Wednesday, March 26, 2008
CTT to bleed commodity traders. Economic Times 27th March 2008
The Budget for FY09 has introduced two measures that would affect the working of commodity markets. The first is the commodities transaction tax (CTT) and the other is service tax. All new taxes naturally hurt the taxed entity, but when it can upset the trading applecart then it is more serious. The CTT is to be 0.17%, which is around five and half times the charges being imposed by commodity exchanges on the transactions. The ostensible reason is that since the market is well developed, it can be brought on par with the securities market with a similar tax rate being imposed. The immediate response has been one of umbrage as prima facie it appears that the traders would see a positive disincentive in trading in this market. How can this affect trading? The peculiarity of the market is that basic liquidity is created by day traders or jobbers, which in turn attracts hedgers and speculators. The jobber rarely holds on to the position for long and would move out as soon as possible. In fact, they would normally look at the minimum variation in price, which is in their favour and would offset the transaction to make their profit. They are not the thinkers, who look at the fundamentals and then take trading calls. Now the price movements in case of the commodities, especially agriculture, is extremely low. The tick size of contracts is as low as 5 paisa for copper, soy oil or mustard and 10 paisa for castor or 20 paisa for gur. Intuitively it can be seen that these jobbers would be putting in their orders at these minimum price variations. These price spreads are very thin here, given the nature of the commodities and the markets. Under normal conditions, when there are no harvests or harvest news in the air, price movements would be minimal and this tick mark would be relevant for traders. Given the uncertainty in waiting, the jobber would be reluctant to hold on to any position for a longer period and would exit with this minimum price movement. The new cost being imposed would make him rethink. This is juxtaposed with the profit that can be made by the trader/jobber by trading this minimum lot size when the price moves up by the tick size, which varies between commodities. The same can be ballooned up for multiple contracts when the quantity traded is larger. To evaluate the cost impact, the service tax impact, though marginal, has been added to the CTT cost. The service tax is assumed to be imposed on a service charge of 0 .01%, which is imposed in the market on an average by brokers. The option for the trader is to either wait for a better tick price change or exit at a loss. The former is always an option, but given the nature of the jobber, it may not be too attractive as one is carrying a higher risk of adverse price movement while waiting. It would make sense to move out of the market, rather than take the risk or make a loss. The repercussions on the market would be felt in case the lower participation of this class leads to declining liquidity that can impact the participation of other players who may not find it too attractive as liquidity dwindles even though they operate with a longer-term view in mind. This would affect liquidity, particularly in the less liquid commodities and even the liquid ones in the off-season periods. It is not surprising that the commodities market is dissatisfied with these twin measures, where the CTT in particular does not get an offset benefit and accounts for over 90% of the new-cost burden.
Monday, March 17, 2008
The Levy is based on wrong assumptions: Financial Express 17th March 2008
The commodities transaction tax (CTT) makes fiscal sense as it is being imposed on a turnover of around Rs 40 lakh crore, which leads to the garnering of Rs 680 crore in revenue. But all new taxes need to be targeted meaningfully so that individual sectors are allowed to grow and meet their objectives. In this case, it is price discovery, especially for hedgers, which will ultimately lead to the inclusion of farmers in the stream of benefits.
The CTT has been imposed on the market based on two assumptions that are debatable. The first is that the market is mature and has come of age. The other is that it needs to be put on par with the securities market. The commodity futures market is now four years old and has followed a fairly rough path in the last two years. There was a ban on trading in four major agro products in 2007, which had pushed the market back by years. Farmers in Punjab had actually protested in favour of futures trading, which had offered them vital price clues in 2006 and 2007.
Liquidity has since then been more or less stagnant in this market and the size is around 20% of the securities market. In fact, there would have been virtually no growth in total traded volumes in FY08 over FY07. Presently, the market caters to the retail segment and corporates with participation coming from commodity brokers in particular. Due to institutional reasons, farmers are out of the ambit and while the exchanges, along with regulator FMC, are struggling to make this happen, the drying up of liquidity will make the job that much tougher.
This, in fact, leads to the second issue of whether this segment is comparable with the securities market. The securities market has been in existence for a much longer time and with the emergence of both NSE and Sebi in the mid-nineties can be said to be nearly a decade-and-a-half old. The array of instruments available is diverse--from cash, futures, options, indices, spreads and so on. The players are diverse, with mutual funds, foreign portfolio investors and hedge funds playing their roles. This diversity of players and instruments has added certain buoyancy to the market today.
Further, present tax laws are skewed in favour of the securities Markets. In this segment, players are allowed to set off losses from trading in futures against... profits from other business. Besides, there is also differentiation between short-term capital gains and long-term capital gains, with long-term capital gains being exempt from taxes. With these facilities not available to the commodities Markets, there appears to be an implicit doubling of the tax burden.
Therefore, to say that the market is mature or analogous to the securities market is not true. The consequences of this tax for the market are more serious. When members are trading on low spreads, this tax becomes serious and would come in the way of traders. In fact, exchanges are presently charging between Rs 2-3 per lakh of transaction, and the CTT comes to Rs 17 per lakh of trading. Hence, the pricing structure of this tax appears to be out of sync with the market mechanics. This, in turn, will reduce the levels of liquidity as the cost of trading increases, which will have a ratchet effect on the market.
Presently, there are a large number of hedgers in sectors such as edible oils, sugar, jewellery, steel and other metal products, spices and pulses. There are several other corporates in the textiles, metals and machinery sectors, which are seriously considering hedging on these platforms. Lower liquidity and the tax will certainly not inspire them.
The Budget appears to be ambivalent in its approach towards the farmers. On one hand it has decided to waive Rs 60,000 crore in bad debts. On the other hand, it is taxing the instrument that has delivered as of now limited results in terms of price discovery and information for farmers, but which has the potential to change their income streams in the future. There does appear to be a contradiction here. As Ayn Rand wrote: “Contradictions do not exist. Whenever you think you are facing a contradiction, check your premises. You will find that one of them is wrong”. Here, there are two premises, and both of them may be incorrect.
The CTT has been imposed on the market based on two assumptions that are debatable. The first is that the market is mature and has come of age. The other is that it needs to be put on par with the securities market. The commodity futures market is now four years old and has followed a fairly rough path in the last two years. There was a ban on trading in four major agro products in 2007, which had pushed the market back by years. Farmers in Punjab had actually protested in favour of futures trading, which had offered them vital price clues in 2006 and 2007.
Liquidity has since then been more or less stagnant in this market and the size is around 20% of the securities market. In fact, there would have been virtually no growth in total traded volumes in FY08 over FY07. Presently, the market caters to the retail segment and corporates with participation coming from commodity brokers in particular. Due to institutional reasons, farmers are out of the ambit and while the exchanges, along with regulator FMC, are struggling to make this happen, the drying up of liquidity will make the job that much tougher.
This, in fact, leads to the second issue of whether this segment is comparable with the securities market. The securities market has been in existence for a much longer time and with the emergence of both NSE and Sebi in the mid-nineties can be said to be nearly a decade-and-a-half old. The array of instruments available is diverse--from cash, futures, options, indices, spreads and so on. The players are diverse, with mutual funds, foreign portfolio investors and hedge funds playing their roles. This diversity of players and instruments has added certain buoyancy to the market today.
Further, present tax laws are skewed in favour of the securities Markets. In this segment, players are allowed to set off losses from trading in futures against... profits from other business. Besides, there is also differentiation between short-term capital gains and long-term capital gains, with long-term capital gains being exempt from taxes. With these facilities not available to the commodities Markets, there appears to be an implicit doubling of the tax burden.
Therefore, to say that the market is mature or analogous to the securities market is not true. The consequences of this tax for the market are more serious. When members are trading on low spreads, this tax becomes serious and would come in the way of traders. In fact, exchanges are presently charging between Rs 2-3 per lakh of transaction, and the CTT comes to Rs 17 per lakh of trading. Hence, the pricing structure of this tax appears to be out of sync with the market mechanics. This, in turn, will reduce the levels of liquidity as the cost of trading increases, which will have a ratchet effect on the market.
Presently, there are a large number of hedgers in sectors such as edible oils, sugar, jewellery, steel and other metal products, spices and pulses. There are several other corporates in the textiles, metals and machinery sectors, which are seriously considering hedging on these platforms. Lower liquidity and the tax will certainly not inspire them.
The Budget appears to be ambivalent in its approach towards the farmers. On one hand it has decided to waive Rs 60,000 crore in bad debts. On the other hand, it is taxing the instrument that has delivered as of now limited results in terms of price discovery and information for farmers, but which has the potential to change their income streams in the future. There does appear to be a contradiction here. As Ayn Rand wrote: “Contradictions do not exist. Whenever you think you are facing a contradiction, check your premises. You will find that one of them is wrong”. Here, there are two premises, and both of them may be incorrect.
Monday, March 3, 2008
Chinks in the Armour: Hindustan Times 4th March 2008
The important question to ask after viewing the provisions of the Union Budget for 2008-09 is as to what is wrong with it. We must look beyond the goodies and the answer must steer clear from the usual clichés that are heard such as non-reduction of certain taxes or surcharges or the introduction of new taxes. After all, if the FM has to garner revenue in some form or the other, somebody has to pay for it.
The significant observation on the Budget is that since this is a pre-Election one, the proposals are laced with propaganda on the success of the ruling UPA government. The problem issues have been tackled head-on, which is good. However, a very myopic view has been taken of things as a result of which five anomalies arise in this budget.
The first is the loan waiver scheme. This is analogous to the ‘loan mela’ schemes in the eighties where loans were perforce disbursed by banks on account of political considerations. Now, banks have to write-off loans to the tune of Rs 60,000 cr. The first issue here is that it sets a bad precedent for future defaults. Borrowers may be tempted to default every 5 years when Elections approach knowing fully well that the government will bail them out. The second is that we need to know as to who will bear this cost. The government has clarified that the burden will be spread over 3 years i.e. banks will be reimbursed by the government. However, the write-offs will take place this year itself. This means that these loans, which are around 2.7% of total bank credit, will be written off with the burden of adjustment also falling on banks. Assuming that Rs 20,000 cr is reimbursed every year, banks have to bear the opportunity cost of not having Rs 40,000 cr of funds to lend at the PLR of 11% which works out to Rs 4400 cr in the second year and Rs 2200 cr in the third year. While the act of saving the farmer is gracious, the result of banks’ losing out does not make banking sense. If the entire amount was reimbursed by the Budget at one shot, then it would have been okay.
The second problem with the Budget is the Pay Commission. The Report will be out by the end of March, and the proposals will then get incorporated. Clearly, there will be no compromise on the recommendations given that the class of government officials is very important elite which matters at the time of Elections. The fiscal numbers are bound to get distorted further and maybe when it comes for final discussion, these numbers will slip in when the Parliament meets.
Thirdly, there have been liberal doses of benefits for the farming community in terms of expenditure on water, soil etc. This is good enough to placate the farmers. However, while admitting that agricultural growth has been a stumbling block this year, the FM should have typically taken a longer term view of things and had concrete plans to raise productivity in wheat, oilseeds and pulses. But, this has not been done as the focus has been very short term. Therefore, the development aspects are missing from the Budget while catering to the immediate requirements.
The fourth problem has been the reaction to the commodity markets. The market, which is in a nascent stage is already faced with the problem of a ban on futures trading in 4 commodities. The FM has imposed the commodities transaction tax which will be a burden on the players. Their withdrawal from the market on account of this burden could mean that the price discovery process would be affected. Therefore, instead of growing this market, which is handicapped today with one single instrument and only retail and corporate participation, the tax will be a dampener.
Fifthly, there are liberal allocations for Bharat Nirman, rural roads, plantation industry etc. However, what would be more pertinent there is the administrative issues of implementation. This becomes important here because while monetary allocation targets are met in these cases, the same does not hold true here.
Now let us look at the pure economic variables. The FM has admitted that growth is lower this year, but the Budget has no clear strategy for spurring growth. In fact, it is assumed that growth will be there at 10%. The few changes in the excise and customs rates will not have a major impact on consumption to start a growth chain.
Further, inflation has been stated as being a concern. If one were serious on inflation, the agricultural plan should have been on, as mentioned earlier, as food along with oil prices have been mainly responsible for inflation in the last two years. The Budget has not addressed this issue. Besides, the Budget has implicitly assumed an inflation rate of 5% for the next year (15% growth in nominal GDP which will mean 10% in GDP and 5% inflation).
Lastly, the Budget gives confusing signals on interest rates. While the fiscal deficit is down, there will be less pressure on the available liquidity in the system. The government has implicitly assumed a marginally higher interest rate of 6.4% this year with interest payments (Rs 190,000 cr) well exceeding total borrowings (Rs 145,000 cr). This is indicative of the fact that notwithstanding the signals that will be given to the RBI, it may be difficult to lower interest rates in the coming year.
The significant observation on the Budget is that since this is a pre-Election one, the proposals are laced with propaganda on the success of the ruling UPA government. The problem issues have been tackled head-on, which is good. However, a very myopic view has been taken of things as a result of which five anomalies arise in this budget.
The first is the loan waiver scheme. This is analogous to the ‘loan mela’ schemes in the eighties where loans were perforce disbursed by banks on account of political considerations. Now, banks have to write-off loans to the tune of Rs 60,000 cr. The first issue here is that it sets a bad precedent for future defaults. Borrowers may be tempted to default every 5 years when Elections approach knowing fully well that the government will bail them out. The second is that we need to know as to who will bear this cost. The government has clarified that the burden will be spread over 3 years i.e. banks will be reimbursed by the government. However, the write-offs will take place this year itself. This means that these loans, which are around 2.7% of total bank credit, will be written off with the burden of adjustment also falling on banks. Assuming that Rs 20,000 cr is reimbursed every year, banks have to bear the opportunity cost of not having Rs 40,000 cr of funds to lend at the PLR of 11% which works out to Rs 4400 cr in the second year and Rs 2200 cr in the third year. While the act of saving the farmer is gracious, the result of banks’ losing out does not make banking sense. If the entire amount was reimbursed by the Budget at one shot, then it would have been okay.
The second problem with the Budget is the Pay Commission. The Report will be out by the end of March, and the proposals will then get incorporated. Clearly, there will be no compromise on the recommendations given that the class of government officials is very important elite which matters at the time of Elections. The fiscal numbers are bound to get distorted further and maybe when it comes for final discussion, these numbers will slip in when the Parliament meets.
Thirdly, there have been liberal doses of benefits for the farming community in terms of expenditure on water, soil etc. This is good enough to placate the farmers. However, while admitting that agricultural growth has been a stumbling block this year, the FM should have typically taken a longer term view of things and had concrete plans to raise productivity in wheat, oilseeds and pulses. But, this has not been done as the focus has been very short term. Therefore, the development aspects are missing from the Budget while catering to the immediate requirements.
The fourth problem has been the reaction to the commodity markets. The market, which is in a nascent stage is already faced with the problem of a ban on futures trading in 4 commodities. The FM has imposed the commodities transaction tax which will be a burden on the players. Their withdrawal from the market on account of this burden could mean that the price discovery process would be affected. Therefore, instead of growing this market, which is handicapped today with one single instrument and only retail and corporate participation, the tax will be a dampener.
Fifthly, there are liberal allocations for Bharat Nirman, rural roads, plantation industry etc. However, what would be more pertinent there is the administrative issues of implementation. This becomes important here because while monetary allocation targets are met in these cases, the same does not hold true here.
Now let us look at the pure economic variables. The FM has admitted that growth is lower this year, but the Budget has no clear strategy for spurring growth. In fact, it is assumed that growth will be there at 10%. The few changes in the excise and customs rates will not have a major impact on consumption to start a growth chain.
Further, inflation has been stated as being a concern. If one were serious on inflation, the agricultural plan should have been on, as mentioned earlier, as food along with oil prices have been mainly responsible for inflation in the last two years. The Budget has not addressed this issue. Besides, the Budget has implicitly assumed an inflation rate of 5% for the next year (15% growth in nominal GDP which will mean 10% in GDP and 5% inflation).
Lastly, the Budget gives confusing signals on interest rates. While the fiscal deficit is down, there will be less pressure on the available liquidity in the system. The government has implicitly assumed a marginally higher interest rate of 6.4% this year with interest payments (Rs 190,000 cr) well exceeding total borrowings (Rs 145,000 cr). This is indicative of the fact that notwithstanding the signals that will be given to the RBI, it may be difficult to lower interest rates in the coming year.
Pareto Optimal Budget Scenario: FE 1st March 2008
The Budget resembles a Pareto optimal situation, where no one is worse-off while some people are better-off. And yet, after all these displays of benevolence, the numbers read very well with a lower fiscal deficit number in absolute terms as well as a ratio of gross domestic product (GDP). This sounds just too good.
If tax rates are being cut almost across the board, and only a few irritants have been ushered in by the finance minister—like the hiking of short-term capital gains tax in the capital market and introduction of a commodities transaction tax along the lines of the securities transactions tax introduced earlier—they should not really matter if the big picture looks good. The FM has based his approach on the one used last year, when a buoyant Economy helped push up tax revenue on both the direct and indirect taxes fronts to ultimately bring down the fiscal deficit to 3.1% of GDP.
In fact, P Chidambaram has reiterated that a simple tax structure with better administration and compliance can deliver good results. Now, the big question is whether or not the good growth numbers witnessed today will be the same in 2008-09.
By the FM’s own admission, there is a slowdown in industry, and since this will be the fulcrum for future growth, there is a big gamble being taken. The approach appears to be based on the tenets of the famous Laffer Theory, where lower taxes and more incentives lead to higher tax collections based on buoyancy.
But, can we be sure of this?
Evidently, this is a wager being taken, as the FM has not been parsimonious with his expenses and there have been liberal doses of expenditure that have been doled out to poorer sections, which is welcome, of course.
It appears to be a case of the FM chalking out his expenditure and then assuming collections based on an optimistic growth scenario. Given that this was the last Budget before general elections, there appeared to be no other way out.
It may be pointed out that these principles of supply-side economics have worked well in the past, albeit only periodically. It cannot be a continuous policy, though, as has been witnessed in the past. In fact, even in the US and UK, where this theory first originated in the early 1980s, it was not found to be sustainable.
So, what do we see here? First, individuals are... happy because they pay less tax. Corporates should not be unhappy, as their rates have not been affected, even though they were hoping for the surcharge to be removed. In fact, some industries have got the benefits of customs and excise cuts. Some minor FBT cuts have been announced to placate them. The capital market will be ambivalent—but then, it is always so, since it has become a habit. The corporate bond market is to be given a boost, which will be good, especially with currency futures also getting the government’s nod, with equal emphasis on credit derivatives and bond Markets. This means that the old cliché of a moribund debt market may no longer hold.
On the other side, Indian farmers must be happy that their loans are being written off and they can still get new loans. There are enormous allocations for education, health, rural infrastructure, etcetera, which if implemented well can only have positive results. A new PDS system is being experimented within a couple of states, which if successful will set benchmarks for others. The focus is completely on financial inclusion, which is a handy slogan that can be taken to the pulpits next year with these Budget numbers. The threshold for taxing the smaller services has been raised, which keeps another group out of the tax net.
Let us see who can be affected adversely on account of the Budget. The banks are still not sure if the Rs 60,000-crore loan waivers will push them back (the sum is certainly quite large), but the immediate sentiment has been negative. The nascent commodity Markets would receive a setback because of the new transaction tax, which, combined with service tax, will push them back a few years and probably lead to the grey market flourishing.
Now, while the economic survey had spoken a lot about controlling inflation, which was presented as a downside risk, the Budget has actually skirted the issue, probably because it is more in the domain of monetary policy. But the high unbridled growth assumed by the finance minister here is likely to be accompanied by significant inflationary pressures, and given that our investment rate too is expected to be over 36%, one can see a demand-pull spiral being triggered. If this happens, it could have an unintended impact on interest rates. The RBI will have to stay on high alert
If tax rates are being cut almost across the board, and only a few irritants have been ushered in by the finance minister—like the hiking of short-term capital gains tax in the capital market and introduction of a commodities transaction tax along the lines of the securities transactions tax introduced earlier—they should not really matter if the big picture looks good. The FM has based his approach on the one used last year, when a buoyant Economy helped push up tax revenue on both the direct and indirect taxes fronts to ultimately bring down the fiscal deficit to 3.1% of GDP.
In fact, P Chidambaram has reiterated that a simple tax structure with better administration and compliance can deliver good results. Now, the big question is whether or not the good growth numbers witnessed today will be the same in 2008-09.
By the FM’s own admission, there is a slowdown in industry, and since this will be the fulcrum for future growth, there is a big gamble being taken. The approach appears to be based on the tenets of the famous Laffer Theory, where lower taxes and more incentives lead to higher tax collections based on buoyancy.
But, can we be sure of this?
Evidently, this is a wager being taken, as the FM has not been parsimonious with his expenses and there have been liberal doses of expenditure that have been doled out to poorer sections, which is welcome, of course.
It appears to be a case of the FM chalking out his expenditure and then assuming collections based on an optimistic growth scenario. Given that this was the last Budget before general elections, there appeared to be no other way out.
It may be pointed out that these principles of supply-side economics have worked well in the past, albeit only periodically. It cannot be a continuous policy, though, as has been witnessed in the past. In fact, even in the US and UK, where this theory first originated in the early 1980s, it was not found to be sustainable.
So, what do we see here? First, individuals are... happy because they pay less tax. Corporates should not be unhappy, as their rates have not been affected, even though they were hoping for the surcharge to be removed. In fact, some industries have got the benefits of customs and excise cuts. Some minor FBT cuts have been announced to placate them. The capital market will be ambivalent—but then, it is always so, since it has become a habit. The corporate bond market is to be given a boost, which will be good, especially with currency futures also getting the government’s nod, with equal emphasis on credit derivatives and bond Markets. This means that the old cliché of a moribund debt market may no longer hold.
On the other side, Indian farmers must be happy that their loans are being written off and they can still get new loans. There are enormous allocations for education, health, rural infrastructure, etcetera, which if implemented well can only have positive results. A new PDS system is being experimented within a couple of states, which if successful will set benchmarks for others. The focus is completely on financial inclusion, which is a handy slogan that can be taken to the pulpits next year with these Budget numbers. The threshold for taxing the smaller services has been raised, which keeps another group out of the tax net.
Let us see who can be affected adversely on account of the Budget. The banks are still not sure if the Rs 60,000-crore loan waivers will push them back (the sum is certainly quite large), but the immediate sentiment has been negative. The nascent commodity Markets would receive a setback because of the new transaction tax, which, combined with service tax, will push them back a few years and probably lead to the grey market flourishing.
Now, while the economic survey had spoken a lot about controlling inflation, which was presented as a downside risk, the Budget has actually skirted the issue, probably because it is more in the domain of monetary policy. But the high unbridled growth assumed by the finance minister here is likely to be accompanied by significant inflationary pressures, and given that our investment rate too is expected to be over 36%, one can see a demand-pull spiral being triggered. If this happens, it could have an unintended impact on interest rates. The RBI will have to stay on high alert
Thursday, February 28, 2008
Doing the Poll Dance: DNA 28th February 2008
Next year’s elections loom large over the Budget and could give it a populist tilt
The Budget is a financial statement of the government, much like the P&L a/c of a company. Yet there is much ado about it and a lot of newsprint goes into the pre and post-Budget analyses. The reason is simple. The Budget sends out very critical signals for the people in terms of the tax proposals and expenditure outlays. Unlike monetary policy where the RBI can intervene during the year and alter rates, the same is not the case with tax proposals. It is hence an important tool for financial planning for individuals and companies alike.
As a rule, individuals and companies want to pay less tax. Further, when it comes to indirect taxes, the task is more onerous. While the auto industry wants duties to come down on steel, the steel industry wants the customs rate to move up to tackle competition. Therefore, a delicate balancing act is called for. To top it all there are committed expenditures like subsidies, interest, and defence, which cannot be compromised. Then there is the ubiquitous development expenditure, which has to be invoked to provide real benefits to the people. After doing all these balancing jobs the fiscal deficit, which is the final test of fiscal virtuosity, needs to be curtailed at 3 per cent of GDP.
This is an Election year Budget because next year there will be only a Vote on Account. Therefore, it has to be benign. There will hence be no increase in the income tax rates. In fact, the exemption limit could be raised to Rs1,25,000 or Rs1,50,000 to placate the masses. The corporate sector would like to have a lower rate with similar adjustments in the MAT (Minimum Alternate Tax) and FBT (Fringe benefit tax).
But the FM has a problem here. This year, he has managed to raise tax collections with ease due to a combination of high growth and better compliance. Overall growth in FY09 is still an unknown quantity and there are some signs that the economy may have slowed down in FY08. This being the case, overall buoyancy in tax collections could dip with the existing structure of taxes. At the same time, increasing rates can be ruled out as the FBT, MAT and STT (securities transactions tax) are unpopular.
The same holds for the indirect taxes where growth in collections has been based on a larger base of imports and industrial production. Higher price of oil, for instance, has increased customs collections. The Budget would address certain specific issues relating to the textiles sector (their existence has been affected by the rupee appreciation). Therefore, on the income side, the government has to base the proposals on higher growth to garner higher revenue.
Alternatively, the government could think of fixing its revenue conservatively by taking in a more moderate growth rate of 8 per cent and then planning its expenditure. But there are problems here which make expenditure planning more problematic this year.
There are essentially two parts to the expenditure story. The first is the development aspect. Special groups to be targeted would be the farmers, through credit waivers and cheap loans. Then there is rural infrastructure, social compulsions like water supply, education, food for work, and so on, which are mandatory expenditures this year. With these amounts being necessary to remain populist, the attention will be on the second part of the story: non-development expenditure.
There are four new problems which are hard to surmount. The first is the food subsidy, which cannot be compromised in an Election year though we could see a new PDS being introduced. Secondly, in the case of the petroleum subsidy, the burden could be too much as it may not be possible for the government to raise the prices of petro products in an Election year.
The third is interest payments, which has been taking a nasty hit on account of the MSS (Market stabilisation scheme) bonds that have been issued to control the inflow of dollars into the country. Unless these flows slow down, which is unlikely, these bonds have to be issued to stabilise the rupee.
The last is the recommendations of the 6th pay Commission which will be submitted later this year and would be adopted immediately, to reach out to the middle class.
The Budget will hence necessarily have to display a lot of character: it has to raise revenue without increasing rates; and at the same time manage development expenditure, subsidies, Pay Commission and interest payments. The strong premise is the bargain on higher growth.
The Budget is a financial statement of the government, much like the P&L a/c of a company. Yet there is much ado about it and a lot of newsprint goes into the pre and post-Budget analyses. The reason is simple. The Budget sends out very critical signals for the people in terms of the tax proposals and expenditure outlays. Unlike monetary policy where the RBI can intervene during the year and alter rates, the same is not the case with tax proposals. It is hence an important tool for financial planning for individuals and companies alike.
As a rule, individuals and companies want to pay less tax. Further, when it comes to indirect taxes, the task is more onerous. While the auto industry wants duties to come down on steel, the steel industry wants the customs rate to move up to tackle competition. Therefore, a delicate balancing act is called for. To top it all there are committed expenditures like subsidies, interest, and defence, which cannot be compromised. Then there is the ubiquitous development expenditure, which has to be invoked to provide real benefits to the people. After doing all these balancing jobs the fiscal deficit, which is the final test of fiscal virtuosity, needs to be curtailed at 3 per cent of GDP.
This is an Election year Budget because next year there will be only a Vote on Account. Therefore, it has to be benign. There will hence be no increase in the income tax rates. In fact, the exemption limit could be raised to Rs1,25,000 or Rs1,50,000 to placate the masses. The corporate sector would like to have a lower rate with similar adjustments in the MAT (Minimum Alternate Tax) and FBT (Fringe benefit tax).
But the FM has a problem here. This year, he has managed to raise tax collections with ease due to a combination of high growth and better compliance. Overall growth in FY09 is still an unknown quantity and there are some signs that the economy may have slowed down in FY08. This being the case, overall buoyancy in tax collections could dip with the existing structure of taxes. At the same time, increasing rates can be ruled out as the FBT, MAT and STT (securities transactions tax) are unpopular.
The same holds for the indirect taxes where growth in collections has been based on a larger base of imports and industrial production. Higher price of oil, for instance, has increased customs collections. The Budget would address certain specific issues relating to the textiles sector (their existence has been affected by the rupee appreciation). Therefore, on the income side, the government has to base the proposals on higher growth to garner higher revenue.
Alternatively, the government could think of fixing its revenue conservatively by taking in a more moderate growth rate of 8 per cent and then planning its expenditure. But there are problems here which make expenditure planning more problematic this year.
There are essentially two parts to the expenditure story. The first is the development aspect. Special groups to be targeted would be the farmers, through credit waivers and cheap loans. Then there is rural infrastructure, social compulsions like water supply, education, food for work, and so on, which are mandatory expenditures this year. With these amounts being necessary to remain populist, the attention will be on the second part of the story: non-development expenditure.
There are four new problems which are hard to surmount. The first is the food subsidy, which cannot be compromised in an Election year though we could see a new PDS being introduced. Secondly, in the case of the petroleum subsidy, the burden could be too much as it may not be possible for the government to raise the prices of petro products in an Election year.
The third is interest payments, which has been taking a nasty hit on account of the MSS (Market stabilisation scheme) bonds that have been issued to control the inflow of dollars into the country. Unless these flows slow down, which is unlikely, these bonds have to be issued to stabilise the rupee.
The last is the recommendations of the 6th pay Commission which will be submitted later this year and would be adopted immediately, to reach out to the middle class.
The Budget will hence necessarily have to display a lot of character: it has to raise revenue without increasing rates; and at the same time manage development expenditure, subsidies, Pay Commission and interest payments. The strong premise is the bargain on higher growth.
Monday, February 18, 2008
Of bonus issues after maiden floats: DNA 19th February 2008
Reliance Power’s latest move sets a precedent that would be hard to reverse
The Reliance Power episode is quite singular in capturing different facets of the capital market.
Think of it. Here is a company that only has a project report to set up 12 power plants for 28,000 MW after three years. Profits would then be possible after a further five years. Yet, the IPO draws an amazing response, with applications amounting to a fifth of the country’s gross domestic product.
What could possibly explain the rush?
Two things, by and large: First, a ‘great name’ as promoter - a name that has always delivered in the past - and second, human greed or avarice. People were willing to buy the share at Rs 450 on hopes that they would make double the amount on listing.
Naturally, they were disappointed when the price crashed (from Rs 430-450 as issue price to a low of Rs 332).
Now, to placate such investors, there is this call for a bonus issue by the promoters. Is the move justified?
The equity market is like a casino where people enter knowing fully well that they can win or lose. Of course, everyone hopes to win, or rather that they will win at some point.
When the stock prices rise without any fundamental change in the economic environment or the company they have invested in, they do not ask why? The companies, on their part, do everything to keep the sentiment up with bonus and rights issues, dividends, and at times also make not-so-good accounts look acceptable.
Therefore, logically speaking, when prices fall, for whatever reason, there is no reason to grumble. If investors stretched too far for the Reliance Power issue, then it is their bad luck, just as what happens to other scrips during various time phases. There can theoretically be no reason for placating the investors with a bonus issue.
Then why is this sop being extended?
Well, a promoter carries a risk when there is an IPO for a project that is yet to take off but has been launched with much fanfare. A fall in price could dent the perceived confidence of the promoter, though it may be due to several reasons as in this case, where global sentiment was depressed and other stocks also too took a beating.
But, even this does not justify the bonus issue since it has been barely a month since the issue opened and this is too short a period to judge the stock, especially since the project was to come up in three years and everyone knows how it is with infrastructure. Quite surely, the long-term investors will remain with the project.
There has thus to be another reason. Reputation risk becomes pertinent here since a promoter who cannot deliver immediately on expected returns could run a problem with future issues, and in this case, it could be the share issues of Reliance Communications and Reliance Infratel.
If the same group has to come out with new issues for existing or new projects, which probably are to reach out to the investors on the strength of the promoter’s name, then the risk of rejection or lower valuation is particularly high.
While such a move would naturally be in accordance with Sebi guidelines — there would be no issue of corporate governance here as it would be run through the regulator — the question to ask is whether the move is desirable.
This is because the bonus issue will set certain precedents which will affect the market for times to come. Every time there is a fall in the price post-listing, there will be a clamour for such an issue from investors, and the promoters will have to think hard. There is hence the fear of segmentation of the issuers, into those who care and those who don’t care for the investors.
And what about existing companies with shares that are listed but not doing well? Would they also be tempted to go in for bonus issues to placate investors? This is the trap companies may be headed towards when such precedents are set by the large and most reputed promoters.
Whether or not we like it or like to accept it, the share price and its movement over time affect the reputation of the promoter/ company in its normal operations. Better price-earnings ratios command a lot of respect when a company goes in for a global depository receipts issue and improve its ability to borrow in domestic and international markets, market capitalisation, etc. Now, companies would be pressurised into resorting to such moves, which will send confusing signals to the market.
The decision, hence, to provide bonus shares to investors on the grounds of compensating them for the trust reposed in the IPO merely because of a fall in the value by say Rs2,000 crore, needs to be debated more closely as it would set precedents that would be hard to reverse in future for the market as well as the promoters.
To quote from Shakespeare: “We still have judgment here, that we but teach bloody instructions, which, being taught, return to plague the inventor.”
The Reliance Power episode is quite singular in capturing different facets of the capital market.
Think of it. Here is a company that only has a project report to set up 12 power plants for 28,000 MW after three years. Profits would then be possible after a further five years. Yet, the IPO draws an amazing response, with applications amounting to a fifth of the country’s gross domestic product.
What could possibly explain the rush?
Two things, by and large: First, a ‘great name’ as promoter - a name that has always delivered in the past - and second, human greed or avarice. People were willing to buy the share at Rs 450 on hopes that they would make double the amount on listing.
Naturally, they were disappointed when the price crashed (from Rs 430-450 as issue price to a low of Rs 332).
Now, to placate such investors, there is this call for a bonus issue by the promoters. Is the move justified?
The equity market is like a casino where people enter knowing fully well that they can win or lose. Of course, everyone hopes to win, or rather that they will win at some point.
When the stock prices rise without any fundamental change in the economic environment or the company they have invested in, they do not ask why? The companies, on their part, do everything to keep the sentiment up with bonus and rights issues, dividends, and at times also make not-so-good accounts look acceptable.
Therefore, logically speaking, when prices fall, for whatever reason, there is no reason to grumble. If investors stretched too far for the Reliance Power issue, then it is their bad luck, just as what happens to other scrips during various time phases. There can theoretically be no reason for placating the investors with a bonus issue.
Then why is this sop being extended?
Well, a promoter carries a risk when there is an IPO for a project that is yet to take off but has been launched with much fanfare. A fall in price could dent the perceived confidence of the promoter, though it may be due to several reasons as in this case, where global sentiment was depressed and other stocks also too took a beating.
But, even this does not justify the bonus issue since it has been barely a month since the issue opened and this is too short a period to judge the stock, especially since the project was to come up in three years and everyone knows how it is with infrastructure. Quite surely, the long-term investors will remain with the project.
There has thus to be another reason. Reputation risk becomes pertinent here since a promoter who cannot deliver immediately on expected returns could run a problem with future issues, and in this case, it could be the share issues of Reliance Communications and Reliance Infratel.
If the same group has to come out with new issues for existing or new projects, which probably are to reach out to the investors on the strength of the promoter’s name, then the risk of rejection or lower valuation is particularly high.
While such a move would naturally be in accordance with Sebi guidelines — there would be no issue of corporate governance here as it would be run through the regulator — the question to ask is whether the move is desirable.
This is because the bonus issue will set certain precedents which will affect the market for times to come. Every time there is a fall in the price post-listing, there will be a clamour for such an issue from investors, and the promoters will have to think hard. There is hence the fear of segmentation of the issuers, into those who care and those who don’t care for the investors.
And what about existing companies with shares that are listed but not doing well? Would they also be tempted to go in for bonus issues to placate investors? This is the trap companies may be headed towards when such precedents are set by the large and most reputed promoters.
Whether or not we like it or like to accept it, the share price and its movement over time affect the reputation of the promoter/ company in its normal operations. Better price-earnings ratios command a lot of respect when a company goes in for a global depository receipts issue and improve its ability to borrow in domestic and international markets, market capitalisation, etc. Now, companies would be pressurised into resorting to such moves, which will send confusing signals to the market.
The decision, hence, to provide bonus shares to investors on the grounds of compensating them for the trust reposed in the IPO merely because of a fall in the value by say Rs2,000 crore, needs to be debated more closely as it would set precedents that would be hard to reverse in future for the market as well as the promoters.
To quote from Shakespeare: “We still have judgment here, that we but teach bloody instructions, which, being taught, return to plague the inventor.”
There's no industrial slowdown: Financial Express: 18th February 2008
The latest round of economic panic in the country has been sparked by the thought of a possible onset of an industrial slowdown. Industrial growth looks pale, with a gradual declining single digit number observed over the last couple of months, against double-digit growth rates last year. Naturally, there is clamour to lower interest rates to boost growth. How far is this feeling justified?
There are two issues here. The first is whether these numbers really tell the real story, because statistics are a curious set of numbers that can be tilted to suit the theme. The other is whether or not one needs to pull the panic trigger on this score.
There are basically six indicators to look at in order to analyse whether an industrial slowdown has commenced. Industrial growth is lower, at 9% during the first nine months of the year. It was 11.2% last year. But that double-digit growth rate came on a base of just 8% growth in the equivalent period of 2005. The base year effect is in operation.
The same holds for infrastructure industries, which have shown a growth of 5.7% during this period, compared with 8.9% last year. In 2005-06, growth was just 4.5%. This is a common error made in interpreting numbers, with low and high base years distorting the view.
Second, exports have been buoyant this year, with growth of 22% (manufactured products constitute over 70% of our exports today), which would not have been possible if industry had slowed down. In fact, this performance has also questioned the oft-repeated grievance that a stronger rupee has weighed export-intensive industries down. Here, it must be admitted that while the macro picture disputes this claim, at the micro level, sectors such as textiles have indeed been affected. Clearly, these industries need to become more competitive, as others already have. Non-oil imports, too, have risen by 33%, which is indicative of robust industrial activity. This can be corroborated with the high growth rate in the capital goods segment of 20.2%, which necessitates higher imports of raw materials and intermediates.
The third indicator of industrial progress is bank credit. Growth in bank credit has been lower on a year-to-year basis till January 25, at 22.6%, as against 29.8% last year. However, the base year effect again comes into the picture. In 2005-06, growth was as high as 31%. While data is not available on the distribution of credit, the impressionistic view is that there has been a slowdown in credit growth to the retail segment, especially mortgages, rather than the manufacturing sector. Further, it must be mentioned that industry accounts for not more than 40-45% of total credit, and the rest goes to sectors such as agriculture and services. Also, unchanged interest rates per se have a limited marginal impact on the corporate sector.
Incremental credit during the year has been around Rs 250,000 crore. A 100 basis points change in interest rates could affect total costs by just Rs 2,500 crore, of which only half would be accounted for by industry, which has sales of Rs 25,00,000 crore. The impact would not be more than 0.05% of turnover, which is insignificant.
The fourth indicator is capital market performance. Total capital issues this year (until December) have been higher than that last year by 14%. Business investment this year is likely to be buoyant. Besides, the performance of the secondary market, though admittedly not a perfect barometer of industrial sentiment, remains an uplifting story when viewed on a chart with longer time calibrations.
Further, corporate performance has been robust this year, as the quarterly results continue to indicate. During these three quarters, based on CMIE data, aggregate sales have grown by 19%, 15% and 18%, respectively, while net profits have grown by 15%, 35% and 22%, respectively. The corporate sector is in fine shape.
Lastly, revenue collections have been more than buoyant this year, as admitted by the Finance Minister himself. This could not have been so unless growth in corporate sales, imports and profits were up sharply, since the Budget had punted on such an outcome while making minimal upward revisions in tax rates. The premise was that with lower or unchanged tax rates, collections will rise on a fast growing business base. Corporate tax collections rose by 37% in the first nine months of the year, on top of growth of 55% last year.
Therefore, there do not appear to be any overt signs of an industrial slowdown, and the explanation for this supposition can be summarised under two sets of factors. The first is the high base year effect. The second relates to our self-imposed fallacious belief that growth must always be exponential.
While exponential growth sure sounds good, as it did for the East Asian economies in the 1980s and 1990s, it is hard to maintain in a globalised environment. As long as we do better than the world’s leading economies, it indicates success. Complete decoupling is not possible.
There are two issues here. The first is whether these numbers really tell the real story, because statistics are a curious set of numbers that can be tilted to suit the theme. The other is whether or not one needs to pull the panic trigger on this score.
There are basically six indicators to look at in order to analyse whether an industrial slowdown has commenced. Industrial growth is lower, at 9% during the first nine months of the year. It was 11.2% last year. But that double-digit growth rate came on a base of just 8% growth in the equivalent period of 2005. The base year effect is in operation.
The same holds for infrastructure industries, which have shown a growth of 5.7% during this period, compared with 8.9% last year. In 2005-06, growth was just 4.5%. This is a common error made in interpreting numbers, with low and high base years distorting the view.
Second, exports have been buoyant this year, with growth of 22% (manufactured products constitute over 70% of our exports today), which would not have been possible if industry had slowed down. In fact, this performance has also questioned the oft-repeated grievance that a stronger rupee has weighed export-intensive industries down. Here, it must be admitted that while the macro picture disputes this claim, at the micro level, sectors such as textiles have indeed been affected. Clearly, these industries need to become more competitive, as others already have. Non-oil imports, too, have risen by 33%, which is indicative of robust industrial activity. This can be corroborated with the high growth rate in the capital goods segment of 20.2%, which necessitates higher imports of raw materials and intermediates.
The third indicator of industrial progress is bank credit. Growth in bank credit has been lower on a year-to-year basis till January 25, at 22.6%, as against 29.8% last year. However, the base year effect again comes into the picture. In 2005-06, growth was as high as 31%. While data is not available on the distribution of credit, the impressionistic view is that there has been a slowdown in credit growth to the retail segment, especially mortgages, rather than the manufacturing sector. Further, it must be mentioned that industry accounts for not more than 40-45% of total credit, and the rest goes to sectors such as agriculture and services. Also, unchanged interest rates per se have a limited marginal impact on the corporate sector.
Incremental credit during the year has been around Rs 250,000 crore. A 100 basis points change in interest rates could affect total costs by just Rs 2,500 crore, of which only half would be accounted for by industry, which has sales of Rs 25,00,000 crore. The impact would not be more than 0.05% of turnover, which is insignificant.
The fourth indicator is capital market performance. Total capital issues this year (until December) have been higher than that last year by 14%. Business investment this year is likely to be buoyant. Besides, the performance of the secondary market, though admittedly not a perfect barometer of industrial sentiment, remains an uplifting story when viewed on a chart with longer time calibrations.
Further, corporate performance has been robust this year, as the quarterly results continue to indicate. During these three quarters, based on CMIE data, aggregate sales have grown by 19%, 15% and 18%, respectively, while net profits have grown by 15%, 35% and 22%, respectively. The corporate sector is in fine shape.
Lastly, revenue collections have been more than buoyant this year, as admitted by the Finance Minister himself. This could not have been so unless growth in corporate sales, imports and profits were up sharply, since the Budget had punted on such an outcome while making minimal upward revisions in tax rates. The premise was that with lower or unchanged tax rates, collections will rise on a fast growing business base. Corporate tax collections rose by 37% in the first nine months of the year, on top of growth of 55% last year.
Therefore, there do not appear to be any overt signs of an industrial slowdown, and the explanation for this supposition can be summarised under two sets of factors. The first is the high base year effect. The second relates to our self-imposed fallacious belief that growth must always be exponential.
While exponential growth sure sounds good, as it did for the East Asian economies in the 1980s and 1990s, it is hard to maintain in a globalised environment. As long as we do better than the world’s leading economies, it indicates success. Complete decoupling is not possible.
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