Month: November 2014 | Page 6

13 November, 2014

The Western growth model is broken and it ain’t getting fixed any time soon

Everyone has a plan until they get hit in the mouth – Mike Tyson

In the aftermath of the financial crisis that started in September 2008, the central banks of Western countries started printing money and pumping it into their financial systems. The hope was that by flooding the financial system interest rates could be maintained at low levels.
At low interest rates people would borrow and spend more and economic growth would return. The Federal Reserve of United States led the money printing race. But money printing hasn’t led to people borrowing and spending as was expected, as can be seen from the accompanying chart.

Source: http://www.pimco.com/EN/Insights/Pages/For-Wonks-Only.aspx

The total loans in the United States currently amount to around $58 million. The loans have been growing at 2% per year in the last five years and 3.5% over the last 12 months. As can be seen from the accompanying graph this rate of loan growth is much slower than the growth in pre-financial crisis years, when the loan growth was at around 10% per year. It even touched 20% in 2007, a year before the crisis broke out.
Hence, economic growth in the United States was a clear function of the loan growth in the pre-financial crisis years. Now that the loan growth has slowed down so has economic growth. So what will it take to bring this growth back?
As Bill Gross who formerly worked for PIMCO, one of the largest mutual funds in the world, put it in a September 2014 column “Over the long term, however, economic growth depends on investment and a rejuvenation of capitalistic animal spirits – a condition which currently does not exist…The U.S. and global economy ultimately cannot be safely delivered with artificially low interest rates, unless they lead to higher levels of productive investment.”
The standard theory that has emerged in the aftermath of the financial crisis is that consumer demand has collapsed in the Western world and this has led to a slowdown in economic growth. In order to set this right people need to be encouraged to borrow and spend. The trouble is that it was “excessive” borrowing and spending that had led to the crisis in the first place.
Raghuram Rajan and Luigi Zingales suggest this in a new afterword to Saving Capitalism from the Capitalists: “For decades before the financial crisis in 2008, advanced economies were losing their ability to grow by making useful things. But they needed to somehow replace the jobs that had been lost to technology and foreign competition… So in an effort to pump up growth, governments spent more than they could afford and promoted easy credit to get households to do the same. The growth that these countries engineered, with its dependence on borrowing, proved unsustainable.”
Interestingly, from 1900 to 1980, 70–80 percent of the global production of goods happened in the United States and Europe. By 2010, this share had declined to around 50 percent, around the same level that it was at in 1860. Also, faced with increased global competition, Western workers were unable to demand the pay increases that they used to in the past. This led to Western governments following an easy money policy, where they encouraged citizens to borrow and spend, and this ensured that economic growth remained strong.
But in the aftermath of the financial crisis this growth model has broken down with people not borrowing as much as they did in the past. So what is the way out? The way out is to create sustainable growth that is not financed through debt-fuelled consumption all the time. As Rajan and Zingales put it “The way out of the crisis cannot be still more borrowing and spending, especially if the spending does not build lasting assets that will help future generations pay off the debts they will be saddled with. The best short-term policy response is to focus on long-term sustainable growth.”
Nevertheless that is easier said than done. A March 2011 working paper by Michael Spence and Sandile Hlatshwayo provides the reason for the same. As the economists point out “Between 1990 and 2008, jobs have seen a net increase of 27.3 million on a base of 121.9 million in 1990..Almost all of those incremental jobs (26.7 of 27.3 million) were created in the nontradable sector. In the aggregate, tradable sector employment growth was essentially flat.”
So what does this mean? Jordan Ellenberg defines the term nontradable sector in his book How Not To Be Wrong—The Hidden Maths of Everyday Life. Nontradable sector is “the part of the economy including things like government, health care, retail, and food service, which can’t be outsourced and which don’t produce goods to be shipped overseas.”
Hence, basically whatever could be outsourced outside the United States has already been outsourced. This is simply because it is cheaper to produce stuff outside the United States. And this is likely to continue in the years to come. Over the coming decades, a billion more people are expected to join the work force in Asia, Africa and Latin America. This will apply a further downward pressure on costs and prices. Hence, Americans will not really be in a position to demand pay increases as they could have in the past.
What is true about the United States is also true about other developing countries as well. Given this, the Western growth model is well and truly broken. And as of now, the way things stand, it doesn’t look like if it will be fixed any time soon.

The article originally appeared in www.FirstBiz.com on Nov 12, 2014

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

10 November, 2014

Tackling black money

Vivek Kaul

One of the promises made by the Bhartiya Janata Party(BJP) before the sixteenth Lok Sabha elections was that it will get back all the black money that has left India over the years. This issue really caught the imagination of the voters. After coming to power, the party and its leaders have reiterated that they are still committed to getting back all the black money that has left the Indian shores.
Nevertheless this remains a difficult task given that the money is spread across tax havens all over the world. The economies of tax havens operate on all the money that is stored in their bank accounts, and so they wouldn’t be exactly be bending over their backs to hand over the money back to India. Also, the government needs to decide whether such an operation is feasible or are there better ways of looking at the situation like tackling the black money problem at home rather than trying to get back all the money that has left the Indian shores.
Before we get any further it is important to define what black money is. A ministry of finance white paper published in May 2012 suggests that “There is no uniform definition of black money in the literature or economic theory.” It then goes on to define black money as “ as assets or resources that have neither been reported to the public authorities at the time of their generation nor disclosed at any point of time during their possession.”
In simple English this is money which has been earned but not been declared as an income and hence, no tax has been paid on it. This is precisely how the National Institute of Public Finance and Policy (NIPFP) had defined ‘black money’ in its 1985 report on Aspects of Black Economy. The NIPFP defined ‘black income’ as ‘the aggregates of incomes which are taxable but not reported to the tax authorities’.
Black money is generated from a variety of transactions including criminal activity. Nevertheless a major portion of black money is generated through legal activities. The ministry of finance white paper points out a number of reasons as to why people do not declare their entire income. “For example, a factory owner may under-report production on account of theft of electricity which in turn leads to evasion of taxes…Sometimes the procedural regulations can be such that complying with them may increase the probability of further scrutiny and thereby the incidence of the burden of compliance, creating a perverse incentive not to report at all and remain outside the reported and accounted proportion of the economy,” the report suggests.
Of course, this leads to under-declaration of income and lower tax collection by the government.
Further, sometimes culture and social practices also play a role “in deciding the preferences of citizens between tax compliance and black money generation.” In a country where not declaring income is a norm, generating black money may be totally acceptable. India fits this perfectly, with only 3.5 crore individuals out of a population of 120 crore paying taxes.
So, how does the country get rid of this menace? There are no easy answers to such a complex problem. Nevertheless, there has to be a starting point. The finance ministry white paper calls “for political consensus as well as patience and perseverance”.
The political consensus is the starting point. But are the Indian political parties really interested in weeding out black money? The answer is no. Allow me to elaborate.
A study carried out by the Centre for Media Studies sometime in March this year suggested that around Rs 30,000 crore would be spent during the 16^th Lok Sabha elections which happened in April and May 2014. Of this amount the government of India would spend around Rs 7,000-8,000 crore, the study suggested. The remaining amount would be spent by candidates and their parties.
Candidates are allowed to spend Rs 70 lakh for fighting a Lok Sabha election in bigger states. For other states the amount varies from Rs 22 lakh to Rs 54 lakh. While officially candidates stay within this limit, unofficially they spend a lot more money, as news reports appearing around election time often point out. The question is where does this money come from? A major part of the Indian elections are financed through black money. Some of this money is essentially black money coming back to India from abroad, particularly from places like Dubai. This money is routed back through the hawala route.
Further, the money that politicians earn through corruption finds its way into real estate. Many real estate companies are essentially fronts for the ill-gotten wealth of politicians. Hence, are the politicians willing to disturb the status quo on this front? Are they willing to carry out reforms in the process of election campaign finance? Or it too lucrative an opportunity to let go of?
A serious effort of tackling black money problem will mean looking into real estate transactions, which generate a significant portion of black money in India. The finance minister Arun Jaitley recently talked about making Aadhar cards compulsory for real estate transactions. While that is a good move, there are certain underlying distortions that need to be set right in the real estate sector, which comprises of close to 11% of the Indian GDP.
The stamp duty to be paid on real estate transactions is close to 5% in many states. This leads to individuals under-declaring the value of the transaction when they are selling the real estate they own. Over and above this there are other transactions costs of searching for a property, registration, commissions to be paid etc. These small things are that need to be improved, if the “real estate” sector is to be made more transparent.
Further, when a fresh purchase is being made from a builder, he usually insists on a significant portion of the total deal value to be paid in cash. This is understandable given that builders are usually fronts for or in partnership with local politicians and politicians cannot be declaring their real incomes.
To conclude, if the black money menace has to be tackled in India, the politicians need to clean up their own acts first. Everything else is just noise.

The column originally appeared in The Asian Age/Deccan Chronicle with a different headline on Nov 8, 2014

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

10 November, 2014

Why Indian politicians need to read Charles Dickens and Anand Bakshi

The writing of very few writers survives across generations. Charles Dickens is one of them. In his book David Copperfield one of the characters Mr Micawber says: “Annual income twenty pounds, annual expenditure nineteen nineteen six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.”
This is something that Indian politicians should be reading and imbibing. If reading Dickens is something that they don’t like, they can try listening to the song aamdani atthani kharcha rupaiya o bhaiyya na poocho na poocho haal natija than than gopal. This song is from the 1968 movie Teen Bahuraniyan. Given that most of the Indian politicians are “old,” they will definitely relate better to this song from the time when they were young, than to Dickens.
The moral in both what Dickens and Anand Bakshi (who was the lyricist for the aamdani atthani kharcha rupaiya song) wrote is that when you spend more than you earn there is trouble ahead. This basic lesson is something that the Indian government (and most other governments around the world) has not understood over the last ten years.
The government has constantly spent more than it has earned and run a fiscal deficit. Indeed, the situation continues to remain worrying on this front, even during the course of this financial year. Data released by the Comptroller General of Accounts(CGA) shows that during the first six months of 2014-2015(i.e. the period between April 1, 2014 and March 31, 2015), the government ran a fiscal deficit of Rs 4,38,826 crore or around 83% of the targeted fiscal deficit of Rs 5,31,177 crore, set at the time of the budget. The number was at 76% during the course of the last financial year.
One reason for this is the fact that the expenditure of the government is front loaded whereas its income is not. Hence, six months into the financial year, the fiscal deficit is not equal to 50% of the annual target.
Between April and September 2014 the total income of the government has risen by only 6.6% in comparison to the same period last financial year. The targeted growth in income in the budget is at 12.6%.So, the income has not grown as fast as it is supposed to grow. On the expenditure front things look a tad better. Between April and September 2014, the total expenditure has risen by 6.6%. The targeted growth in expenditure is at 7.8%.
In fact, with oil prices coming down the oil under-recoveries suffered by the oil marketing companies will come down. For a very long period of time oil marketing companies were selling diesel at a price at which they did not recover their cost of producing it. Cooking gas and kerosene continue to be sold at a price below their cost of production.
The government compensates these companies for their under-recoveries. This pushes up the expenditure of the government and hence, its fiscal deficit.
Kaushik Das and Taumir Baig economists at Deutsche Bank Research expect the under-recoveries for this financial year to be at Rs 85,300 crore against around Rs 1,40,000 crore, during the last financial year. This calculation was made in early October and oil prices have fallen further since then. As seems likely oil prices will continue to remain low in the short run and this will help the government contain its expenditure towards oil under-recoveries.
Nevertheless, before you uncork that bubbly, there are some other points that need to be considered. Around Rs 50,000 crore of food subsidies remain unpaid. In case of fertilizer subsidies pending bills amount to Rs 38,000 crore. This should largely neutralize the gains on account of oil prices falling. The previous finance minister P Chidambaram had pushed the payment of more than Rs 1,00,000 crore of subsidies into the current financial year, in order to ensure that he met his budget targets.
Also, there are other long term concerns on the fiscal front. The public sector banks are in a mess. They will need regular infusions of capital from the government, if they need to continue to function. This is a ticking time bomb which no one seems to be talking about. In fact, the Report of The Committee to Review Governance of Boards of Banks in India (better known as the PJ Nayak committee) released in May 2014, goes into the substantial detail regarding this issue. It estimates that between January 2014 and March 2018 “public sector banks would need Rs. 5.87 lakh crores of tier-I capital.”
The report further points out that “assuming that the Government puts in 60 per cent (though it will be challenging to raise the remaining 40 per cent from the capital markets), the Government would need to invest over Rs. 3.50 lakh crores.”
Where is this money going to come from? In fact, there has been very little activity on this front from the government during this financial year. As and when the government allocates money towards this, its expenditure will go up again. The other option is to let the private sector take over some of these banks. But that is a political minefield and also the money required for the capital infusion is not small change exactly.
Another long term issue on the fiscal front are the recommendations of the seventh finance commission which will come into force in 2016. As happened in the case of the sixth finance commission, the salaries of government employees will go up again. This will lead to a greater expenditure for the government and in turn, a higher fiscal deficit.
Immediately after the seventh finance commission recommendations are implemented, state government employees all across the country will ask for hikes as well. The state governments, as has been the case in the past, will be happy to oblige, even though they don’t have the money for it. This will mean that the total government borrowing (states + centre) will shoot up and crowd out the private sector borrowing and push up interest rates, which have only recently started to fall. These are issues that the government needs to tackle if it hopes that interest rates continue to fall.
In fact, during the course of the last financial year, the fiscal deficit crossed its annual target in January 2014. Something similar will happen this year. Nevertheless, by the time March 2015 comes, the government would have managed to bring back the fiscal deficit to the targeted level. This is because tax collections shoot up during the last three months of the year. Further, the government will go in for disinvestment of its holdings in public sector companies at that point of time. This year the government has targeted an income of Rs 58,400 crore through the disinvestment of shares. This seems to have become standard practice over the years. But the danger here is that shares once sold cannot be resold. But the expenditure they are financing is more or less permanent.
To conclude, it is important that the government looks at increasing its income, if it hopes to finance its ever burgeoning expenditure efficiently. In other words, it has to follow the advise of both Charles Dickens and Anand Bakshi.
In order to that the government has to look at increasing the number of income tax payers for one. Currently, only 3.5 crore individuals out of a population of 120 crore pay the income tax. A quick implementation of goods and services tax regime will also help. Hence, the government needs to tackle the black money economy in India seriously. The question is will get around to doing that?

The article originally appeared on www.equitymaster.com on Nov 7, 2014

6 November, 2014

Busting a few myths about black money

Vivek Kaul

Growing up in erstwhile Bihar in the late 80s and early 90s, one of the first economic terms that I came across was “black money”. Those were pre Android phones, pre Google, pre internet, pre mobile phones and in large cases even pre landline phone days.
So, what did one do when one had a doubt like this and wanted to know what black money really was? One asked. Parents. Friends. Friends of friends(Okay, these were real friends of friends, not the Facebook variety that we have these days). Neighbourhood uncles and aunts. Bhaiyyas and Didis preparing for the UPSC or the state public service exam. And hopefully an economist.
Ranchi was a small town during those days. My social studies text book even called it a “hill station”. And the chances of finding an economist there, were next to none (not that the chances have gone up now).
So, what you got were vague explanations like, black money was black money. People looked at you and probably wondered, why is the fellow even asking this.
And so the doubt remained. As time went by, as happens in such small towns, everyone who could leave the place, got up and left, including me. Of course, over the years, I figured out what black money was. Black money was black money, one of the few economic terms which are a definition in themselves.
In April 2009, the newspaper I worked for back then, asked me to interview Proffesor R Vaidyanathan of the Indian Institute of Management at Bangalore. The professor put a number to the entire black money debate, which thanks to the Bhartiya Janata Party (BJP) was just about erupting then.
He said that around $1.4 trillion of Indian black money was stashed away abroad. This money, he elaborated could be in Switzerland and various British/US islands which are tax havens.
His estimate was based on a report titled Illicit Financial Flows from Developing Countries: 2002—2006, brought out by Global Financial Integrity(GFI), a Washington based non profit organization.
The 2013 report of GFI said that nearly $343 billion of black money left India during 2002-2011. This amounted to around 3% of India’s economic output during the period. The number was particularly high in 2011, when around $84 billion may have left the country, the report suggested.
The GFI’s estimate does not take into account criminal activities as well as corporate tax evasion. These are massive sources of black money. Nevertheless, this is the most comprehensive study of black money which leaves emerging markets like India and hence, does give us a good idea of the amount of black money leaving the country.
In the recent past, prime minister Narendra Modi has taken up the issue of bringing back black money that has left India. In his latest radio broadcast over the weekend he told the country that “As far as black money is concerned, you should have faith on this ‘pradhan sevak’. For me, it is an article of faith. Every penny of the money of poor people in this country, which has gone out, should return. This is my commitment.”
While this is a good stand to take in public, getting back all the ‘black money’ that has gone out, back to India, is not a feasible proposition. The simple reason is that all this money is not lying around at one place.
There is a great belief that all this black money is lying around in Switzerland. This isn’t true. Data released by the Swiss National Bank, the central bank of Switzerland, suggests that Indian money in Swiss banks was at around Rs 14,000 crore (2.03 billion Swiss francs). India was at the 58th position when it came to foreign money in Swiss banks. The total amount had stood at Rs 41,400 crore in 2006.
The reason for this is simple. Over the last few years as black money and Switzerland have come into focus, it would be stupid for individuals or companies sending black money out of India, to keep sending it to Switzerland.
There are around 70 tax havens all over the world. And so this money could be anywhere. Getting all this money back would involve a lot of international diplomacy and cooperation. Also, the question is why would tax havens return this money. Their economies run because of this black money and no one undoes a business model that is working.
An estimate made by the International Monetary Fund suggests that around $18 trillion of wealth lies in international tax havens other than Switzerland and beyond the reach of any tax authorities. Some of this money must have definitely originated in India.
Further, in the aftermath of the global financial crisis, interest rates in Western economies have crashed. Switzerland is no exception on this front and hence, Swiss banks have been paying very low interest rates over the last few years. Given this it doesn’t make any sense for Indian black money to go to Switzerland, when there are better returns to be made elsewhere.
Indian black money found its way into places like Switzerland when India had limited investment opportunities. But that is not the case now. Hence, chances are that over the last few years, Indian black money has largely stayed in India where it has been invested in areas like real estate or in metals like gold. Further, chances are that a lot of black money is being round-tripped into India through hawala to be invested in physical assets like land, apartments etc.
Hence, it is important that instead of chasing black money stashed all over the world, the government starts looking at transactions which generate black money in India. The two sectors which generate a lot of black money are real estate and education. No real estate deal is complete without paying a certain amount of the deal amount in “cash”. And even school admissions these days lead to money changing hands in the form of a “donation”.
Why can’t the government start local when it comes to unearthing black money? The answer is fairly straightforward. Many real estate companies and education institutes are run by politicians. Try taking a taxi around Mumbai and you will realize that most so called “education institutes” are run by politicians. The way this works is that the education institute is run by a non profit organization but all the assets(like the building in which the education institute is run) are owned by a private limited company and the education institute pays a rent to the private limited company for using all the assets. This is how money is tunnelled out. Why can’t the government look at these transactions?
It is ironical that we don’t even have a decent estimate for the total amount of black money in this country. As a 2012 white paper released by the ministry of finance stated “There are no reliable estimates of black money generation or accumulation, neither is there an accurate well-accepted methodology for making such estimation.”
If the government is serious about tackling the black money menace it first needs a reasonable estimate of the total amount of black money in this country. It needs a comprehensive mechanism to figure out how black money is being generated and how and where it being hidden.
Further, the central idea in unearthing black money should be to bring more and more people under the tax bracket. The situation is abysmal on this front. As the former finance minister P Chidambaram said in his February 2013 budget speech “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 is a totally ridiculous number. There are probably more people making that sort of money just in South Delhi.
If the government is serious about the black money issue, it should be going after these people who are hiding their income and not paying taxes. But the question is can it do that? The income tax department is one of the most corrupt institutions in the country and given half an opportunity they are ready to sell themselves out lock, stock and barrel.
Further, it is worth remembering that a lot of black money that is generated is ultimately used by politicians to fight elections. Hence, it is in their interest that the status quo continues. To conclude, black money stashed away in foreign destinations is not the real issue. The real issue is the black money that continues to be generated and hidden in India and the inability of the government to tackle it.

The article originally appeared on www.equitymaster.com on Nov 6, 2014

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

6 November, 2014

Mr Jaitley here is why Indians can’t buy a home to live in

Politicians and intellectuals who rarely venture out of their homes in Delhi, seem to have a table top theory to explain everything that is wrong with this country. A favourite theory doing the rounds these days is that India is not progressing because interest rates are too high. And given that, the Reserve Bank of India needs to cut interest rates. Once it does that people will buy homes, cars and what not, and high economic growth will return again. QED.
But is that really the case? Recent data released by the real estate research firm Liases Foras clearly shows that homes in Indian cities are terribly expensive.

The weighted average price of a flat in Mumbai is Rs 1.34 crore. For Bangalore this stands at Rs 88 lakh and for the National Capital Region at Rs 75 lakh. Nevertheless, this table does not tell us how bad the situation really is. In order to understand that we need to take the per capita income of these cities into account.

The state level economic surveys give out the per capita income of various cities. The only trouble here is that the latest numbers are not available. Hence, in order to account for that I have adjusted these incomes by assuming an average increase in per capita income of 10% per year. (Further, I couldn’t find the average income of Chennai, and hence haven’t taken it into account for making this calculation. Also, for the Mumbai Metropolitan Region I have used the average of the per capita incomes of Mumbai and Thane, respectively. For the National Capital Region, I have used the per capita income of Delhi, and hence the calculation is a little understated to that extent.)

The following table gives the per capita income of five cities in 2014-2015. In order to show how

high the real estate prices are we will basically divide the entries in the first table by the entries in the second table. Hence, we will end up calculating that how many years of current income is needed to buy a flat in a particular city. And the results are very interesting.
It takes 68 years of current income to buy a flat in the Mumbai Metropolitan Region. For Bangalore the number is at an even higher 81.5 years. This seems on the higher side. And there is a reason for it. I have used the per capita income of Bangalore division (which is what I could find in the

Karnataka Economic Survey of 2013-2014). And Bangalore division includes not just Bangalore but also other places like Kolar, Shimoga, Tumkur etc., where per capita incomes are lower than that in Bangalore.
Even if we assume that per capita income in Bangalore is double the per capita income in Bangalore division, it will take around 40 years of current income to buy a home in Bangalore.
Of the five cities, Pune is the cheapest to buy a home in. But even there is takes close to 32 years of current annual income to buy a home.
Further, home prices continue to remain despite the fact that there is a huge inventory of unsold homes, as the following table from Liases Foras shows us.

National Capital Region has an inventory of 83 months. What this means is that if the current number of unsold homes is to be sold, it would need nearly 83 months or around seven years for that to happen. One reason for the unsold inventory is that most builders are not interested in developing affordable homes. Everyone wants to cater only to the richer segment of the population.
Also, the tables clearly prove that high interest rates are really not why people are not buying homes. They are not buying homes because homes are very expensive. Fresh home loans can be got these days at anywhere between 10-11 percent. Assuming this interest rate where to fall in the days to come, how much difference would it make? Would people buy homes?
Let’s understand this through an example of an individual who wants to buy a home in Hyderabad. As mentioned earlier the average price of a home in Hyderabad is Rs 75 lakhs. The individual puts in a downpayment of Rs 15 lakh (20% of the value of the home) and takes a home loan of Rs 60 lakh at 10 percent to repaid over 20 years. On this the EMI would work out to around Rs 57,900.
If the interest rates were to fall to 9 percent, the EMI would fall to around Rs 54,000. So, would the individual now buy a home just because the EMI will be around Rs 4,000 per month lower? Unless, home prices fall and builders start concentrating a little more on affordable housing, lower EMIs are not going to help.
This is something that Jaitley and others of his ilk operating out of Delhi, need to realize. To conclude, if Jaitley, the quintessential dilli-wallah, had asked one of his IIT educated babus to do some basic number crunching, he wouldn’t be saying the silly thing that he did.

The article was originally published on Nov 6, 2014 on www.FirstBiz.com

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)