Vivek Kaul
There are no free lunches in life, though at times its not obvious who is footing the bill. Take the case of the right to food security bill which guarantees 80 crore Indians or two thirds of the population, subsidised rice, wheat and cereals.
The bill proposes to provide 5 kg of food grains to an individual every month at the rate of Rs 3 per kg of rice, Rs 2 per kg of wheat and Rs 1 per kg of cereals. The food minister KV Thomas expects that the extra burden on food subsidy will be about Rs 20,000 crore. Also 61.23 million tonnes of food grain would be needed.
Prima facie this is a very noble idea. But the question is who will be footing the bill for this? The answer is the tax paying salaried middle class. Allow me to explain.
In the financial year 2011-2012 (i.e. the period between April 1, 2011 and March 31,2012) the Indian government through the Food Corporation of India(FCI) and other agencies procured 63 million tonnes of grains (primarily rice and wheat).
If the right to food security bill is passed by the Parliament (as it is likely to be, why would any political party in their right sense oppose it?), the government will have to procure a greater amount of grains. The government estimates suggest that 61.23 million tonnes of food grain will be needed just to meet the requirements of the right to food security. There are other government food programmes running as well, and hence the 63 million tonnes of grain that the government currently procures may not be enough.
So the government will have to buy a greater amount of grain in the coming years. In order to do that it will have to keep offering a higher price. The government sets a minimum support price(MSP) for wheat and rice (and other agricultural commodities as well) every year and this has been going up over the last few years.
FCI and other state agencies acting on the government’s behalf buy grains produced by the farmer at the MSP. In the years to come the government is likely to buy more rice and wheat at a higher MSP. This means a lesser amount of rice and wheat will land up in the open market and thus push up prices. This argument does not work only if the amount of rice and wheat being produced goes up significantly and that cannot happen immediately in the short run.
Who does this hurt the most? The tax paying salaried middle class is the answer as they will have to pay more and more for the food that they buy.
There are other problems as well. The total storage capacity of FCI as on April 1, 2012, stood at 33.6 million tonnes. The Central Warehousing Corporation has 466 warehouses with a total capacity of 10.56 million tonnes. This brings the total storage capacity of the central government to a little over 44 million tonnes. Then there is the storage capacities of various state warehousing corporations which are also used to store grains. But even with that the government does not have enough storage capacity to store the amount of grain that it currently procures and will have to procure from the farmers in the years to come.
This means more grains will be dumped in the open and will rot as a result. As The Indian Express wrote in an editorial yesterday “The government will be required to procure more foodgrain at a huge cost, which would require pushing procurement prices even higher, creating storage facilities, and distributing the partly rotted foodgrain through a dysfunctional public distribution system.”
So more rotten food grain will be distributed in the years to come.
The major reasoning behind right to food security is that if subsidised food is offered to people, their nutrition will improve. This is not always the case. Abhijit Banerjee, professor of economics at the Massachusetts Institute of Technology explains this through an example. “We carried out a nice experiment in China. We gave some people a voucher to buy cheap rice. Instead of buying rice lets say for Rs 10, they could buy it for Rs 2, using the vouchers. The presumption was that this would improve nutrition. This was done as an experiment and hence some people were randomly given vouchers and others were not. When people went back and looked at it, they were astounded. People with vouchers had were worse off in nutrition. They felt that now that they have the vouchers, they are rich and no longer need to eat rice. They could eat pork, shrimps etc. They went and bought pork and shrimps and as a result their net calories went down. This is perfectly rational. These people were waiting for pleasure.”
A similar thing might play out in India as well. The money people will save on buying subsidised rice/wheat, might get channelised onto other unhealthy alternatives. But then that’s an individual decision that people might make and hence needs to be left at that.
The broader point is there hasn’t been enough discussion/debate/trials to figure out the unintended consequences of the right to food bill. One unintended consequence that is visible straight away is the rise in prices of non cereal food.
The money people save on buying rice/wheat can get channelised into buying fruit, vegetable, pulses, fish, meat, eggs etc. But the production for this may not go up at the same pace leading to higher price. As The Indian Express points out “The production of fruit, vegetable, pulses, fish, meat and eggs will continue to stagnate, however, as more resources will need to be allocated to push up the production of foodgrain. Instead of land, labour, capital, fertilisers and infrastructure being devoted towards meeting the needs of the population as determined by households that choose what they wish to eat, the country will be diverting resources to producing what the state decides the population must consume.”
As the government offers higher MSPs on rice and wheat, the farmers are more likely to produce that than non cereal food. This for the simple reason that the MSP is set in advance and it gives the farmer a good idea of how much he should expect to earn when he sells his produce a few months later. The same is not true for something like pulses where the government does set an MSP, but does not have the required infrastructure for procurement.
The “nutrition” problem will also continue. As Howarth Bouis , director of HarvestPlus, International Food Policy Research Institute (IFPRI), Washington, pointed out in a recent interview to Mint “If you look at all the other food groups such as fruits, vegetables, lentils, and animal products other than milk, you will find a steady increase in prices over the past 40 years. So it has become more difficult for the poor to afford food that is dense in minerals and vitamins. That probably explains the poor nutritional outcomes .” The right to food security will ensure that the poor will find it even more difficult to buy non cereal food which is high on nutrition as it becomes more expensive.
The nutrient deficit of India will continue to remain unaddressed. The right to food security works with the assumption that most of India’s poor may not have access to even the most basic food. That is really not correct as the government’s own data shows. As The Mint points out in a recent news report “Apart from the extremely poor, who form a small fraction of the population, nearly everyone else can afford the rice and wheat they require… A February report of the National Sample Survey Office shows the proportion of people not getting two square meals a day dropped to about 1% in rural India and 0.4% in urban India in 2009-10. Interestingly, the average cereal consumption of families who reported that they went hungry in some months of the year (in the month preceding the survey) was roughly equal to the average cereal consumption of those who reported receiving adequate meals throughout the year. The stark difference across income-classes lies in the level of spending on non-cereal food items, the survey points out.”
So what India needs to eat is more of eggs, vegetables and fruits, and not rice and wheat, as the government seems to have decided to. “Most of the poor can afford as much of rice, or wheat, as they can eat. And if you look at consumption patterns of these items across income groups, it does not change very much. The huge difference between low-income and high-income groups is in the consumption of non-staple foods—fruits, vegetables and pulses. I think that’s what is limiting better nutrition, not just in India but in much of the developing world,” Bouis told Mint.
What all this means is that the right to food security will drive up food prices higher than what they already are. Hence, food inflation will continue to remain high, which in turn will push up consumer price inflation as well. The right to food security will not only hurt those it is intended to benefit, but it will also hurt the tax paying salaried middle class, as they will continue to face higher prices on food.
The passing of right to food also signals that the Congress led UPA government remains committed to higher expenditure, without really figuring out where the revenue to finance that expenditure is going to come from. In simple English that means the government is going to continue to borrow more. Banks will thus have a lower pool of savings to borrow from, which means higher interest rates and higher EMIs will continue. Now who does this hurt the most? The tax paying middle class again.
Estimates made by Global Financial Integrity suggest that between 2001 and 2010, nearly $123 billion of illicit financial flows went out of India. This means around $12 billion per year on an average. At current conversion rate of one dollar being worth around Rs 54, this is around Rs 65,000 crore per year. So Rs 65,000 crore of black money is leaving the country every year. The black money being generated within the country would be many times over.
Of course people who have this black money are better placed to bear inflation because they don’t pay tax. That is clearly not the case with the salaried middle class, who pay tax and also have to bear higher food inflation. The government should be looking at ways of taxing this black money.
Over and above this agricultural income in this country continues to remain untaxed. This is totally bizarre. As Andy Mukherjee of Reuters Breaking Views writes in a slightly different context “No government today can muster the political courage to tax the incomes of even very large farmers. But to keep the section of the economy that accounts for 60 percent of employment out of tax undermines the system’s legitimacy…It’s ironic that villagers should have political representation without taxation, while the urban middle class finds itself heavily taxed but politically alienated.”
Taxing agricultural income remains out of question. Meanwhile, the salaried tax paying middle class will continue to be screwed.
The article originally appeared on www.firstpost.com on March 20, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)
Month: March 2013
Arindam Chaudhuri and the impending death of newspapers
Vivek Kaul
Talking about contradictions, here is an interesting one.
The Times of India edition dated March 18,2013, had a huge advertisement featuring Arindam Chaudhuri, the pony tailed bossman at IIPM(Indian Institute of Planning and Management) and his father Malay Chaudhuri. The advertisement congratulated Chaudhuri senior for having turned seventy five and had the vision to launch IIPM forty years back.
This advertisement came four days after Arindam Chaudhuri wrote a column titled Are you still a moron advertising in newspapers? The column ended with the rather prophetic line “However, yes, your business may not be able to cater to the next generation unless you realise that you are a moron to be still advertising in newspapers!”
Why Chaudhuri chose to contradict himself is something only he can explain. But his column does offer reasons for why IIPM seems to gradually moving its advertising budget away from newspapers, the front page advertisement in The Times of India notwithstanding.
As Chaudhuri writes “It all started changing around 2009 to 2011! As everyone knows, we were one of the country’s biggest ad-spenders till 2012! But interestingly, our returns from newspaper advertising started dropping sharply from 2009-2010. The first year, the admission applications we received from students due to our newspaper advertisements dropped to 40% of the levels we had in 2008-09. The next year, the same was 25% compared to 2008-09 levels. And finally in 2011-12, our applications from advertisements were, hold your breath, just 5% compared to 2008-2009! So basically, in three years, our returns from newspaper advertising came down by a mind numbing 95%!”
While this might also be a result of the falling reputation of IIPM, given the negative coverage its constantly got in the media over the last few years, but Chaudhuri does make an important point here.
IIPM’s target audience would be people in their early 20s, living in cities and who come from reasonably rich families (given the high fees that IIPM charges). There is enough anecdotal evidence to suggest that people belonging to this demographic group consume news largely online by logging onto the internet through their computers and now their mobile phones. Or as Chaudhuri aptly puts it “if you wanted to target the youth, or actually anyone born after 1980 for certain! None of them is reading newspapers anymore! So how will this segment see your ads in the first place and how will they pick up your application form? Yes, that’s the hard fact!”
Various readership surveys have shown over the years that print readership in India has remained stagnant. In comparison people logging onto the internet is growing at a very fast pace, albeit on a lower base. It would be safe to say that a large number of advertisers are interested in this lower base which typically comprises of youth coming from reasonably well to do families living in cities. In short these are the people who have the money to spend (either their own or that belonging to their parents).
So the moral of the story is that Arindam Chaudhuri is making an important point though he has chosen to contradict it himself.
What Chaudhuri’s column does not answer is why is newspaper readership stagnating? When it comes to the city bred youth at some level its a matter of what we can call the Levis syndrome. The jeans brand Levis over the years came to be associated as something that their parents wore, in the mind of the American youth. The same stands true for newspapers as well. Reading newspapers is not cool at least among the youth.
The newspapers in India have tried to tackle this through what they feel is younger and funkier design. The looks are getting trendier and there is more sex and entertainment in the newspaper. But this hasn’t worked beyond a point. As Chaudhuri puts it “naked bodies and titillation are far more easily available and in greater variety on the internet.” And all said and done a newspaper has its limits on this front. The internet doesn’t.
An extension of filling the newspaper with sex and entertainment has been the conclusion that most readers are not looking for serious content in a newspaper. This is what we can call The Times of India syndrome. Since, this kind of positioning has worked for India’s most profitable newspaper, newspapers (across different languages) have been looking to do the same thing. But what works for The Times of India doesn’t necessarily work for others as well.
As marketing guru Al Ries told me in an interview “Everyone assumes the No. 1 brand must be doing the right thing because it’s the market leader. Therefore, we should do exactly the same thing, but better. That seldom works.” There are newspapers which have lost hundreds of crore trying to bring out a better Times of India than The Times of India.
They forget a very basic point. If I as a reader want to read The Times of India, I will read The Times of India, and not a clone. More newspapers (at least the top English and the top Hindi newspapers) have been trying to bring out different versions of The Times of India, though their managers, editors and promoters will never admit to the same. This has stagnated readership at one level as the standard of content has fallen dramatically. There is inherently better content available on the web in India, if you know where to look.
Another reason for worry for most newspapers is that their business model is not working. In the late 1980s a copy of the Delhi edition of The Indian Express (with air surcharge) used to cost around Rs 3.50 in Ranchi, where this writer grew up. Now nearly 25 years laterThe Indian Express costs Rs 4.50 in Delhi and Rs 4 in Mumbai. Most other English newspapers cost around Rs 3-5 i.e. if you buy them off a news stand. The price point of a newspaper hasn’t really taken inflation into account at all.
If you are annual subscriber the cost can be very very low. In Mumbai newspapers have been known to offer an yearly subscription for as low as Rs 99. This basically meant that the daily newspaper was priced at 27 paisa (Rs 99/365 days). No wonder people bought newspapers so that they could accumulate good raddi and then sell it.
The idea behind this business model was to lock in a subscriber for a year by giving away the newspaper almost for free, and then go to the advertiser and tell him, we have so many readers, why don’t you advertise with us.
This has meant that most newspapers are now totally dependent on advertisers to make money. This business model worked during the period between 2002 and 2008, when companies were falling over one another to advertise. It doesn’t work at all in a low growth scenario, where everyone is looking to cut costs. Also with the advertiser getting top billing any negative stories that hurt a prospective advertiser are a strict no no. This makes more newspapers concentrate on the feel good and have a pro business attitude. In short, most newspapers dish out more of the same. There is not enough differentiation for a wide variety of taste that people have.
The other thing this business model does is, it limits readership beyond a point. The newspaper cannot expand because its not viable unless extra advertising comes in. Newspapers are a rare business in which selling an extra number of units can increase losses instead of profits. This is because the reader doesn’t pay for the newspaper. If newspapers in India have to survive, they have to figure out some way of getting out of the subscription based business models that they have got themselves into and can’t seem to come out.
These were points that go against a newspaper, but what about the internet? Newspapers are a very limited medium of communication. You only read what the promoter(and not the editor) of the newspaper wants you to read. In case of the internet people can create their own content. Hence, there can (and is) a tremendous diversity of opinion which one can never get in a newspaper. Also space is not a problem on the internet. It is in a newspaper. Thus, internet can have more diversity of opinion and thus appeal to more people than a newspaper can.
Also as the world gets inherently more complicated, the limited space in a newspaper tends to make things overtly simplistic rather than just simple. On the internet things can be explained and arguments and counter arguments can be made in detail. For anyone who is looking to understand the way the world works around him, the internet is an inherently better medium.
On the internet news can be consumed almost instantly. A reader need not wait for the next day’s newspaper to be updated on what is happening in the world around him. Even analysis on the internet is up and ready, before it comes out in a newspaper, the next day. Also, the internet is now accessible almost anywhere and one doesn’t have to go looking for it, like one has for a newspaper that one does not subscribe to.
Internet is a very low cost medium. A newspaper is a very high cost operation which involves buying land to set up a printing press and cutting trees to make newsprint on which the paper is printed.
So there are many good things going for news on the internet. The trouble though is that almost no one has till date figured out how to make money on the internet through news. Internet as a medium tends to be associated with “free”. Hence, digital subscriptions have not worked almost anywhere. Also people tend to ignore advertisements on the internet. A part of this equation is falling into space through Google Ads. Now only if websites could figure out the other half, newspapers would be dead sooner rather than later.
The article originally appeared on www.firstpost.com on March 19,2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)
RBI may cut rates, but your loan rates may not fall
Vivek Kaul
The monetary policy review of the Reserve Bank of India(RBI) is scheduled for March 19,2013 i.e. tomorrow. Every time the top brass of the RBI is supposed to meet, calls for an interest rate cut are made. In fact, there seems to be a formula that has evolved to create pressure on the RBI to cut the repo rate. The repo rate is the interest rate at which RBI lends to banks.
The formula includes the finance minister P Chidambaram giving statements in the media about there being enough room for the RBI to cut interest rates. “There is a case for the Reserve Bank of India (RBI) to cut policy rates, and the central bank should take comfort from the government’s efforts to cut the fiscal deficit,” Chidambaram told the Bloomberg television channel today.
Other than Chidambram, an economist close to the Prime Minister Manmohan Singh also gives out similar statements. “The budget has also gone a long way in containing the fiscal deficit, both in the current year and in the following year, and played its role in containing demand pressures in the system. Therefore, in some sense there is greater space for monetary policy now to act in the direction of stimulating growth,” C Rangarajan, former RBI governor, who now heads the prime minister’s economic advisory council, told The Economic Times. What Rangarajan meant in simple English was that conditions were ideal for the RBI to cut interest rates.
And then there are bankers (most those running public sector banks) perpetually egging the RBI to cut interest rates. As an NDTV storypoints out “A majority of bankers polled by NDTV expect the Reserve Bank to cut interest rates in the policy review due on Tuesday. 85 per cent bankers polled by NDTV said the central bank is likely to cut repo rates.”
Corporates always want lower interest rates and they say that clearly. As a recent Business Standard story pointed out “An interest rate cut, at a time when demand was not showing any sign of revival, would boost sentiments, especially for interest-rate sensitives like the car and real estate sectors, which had been showing negative growth, a majority of the 15 CEOs polled by Business Standard said.”
So everyone wants lower interest rates. The finance minister. The prime minister. The banks. And the corporates.
Lower interest rates will create economic growth is the simple logic. Once the RBI cuts the repo rate, the banks will also pass on the cut to their borrowers. At lower interest rates people will borrow more. They will buy more homes, cars, two wheelers, consumer durables and so on. This will help the companies which sell these things. Car sales were down by more than 25% in the month of February. Lower interest rates will improve car sales. All this borrowing and spending will revive the economic growth and the economy will grow at higher rate instead of the 4.5% it grew at between October and December, 2012.
And that’s the formula. Those who believe in the formula also like to believe that everything else is in place. The only thing that is missing is lower interest rates. And that can only come about once the RBI starts cutting interest rates.
So the question is will the RBI governor D Subbarao oblige? He may. He may not. But the real answer to the question is, it doesn’t really matter.
Repo rate at best is a signal from the RBI to banks. When it cuts the repo rate it is sending out a signal to the banks that it expects interest rates to come down in the days to come. Now it is up to the banks whether they want to take that signal or not.
When everyone talks about lower interest rates, they basically talk about lower interest rates on loans that banks give out. Now banks can give out loans at lower interest rates only when they can raise deposits at lower interest rates. Banks can raise deposits at lower interest rates when there is enough liquidity in the system i.e. people have enough money going around and they are willing to save that money as deposits with banks.
Lets look at some numbers. In the six month period between August 24, 2012 and February 22, 2013 (the latest data which is available from the RBI) banks raised deposits worth Rs 2,69,350 crore. During the same period they gave out loans worth Rs 3,94,090 crore. This means the incremental credit-deposit ratio in the last six months for banks has been 146%.
So for every Rs 100 that banks have borrowed as a deposit they have given out Rs 146 as a loan in the last six months. If we look at things over the last one year period, things are a little better. For every Rs 100 that banks have borrowed as a deposit, they have given out Rs 93 as a loan.
What this clearly tells us is that banks have not been able to raise enough deposits to fund their loans. For every Rs 100 that banks borrow, they need to maintain a statutory liquidity ratio of 23%. This means that for every Rs 100 that banks borrow at least Rs 23 has to be invested in government securities. These securities are issued by the government to finance its fiscal deficit. Fiscal deficit is the difference between what the government earns and what it spends.
Other than this a cash reserve ratio of 4% also needs to be maintained. This means that for every Rs 100 that is borrowed Rs 4 needs to be maintained as a reserve with the RBI. So for every Rs 100 that is borrowed by the banks, Rs 27 (Rs 23 + Rs 4) is taken out of the equation immediately. Hence only the remaining Rs 73 (Rs 100 – Rs 27) can be lent. This means that in an ideal scenario the credit deposit ratio of a bank cannot be more than 73%. But over the last six months its been double of that at 146% i.e. banks have loaned out Rs 146 for every Rs 100 that they have raised as a deposit.
So how have banks been financing these loans? This has been done through the extra investments (greater than the required 23%) that banks have had in government securities. Banks are selling these government securities and using that money to finance loans beyond deposits.
The broader point is that banks haven’t been able to raise enough deposits to keep financing the loans they have been giving out. And in that scenario you can’t expect them to cut interest rates on their deposits. If they can’t cut interest rates on their deposits, how will they cut interest rates on their loans?
The other point that both Chidambaram and Rangarajan harped on was the government’s effort to cut/control the fiscal deficit. The fiscal deficit for the current financial year (i.e. the period between April 1, 2012 and March 31,2013) had been targeted at Rs 5,13,590 crore. The final number is expected to come at Rs 5,20,925 crore. So where is the cut/control that Chidambaram and Rangarajan seem to be talking about? Yes, the situation could have been much worse. But simply because the situation did not turn out to be much worse doesn’t mean that it has improved.
The fiscal deficit target for the next financial year (i.e. the period between April 1, 2013 and March 31, 2014) is at Rs 5,42,499 crore. Again, this is higher than the number last year.
When the government borrows more it “crowds out” and leaves a lower amount of savings for the banks and other financial institutions to borrow from. This leads to higher interest rates on deposits.
What does not help the situation is the fact that household savings in India have been falling over the last few years. In the year 2009-2010 (i.e. the period between April 1, 2009 and March 31, 2010) the household savings stood at 25.2% of the GDP. In the year 2011-2012 (i.e. the period between April 1, 2011 and March 31, 2012) the household savings had fallen to 22.3% of the GDP. Even within household savings, the amount of money coming into financial savings has also been falling. As the Economic Survey that came out before the budget pointed out “Within households, the share of financial savings vis-à-vis physical savings has been declining in recent years. Financial savings take the form of bank deposits, life insurance funds, pension and provident funds, shares and debentures, etc. Financial savings accounted for around 55 per cent of total household savings during the 1990s. Their share declined to 47 per cent in the 2000-10 decade and it was 36 per cent in 2011-12. In fact, household financial savings were lower by nearly Rs 90,000 crore in 2011-12 vis-à-vis 2010-11.”
While the household savings number for the current year is not available, the broader trend in savings has been downward. In this scenario interest rates on fixed deposits cannot go down. And given that interest rate on loans cannot go down either.
Of course bankers understand this but they still make calls for the RBI cutting interest rates. In case of public sector bankers the only explanation is that they are trying to toe the government line of wanting lower interest rates.
So whatever the RBI does tomorrow, it doesn’t really matter. If it cuts the repo rate, then public sector banks will be forced to announce token cuts in their interest rates as well. Like on January 29,2013, the RBI cut its repo rate by 0.25% to 7.75%. The State Bank of India, the nation’s largest bank, followed it up with a base rate cut of 0.05% to 9.7% the very next day. Base rate is the minimum interest rate that the bank is allowed to charge its customers.
A 0.05% cut in interest rate would have probably been somebody’s idea of a joke. The irony is that the joke might be about to be repeated in a few day’s time.
The article originally appeared on www.firstpost.com on March 18,2013.
(Vivek Kaul is a writer. He tweets @kaul_vivek)
Arindam Chaudhuri's business model is similar to other private institutes
Vivek Kaul
Today’s edition of The Economic Times has a very interesting story on the IIPM bossman Arindam C
haudhuri. Chaudhuri sits at the top of an empire of four companies which in 2010-2011 generated revenues of Rs 533 crore, on which there was an overall loss of Rs 5 lakh (but not all the companies were loss making) and an income tax of just Rs 5 crore was paid.
This is typically how most private education institutes in this country tend to operate. While there revenues are decently high, they typically tend to make a loss and pay very low income tax. And there is a clear method to the way they operate.
The money spinning machine at the heart of any education empire is the education institute where students come to study. The same is true in case of Chaudhuri. The education business remains a major revenue earner within the group. In 2010-2011 its total revenues stood at Rs 349 crore. On this it made a loss of Rs 2.3 crore.
Typically in most such cases the education institute doesn’t own any assets. To give you a simple example, the building in which the education institute operates out of might be owned by a private limited company. The private limited company will be in turned owned by the entrepreneur who also runs the education institute. Hence, the rent that is paid by the education institute is legally tunneled out and goes into the pocket of the entrepreneur.
As The Economic Times points out “For example, in 2010-11, the education arm paid Rs 37.6 crore to the consulting arm, Planman Consulting—Rs 31 crore for services received and Rs 6.6 crore as rent.” While it is not specified what this rent was for, it was a rent nonetheless. Planman Consulting is the consulting company of Arindam Chaudhuri. What is interesting is that the education arm was responsible for 84% of the total revenues of Rs 45.8 crore revenues earned by Planman. The company also earned a profit of Rs 7.8 crore whereas the education business made losses.
There are other legal ways of tunneling out money. The computers and other infrastructure in the education institute might also not be owned by the institute and may be on rent from a private limited company owned by the entrepreneur or by one of his close relatives. Or if the institute does own the computers, it buys them from a company owned by the entrepreneur.
Similarly insurance contracts that the education institute might enter into are also facilitated through an insurance broker close to the entrepreneur. Another legal way of tunneling out money is through advertisements. The advertisements that are placed in the media are done through an advertising agency owned by the entrepreneur or one of his relatives. The agency gets a cut on this.
Chaudhuri though has taken this trick to the next level by launching his own magazines and placing his own advertisements in them. As The Economic Times points out “The latest issue of The Sunday Indian had 44 edit pages and 19 ad pages (including 10 pages of group ads)….In 2008-09, the latest year for which financials were available for Planman Media, it earned revenues of Rs 41.4 crore. Of this, just Rs 1.6 crore came from magazine sales.” Interestingly claims are made that Chaudhuri’s magazines sell more than magazines like India Today and Outlook in the general segment and more than any other business magazine, in the business segment. So then why is Planman Media earning only Rs 1.6 crore through magazine sales? Also if magazine sales is not bringing in the moolah for Planman Media, what is? Advertisements from other group companies owned by Chaudhuri?
So moral of the story is this. Whenever the education institute spends money on anything there is a private limited company owned by the entrepreneur waiting to capture it. In fact, entrepreneurs further tunnel out money even from these private limited companies by giving themselves high salaries.
Chaudhuri is no exception to this. As The Economic Times points out “Chaudhuri and his wife, Rajita, who are executive directors in Planman Consulting, drew a total remuneration of Rs 6.96 crore from the company that year.” So Chaudhuri and his wife took away more than 15% of the Rs 45.8 crore revenue of Planman Consulting as a remuneration.
Entrepreneurs have other innovative ways of tunneling out money. They set up placement agencies. And these agencies get paid for placing students as well as appointing teachers at the education institute. Interestingly, some of the biggest private business schools in the country (including IIPM) tend to place their ‘unplaced’ students in one of the group companies. The idea is of course to show decent placements. Other than that it gives these students a little more time to find themselves a decent job. And once they do that on their own, the institute can always claim that they were placed by the institute.
Of course, if the student is unable to find a new job within a certain time period, he or she is asked to leave, given that by then a new batch of students is ready to be placed. The institutes can afford to do this because of the high fees that they charge for their courses. If some of it goes back to the student, it does not do them much harm. Its all a part of the game.
To get back to the main story, the question is why do education institutes do this? As The Economic Times points out “An accounting expert, speaking on the condition of anonymity, says it’s a common industry practice for the education arm to show losses and group companies that provide services to this company to earn profits. “Promoters adopt this to circumvent Indian regulation, which prohibits profitmaking companies in the education sector,” he says. “But firms that provide services to the company that runs the education business are not bound by it.”
This essentially ensures that the education entrepreneur surrounds the institute with a web of private limited companies and uses them legally to tunnel out the revenue being generated out of the fees that students pay the institute. Of course, everyone does not operate at the same scale and is not as successful as Arindam Chaudhuri is.
There is a scope for great debate here. Why cannot education be a profitable business? This specially in a country where education is in such a short supply. Ironically, private equity investors have been greater investors in coaching institutes which coach students to get into education institutes or sit for various board exams. But given that the education institutes are not supposed to be profitable in a normal way, these investors have stayed away.
And entrepreneurs who have entered the education business are more interested in making a quick buck, rather than building an infrastructure which provides quality education at a decent price over a long period of time. Typically big private money has stayed away from this sector. Those who have entered it are typically politicians, who are good at financial shenanigans and are looking to put their black money to some use.
The article originally appeared on www.firstpost.com on March 15,2013
(Vivek Kaul is a writer. He tweets @kaul_vivek. He studied in a private business school. And also worked for one)
Why the disinvestment process is getting messier
Vivek Kaul
This song from the 1968 Hindi movie Teen Bahuraniyan best explains the state of the Congress party led United Progressive Alliance government. As the lines from the song go “aamdani atthani kharcha rupaiya, bhaiya, na poocho na poocho haal, nateeja than than gopal”. Loosely translated this means that when you keep spending more than what you earn, you are bound to end up in a mess sooner rather than later.
One area where the mess is getting more obvious by the day is the area of disinvestment of shares held by the government in public sector companies. The idea was that by selling these shares the government would be able to reduce a part of its fiscal deficit. Fiscal deficit is the difference between what a government earns and what it spends.
During the course of this financial year (i.e. the period between April 1, 2012 and March 31, 2013) the government had expected to earn Rs 30,000 crore by selling shares of public sector companies to the public. This number has since been revised to Rs 24,000 crore.
This has been a tad better than the last financial year (i.e. the period between April 1, 2011 and March 31, 2012) when the government had targeted to raise Rs 40,000 crore through the disinvestment of shares but finally managed to raise only Rs 13,894 crore.
What is interesting is that even the amount that will be raised by selling shares of the PSUs during the course of this financial year, wouldn’t have been raised if the government hadn’t forced the Life Insurance Corporation (LIC)of India to come to its rescue.
The insurance major is supposed to have bought 46% of the 69 million shares of RCF that were disinvested last week. LIC as expected denied that it had rescued the government. “We have not bailed out anyone. We have examined this (RCF) issue by its own strength and then taken a decision to participate. We will examine the future issues in a similar manner and then take a call,” D K Mehrotra, chairman of LIC, told Business Standard on March 13, 2013. In November 2012, LIC had come to the rescue of the government by picking up 43.6% of the nearly 52 million shares of Hindustan Copper that were being sold.
In March 2012, LIC had picked up 88.3% of the 427 million shares of ONGC that were being sold. When a government owned insurance company has to pick up 88% of the shares being sold, what it clearly tells you is that there was no real demand for the share in the stock market. The government thus raised around Rs 11,275 crore from LIC. The government was also expected to sell shares in Metals and Minerals Trading Corporation(MMTC) of India, but that has been postponed. The government and the merchant bankers of the issue could not agree on the price at which the shares of MMTC would be sold. The merchant bankers seem to have told the government that Rs 75 per share was a fair price of an MMTC share. The trouble though is that currently one MMTC share is worth around Rs 302 (as I write this) in the stock market.
But there is a simple explanation for this huge difference. As an editorial in Business Standard points out “However, rather than getting carried away with the wide gap between the market price and the fair value assigned to the company’s shares by merchant bankers, the government should note that the current stock price of MMTC Ltd is produced by market dynamics – but with constrained supply. Only 0.6 per cent of the stock is freely floating.”
The point is that the government is being greedy here. But that ‘greed’ of course comes with the confidence that LIC can always be made to buy these shares. The MMTC situation is similar to that of ONGC, where the shares were priced so high that the investors were simply not interested in buying it. As the Business Standard points out “ The government may have deferred the proposed stake sale in the state-owned mineral trading company MMTC Ltd over valuation differences with merchant bankers, but it would do well to recall the debacle associated with the share sale of the state-controlled oil company ONGC last March. On that occasion, the government priced ONGC’s shares at Rs 290 each; institutional investors saw little value in bidding for them at that price – higher than the market price that was prevailing then. The government had to ask the Life Insurance Corporation of India to bail out the issue.”
The disinvestment of other companies like Steel Authority of India Ltd (SAIL) and National Aluminium Company Ltd (NALCO) also seems to be in trouble. The share price of both these companies is currently at more or less their one year low levels. The same stands true for MMTC as well.
What the ONGC experience hopefully must have taught the government is that while selling shares of a company which is already listed on the stock exchange it cannot demand a price that is higher than the price the share is selling at, in the stock market. So if a share is selling at a price of Rs 100, the government cannot demand Rs 120, simply because the investor has the option of buying the share from the stock market.
Given this, it means that if the government wants to sell the shares of SAIL, MMTC and NALCO, it will have to sell them at a price which is lower than their market price to make it an attractive proposition for investors. And since the market price is at around the one year low level, the government will be unable to raise as much money from these stake sales as it had expected to. Of course the government can always dump these shares on LIC , which would be more than happy to buy it. The disinvestment of NALCO which is located primarily in Orissa is being opposed by the ruling party in the state, the Biju Janta Dal.
There are several points that stand out here. If the government is having so much trouble achieving a scaled down disinvestment target of Rs 24,000 crore for this year, how will it achieve the target of Rs 54,000 crore which it has set for itself in the next financial year? It also raises the question that was a high figure of Rs 54,000 crore just assumed to project a lower fiscal deficit for the next year?
The second point is that at Rs 54,000 crore, disinvestment receipts are expected to bring in 6% of the total revenues of the government during the next financial year. This a rather huge number to be left to the vagaries of something as moody as the stock market. The government is only doing this because it is confident that it can get LIC to pick up the tab if the stock market is not interested.
In fact that is why it has passed a special regulation allowing LIC to own upto 30% of shares in a company against the earlier 10%. This in a scenario where the other insurance companies can own only upto 10% of a listed company. How can there be two separate rules for companies in the same line of business?
Also what happens in a situation when LIC ends up investing in a company which turns out to be a dud? Imagine what would happen when LIC decides to get out of the shares of such a company. The stock price of the company will fall, impacting returns of investors who have bought insurance plans from LIC. As the old saying goes, “putting all eggs in one basket” is a pretty risky proposition and goes against the basic principles of investing. What makes the situation even more dangerous is the fact that it is public money that is at stake.
Also when LIC has to anyway pick up these shares why go through this entire charade of disinvestment in the first place? The government can simply sell these shares directly to LIC and get done with it.
There is another basic issue here. Amay Hattangadi and Swanand Kelkar of Morgan Stanley Investment Management point this out in a report titled Connecting the Dots: “As trained Accountants, we have learnt that sale of Assets from the Balance Sheet are one-off or non-recurring items.”
In simple English what this means is that shares once sold cannot be resold. By selling shares the government is raising a one time revenue. On the other hand, using this revenue it is committing to expenditure which is more or less permanent. And that really can’t be a good thing in the long run.
But politicians really don’t live for the long run. They survive election by election. And there is one due next year.
The article originally appeared on www.firstpost.com on March 14, 2013.
(Vivek Kaul is a writer. He tweets @kaul_vivek)