock markets are considered to be a barometer of how the economy is interpreted at the broader level even though it is based on expectations of how companies will perform. This is where the conundrum begins. 

The interesting thing is that markets across the world are spinning upwards. The S & P 500is up by around 16% over December and the American economy is grappling with inflation every day as there is still no light at the end of the proverbial tunnel. The Fed’s talk of another rate hike or no rate hike has impacted markets all over as FPIs have turned bullish or bearish on a near real time basis. This has been the true manifestation of globalisation which is otherwise ebbing to a near state of ‘withering away’ in Marxian terms. The Nikkei 225 is up by 28%; and hence Sensex going ahead by around 8% looks fairly modest. The Euro STOXX 50 is up by 15% with most major constituent countries doing equally well. And this comes at a time when the world has just escaped a recession but will be slowing down considerably against 2022. The UK is the only outlier where the FTSE is marginally down. The linking of the index movements with GDP growth does look out of place. 

Emerging markets have a different story to tell. Along with India, Taiwan and Korea have seen optimism as has Pakistan where the economy is in a decrepit state. China is up by a modest 4.3% while stock indices in Malaysia and Indonesia have fallen. Again, no clear pattern is discernible. 

What appears to be common is that the movements in stock indices have nothing to do with the state of the economy. If one looks at India, the picture reads like this. Economic growth is to slow down to 6.5% going by the RBI which is lower than 7.2% witnessed last year. We are still uncertain of inflation, which is the case across the world. Countries like Australia which lowered their rates had increased once again even though global commodity prices appear to be fairly stable at lower levels. Wage and cost inflation along with demand side pressures have added to the pressures. 

The industrial growth rate is just about stable at less than 5% though numbers are getting hard to interpret given the base effects. Exports growth has turned negative quite sharply for the last 5 months which is expected due to the global slowdown. FDI slowed down last year by $ 13 bn in fresh equity after being in the region of $ 60 bn. Again, the quantitative tightening in the west has meant fewer resources to invest. Companies are still talking of the elusive rural demand and going by their commentaries when announcing their Q4 results these have turned out to be rolling expectations with the same being carried to the next quarter. Clearly high inflation in the last three years has eroded real consumption even though the pent-up demand phenomenon played outlast year. 

The driving factors have been both the FPIs and mutual funds. FPIs are definitely bullish about the Indian economy and believe that this pocket of world geography will witness sustained growth in the next five years or so. While there are problems, these (consumption and investment) have been there for some time which is being addressed through various policy measures on the supply side. The rising income levels provide consumption opportunities and being basically a domestic economy, which grows because of non-exports means that there is some critical decoupling from the world economy. Hence FPIs are bullish and in the first six months of the calendar year have put in $ 11.9bn as against negative $ 14.3 bn last year. In fact, post March in the three months ending June the amount was $ 11.9 bn (March inflows netted out the outflows in Jan and Feb). 

Mutual funds have also been investing heavily in equities especially in the first quarter. There has been renewed interest in the market by both the retail and wholesale investor as returns on debt appear to be much lower compared with equity. Hence it is not surprising that both direct investment in the equity market as well as indirect through mutual funds have been buoyant. 

When FPIs and mutual funds keep investing in the market it is but natural that a self-fulfilling chain is set in motion. The other factor that plays a role here relates to corporate announcements which appear to be sanguine as usual. Forecasts of earnings are in the double-digit range for the first quarter which is another trigger to keep the market upbeat. But the state of the monsoon, the El Niño effect and kharif prospects can be a dampener and corporate boardrooms still discuss these issues albeit in hushed tones. 

Putting all the pieces together, the emerging picture is that stock market movements on a real-time basis are not really reflective of the buoyancy of the economy. It is a combination of various sentiments that keep changing by the day. The demand side plays a critical role and becomes self-reinforcing. This is what is being seen today. Often times such buoyancy in the Sensex is used to conclude that the economy is doing very well. This is certainly not the case and the pictures in other countries prove this point. It seems more like going with the tide these days with some bright images buttressing hope. 

FPJ Anniversary 2023: India Is A Major Economy Which Qualifies The Rupee To Be Considered As A Global Currency: Free Press Journal 21st July 2023

 Coming close on the RBI report on internationalisation of the rupee was the deal signed by India with UAE on the use of rupee as transaction currency. In fact, earlier too RBI had allowed for using rupees to settle payments for exports, with a rider being that the recipient can use the rupee for buying goods from India or else invest in government paper. Therefore there are positive signs that can be seen as a way to preserve our forex reserves. With Germany and France ready to tow the line of UAE, acceptance of the rupee internationally is signified.

But then can things be so good and easy?

The answer is that there is a clarion call across the world to move away from the dollar as an anchor currency and look for alternatives beyond the Western currencies. This gives hope to the concept of countries using their own currencies for the settlement of payments. It is in this environment that India has been looking to get countries to accept payments in rupees.

India is a large economy and is probably one of the fastest growing, which can maintain momentum for a longer period of time than other nations. Foreign investment into the country is high and India is a major recipient of foreign direct investment. Therefore there is implicit faith reposed in the country’s economy.

Given the size of the population and the movement of people swiftly to higher income levels, the market provided to foreign companies is large. Further at the policy level, there has been a lot of prudence shown in managing budgets in the last 10 years which gives confidence to investors. India is hence a major economy in terms of size and scope which qualifies the rupee to be considered as a global currency. There is reason to believe that the rupee can find its way to other countries for use.

However, for such agreements to work, the clue lies in acceptance of the currency. Ideally, all countries would like to have their currencies used for settling transactions. But the receiving country needs to be comfortable with the same. This comfort comes provided the recipient country can use the currency for settling payments of its imports.The advantage of the dollar and euro is that around 80-85% of global transactions are carried out in these currencies. The recipient can use these hard currencies for purchasing goods from other countries as there is acceptance. Hence, the success of all arrangements that we sign will depend on the recipient country accepting the rupee. This will be possible only in case it can use rupees for importing goods from other countries.

This is the problem with importing oil from Russia and paying for the same in rupees. India runs a trade deficit with Russia. Last year imports peaked at $46 bn while exports were just $3 billion. In such a situation Russia will find it hard to use the rupees paid for its exports as the countries from where it imports would not accept rupees.

Similarly, it needs to be seen if the agreement with the UAE can mean Indians travelling to Dubai and shopping and paying in rupees. India imported around $53 bn of goods from UAE last year while exports were around $32 bn. Unless UAE is able to use the rupee equivalent to import from other countries, the effect of such agreements will be limited.

The agreement with UAE is hence significant because there would be no regulatory hurdles on either side when it comes to use of domestic currency for foreign transactions. In fact the UPI interface would be blended with UAE’s IPP (Instant Payments Platform) to facilitate individual payments. This is a great start. But finally, the recipient would have to be willing to accept the rupees or dirham which can be used for other transactions with a third party.

But, it is essential, nonetheless, for India to keep talking to countries and signing such agreements so that the circle of acceptance increases. This surely will take time but a start has to be made now. The time is also opportune as almost all non-western countries are exploring the use of alternatives for settling international transactions as the ban put by the USA on Russia being a part of the SWIFT system did ring an alarm all over.

There has been some talk of the BRICS group getting together to agree to use of local currencies but there are apprehensions as the countries are dissimilar when it comes to the form of governance as well as economy.

India should keep exploring such agreements with countries in Asia – East and South, so that the network is widened. This will require patience and tact because the South Asian countries for example have been known to be quite careless with their economic models. There is also an understanding with Singapore on the use of UPI which can be extended over time with rupee trade too. This can then be extended to Africa.

The use of the rupee for international transactions will automatically improve our balance of payments situation and make the currency stronger in the global market. But, this will be a slow process for sure.

Re internationalisation is not easy to achieve: Businessline 21st July 2023

 It is quite timely that the Inter-Departmental Group of the RBI has released a report on the internationalisation of the rupee. The talk of making currencies international has gathered momentum ever since the US put an embargo on dealing with Russia. By blocking all payments through the SWIFT system to Russia, the message sent was this can happen to any country. This has led countries to seriously discuss the issue of de-dollarisation, with internationalisation of local currency as part of the package.

If a group of countries decide to conduct business with one another in their currencies, then an optimal solution can be achieved. But the issue is that there will always be surpluses with some countries and deficits for others. Those with a deficit are better off using such arrangements while those with surpluses may not know how to use the currencies as they are not acceptable outside this perimeter.

Therefore, while the regulation on foreigners or Indians holding rupees outside India can be liberalised, getting countries to accept the same is the challenge. Currently, one is not allowed to carry more than ₹25,000 outside the country. An argument put forward often is that this should be withdrawn because if there are takers for the same outside, it saves dollars for the country.

Forex reserves

There are some interesting facts that need to be considered when one looks at internationalisation of currencies. The first is that today around 60 per cent of the world’s forex reserves are held in dollars, 20 per cent in euros, and 5-5.5 per cent in yen and pounds each. Hence 90 per cent of the holdings are in these four currencies.

While China has tried its best to make inroads, the share of its currency is a mere 2.6 per cent; slightly higher than the Canadian and the Australian dollar at 2.4 per cent and 2 per cent, respectively. Therefore, size of the economy does not matter today. China, despite being the second largest economy, is unable to find greater global acceptance of its currency.

Second, the structure of exports throws light on another aspect of global currencies. If a country exports a lot of goods, then there can be an incentive for countries to accept the currency as a mode of payment. World Bank data for 2021 shows that the euro region accounted for 26 per cent of total global exports of $28.16 trillion. The US accounts for a share of only 9 per cent, but the dollar is favoured globally when it comes to holding forex reserves. China has the second highest share in exports of 13.6 per cent, but accounts for a much lower share in forex reserves. Japan follows next with 3.2 per cent, Singapore 2.8 per cent, South Korea 2.7 per cent, Hong Kong 2.7 per cent and India with 2.4 per cent. Canada, Singapore and Russia had shares of around 2 per cent each while Australia had share of just 1.2 per cent. The Australian dollar, however, is a preferred currency by the IMF when it comes to forex reserve holdings. India comes 9th in this ranking, and can hence pitch for inclusion as an international currency.

A third indicator that can be an argument for supporting internationalisation of any currency is the share in FDI outflows. If a lot of domestic investors are investing in other countries, then the currency becomes a strong candidate for internationalisation. UNCTAD’s data on world investment outflows for 2022 shows that $1,489 billion had moved out from countries. Here, the US dominated with a share of 25 per cent. This is followed by Japan with 11 per cent, China around 10 per cent, England 9 per cent, Hong Kong 7 per cent, EU 6.5 per cent, and Korea and Singapore with 3.5-4 per cent each. India’s share is around 1 per cent.

All this data shows that when one is thinking of internationalising the rupee, both the demand and supply sides matter. Policy can drive supply which is the easier option because allowing residents of other countries to hold rupees can be permitted. But the demand for the same can be generated only over time. China has a fairly good share in both global FDI outflows and exports. Yet it is not really favoured as a foreign exchange reserve by most countries. There would however be political and economic factors driving the perception. The value of the yuan is not considered to be market determined and is generally seen as guided by the central bank. This makes it a poor candidate for acceptance.

India is going the right way by making sure that the cogs on the supply side are removed. Allowing rupee trade with other countries is a good step and it needs to be seen how this catches on. Ideally, signing treaties with countries in East and South Asia and the GCC (Gulf Cooperation Council) countries would be useful as the rupee can be used by the receivers to import goods from other nations. In this loop, involving Japan, a developed nation, would be helpful. There was a time when a BRICS loop was spoken of, but given the high level of distrust involving some members, it may not materialise.

A major stumbling block however for internationalising any currency, which will hold particularly so for India, is the sovereign country rating. It can be seen that currencies which are part of the forex reserves basket are mainly in the A+ and above category. Canada and Australia with low shares are rated AAA. The US has a rating of AA+ (Standard and Poor). The euro region has AA, which is the same as the UK. Japan and China have A+.

India with BBB- will find it hard to get universal acceptance, notwithstanding the size of its economy and a fairly dominant position in exports. In fact, the rating is just about investment grade and hence the pitch that is being made by the government regularly is necessary to change the perception.

Having Indian bonds in global indices could be a useful starting point to showcase the strengths of the country and hence the rupee. Therefore, the several steps which are being taken by the government and the RBI together can coalesce to strengthen the case of internationalisation. Ultimately it is perception that matters and India is doing well on this score.

Right decision on taxing online gaming: Financial express 19th July 2023

The decision taken by the CBIC/GST Council to tax online gaming by 28% is most appropriate as it brings in a level playing field with other similar activities. In fact, it corrects an anomaly in the existing system. The industry is definitely not pleased with this move and believes that this can hinder the growth of the sector and also keep FDI out. The argument has also been extended to highlight the possible loss of employment on this score. Hence, as usual, there are two diametrically opposite views here—one based on rationale and the other more on emotion.

Online gaming is like any other recreational activity with stakes involved. The government has clarified that in case there is no money involved, there would be a lower level of taxation. In case one can make money either through perceived skill or pure luck, it qualifies as gambling and is liable to this levy. Earlier, the gain was being taxed at 30% while the gross gaming revenue (GGR) was taxed at 18%. But now, the sum that is being put on the table would be liable for the 28% levy. Curiously, this holds for other recreational activities presently.

IPL tickets are subject to 28% GST as it is organised by private organisations. This has not come in the way of people watching the matches. Therefore, it is pertinent to note that the tax will be paid by the customer. Even if it is argued that it is not gambling but a game of skill, there is a parallel here. By not taxing gaming at 28%, the IPL followers could have argued for a rollback.

The imperatives for the government to act the away it did are worth examining, to begin with. First, there needs to be a level playing field across the sector and there should be no distinction for activities which involve betting—horse riding and casinos also fall in this ambit.
Second, the policy so far has been to tax sin products at a higher rate. As gaming is analogous to the same, it should be taxed at a higher rate. Such games become addictive and, hence, if a higher tax acts as a deterrent at a lower level of income, then it is beneficial for society. At higher income levels, this tax may not really matter—there is a moral issue here.

Third, the government has progressively been trying to plug all the loopholes when it comes to black money. This measure can be seen as an extension of the same, where activities that got away under the camouflage of being skill-oriented are targeted. It is hard to be convinced that that selecting a team which performs the best before a cricket match is played is a game of skill.

Fourth, last year, the government brought cryptocurrency under the tax fold. This was a progressive move as a lot of unaccounted money was channeled through crypto exchanges based in other countries. Getting these companies under the fold seems to be in order. Even the introduction of the tax collected at source rule was another attempt to ensure there is an audit trail over forex expenses.

Last, presently, only the platform fee is taxed at 18%, and as stated by the GST Council, it comes effectively to 3%, lower than the tax rate on essential goods. This is a major anomaly in the tax structure as the two cannot be equated.

The revenue gain for the government would be around Rs 20,000 crore. But as stated by the government, the argument is more on moralistic grounds of curbing gambling, especially by people who do not have the monetary wherewithal to bear losses.

The industry view is at the other end. Being used to preferential treatment on account of not being on the radar so far, the argument is that the tax is a big blow for its sustenance. A lot of investment has already been made in the infrastructure which will now get wasted progressively. As this industry attracts FDI, this will ebb. The initiative taken at creating these new startups will be pushed back significantly.

It has been seen that tax rates are rarely a deterrent to consumption, as seen for other sin products. It would, however, check bets taken by participants at the lower income levels, where their households can be in jeopardy. There is larger participation for online games compared to casinos and horse racing, considered to be elitist. This explains that the apprehension expressed by the industry is more of an immediate emotion.

When GST was introduced, it was understood that there would be fine-tuning with time. New activities that were not significant have come to the forefront, which deserve reviewing. This is what has happened to online gaming. The issue of the levy being prospective or retrospective is relevant as ideally, all such measures should apply to the future. But if it is a case of the present levy being a clarification rather than a new measure (which is what has been said), then probably the courts will have to come in. But overall, this strikes a right balance and looks at the broader picture.

Corporate social responsibility projects demand expertise too: Mint 10th July 2023

 

REMIUMThe issue is that there has been a concentration in three activities: education, health and rural development.

The ministry of corporate affairs has raised some concerns related to the money spent by companies on corporate social responsibility (CSR) activities. Companies above a threshold level of profit, sales or net worth are mandated to invest 2% of their average profit for the last 3 years on CSR activities, which are defined. This could be capital spending or otherwise.

The first issue is that there has been a concentration in three activities: education, health and rural development; 77% of the total amount spent between 2014-15 and 2020-21 was on these three. CSR activities, therefore, aren’t covering adequately other important areas such as poverty eradication, gender equality, climate change, etc.

Second, there has also been a concentration of spending in some large states: Maharashtra, Gujarat, Andhra Pradesh, Karnataka, Uttar Pradesh, Tamil Nadu, Rajasthan and Madhya Pradesh. The money is not being spent equitably across geographies, as it tends to flow to states that are better-off to begin with, relative to states in the Northeast, for example. It is seen that companies are investing their funds in states that are more developed and have better infrastructure, as this makes the administration of funds easier.

The fundamental question that arises is whether or not companies have any core competence in these areas. They are set up to do business and have to reward their owners, who are shareholders. While doing business, they make profits and pay taxes on it. Asking them to undertake responsibilities that are alien to their core function leads to a fundamental contradiction. Invariably, they deploy internal staff that is not competent to do this work. Some hire experts from industry to look after these operations. But low-effort exercises like distributing water coolers or laptops to schools are more typical. This is not the best way to carry out CSR activities.

The belief that all companies can get involved in CSR is misplaced because when the threshold is, say, ₹5 crore, the company will be too small to have the wherewithal for CSR programmes. In fact, the rule also says that there has to be a board-level committee to administer the chosen CSR activity and regular reporting of it. This can get onerous and it is not surprising that companies look for easy ways out. In fact, transferring the money to a centralized fund like the Prime Minister’s National Relief Fund always looks appealing. Otherwise, a lot of management time has to be expended on CSR compliance.

The premise here is that companies are not cut out to do social work, which is the responsibility of the government. While some companies have been doing it for decades, there is usually a personal level of commitment among business leaders who deploy dedicated outfits and staff. The impact of their work is powerful. At times, they even develop townships where such work is carried out and worthy goals, such as empowering women or educating girls, are pursued. But not all companies have the competence for it.

A sample of around 1,200 companies with net profits of above ₹5 crore in each of the last 3 years had an average profit-after-tax of around ₹8.8 trillion, which translates to ₹17,600 crore of CSR spending. This is a large sum that can bring meaningful change. Two choices exist here.

The first is for the government to set up a separate organization to work on the deployment of these resources. If setting up a new organization is too bureaucratic and costly, the Niti Aayog could be entrusted with this responsibility. There is abundant expertise in most of these targeted areas, which can be deployed to make the spending of resources more effective.

As corporate tax is a central tax, the prerogative would be with the Centre how to deploy these funds. To make funds flow more smoothly, the corporate tax rate can be increased by 2% or an equivalent cess can be imposed on companies. Alternatively, the amount can be paid by companies once they announce their final results in May so that the money is available to the government as a lump-sum to deploy based on its social-sector priorities.

The other option is for the government to draw up a list of all CSR projects underway in the country. Since the universe of companies involved would be not greater than 2,000, the list would not be all that long. Then there could be a system of directed or suggested CSR spending, with advice given routinely to firms on where money should be spent and for what exact activity. For example, a hospital in need could let the government know its requirement, so that companies are informed of it. This way, businesses would be relieved of the time and effort taken to identify CSR projects even as the broader objective of the programme is met.

Presently, the concept of CSR is appealing but the route being taken may not be the best. It needs to be recognized that CSR activity is not something everyone has expertise in. There are several NGOs that would like to get involved, but it is hard to sift through them. Therefore, there is a good case to let the Niti Aayog handle CSR activities. The whole exercise should be aligned better with what the ministry expects of it.

The animal spirit of investing: An interesting analogy between animal kingdom and investors serves as guide to markets: Financial Express 10th July 2023

 Investing in stocks is always an enigma because of the plethora of advice available by various experts everywhere. Representatives of brokerage firms as well as fund managers are in the media every day, suggesting the best options while asking potential investors to weigh risks. In fact, hearing them on a daily basis can confuse the layperson as they frequently get technical while doling out advice. Movements in the stock indices by virtue of their components moving up or down often lead to herd mentality and become self-fulfilling. Are there better ways out?

Here, Pulak Prasad, the founder of Nalanda Capital, a Singapore-based fund, has a different take, similar to maybe what a Warren Buffet might recommend. While asking investors to be conservative and not give in to animal spirits is the general theme of this book, the author uses basic principles of how species operate to tell us how to keep it simple.

He supports three principles when working in the market. First is to not take unnecessary risks, which is what even animals do. The second is to invest in high quality companies at a fair price. When they are of high quality, the prices never tend to be exaggerated even at the best of times. Here one can see similar advice given by another market guru, Saurabh Mukherjea. The third is even more compelling when he asks us not to be lazy but be ‘very lazy’. This means that one should buy and hold and not get swayed by the moods of the market, which are always short-term in nature.

Each of these principles is explained drawing analogies from the animal species, which also follow these tenets in a similar manner for reasons that may be different. For example, about not taking big risks, animals do so to ensure that they are alive. Therefore, to be a good investor one must know how to reject stocks that don’t sound right. Now this may sound a bit quizzical as prima facie it is hard to figure out which stocks are risky.

The author takes us through some of the factors that sound big trouble. He says one should avoid ‘criminals and crooks’. Well, no company says they are criminals, but his research and experience show that owner-driven companies could tend to fall in this category and hence need greater investigation before investment. He uses third parties to do the audit before taking a decision. In particular, this pertains to IPOs where one can end up being swindled. He says that while one may miss out on some good issuances, as all of such companies are not bad, it is better to skip than to be sorry taking this risk when one is not certain.

The other kind of stock he avoids are those which are famed for turnarounds. New CEOs who did well in their earlier companies cannot be trusted to carry on the same work forever. One can’t be certain and hence the risk can be avoided. He is also against companies that have large debt, which sounds fairly logical. Often one looks only at profit or sales numbers to believe that the stock will do well. But once there is a pile up of debt, other compulsions follow and often diminish strategic flexibility and long-term value creation. Next, the author is not a fan of M&A companies as the probability of failure has always been high. In this process one could miss some good picks, but that does not matter in the larger scheme of things.

In short, the author writes that Nalanda invests in companies that have a high return on capital employed, minimal or zero debt, a strong competitive advantage, fragmented customer and supplier base and a stable management in a slowly changing industry. This sounds logical enough, as one can intuitively see that all these characteristics make a company look strong in the medium to long term.

When the author advises to be very lazy, the suggestion is that we should buy and hold the good stocks and not get swayed by everyday events. Companies always go through different cycles and there will always be good and bad phases. One should accept the two and not panic and sell when the going is bad. If the company is good and the prospects steady and positive (an example given by almost any stock analyst is Asian Paints), there is no reason to lose faith.

In this context he says something that is significant. We should not pay too much attention to press releases, management discussions, investor conference, etc, when taking a purchase-sale decision. The honest information is the financials. All communication made verbally by CEOs are heavily biased to sounding good and the picture is always rosy. That’s why there is less honesty there.

Therefore, his approach is similar to Warren Buffet’s, who refuses to sell, as empirical studies show that for a 90-year perspective, great businesses create enormous wealth and the concept of holding forever works well to give value to investors. He attributes the success of Nalanda Capital to being better while buying rather than selling, which is sound advice. In a way the concept of index buying falls in place here.

Prasad’s book is quite insightful and warns against the pitfalls of being influenced by swings seen in some companies. One has to be cautious when buying as this is when one can fall into the trap of herd mentality. Some bits of advice on what are dodgy companies are noteworthy and one can identify with this template when one looks at the performance of some of the IPOs in India in the recent past.

The so-called alpha stocks need to be analysed closely before investing and one should be able to put ticks to most of what Prasad has mentioned in the book. In this process one may miss some good picks, but there is no reason to regret. By drawing in analogies from biological evaluation there is added novelty in the narrative. It may get a bit heavy at time on this side, but is interesting nonetheless. The stock investor will agree with most of what has been written in this book.

What I Learned About Investing from Darwin

Pulak Prasad

Columbia Business School

Pp 312, Rs 799

Note Withdrawal: If Not Black Money, Then What? Free Press Journal 8th July 2023

 The RBI’s press release on the withdrawal of the Rs 2000 notes is quite revealing. The RBI has indicated that around Rs 2.72 lakh crore of the total of Rs 3.56 lakh crore of these notes have come back into the system which is about 76%. Therefore it does look like that the entire amount would come back in due course of time which is by September 30. What is one to make of this?

The first is that it does not look like that these notes were used for storing black money. The fact that deposits have accounted for 87% of the exchanged money means that there is an audit trail for the government and the tax department. Intuitively all this is clean money as one would not have deposited the same in the bank account if these amounts could not be justified.

Second, the fact that this amount has been put in as deposits has changed the liquidity situation in the system as banks have suddenly found themselves with extra funds. It may be recollected that bank deposits had grown at a slower rate than credit in FY23 which led to a gap between demand and supply of funds. Some of the banks had dipped into their capital for lending purposes. Now with Rs 2.36 lakh crore of money coming in for banks, the supply side issue has been addressed.

Third, this development also raises a conundrum for banks. On one hand with these deposits increasing, it may not be necessary to raise interest rates any further. The RBI is expected to maintain status quo until February 2024; and in the absence of these deposits there could have been pressure on banks to raise deposit rates to fund credit growth. This will provide comfort to the banks.

However, on the other hand such a large quantum coming in exogenously will also push up their interest costs. If we assume that the same ratio of 85% plus would be maintained for the balance Rs 0.84 crore of notes that have to come back to the system as deposits, then the total of around Rs 3 lakh crore would be with the banks. Assuming an average of 5% is paid (as one cannot be sure as to how much would be in the form of savings and term deposits), there would be an additional cost of Rs 15,000 for the system. This amount has to be deployed in the form of credit and in case there is less demand, would have to be used in the market for treasury activity.

Fourth, from the point of view of the RBI there will be probably be more intervention expected which can be seen even today. With liquidity being in surplus, the RBI has had to take a different position as far as the markets are concerned. From a stage where the central bank was working on providing liquidity in the market through the V2R auctions (variable rate repo term auctions), it has not moved to V3R (variable reverse repo rate auctions) to mop up liquidity and ensure that the money market rates remain stable. This will be work in progress for sure until the excess liquidity gets assimilated in the system. In this context it would be interesting to see if the RBI fast tracks the borrowing programme of the government given the availability of funds.

Fifth, as around 13-15% of the total currency has been exchanged for lower denomination notes and will probably carry on in the same vein, the cost of printing notes would be involved though admittedly this may not be very significant given that the majority has gone into deposits.

An interesting statement made at the time of announcing the withdrawal of the Rs 2000 notes was that this was part of a regular policy of the central bank on clean notes, which essentially means removing old notes and having them replaced with new ones. As the Rs 2000 note was issued along with other notes in the denomination of Rs 500, Rs 200 and Rs 100, the important question in the minds of citizens would be whether or not the same would be done with these notes given that a large part of the notes exchanged in the 2016 exercise was also in these denominations.

As the withdrawal of the Rs 2000 note had a surprise element it was largely believed that getting after black money was a motivation behind this decision. Black money is still a hard nut to crack as holding such money would tend to migrate to currencies with lower denomination. Therefore there will be migration to Rs 500 notes. As long as the system provides avenues for ‘rent seeking’ there would always be scope for creation of black money. Today land sales still take place with cash payments and the rationale is that the seller who accepts cash has paid the same when acquiring the property. Real estate developers have to bribe their way through the systems to get power connections, municipal clearances and so on. We have not managed to really accomplish the task of getting in a single window system where everything is seamless and there is no manual intervention.

Similarly elections involve a large amount of cash transactions for paying the voters as well as spending on campaigning. While the Election Commission has placed limits, one can see that much larger amounts are spent on these campaigns. Similarly, ceremonies and functions open the doors to using cash to escape paying taxes. Probably more moderate taxes can address these issues.

Hence, if the move to withdraw the notes was purely an administrative motivation, it would be regarded a success. However, if the underlying aim was to capture black money in the system, it does look like that there is still a long way to go. GST and RERA has plugged some gaps with success, but the system needs more affirmative system-linked actions.

How good a scheme is PLI? Business Line 4th July 2023

 The Production Linked Incentive (PLI) scheme is not easy to assess. Three years after its inception, manufacturing remains stagnant and the picture that emerges is mixed and complex.

Under the PLI scheme, the government, with an outlay for ₹2-lakh crore over a period of five years, gives an incentive in the form of a payback to the extent of 4-6 per cent (modified at different points of time). It covers 14 sectors and includes ones like food processing, electronics, specialty steel, pharma, textiles, auto, solar panels, drones, and so on. There has to be a certain incremental output for the company to claim the same. If the average incentive is, say, 5 per cent and the total subsidy of ₹2-lakh crore is used, there has to be incremental output of at least ₹40-lakh crore over five years in these sectors.

The thought process behind the PLI has been manifold. First, the idea was to provide a stimulus to the manufacturing sector. Second, there is a pressing call for becoming Atmanirbhar in the sense of lowering imports. The old dogma of import substitution has been remodelled through the PLI. This approach is now common in several countries where there is emphasis on development of local industry and a tilt towards making economies more self-sufficient — the resurrection of protectionism through the back door. Third, the PLI also aims to combine import substitution with export promotion. Hence the sectors chosen satisfy one or more of these three objectives.

A multitude of companies have applied for PLI and received approval. The incremental investment and output have to be with respect to a base year which can be FY21 or FY22, depending on when the window was opened. The question is how one measures the same as there have been targets set for investment as well as sales.

Electronics has been quoted as being one of the success stories of late. There has been an increase in exports of electronics from $15.6 billion in FY22 to $23.6 billion in FY23. Prima facie this sounds good. However, imports increased from $73.7 billion to $77.3 billion. How can this be interpreted? One way is to look at the growth in exports, which was impressive at 50 per cent. But is this due to the PLI or is it under the normal course? Imports growth was around 4 per cent which is lower than that in exports. Besides, it has been seen that India is the hub for assembling.

Going by IIP data, production of computer, electronics and optical products fell by 6.5 per cent last year. So, has the sector done well or not?

These are precisely the ambiguities that come in when evaluating the companies or sectors which qualify for PLI. Companies in the normal course would be increasing their investment as part of the long-term plans and hence it will be hard to distinguish between those which have done so on account of the PLI.

Further, the scheme may be biased towards larger companies which can put in the level of investment that the scheme is talking about. While thresholds have been placed at lower levels to enable not-so-large companies to compete, there is no specific scheme for SMEs and hence they would get left out. At the broader level, some issues remain. First, can such protectionism be sustained for long given that at some stage countries which support local industry will face retaliatory measures.

Second, Indian industry will once again slip into somnolence and lose out on efficiency. It has been seen that once subsidies are given and the recipient gets used to the same, it becomes hard to withdraw the incentive. It can come in the way of innovation.

Demand matters

Third, while giving such incentives is a good supply side measure from the point of view of the government, the real problem for India is on the demand side. Hence producing more will help provided there is growing demand, which can happen only if income is generated through more job creation. In the present environment of a global slowdown, pushing exports will always be a challenge.

Fourth, sectors left out may find this policy discriminatory as presently it is only a fixed set of industries that have been included, although there is a sunset clause. Will this lead to accelerated growth in industry? Incentives can work both ways. Beneficiaries can use it to improve efficiency or alternatively may fall back on the same knowing that there is a return coming from the government. In some sectors the larger companies will be more nimble footed and take advantage of the same, which include foreign companies as well, many of which are anyway planning to shift to India as part of the China Plus One policy. This will accelerate allocation of resources and FDI can improve.

Therefore, on the whole, there will be a mixed effect. It would be useful if the government provides detailed progress reports on which companies have been allotted the benefit and the incremental investment and output generated on this count.

Often, companies produce a variety of products and the balance sheets do not give the details, and hence there have to be separate submissions made to the government. The crux hence is to ensure continuous monitoring to ensure targeting of benefits, and evaluating the impact.