Month: June 2014 | Page 4

15 June, 2014

The secret is out: The end consumer does not get any oil subsidy

Vivek Kaul
Over the last few days, there has been a lot of talk in the media about the government considering petroleum subsidy reforms (You can read about it here and here). One of the most well kept secrets in India has been the fact that the end consumer does not get any subsidy on petroleum products. But what we have been told is exactly the opposite.
What we have been told over the years is that the oil marketing companies have been selling products like petrol, diesel, cooking gas and kerosene, at a loss (The price of petrol was deregulated on June 26, 2010, so that is no longer the case). To a large extent, the government compensates the oil marketing companies for this loss. Hence, these products are subsidised. Subsidies are bad and they need to be done away with.

The truth is however a little more nuanced than that. Let’s take a look at the following table.

In 2012-2013, the under-recovery of the oil marketing companies on selling oil products had stood at Rs 1,61,029 crore. Of this the government provided a cash assistance of Rs 1,00,000 crore. Rs 60,000 crore came in from upstream oil companies like ONGC and Oil India Ltd.
So far so good. But does this amount to a subsidy to the end consumer? As Surya P Sethi writes in an article titled “Analysing the Parikh Committee Report on Pricing of Petroleum Products“It is clear that Indian consumers are paying the highest price for lower quality petrol and more for lower quality diesel when compared to the US and Japan – the two most vociferous proponents of removing fuel subsidies. Also, Japan and the UK and, indeed, several other countries tax diesel at a lower rate.”
A major portion of the price that we pay on buying petrol and diesel essentially consists of taxes collected by both the central and the state governments. At the central government level a huge amount of tax on oil products is collected through excise duties. At the state level, the value added tax on petroleum products is the major contributor.
For the calculations here, we will ignore the various taxes collected by the state government on petroleum products. We will consider only taxes earned by the central government. This includes excise duty, customs duty, cess on crude oil, income tax, dividend and dividend distribution tax paid by oil companies, as well as profit from exploration, among other things.
If all this is taken into account for the year 2012-2013 the central government earned Rs 1,17,422 crore. In comparison it paid out Rs 1,00,000 crore in the form of cash assistance to oil marketing companies. That still meant a surplus of Rs 17,422 crore.In 2011-2012, it earned Rs 1,19,850 crore from petroleum products and companies. The cash assistance to oil marketing companies during that year stood at Rs 83,500 crore. That meant a surplus of Rs 36,350 crore.
The scenario looks similar during the first nine months of 2013-2014 as well. The cash assistance to oil marketing companies stood at Rs 35,772 crore. In comparison, the central government had earned Rs 83,619 crore, leading to a surplus of Rs 47,847 crore.
Hence, the end consumer does not get any subsidy on petroleum products as a whole, even though the oil marketing companies suffer huge under-recoveries in the sale of diesel, cooking gas and kerosene.
A criterion that the International Energy Agency uses for defining something as a subsidy is whether it “lowers the price paid by energy consumers.” As A Citizens’ Guide to Energy Security in India points out “consumer subsidies, as the name implies, support the consumption of energy, by lowering prices at which energy products are sold.” That is clearly not the case in India.
Given this, the government and the media should stop using the word subsidy when it comes to talking about petroleum products as a whole. Second, the surplus that the government generates through taxing petroleum products and companies, should actually be paid out as cash assistance to the oil marketing companies. Once, that is done the burden on the upstream oil companies like ONGC and Oil India Ltd, which finance a part of the under-recoveries, will come down.
This is very important given that India imports more than 80% of the oil that it consumes. With the pressure on ONGC to finance the under-recoveries coming down, it can spend more money on exploring for oil. This will go long way towards beefing up the energy security of India.
The trouble is that the surplus that the government makes by taxing petroleum companies and petroleum products goes towards bringing down the fiscal deficit. The fiscal deficit is the difference between what a government earns and what it spends.
In fact, once we consider the total amount of taxes earned by the state government the real situation comes to the fore. During the first nine months of 2013-2014, state governments earned Rs 1,01,493 crore from taxing petroleum products. The state governments are highly dependent on these taxes to finance their expenditure. If the price of petroleum products needs to be controlled, it is this dependence that needs to come down. And that is easier said than done.

Vivek Kaul is a writer. He can be reached at [email protected]

The article originally appeared on www.firstbiz.com on June 15, 2014

12 June, 2014

What Modi can do to bring acche din for home buyers

Vivek Kaul

People have taken the Bhartiya Janata Party’s election slogan “acche din aane waale hain”a little too literally. I have often been asked on the social media over the past few weeks whether real estate prices will fall, now that Narendra Modi government is in power. I wish I had a definitive answer for that.
Nevertheless, there are many things that the Modi government can do so that home prices start to mirror the actual demand from people looking to buy homes to live in. Right now, a major part of home demand comes from investors and speculators looking to park their money. How can this be taken care of?
There are a number of steps that can be taken.
a) The Modi government wants to get back the black money Indians have stashed away internationally. As per data from Global Financial Integrity, this amounted to a whopping $644 billion as of 2011. While the intention to get back all this black money is certainly noble, how practical is it? Also, if the idea is to recover black money then why discriminate between those who have managed to transfer the money abroad and those who haven’t.
It will be certainly easier to recover black money that is still there in the country. Also, the amount of black money that has remained in the country is likely to be significantly more than what has left the shores. A lot of this money has been diverted into buying real estate. This link between black money and real estate needs to be broken.
Former finance minister in the budget speechhe made on February 28, 2013, said “There are 42,800 persons – let me repeat, only 42,800 persons – who admitted to a taxable income exceeding Rs 1 crore per year.” This number is totally unbelievable given that nearly 27,000 luxury cars are sold in India each year. Over and above this estimates made KPMG suggest that there around 1.25 lakh high networth individuals in India who have an investible wealth of at least a million dollars(around Rs 6 crore), and also own a house and other durables.
What this clearly tells us is that as a nation we barely pay taxes. This means we are generating a lot of black money. A large amount of this money goes into real estate, and ensures that real estate prices remain firm. This wouldn’t have been possible without the cooperation of the highly corrupt Income Tax department.
In fact, the Modi government could do some out of the box thinking like the Greek government, to recover this black money. The Greek government used Google Earth to track those who have swimming pools and then cross indexed their address with the amount of tax they are paying. Ideas along similar lines need to be come up with. The property dealers of the National Capital Region and the amount of taxes they pay, will be a good target to start with.
If real estate prices need to fall, more and more people need to be forced to report their income properly and made to be paid a tax on it.
b)One of the most well kept secrets of the Income Tax Act is that it actually encourages people to speculate in real estate. There is no restriction on the number of homes against which you can claim a tax deduction on the interest paid on the home loan to fund the property. Only one of these properties needs to categorized as a self-occupied property. On this self-occupied property, an interest of up to Rs 1.5 lakh can be claimed as a tax deduction.
But this limit does not apply to the remaining homes that an individual may choose to buy. Any amount of interest paid on home loans can be claimed as a deduction as long as a “notional rent” is added to the income. We all know that these days “rents” are relatively low in comparison to the EMIs that need to be paid in order to repay the home loan. Hence, the interest component tends to be massive during the initial years and helps people with two or more homes, claim huge tax deductions.
This “loophole” has been used effectively by well paid corporate employees to bring down their taxable income over the years. People who use this deduction are more interested in claiming the deduction than actually making money from an increase in price. Hence, they are likely not to sell, even in a scenario where prices may be falling.
While offering a tax deduction on a self occupied property makes some sense, there is no logic to offering a tax deduction on a home, one is not living in. This “loophole” needs to be plugged immediately.
c) The Modi government needs to work towards building a credible real estate index. Currently, there is no way of figuring out which way the real estate market is heading. Are prices rising? Are they flat? Or are they falling? These are important questions for anyone looking to buy a home to live in. Brokers will always tell you that prices are going up. Real estate consultants bring out reports on home prices, now and then. But given that they make their money from real estate companies, these reports needed to treated with a pinch of salt.
The National Housing Bank does have a real estate index. But not many people know about it. Also, it is a quarterly index, and by the time the data actually comes out, it is not of much use. As of now the datafor up to December 2013 is available. But we are already in June 2014. The government needs to look at building an index along the lines of the Case-Shiller real estate indices in the United States. This will not lead to results immediately but will really help over a long term.
d) In the short term the government needs to look at the real estate lending of banks closely. Most recent data released by the Reserve Bank of India shows that between April 19, 2013 and April 18, 2014, the overall bank lending grew by 13.9%. During the same period the lending to commercial real estate grew by a significantly higher 19.8%.
This, in an environment where real estate companies have huge inventories. So, why are banks lending money to real estate companies? And what are real estate companies doing with that money? One possible explanation is that banks have been giving fresh loans to real estate companies so that the companies can repay their old loans. This has allowed real estate companies to not cut prices on their unsold inventory and ensure that prices do not fall.
This is something that needs to be looked into closely.
e) These days more and more real estate companies seem to be interested in launching new projects, rather than delivering the homes that they have already sold to the consumer. Companies use the money they raise for new projects to pay off interest on debt as well as repay debt that they have taken on over the years. Hence, there is no money left to build homes.
In this situation, the only way left for the company to raise more money to build homes is by launching newer projects. The money raised for one project is used to pay off interest on outstanding debt as well repay debt that is maturing. In order to build homes promised under the project, another project needs to be launched. This leads to the first project being delayed. To build homes promised under the second project a third project needs to be launched.
And so the cycle continues. In order break this cycle, the idea of a real estate regulator had been proposed a while back. That does not seem to have gone anywhere. It needs to be re-considered, even though it may not lead to immediate results.
If these steps are taken in the days to come, there might be some relief for people looking to buy homes to live in.
The article originally appeared on www.FirstBiz.com on June 13, 2014

(Vivek Kaul is a writer. He can be reached at [email protected])

11 June, 2014

Modi's first fiscal challenge

Vivek Kaul

N Chandrababu Naidu, the chief minister of new Andhra Pradesh (what remains of the state after the creation of Telangana), wants to waive off bank loans to farmers and women’s self-help groups amounting to a whopping Rs 54,000 crore. Naidu promised this freebie during the course of the election campaign and now wants to fulfil it.
The trouble of course is that the banks which made these loans will have to be adequately compensated. And for that the newly elected state government will need money, which it does not have. It is estimated that the revenue deficit of Andhra Pradesh will amount to Rs 13,579 crore during the course of this financial year(April 1, 2014 to March 31, 2015). Revenue deficit is the difference between the revenue expenditure and the revenue income of a government.
Hence, the question is where will the government get this money from? Naidu is hoping that the Narendra Modi led government at the centre (BJP fought elections along with Naidu’s Telgu Desam Party both at the state and the national level) will help him fulfil his electoral promises.
But the central government is already stretched on the finance front. In the interim budget presented in February 2014, the fiscal deficit for this financial year was projected to be at Rs 5,28,631 crore or 4.1% of GDP. Even this projection was primarily achieved by cutting down on the asset creating planned expenditure and by not recognising’certain’expenses which in total amounted to more than Rs 1,00,000 crore. Hence, the actual fiscal deficit would have been significantly higher. Fiscal deficit is the difference between what a government spends and what it earns.
If the central government chooses to assist the new Andhra Pradesh government with the entire Rs 54,000 crore that is needed, then it will end up adding to its already high fiscal deficit. In fact, the amount that the new Andhra Pradesh government needs to waive off loans is more or less equal to the assistance that the old Andhra Pradesh received from the central government over the last 10 years(between 2004-2005 and 2013-2014). This assistance amounted to a total of Rs 54,613.4 crore. This comparison clearly tells us the astonishing amount of money that is needed to write off these loans.
One reason that the Modi government might choose to entertain Naidu is the fact that it does not have enough numbers in the Rajya Sabha. But if it entertains Naidu, then it will also have to entertain the likes of Naveen Patnaik and J Jayalalitha, who have been demanding special packages for their states, in return for their support in the Rajya Sabha. And where is all that money going to come from?
Also, it will go against the Modi’s entire electoral pitch of the government creating an enabling environment that allows people to progress, instead of giving out doles to them. It is worth remembering here that the new Andhra Pradesh has around 5% of India’s population. Given that, the question is that whether the central government should be spending such a huge amount of money in a single year on one single state? And the answer is no.
The other option for the new Andhra Pradesh government is to borrow this money by issuing bonds. The trouble is that a state cannot borrow an unlimited amount of money. The borrowing limit for old Andhra Pradesh had been set at Rs 29,000 crore, at the beginning of this financial year. Hence, the borrowing limit for the new Andhra Pradesh will clearly be less than that. Also, as pointed out earlier the state is already expected to run a revenue deficit of Rs 13,579 crore during this financial year.
The moral of the story is that the math for waiving off loans made to farmers and self help groups, does not really work out. News reports suggest that the bankers have requested the ministry of finance to try and convince the new Andhra Pradesh government, not to go ahead with this plan. Other than the math not working out, there are other reasons why the new Andhra Pradesh government shouldn’t be going ahead trying to waive off loans.
First and foremost, it is not fair on the people who have honestly repaid their loans in the past. Also, it will reward those who have defaulted on their loans.
Second, it brings the issue of moral hazard to the core. Economist Alan Blinder in his book After the Music Stopped writes that the “central idea behind moral hazard is that people who are well insured against some risk are less likely to take pains(and incur costs) to avoid it.”
What it means in this context is that after the loans are waived off this time around, people of the state of new Andhra Pradesh, will think twice before repaying their loans, in the days to come. If the government can waive off loans once, why can’t it do it all over again, is a question that the people of Andhra Pradesh will be asking themselves?
Third, in the next election the Telgu Desam and the other parties, will compete to promise even bigger freebies.
Fourth, loans being waived off benefits those people who are in a position to take a bank loan, in the first place. Typically, farmers with large landholdings tend to fall in this category. The small farmer is not in a position to fulfil the requirements that need to fulfilled in order to take a bank loan. Hence, the question is do the large farmers really need to be subsidised?
Fifth, the government of Andhra Pradesh needs to build a new capital over the next years. It will need a lot of money in order to do that. Hence, it makes sense for it to be fiscally responsible during its initial years.
All these reasons suggest that Chandrababu Naidu should reconsider his decision of waiving loans to farmers and self help groups of the New Andhra Pradesh.

The article originally appeared in The Asian Age/Deccan Chronicle dated June 11, 2014.
(Vivek Kaul is the author of the Easy Money trilogy. He can be reached at [email protected])

6 June, 2014

Easy money: Will the ECB have no choice but to be a copycat of the US?

Vivek Kaul

In July 2012, Mario Draghi, president of the European Central Bank (ECB) had said that “the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.”
Yesterday, the ECB cut its deposit rate to – 0.1%. European banks need to maintain a certain portion of their deposits with the ECB as a reserve. This is a regulatory requirement. But banks maintain excess reserves with the ECB, over and above the regulatory requirement. This is because they do not see enough profitable lending opportunities.
In April 2014, the European banks had excess reserves amounting to € 91.6 billion. This was over and above the reserve of €103.6 billion that they needed to maintain as per regulatory requirement. The ECB currently pays no interest on the excess reserves of banks. With effect from June 11, 2014, it will pay an interest of – 0.1% on the excess reserves. What this means is that the ECB will charge the banks for any excess reserve that they maintain with it.
This has been done to ensure that the banks do not maintain any excess reserves with the ECB and go out and lend that money instead. The lending to the private sector in Europe has been declining at the rate of 1.8%. Over and above this, the economic growth in the Euro Zone (18 countries in Europe which use Euro as their currency) has been very slow.
During the period of January to March 2014, the economic growth was at a minuscule 0.2%. The Eurzo Zone managed to avoid an economic contraction primarily due to a strong performance by the German economy.
What this means is that economies of certain countries in Europe are contracting. Economies of Italy, Holland and Portugal contracted during January-March 2014. The economy of France did not grow at all. What makes the situation worse is the latest inflation number. In May 2014, the inflation in the Euro Zone fell to 0.5%. It was at 0.7% in April 2014. This is well below the ECB’s target inflation of 2%.
If inflation keeps falling, the Euro Zone will soon be experiencing a deflationary scenario in which prices will keep falling. In such a scenario people will postpone consumption in the hope of getting a better deal in the days to come. And this will further impact economic growth.
Due to these factors the Draghi led ECB has decided to cut the deposit rate to – 0.1%. The hope is that banks will withdraw their excess reserves from the ECB and lend that money. But how good are the chances of something like that happening? The ECB had cut the interest rate on excess deposits to 0% in July 2012. Its been around two years since then and as mentioned earlier the lending to the private sector in Europe has been going down at the rate of 1.8%.
Also, banks always have the option of maintaining their excess reserves in their own vaults than depositing it with the ECB. They can always exercise that option and still not lend. Interestingly, in July 2012, the central bank of Denmark had taken interest rates into the negative territory. The lending by Danish banks fell after this move. Banks will go slow on lending unless they feel that their lending will turn out to be profitable. And that is something the ECB or for that matter any central bank, cannot do much about.
So, that brings us back to the question of why did the ECB take interest rates into the negative territory? The only possible answer seems to be that ECB wants to weaken the euro against other currencies. The euro has appreciated against the yen since October 2012. In October 2012, one euro was worth around 100 yen. Currently, one euro is worth around 140 yen. This has happened because of the massive money printing carried out by by the Bank of Japan, the Japanese central bank, since early 2013.
Germany is the export powerhouse of Europe and competes directly with Japan in many hi-tech sectors. Nevertheless, despite the euro appreciating against the yen, the Eurozone as a whole has been running a trade surplus i.e. its exports have been greater than its imports. In February 2013, the Eurozone ran a trade surplus of €13.6 billion.
This is primarily because a collapse in demand in many Eurozone countries has led to a significant cut down in imports. Also, with a collapse in internal demand businesses have been forced to look for external growth.
Now with the ECB looking to cheapen the euro, it will lead to German exports becoming more competitive than they were in the past and this in turn will push up the trade surplus of the Eurozone further. Whether this will benefit countries in the Eurozone other than Germany, remains to be seen.
In a press conference yesterday, Mario Draghi said “We think this is a significant package…Are we finished? The answer is no. If required, we will act swiftly with further monetary policy easing. The Governing Council is unanimous in its commitment to using unconventional instruments within its mandate should it become necessary to further address risks of prolonged low inflation ”
Speculation is rife that the Draghi led ECB will soon enter the full blown quantitative easing territory and print money to buy bonds, something that the Federal Reserve of the United States and the Bank of Japan have been doing for a while now.
But it may not be so easy to initiate quantitative easing in the Eurozone, given that 18 countries of the Eurozone will have to support the decision. But as Guntram B. Wolff, director of Bruegel, a research organization in Brussels told The New York Times “The conventional measures are all done…What remains is quantitative easing.”
In short, the era of “easy money” will continue.

The article originally appeared on www.firstbiz.com on June 6, 2014

(Vivek Kaul is a writer. He can be reached at [email protected])

4 June, 2014

SLR cut: A central banker shouldn't jump into bed with his finance minister

Vivek Kaul

Since yesterday there has been a lot of analysis about the Raghuram Rajan led Reserve Bank of India (RBI) cutting the statutory liquidity ratio(SLR) from 23% to 22.5%. Earlier the banks had to maintain 23% of their deposits in government securities. Now they need to maintain only 22.5%, a cut of 50 basis points. One basis point amounts to one hundredth of a percentage.
This cut, the analysts have concluded will lead to bank giving out more loans. The Business Standard estimates that “the cut will free up about Rs 35,000 crore with banks which they can now lend.”
The newspaper does not explain how they arrived at that number. But an educated guess can be made. Currently, the aggregate deposits of scheduled commercial banks in India amounts to Rs 7,855,520 crore. The SLR ratio has been cut by 50 basis points or 0.5%. This amounts to around Rs 39,278 crore (0.5% of Rs Rs 7,855,520 crore) of the total deposits of banks. From this number, the ballpark number of Rs 35,000 crore seems to have been derived.
It is important to make things simple, but not simplistic. The assumption being made here is that now that banks need to invest a lesser amount in government securities, they will do so and prefer to lend more money instead.
But is that really the case? The latest numbers released by the RBI show that scheduled commercial banks had invested nearly 29.27% of their deposits in government securities. This when the SLR had stood at 23%. What does this tell us? It tells us that banks prefer to invest in government securities than lend money.
This is not a recent phenomenon. In late September 2007, when the economic scenario was significantly better than it is now, scheduled commercial banks had nearly 31% of their deposits invested in government securities. In mid May 2012, the number had stood at 30%.
Given this, even though banks are required to maintain only a certain portion of their money in government securities, they have maintained a significantly higher amount over the years. Whether this is lazy banking or the lack of good investment opportunities that only the banks can tell us.
In fact, it is interesting to see how things panned out after the RBI cut the SLR from 24% to 23% on July 31, 2012. As on July 28, 2012, the banks had invested nearly 30.6% of their deposits in government securities. Three days later, the RBI cut the SLR. A little over six months later in early February 2013, the government securities to deposit ratio stood at 30.4%. So, the banks did cut down on their exposure to government securities, but not significantly. In fact, as on July 26, 2013, nearly a year later, the government securities to deposits ratio stood at 30.8%. This was higher than the ratio before the SLR cut.
What this clearly tells us is that a cut in SLR does not necessarily mean that banks will invest less in government securities and lend that money instead.
The RBI of course understands this. If it really wanted to ensure that banks had more money to lend it would have cut the cash reserve ratio (CRR). CRR is the portion of their deposits that banks need to hold with the RBI. It currently stands at 4%.
The RBI does not pay any interest on the money that banks maintain with it to fulfil their CRR obligations. Hence, when the RBI cuts the CRR, banks have an incentive to lend the money that is freed up. The same scenario does not hold in case of an SLR cut because banks get paid interest on the money they invest in government securities.
So that brings us to the question, why did Rajan cut the SLR? My guess on this is that there was pressure on him from the Finance Ministry to show that RBI was serious about “economic growth” and do something that forced banks to lend more. And that something came in the form of an SLR cut. It was his way of telling the government, look you wanted me to do something, I did something. If banks are still not lending, what can I do about it?
In the monetary policy statement Rajan said that there were still “Upside risks” to inflation “in the form of a sub-normal/delayed monsoon on account of possible El Nino effects, geo-political tensions and their impact on fuel prices, and uncertainties surrounding the setting of administered prices.” What this tells us clearly is that Rajan is still not totally convinced that we have seen the last of the high inflation that has prevailed over the years.
What this further tells us is that Rajan continues to be his own man as he was in the past and is unlikely to be weighed in by pressure from the finance ministry. It is important to remember here what economist Stephen D. King writes in When the Money Runs Out “A central banker who jumps into bed with a finance minister too often ends up with a nasty dose of hyperinflation.”Given this, it is important that Rajan stays as independent as he has been since taking over as the RBI governor in September 2013.

The article originally appeared on www.firstbiz.com on June 4, 2014

(Vivek Kaul is a writer. He can be reached at [email protected])