The enigma of 5: Financial Express 23rd March 2013

Just like a score of 5 made Niro’s team ecstatic in Silver Linings Playbook, Indians are learning to live with 5% GDP growth and deficit
In the climax scene of the movie Silver Linings Playbook, the protagonists enter a dance competition where other couples score high 8s and 9s. When Bradley Cooper and Jennifer Lawrence come on floor with their passionate, though hilarious moves, the average score awarded is 5. Their entire team, including Robert De Niro, gets ecstatic as this was what their bets were—a score of at least 5. The programme announcer is shell shocked with surprise; and with confusion on his face exclaims, “Why are they so excited about a 5?”Let us take the analogy back home on the economic front and we can ask ourselves, why are we excited about 5? There seems to be renewed feeling of zest and optimism as the financial year comes to an end and we start on a new year. Everyone is gung-ho on how things can only improve in FY13. Even our Budget has assumed a higher growth rate closer towards 7%.Now, let us look at the 5s that we are living with. GDP growth for FY12 is expected to be rather low at 5%, which is the lowest rate since FY03. The declining quarterly trend is disturbing—the Q3 number at 4.5% is the lowest in the last 15 quarters. Discussions today are centred on whether 5% is an understatement, and the perspicuous few who see green shoots in the arid topography are arguing that it would be higher at 5.2-5.3%, though industrial growth is crawling around the 1% mark. Anyway, this is a major comedown from the 8% growth numbers we had taken for granted.We are quite happy with the fiscal deficit number of 5.2% last year and 4.8% for the coming year—an average of 5% again, though we are not quite sure how the assumptions of growth will be achieved and the targets of disinvestment and spectrum sale will be attained. The Budget is based on certain strong assumptions, which has to be the case for any FM, and one can only cautiously view the possible achievement of the set targets. There surely is great resolution showed last year to get this number right, but the cuts in expenditure that were invoked helped a lot, which we cannot afford for another year as we are looking for a Keynesian impetus from this end. Disinvestment in FY13 seems to be more of a forced variety and not the type that took place a couple of years ago when Coal India was divested.If we turn to our current account deficit, it stands at 5.4% of GDP in Q2, which again is some kind of a new record high in any quarter. Last year, at 4.2% of GDP, the current account deficit was the highest recorded in the last three decades or so. While everyone has voiced concern, the disturbing element is that there is no solution here as all components are exogenously determined and hence cannot be controlled by any regulatory body. The problem is not that serious today because we have had capital flows protect this imbalance, which has made our forex reserves stable. It is not surprising that any policy to do with FII flows has to be looked at with double caution as we cannot antagonise these investors.We can just as well spoil the party by asking why we are so excited by the number 5. In fact, inflation remains as high as ever with CPI inflation being around 11%. After a lot of talk of targeting CPI inflation, we have reached the point of no return. We first said that interest rates can bring down CPI inflation. That did not work. Next we said that inflation rose because people were consuming more. That is a reason but not a solution. The novel concept of protein consumption also did not quite help ease the pain, especially so since output did not show a commensurate decline. In fact, the economic reasons espoused fell flat when cereals have shown the highest increase in prices even as we boast of having the highest output levels of wheat and rice. The fact that the FCI is stocked with nearly 63 million tonnes of foodgrains demolishes a lot of the supply bottlenecks clichés that have been given.What, then, makes us cheerful? Is it just the announcement effects of the Budget and the assumption that RBI will lower interest rates during the year because the high internet rate regimes have not lowered inflation anyway? RBI has acquiesced to the demand and lowered rates this time, but has warned that this cannot be interpreted as the beginning of a new trend. Or are we now used to high inflation of 7% WPI and double-digit CPI inflation that nothing really matters. The answer is, really, a combination of all of them.Growth has come to such a level that things can only look upwards from now on. FY13 will be one year when growth would have happened with no contribution from industry. This being the case, any progress in manufacturing should necessarily be good for the country. Similarly, inflation is now at around 7% or 11%, whichever way we look at it. From now on, given a normal monsoon, things cannot get worse as the base effect will help, even though we have imposed the fuel burden on ourselves for the entire FY14. Looking at the current account deficit, exports will pick up as the global economy cannot do worse, and from a negative growth rate there can be a marginal pick up. Also, imports, while increasing, will be subdued as growth will be only marginally upwards. Therefore, assuming stable oil prices, things can get better or remain the same—but cannot deteriorate further.This being the case, it is only but natural for one to expect to see green shoots. But we need some action at the ground level. The government has suddenly sprung into action in clearing projects, which should have really been done earlier—but then, as the adage goes, better late than never. So, while we can be justified in being sanguine, we should also be realistic in the present state. A 6% growth with 6-7% inflation and 4% CAD look more reasonable when looked at conservatively. If any number gets better, then one can feel good. It is better to wait for good things to happen, rather than lay the foundations of the proverbial castles (in the air).

Has CAD become the new FAD? Financial Express 15th March 2013

Linking fiscal deficit with the CAD is incorrect and misleading. Ideally, India should encourage more FDI to narrow the gap
Going by the obsession of both RBI and now the finance ministry, attention has been deflected from the fiscal account deficit (FAD) and interest rates to the current account deficit (CAD). We have probably now assumed that growth has bottomed out and can only improve from here and that inflation is something over which we have no control. With the usual tossing of issues of interest rates and growth stimulus between the RBI and the ministry of finance becoming passé, the CAD has caught everyone’s attention. At times, we have gone overboard to also say that the fiscal account deficit (FAD) is responsible for the CAD. Are we missing something somewhere?The CAD is actually one aspect of the economy over which no one has any control and is largely market-driven. It happens exogenously and neither RBI nor the government is responsible for the number. As the government is not really involved in most of the components of the external account (except for loans from IMF, etc), tracing the problem to the fiscal side is questionable.The two components are the trade deficit and the invisibles account. Exports increase or decrease due to demand or competitive conditions. The commerce ministry can provide sops to exporters, but if they have to push forward their product, the price and quality matter. The rupee has been under pressure and should have given an impetus. But that has not worked with the global economy in a tailspin. The fiscal deficit does not matter here.The same is the case with imports. As mentioned by the FM, the imports nemesis is the COG bill—coal, oil and gold. The government is not spending on these items, but the public is. Therefore, the government does not come into the picture as has been alleged. The best the government can do is to raise duty rates or restrict quantitative imports—which it is loath to do given that we have agreed to the rules of WTO, which accepts tariffs but discourages quotas. There have been measures taken to curb the import of gold by making it expensive, which has worked at the margin. Fiscal spending again does not directly affect the trade deficit. The subsidy provided on fuel products only protects sections of society from the price changes and does not add on its own to the demand for oil.A thought worth considering is to have quotas for gold imports and also restrict the end-use of forex taken under the R2 lakh allowance. While it is true that a black market will emerge, it will not involve official forex reserves and hence this could be one way of drawing out black money from the system as these transactions would have to be off the official channels—both dollars and gold.The other component, invisibles, again does not feature the government anywhere in its spending. The receipts come from remittances and earnings of IT companies, which, linked with the global fortunes, have no government intervention. Therefore, linking the FAD with the CAD is incorrect and misleading. The two are distinct entities and while theoretically the CAD is the difference between savings and investment, where government dis-saving on account of high spending lowers the savings rate, none of the transactions per se actually affect the CAD significantly. The theoretical formulation of this linkage is more an ex-post identity.This also means that RBI also can do little to influence any of these components and, like the government, can only amend policies to encourage countervailing flows to make up for the widening CAD. As the current account has been opened up for all practical purposes, there is little scope for having any restrictive conditions here. Our recognition that the CAD is a problem is noteworthy, which has been reiterated by the FM in the Budget speech. The solution is more in the area of opening up the windows to capital flows. But this has to be viewed with caution. Quite clearly, if the CAD widens and we want to protect our forex reserves and thereby the exchange rate so that RBI does not have to intervene regularly to steady the rupee, foreign investment has to be welcomed in a big way. We are tending to focus more on investment through the portfolio route, but the only concern is that their enlarged limits in government securities market and the other debt segments actually shakes the stance we have taken so far that our debt levels may be high—the government’s in particular—but is being internally financed. The possibility now is that this component will increase as we gradually draw in more such funds. Ideally the concentration should be on FDI, but quite a few of our policies relating to FDI in retail, insurance and pensions are still stuck in an intellectual imbroglio. The other step taken by RBI in allowing more scope for ECBs is commendable but leads to an increase in our external debt, which is now well above our forex reserves at over $350 billion. Therefore, while we do need to have proactive policies to counter the CAD, which is the only way out, these other considerations, should be kept in mind as we go along. Also, this dependency does tend to make policies rather skewed towards such investment in order not to offend such flows. To that extent, the government loses some degrees of freedom when it comes to policy formulation. Last year, the announcement on GAAR had a severe backlash with an outflow of dollars leading to the rupee taking a major hit, which was reversed only after clarifications were made and the policy was withdrawn to be deferred for a later date. The CAD issue needs to be understood in the right perspective and we should not bark up the wrong tree for a solution. The situation is different from 1991-92 when the capital account existed only in the form of loans from governments and multilateral agencies. While policies relating to capital flows should be revised and liberalised, the downside risks need to also be kept in mind. This also means that we need not seriously consider capital account convertibility for some more time.

There's very little for everyone: DNA 2nd March 2013

Individual households have a reason to be aggrieved as there were hopes that the tax slabs would be altered and that their savings under Section 80C would be enlarged so that they could channelise more funds into these instruments. This is more so on account of high inflation which has dented both purchasing power and saving ability. With little being done on these ends, there will be a modicum of dissatisfaction. The FM, however, has been quite open in saying they cannot give away much, given the fiscal stringency being faced.
Corporates would have a mixed reaction to the Budget. Tax rates have been changed at the margin for some commodities and there are some sops on investment allowance, which should help. But they would be wary of the government’s tendency to cut back on project expenditure in the past to balance the Budget. This could happen again in case there is slippage which is not good because it holds back their own investment in the form of incomplete projects which are being serviced. Therefore, there would be some uncertainty here.
Capital market investors are better-off with the STT being reduced and greater role of the FIIs in this space. SMEs, too, would find this market friendlier. But the absence of any other benefit for investors except for the continuation of the RGESS, which of course will not be bringing in large quantum of funds, has not quite encouraged the market, which fell around 300 points on this score on the Budget day. In fact, the cautious note of the Budget had signalled the downtrend in the Sensex and the absence of any significant benefit exacerbated the pace of decline.However, the higher inflow of FIIs on account of the easing of administrative blockages would probably help at the margin

Little to cheer or fret about: 1st March 2013: Free Press Journal

Given the feelers that were sent by the government before 28th February, the Budget should have been considered to be a non-event. However, given our tendency to hype such occasions, a lot was expected from the FM today with some even expecting it to be a game changer, which is the term now in vogue. It is not surprising that one could have ended up feeling disappointed to a large extent as aspirations have not been met. The market has definitely not taken positively to the content as seen by a fall of nearly 300 points in the Sensex. But we need to be realistic when judging the budget and the situation in which it was presented.

Let us look at households. With inflation around 10%, logically an increase in the exemption limit was called for. In fact, this should be automatic as individuals should be compensated for inflation or else price rise cuts into one’s consumption and savings. However, the Budget helps people out in one income bracket, which makes the move look half hearted. Therefore, individuals have reason to be disappointed. Also the so called thrust on savings is more an extension of the existing schemes. There is some talk on having inflation indexed deposits or bonds, which though sound interesting, may not be attractive especially since there is also a downside, which savers would not like to accept.

How about the market? There are several measures which would enthuse players in this segment, especially foreign investors. FIIs in the forex derivative segment will provide a further boost to a growing market. But at the individual level, the restoration of the infra tax bonds would have helped. In fact, given the problem of falling financial savings, it was very much expected that the budget would have provided incentives through higher limits for tax emption for savings in deposits, insurance, provident funds etc. In the absence of this mention, households have reason to feel let down considering that there is no guarantee that inflation will come down. So both ways, this constituency has reason to feel let down. The reduction in STT is beneficial but is unlikely to turn the tide for the stock market.

How about industry? The government has fairly comprehensive plans to speed up spending in areas of social development and infrastructure. This sounds good for the related industries. With more IDFs coming up and IIFCL playing a larger role in the debt market, one can expect movement in the infrastructure space. This in turn should help connected industries such as steel, cement, electric cables, glass and so on to grow when conditions are otherwise unstable. Add to this the sops given on interest on housing loans, and the overall impact would be positive for the housing and construction segments. The only apprehension is that in case there are threats of fiscal slippage along the way, the FM would cut back on such expenditure. Last year, the FM has cut back on capital expenditure around 18% as revenue expenditure got out of range. This has affected a number of projects in the private sector too. Therefore, while the present budget does have sound plans for the year in terms of government expenditure, one should look at it with caution.

 

 

 

 

 

 

So how can we rate this Budget? If one were not too optimistic the budget is a reasonable one that does not promise too much and channels funds in priority areas. It does not stoop to populism as was suspected by some on account of the oncoming elections. True there are allocations on subsidies and the NREGA programme, but appear to be within limits and cannot really be questioned as governments have to look at the concerns of the poor. The projections of income are realistic though the growth assumption made is the only one that can be questioned. It is based on growth of upwards of 6.5% for FY14 and the entire edifice will get shaken in case it does not materialize. Otherwise, it is a convincing document that moves along cautiously – reminding us constantly that fiscal prudence is our primary goal which will be adhered to at any cost-even if it means pruning project expenditure at the end of the day, if so warranted.

Fiscal deficit target on expected lines: Business Standard March 1 2013

The projected fiscal deficit for the financial year 2014 at 4.8 per cent is more on the expected lines though it will need to be seen if the revenue collections would be according to schedule. The resulting net borrowing programme may not be a major concern for liquidity as it is around Rs 20,000 crore more than last year and it can be absorbed in the system.

There is no fear of any crowding out of private investment by the scale of government borrowing. But a lot will depend on how the Reserve Bank of India views inflation.

It is intriguing that the Budget still talks of raising Rs 20,000 through the MSS (market stabilisation scheme) bonds, indicating that a surplus of foreign funds is being expected, which will be good news if it does materialise given our current account deficit problems.

Finance Minister P Chidambaram has worked on a relatively higher growth rate of between 6.5 and seven per cent. This will determine largely whether or not the revenue targets are met.

Otherwise, the Budget looks fairly conservative and prudent with the expenditures too being in the appropriate channels. The subsidy bill too will not throw any surprise as we already have in place a policy of fuel prices.

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What should the common man look forward to? Free Press Journal 26th February 2013

The interest for the common man in the Union Budget is largely to the extent of whether or not we will be better off in terms of tax payments and prices, and whether there are any concessions to be had in terms of financial investments. Fiscal prudence is more of an academic exercise which appeals to the intellectual or critic but may mean less to the man on the street who has to contend with problems of high inflation and is not really directly interested in a more sound fiscal deficit number.

Presently we have had relentless inflation at over 10% per annum (going by the CPI) in the last 2 years. Incomes are not increasing commensurately though stock markets continue to do well. This being the case we as citizens have had less purchasing power while those who also operate in the stock markets have gotten relatively better returns as well as paid lower taxes, as capital gains taxes are favorable in the equity segment.

The government has limited flexibility when it comes to tinkering with tax rates. We are committed to having the Direct Tax Code (DTC) implemented as well introducing the Goods and Services Tax (GST) after the states agree to the compensation formula. Therefore, any changes in the tax rates will have to be within the confines of these two codes.

Two issues are bound to come up for income tax. The first is the tax exemption limit will probably be increased by 10% which will help adjust for inflation. In fact, ideally just like how capital market gains are indexed with inflation based on the CPI so should the tax exemption level. Second, with talk on taxing the rich being the flavour of the season, a surcharge on incomes above a threshold would be on, and the only element of conjecture would be the definition of the super rich. Would it be Rs 20 or Rs 50 Lakhs per annum? The FM will have a final say here.

The excise and customs rates would remain largely unchanged for most goods, and the two areas that could attract attention could be gold and consumer goods for higher customs rates. With the country’s current account deficit being under pressure, it is but natural that gold imports will be discouraged further through duty enhancement. Consumer goods, especially food items could also come under this thought process. Also the service tax would be extended to more services, tough at the margin collections do not increase commensurately as these services are in the unorganized sector and difficult to trace.

The capital market has always been regarded as the barometer of economic success. Governments try hard to woo investors as a robust market means more funds coming in which helps investment and growth. Here there is likely to be some action. There could be a reduction in the STT for non delivery based trades. Further, the RGESS equity scheme would be extended for a longer time period with larger coverage in a bid to get in financial savings which have been dipping in the recent past. This combined with the reintroduction of tax free infrastructure bonds could be realistically expected in this Budget. As financial savings in the country are coming down, the FM may hike the limit for savings in specified instruments including insurance, provident funds, long term deposits etc by Rs 20,000.

The rest of the budget would be more on getting the fiscal arithmetic right. This would mean lowering the fiscal deficit ratio for the year which in turn will have a bearing on the government’s borrowing programme and future course of monetary policy. A lower deficit can be a precursor to the RBI leering rates in the course of the year, which will be beneficial for industry and investment. This will mean further rationalization of expenditure more in the area of subsidies. The fuel subsidy bill will be checked with the decision already taken to price diesel at market levels. With the impending elections in 2014, and the food security hill to be passed this year, food subsidy will be high on the agenda with the silver lining being that the large stock of food with the FCI would provide substantial cover for the first two years even when implementing the programme.

Therefore, in short we should not expect much in the budget. The thrust will be on fiscal discipline with some tax concessions provided on the way to assuage the middle class. Expenditure rationalization which has already commenced will continue, albeit gradually but ensuring all the time that the fiscal numbers look satisfactory.

 

Budget 2013: Fix revenue first, then tighten belt: DNA 26th February 2013

One of the most hyped up issues is the Union budget. Everybody wants something from what was originally a plain financial statement of the government. This has evolved to be expected to be a catalyst for everything that is good for the economy.
Individuals want to pay less income tax and want prices to come down with indirect taxes being reduced. Corporates want the tax rates to come down and expect more leeway to enable investment.
Economists want fiscal prudence to be maintained. Rating agencies want to see progressive reforms as merely stating palatable numbers does not mean that anything will be achieved. Then, there are the elections coming up and prudent politics may dictate that the government should do things like loan waivers or higher outlays on NREGA which others may not approve. Any FM facing these expectations would have a tough job on hand.

The journey through 2012-13 has been challenging. The final numbers may look true, though it has been achieved by forcing disinvestment and cutting ruthlessly expenditures of various ministries which may not be the best way to go about things. Therefore, the starting point is to get the numbers right. The FM should have a budget where growth numbers assumed are realistic — say 6% real GDP growth and 6% inflation to get in nominal growth of 12-12.5%.
Instead of working backwards from expenditure allocation and then revenue projections, the approach should be to fix revenue first and then be uncompromising on expenditure. Just like we had assumed subsidy bill will be 2% of GDP and nothing more, the number once fixed should be sacrosanct.
It will be easy this time on the fuel side as we are now used to having market-linked prices. The task will be on food security where the impact could be on the food subsidy bill. This is where the FM should show resolve during the course of the year and ensure that allocations stop once the limit is reached. There could be warning triggers when 75 and 90% of the amount is reached.
At any rate, for this exercise to be successful, the assumption of growth should be right as it would have a bearing on the resources raised through tax revenue in the form of excise and corporate taxes. Any unrealistic assumptions would mean problems in future.
This done, the next step is to ensure that capital expenditure on projects takes off. Last year around Rs1 lakh crore was to be spent on this purpose. Even if the number is lower, it should be spent for sure so that the government can kickstart the growth process in a limited manner. Typically this gets spent in the infra space and should be expedited so as to have a chain effect on other sectors.
Having populist measures is a necessity and need not be debated. That is so because governments are not corporates and have to spend where no one else does. Governments come to power based on manifestos that promise certain largesse which has to be met.
Besides, everyone gets benefits from the government and this can be seen from the revenue foregone statement of the Budget where the corporates benefit a lot. So why not the common man? The only condition should be that these numbers should not be breached. If this is done, then the budget can be a success.
The budget would definitely make every segment pay a little more in the form of taxes. Corporates would probably have to bear a higher MAT. Richer individuals would probably have a surcharge on their incomes. More services under the net would be a certainty and taxing of transactions in the commodity market may be inevitable in certain areas such as non-farm commodities. Custom duties on gold would be increased further to deter purchase while excise duty rationalisation across some commodities would be in order within the overall framework of GST.
But, quite certainly the FM will have to manage expenditure in a more effective manner. The focus should be on doing things within the limitations of growth which takes place exogenously over which the state has no control. If this is done, half the battle would be won. The FM is astute and probably will follow the same path and draw a balance between political expediency and fiscal prudence.