The ten best Nonfiction books of 2014

single-man-coverVivek Kaul

It is that time of the year when media houses go around writing about the best of the year that was. Given this, I thought it would be an appropriate time to put out a list of what I think are the best nonfiction books that I read in 2014. The list is biased to the extent of what I read, which are basically books in the area of finance and economics. Also, some of the titles were released earlier and I only happened to read them in 2014. The books are listed out in a random order. So here we go.

Saving Capitalism from the Capitalists by Raghuram Rajan and Luigi Zingales: I had read this book when it was first published in 2003. At that point of time I was basically trying to figure out what to do with my life, having finished an MBA in information systems in 2002 and at the same time having realized that the MBA degree was one big con job. In 2014, the book was published again with a new afterword. I read it again and appreciated the book much more than I had done in 2003. The book is a great read for anyone who believes in the idea of free markets. It tells you loud and clear that the incumbent capitalists are the greatest enemies of the free market. The book also helped me understand why so many big businesses in India manage to default on their bank loans without the industrialists having to face the consequences of the same.

After the Music Stopped by Alan S Blinder: This book was published in 2013, but I happened to read it only this year. The best books on historical events are written many years after the event has happened. Take the case of what I think is the best book on the Great Depression—The Great Crash 1929, written by John Kenneth Galbraith. The book was first published in the mid 1950s almost quarter of a century after the Depression started. One possible explanation for this is the fact that writing many years later, the author can leave out all the noise and concentrate on the most important issues. Over the last six years many books have been written on the financial crisis, but After the Music Stopped, in my opinion is perhaps the best book on it. It summarises the economic, the political as well as the legal angles of the financial crisis very well. If you are looking for a ready reckoner on the financial crisis, this has to be your go to book. Capital in the Twenty-First Century by Thomas Piketty: This was by far the bestselling title in economics during the course of this year, having been the number one book on for a while. It is very rare for an economics book running into 700 pages to be number one on Amazon. In this book the core argument offered by Piketty, who is a French economist, is that capitalism has led to greater inequality among people over the years. Piketty offers a lot of data from the developed countries to make his point. The book did not go down well with the American economists, and after it appeared many of them tried to discredit it by trying to find mistakes in the data and methodology used by Piketty. Who is right and who is wrong is too long a debate to get into here. Nevertheless, Piketty’s book remains a must read for the fantastically lucid way in which its written and the several original ideas that it offers. The Dollar Trap by Eswar S. Prasad: The United States is in a huge financial mess. Nevertheless, dollar remains the go to currency of the world at large. Whenever there is a whiff of a crisis anywhere in the world, money is pulled out and moves to the dollar. Ironically, even when the rating agency Standard and Poor’s cut the rating of the debt issued by the United States government from AAA to AA+, money moved into the US dollar. Prasad explains this “exorbitant privilege” of the dollar and the reasons behind it. While the US may not be in a great financial shape, but the world at large still has faith in the dollar. Prasad summarizes the situation well when he says: “It is possible that we are on a sandpile that is just a few grains away from collapse. The dollar trap might one day end in a dollar crash. For all its logical allure, however, this scenario is not easy to lay out in a convincing way.” The book is a great read for anyone trying to understand one of the most fundamental disconnects of the times that we live in. Flashboys by Michael Lewis: No one quite writes about finance like the way Lewis does. From his first book Liars Poker to the latest Flashboys, each one of his books on Wall Street and its ways has been a bestseller. One reason for the same is the fact that Lewis started as a Wall Street insider in the investment bank Salomon Brothers (which has since gone bust) and has managed to maintain his contacts since then. Flashboys is essentially a story of the people and systems that make up algorithmic trading that has taken Wall Street by storm. A majority of the trades on Wall Street are not driven by humans any more. They are driven by computers with a lot of processing power. And that is the fascinating story of Flashboys. If you are the kind who likes reading thrillers over weekends, this is just the right book for you.

Business Adventures by John Brooks: I first discovered Brooks in the process of writing and researching my books. Someone suggested that I should be reading Brooks’ version of the Great Depression called Once in Golconda: A True Drama of Wall Street 1920-1938. The book was a fantastic read and made me realize that Wall Street had a Michael Lewis even before the real Michael Lewis appeared on the scene. Early this year, Bill Gates wrote a blog on one of Brooks’ other books called Business Adventures. He called it the best business book that he and Warren Buffett had ever read. This blog pushed the book to the top of the Amazon charts. It was re-issued after this. The book is a collection of twelve long articles that Brooks wrote about the American businesses, government as well as Wall Street, for the New Yorker magazine. And it has tremendous lessons for almost everyone connected with business and finance.

Single Man—The Life & Times of Nitish Kumar of Bihar by Sankarshan Thakur: This book is the joker in the pack. In a list full of books on economics and finance, here is a book on politics. Having been born in erstwhile Bihar, I have always been interested in the politics of Bihar. And there is no better writer on Bihar in English than Thakur, who works as a roving editor for The Telegraph newspaper. Thakur chronicles the rather turbulent life of Nitish Kumar, starting a little before the Emergency, and goes on to chronicle the life of the Bihari politician over the next four decades. As he does that he also goes into the history of Bihar over that period. Unlike a lot of other biography writers, Thakur also goes into Kumar’s unhappy personal life. The book is an excellent model for how to write a biography of an Indian politician. What we normally get to read are either hagiographies or out and out criticism (as is the case with so many books on Narendra Modi which swing at both ends). There is rarely a biography of an Indian politician which takes the middle path. If I had to choose just one book to read this year, then Single Man would have to be it. And this would be more for Thakur’s andaz-e-bayan(the way he tells the story) than Kumar’s story per se. How Not to Be Wrong—The Hidden Maths of Everyday Life by Jordan Ellenberg: This is another joker in the pack. I absolutely love to read good books on Mathematics. Ellenberg in this book goes around explaining the practical aspects of Maths in everyday life. He explains in great detail how media often uses Maths incorrectly to draw wrong conclusions. He also tries to answer some really interesting questions: How early should you get to the airport? What’s the best way to get rich playing a lottery? And does Facebook know you are terrorist? If you are feeling a little adventurous and want to go a little out of your comfort zone, this is just the right book for you.

The End of Normal by James Galbraith: I am reading this book currently and am around half way through it. James Galbraith is the son of John Kenneth Galbraith, who I feel was one of the most lucid writers on economics that the twentieth century saw. Galbraith junior writes in the same lucid way as his father did. Since the financial crisis broke out, economists and politicians have tried to tell the world at large that “all is going to be well,” and that the financial crisis was just caused by bad policy and bad people. Galbraith challenges this world view and offers four reasons against it: the rising cost of real resources, the futility of military power, the labour saving consequences of the digital revolution and the breakdown of law and ethics in the financial sector. Long story short: The global economy will not see acche din(good days) any time soon. Hormegeddon—How Too Much Of a Good Thing Leads to Disaster by Bill Bonner: The regular readers of The Daily Reckoning would know by now that this has been one of favourite books of the year, given the number of times I have already quoted from it in my columns. I have been a big fan of Bonner’s writing since I first met him in late 2008. In this book Bonner goes about explaining how too much of a good thing in public policy, economics and businesses, leads to disaster or what he calls FUBAR (f***ed up beyond all recognition). Bonner offers many examples from history to make his point—from Napoleon’s decision to invade Russia to the outbreak of the Second World War to America’s War on Terror. He then goes on to show that these disasters cannot be prevented by well-informed people with good intentions because they are the ones who cause them in the first place. 

So that was my list of what I thought were the ten best books that I read this year. Happy reading. The India edition of The Daily Reckoning will be taking a year end break and will be back early next year on January 3. Here is wishing you a Merry Christmas and a Happy New Year. Meanwhile you can continue reading the international edition of The Daily Reckoning authored by Bill Bonner. The article originally appeared on as a part of The Daily Reckoning, on Dec 24, 2014

Has the Chief Economic Adviser ever read George Orwell?

george orwell

Vivek Kaul

The writer George Orwell in his dystopian novel 1984 came up with the concept of “doublethink”. He defined this as a situation where people hold “simultaneously two opinions which cancelled out, knowing them to be contradictory and believing in both of them”. Arvind Subramanian, the chief economic adviser to the ministry of finance, seems to be in a similar situation these days. While speaking to the press after the Mid Year Economic Analysis was presented to the Parliament, Subramanian said that the government should consider increasing public sector spending in the medium term to revive economic growth . At the same time Subramanian said that the government was committed to meeting the fiscal deficit target of 4.1% of GDP during the current financial year. Fiscal deficit is the difference between what a government earns and what it spends. How is it possible to stand for two absolutely opposite ideas at the same time? How can there be a commitment to increased government spending and maintaining the fiscal deficit at the same time? If the government spends more without earning more, its fiscal deficit is bound to go up. Nevertheless, before getting into this issue in detail let’s try and understand why Subramanian makes a case for increased public investment. In the Mid Year Economic Analysis Subramanian suggests that the public private partnership (PPP) model for infrastructure development hasn’t really worked. “There are stalled projects to the tune of Rs 18 lakh crore (about 13 percent of GDP) of which an estimated 60 percent are in infrastructure. In turn, this reflects low and declining corporate profitability as more than one-third firms have an interest coverage ratio of less than one (borrowing is used to cover interest payments). Over-indebtedness in the corporate sector with median debt-equity ratios at 70 percent is amongst the highest in the world. The ripples from the corporate sector have extended to the banking sector where restructured assets are estimated at about 11-12 percent of total assets. Displaying risk aversion, the banking sector is increasingly unable and unwilling to lend to the real sector,” the Mid Year Economic Analysis points out. What this means is that over the last few years corporates have borrowed more than what they can hope to repay. This has led to them defaulting and banks ending up in a mess. Currently the corporates are not willing to invest and banks are not ready to lend. In the process projects worth Rs 18 lakh crore (which is slightly more than the annual budget of the government of India) have been stalled. So what is the way out of this mess? “First, the backlog of stalled projects needs to be cleared more expeditiously, a process that has already begun. Where bottlenecks are due to coal and gas supplies, the planned reforms of the coal sector and the auctioning of coal blocks de-allocated by the Supreme Court as well as the increase in the price of gas which should boost gas supply, will help. Speedier environmental clearances, reforming land and labour laws will also be critical,” the analysis points out. But even this will not be enough, given that the PPP model hasn’t really delivered. In this scenario Subramanian suggests that “it seems imperative to consider the case for reviving public investment as one of the key engines of growth going forward, not to replace private investment but to revive and complement it.” The question that crops up here is on what should the government be spending money on? Subramanian suggests “there may well be projects for example roads, public irrigation, and basic connectivity–that the private sector might be hesitant to embrace.” He further suggests that one of the main lessons from PPP not working is that “India’s weak institutions there are serious costs to requiring the private sector taking on project implementation risks.” Hence, risks like “delays in land acquisition and environmental clearances, and variability of input supplies (all of which have led to stalled projects) are more effectively handled by the public sector.” And above all weak infrastructure (lack of power supply and poor connectivity) remains a major reason as to why the manufacturing sector hasn’t taken off in India. Increased spending by the government could address all these issues. The reasons presented by Subramanian for increased government spending make sense. One cannot argue against them. Nevertheless, he doesn’t address the most important question, which is, where is the money for all this going to come from? All he says in Mid Year Economic Analysis is that: “consideration should be given to address the neglect of public investment in the recent past and also review medium term fiscal policy to find the fiscal space for it(Italics in the original).” What he means here is that the government will have to somehow figure out how to finance the increased spending in the budgets to come. A document which runs into 148 pages could have done slightly better than that. So, let’s look at the options that the government has? It is not in a position to raise the tax rates, given the economic scenario that we are in. The other possible option is to cut down on non-plan expenditure which makes up for around 68% of the total expenditure of the government and use the money saved to increase public spending. Interest payments on debt, pensions, salaries, subsidies and maintenance expenditure are all non-plan expenditure. As is obvious a lot of non-plan expenditure is largely regular expenditure that cannot be done away with. The government needs to keep paying salaries, pensions and interest on debt, on time. Hence, slashing this expenditure is easier said than done. Another option for the government is to sell its assets, put that money into some sort of an infrastructure fund and use that money to finance higher public spending. But as we have seen over the last few years the disinvestment process has been a non starter. Now that leaves the government with only one option i.e. to finance the higher expenditure by borrowing more. This will lead to several other issues. As T N Ninan writes in the Business Standard: “The government could borrow more and invest, but the history of public sector investment is that, outside of sectors like oil marketing, the return on capital employed is lower than the government’s cost of borrowing.” While return on capital employed is not the best way to judge increased public spending, there are other issues that need to thought through as well. The government of India had managed to push its fiscal deficit down to 2.7% of GDP in 2007-2008. In 2008-2009, it decided to start increasing its expenditure to finance social schemes like NREGA and to give out subsidies as well. This pushed up the fiscal deficit to 6.4% of the GDP in 2009-10. This increased spending by the government helped the country grow at greater than 8% during a time when growth was collapsing all around the world in the aftermath of the financial crisis which started in September 2008. But it also led to a scenario of high interest rates and inflation, and a huge fall in household financial savings. The household financial savings have fallen dramatically over the last few years. The household financial savings rate was at 7.2% of the gross domestic product in 2013-2014, against 7.1% of GDP in 2012-2013 and 7% in 2011-2012. It had stood at 12% in 2009-2010. Household financial savings is essentially the money invested by individuals in fixed deposits, small savings scheme, mutual funds, shares, insurance etc. A fall in these savings led to high interest rates. The government was not creating any physical infrastructure through this increased spending. It was basically doling out money to asection of the population. As this money chased the same amount of goods and services it led to high inflation. Subramanian’s plan on the other hand is to use the increased government spending to create some physical infrastructure. Hence, increased government spending will not directly translate into inflation, as was previously the case. Nevertheless, all government spending in India has leakages and these leakages are likely to lead to some inflation. Further, there has been sharp fall in productivity over the last couple of years. As Swaminathan Aiyar puts it in his today’s column in The Economic Times:After 2012, the investment needed to produce one unit of output has gone up from four to seven units.” Long story short—these issues need to be thought through. Further, an increase in spending can push up fiscal deficit again to a level, which the international rating agencies as well as foreign investors may not like. If the rating agencies downgrade India or even threaten to downgrade India that will lead to a huge amount of foreign money leaving the debt and the equity market. If the foreign investors see the Indian fiscal deficit going out of control they can also choose to exit India. This will lead to the rupee falling to levels which are not health for the Indian economy. And since we import more than we export any fall in the value of the rupee tends to hurt us more. This is something that the country went through only last year, and it should not be so forgotten so quickly. Even if a part of the money invested in the debt market starts to leave the country, the rupee will crash against the dollar. This is precisely what happened between June and November 2013, when foreign institutional investors sold debt worth Rs 78,382.2 crore. The rupee crashed to almost 69 to a dollar. Over the last five years economists and columnists have been complaining about a high fiscal deficit, high interest rates and high inflation. A major part of this came out because of the huge jump in government spending starting in mid 2008. Ironically, the same guys are now recommending that the government needs to increase its spending to create economic growth. In fact, this noise is only going to get louder in the new year. What this tells us is that economists and columnists (who also fancy themselves as economists) basically have two ides: cut interest rates (an idea which came from Milton Friedman) and increase government spending (an idea which came from John Maynard Keynes). These two ideas keep repeating themselves in cycles. And now that Raghuram Rajan hasn’t obliged with an interest rate cut, the economists have jumped on to the increasing public spending idea. A version of the second idea is when the government decides to increase spending through printing money. The conspiracy theory going around is that is exactly what the government may be planning. Meanwhile, I am waiting for the day when an economist comes up with a third idea. The column appeared on as a part of The Daily Reckoning, on December 23, 2014

A 400 year old economic theory that the world has forgotten about

yellen_janet_040512_8x10Vivek Kaul

The Federal Open Market Committee (FOMC), which decides on the monetary policy of the United States, had its last meeting for this year scheduled on December 16-17th, 2014. After this meeting, Janet Yellen, the Chairperson of the Federal Reserve spoke to the media.
Everything Yellen spoke about during the course of the press conference was closely analysed by the financial media all over the world. The gist of what Yellen said at the press conference was that she expects that the Federal Reserve will start raising the federal funds rate sometime next year.
The federal funds rate or the interest rate at which one bank lends funds maintained at the Federal Reserve to another bank, on an overnight basis, acts as a benchmark for the short-term interest rates in the United States. The last time the Federal Reserve increased the federal funds rate was in 2006.
In the aftermath of the financial crisis, the Federal Reserve decided to print money and pump it into the financial system by buying government bonds and mortgage backed securities. The Federal Reserve referred to this as the asset purchase programme. The economists called it quantitative easing. And for those who did not want to bother with jargons, this was plain and simple money printing.
This was done to ensure that there was enough money going around in the financial system and interest rates remained low. At low interest rates the hope was that people would buy homes, cars and consumer durables. This would drive business growth, which in turn would drive economic growth, which would create both jobs and some inflation.
While this has happened to some extent, what has also happened is that a lot of money has been borrowed by financial institutions at very low interest rates and has found its way into stock markets and other financial markets all over the world. This has led to bubbles.
The economic theory explaining this phenomenon was put forward by Richard Cantillon, an Irish-French economist who lived during the early eighteenth century. He basically stated that money wasn’t really neutral and that it mattered where it was injected into the economy.
Cantillon made this observation on the basis of all the gold and silver coming into Spain from what was then called the New World (now South America). When money supply increased in the form of gold and silver, it would first benefit the people associated with the mining industry, that is, the owners of the mines, the adventurers who went looking for gold and silver, the smelters, the refiners and the workers at the gold and silver mines. These individuals would end up with a greater amount of gold and silver, that is, money. They would spend this money and thus, drive up the prices of meat, wine, wool, wheat, etc.
This rise in prices would impact even people not associated with the mining industry, even though they hadn’t seen a rise in their incomes, like the people associated with the mining industry had. This was referred to as the Cantillon effect.
Interestingly, Cantillon was also an associate of John Law. In 1705, John Law published a text titled Money and Trade Considered, with a Proposal for Supplying the Nation with Money. Law was of the opinion that money was only a means of exchange and that a nation could achieve prosperity by increasing the amount of money in circulation.
The problem of course was that when it came to gold and silver coins, only so much currency could be produced. But this disadvantage was not there with paper money. Law firmly believed that by circulating a greater amount of paper currency in the economy, commerce and wealth of a nation could be increased.
His theory was in place. But, like a physicist or a chemist, it could not be tested in a laboratory. Law needed a nation that was willing to let him test his theory. And France proved to be that nation. In 1715, France was the richest and the most powerful country in the world. But at the same time it was also almost bankrupt.
This was primarily because the country did not have a central bank of its own like the Dutch and the British had. Law’s idea was to create a central bank which would have the right to issue paper money which would be a legal tender. He also wanted to create a company which would have a monopoly of trade. This would create a monopoly of both finance as well as trade for France and the profits thus generated would help pay off the French debt.
Law went around establishing a bank called the Banque Royale and formed a company called the Mississippi Company, which was given a 25-year-long lease to develop the French territory along the Mississippi River and its tributaries in the United States. The Banque Royale was allowed to issue paper notes guaranteed by the French Crown.
Cantillon was an associate of John Law and observed the entire thing very closely. As Bill Bonner writes in Hormegeddon—How Too Much of a Good Thing Leads to Disaster: “Cantillon noticed that Law’s new paper money backed by the shares of the Mississippi Company—didn’t reach everyone at the same rate. The insiders—the rich and the well connected—got the paper first. They competed for goods and services with it as though it were as good as the old money. But by the time it reached the labouring classes, this new money had been greatly discounted—to the point, eventually, where it was worthless.”
This was the Cantillon effect. As analyst Dylan Grice told me during the course of an interview: “Cantillon, writing before the days of Adam Smith, was the first to articulate it. I find it very puzzling that this insight has been ignored by the economics profession. Economists generally assume that money is neutral. And Milton Friedman’s allegory about the helicopter drop of money raising the general price level completely ignores the question of who is standing under the helicopter.”
The money printed by the Federal Reserve in the aftermath of the financial crisis has been unable to meet its goal of trying to create consumer-price inflation and getting consumer spending up and running again. But it has benefited those who are closest to the money creation. This basically means the financial sector and anyone who has access to cheap credit. They were the ones standing under the helicopter when the money was printed and dropped.
Institutional investors have been able to raise money at close to zero percent interest rates and invest it in financial assets all over the world, driving up the prices of those assets and made money in the process.
It has also left these investors wondering what will happen once the Federal Reserve decides to end the era of “easy money” and start raising interest rates. In October 2014, the Federal Reserve brought its asset purchase programme to an end. This did not lead to a panic in the financial markets simply because the Fed made it clear that even though it would stop printing money, it would not start immediately withdrawing the money it had already printed and pumped into the financial system over the years.
But that is going to happen one day. Yellen is trying to get the financial markets ready for interest rate hikes starting next year. At least, that is the impression I got yesterday after watching her press conference.
Once the Fed decides to start withdrawing the money that it has printed and pumped into the financial system, and which in turn has found its way into financial markets all over the world, interest rates will start to go up. That will happen sooner rather than later. Maybe 2015. Maybe 2016. Who knows.
And once interest rates start to rise, the arbitrage of borrowing at low interest rates and investing money in financial markets all over the world, won’t be viable any more. It is difficult to predict precisely how exactly the situation will play out.
Nevertheless, Bonner summarizes the situation well when he says: “What exactly will happen, and when it will happen, we will have wait and find out. But it will be bad, that much is certain. We will hit rock bottom.”
All I can say to conclude is—Watch this space.

The column originally appeared on as a part of The Daily Reckoning, on December 19, 2014

M. Thornton, “Cantillon on the Cause of the Business Cycle,” The Quarterly Journal of Austrian Economics 9, 3(Fall 2006): 45–60 

J.E. Sandrock, “John Law’s Banque Royale and the Mississippi Bubble.” Avail­able online at

C. Mackay, Extraordinary Popular Delusions and the Madness of Crowds (Project Gutenberg, 1841). Available online under Project Gutenberg.

Arun Jaitley’s Rs 1,05,084 crore problem does not deserve a clean chit

Fostering Public Leadership - World Economic Forum - India Economic Summit 2010Vivek Kaul

Spoiler alert: For those who have not watched PK there is at least one spoiler ahead.

One of the advantages of not being employed is that one can still go and watch a movie when it releases on a Friday morning. And that is what I do from time to time, when all the reading and the writing starts getting to me.
So, this Friday I ended up watching an early morning show of Rajkumar Hirani’s PK, on the day of its release. A friend who works the film industry had already told me who or what PK was. So, I wasn’t really interested in finding that out, like a lot of people are. But I did enjoy watching the movie, given that it tackles a very difficult subject of religion, god and godmen and what they mean to each one of us, in a very upfront manner.
The most surreal moment in the movie is when after a bomb blast, the immortal words written by Sahir Ludhianvi, set to tune by Khayyam and sung by Mukesh, from the movie
Phir Subah Hogi, start playing: “Aasman pe hai khuda aur zameen pe hum. Aaj kal wo is tarf dekhta hai kum”.
I don’t know if the finance minister Arun Jaitley was able to watch
PK over the weekend, but if he did, he would be definitely complaining that the “economic god” seems to have abandoned him and his government.
On Friday i.e. December 19, 2014, the ministry of finance released the
Mid-Year Economic Analysis for this financial year. On page 6 of this report is a very interesting table. As per this table the government has overestimated the tax revenues this year to the extent of Rs 105,084 crore. This has primarily happened due to two reasons, the report says.

Estimating the Revenue Over-Projection in the Union Budget 2014-15

Source: Ministry of Finance

Notes: a) Budgeted GDP for 2013-14 is Rs 1,28,76,653 crore assuming a growth rate of 13.4 per cent whereas the actual GDP is Rs 1,25,58,711 crore @ 10.6 per cent growth rate achieved so far in 2014-15.
b) In the year 2010-11, there was an accelerated upward trend in the gross tax revenue majorly due to an increase in the growth rate of corporation tax, customs duties and union excise duties and also on account of dismal performance of tax revenue collections in the preceding years.
c) The year 2013-14 witnessed a downward trend in indirect tax collections.
1. Computed as the ratio of average growth rate of tax revenues to average growth rate of nominal GDP during 2008-09 to 2013-14. Alternative sample periods could be considered for computing historical buoyancy. A longer sample risks including periods where significant changes occurred in the tax base and rates. The sample chosen, although short and restricted to the post-crisis period, has the virtue of not having witnessed significant policy changes.
2. Computed as ratio of growth rate of tax revenues in 2013-14 (Provisional Actuals) to budgeted growth rate of nominal GDP in 2014-15.
3. Computed as the product of difference between historical and budget 2014-15 buoyancy, the actual GDP growth rate for 2014-15 and the tax collections in 2013-14 (Provisional Actuals).
4. Computed as the product of difference between the budgeted GDP growth rate and the actual GDP growth rate for 2014-15, the historical buoyancy and tax collections in 2013-14 (Provisional Actuals).
5. For Customs duty, buoyancy has been computed as the ratio of growth rate of import duty collections to growth rate of imports.

The first reason is the overestimation due to growth optimism. In the budget it was assumed that the nominal GDP for the current financial year would grow by 13.4 per cent to Rs 1,28,76,653 crore. Nevertheless, the actual growth between April and September 2014(the first six months of the financial year) was at only 10.6%, which means a nominal GDP of Rs 1,25,58,711 crore.
The taxes collected ultimately are also a function of how fast an economy grows. Given that the economy has grown at 10.6%, the taxes collected are lower in comparison to a situation where the economy had grown at 13.4% assumed in the budget. The short fall due to this overestimation is expected to be Rs 27,079 crore.
The second reason is the overestimation of the tax buoyancy. The report defines tax buoyancy as the ratio of revenue growth to the growth in the corresponding base, typically nominal GDP. So what does that mean in simple English? It essentially refers to a situation where the amount of taxes collected is expected to increase at a much faster rate in response to the growth in nominal GDP. That hasn’t turned out to be the case.
The nominal GDP as mentioned earlier was expected to grow at 13.4%. The total taxes collected by the government were expected to grow 16.9%. During the first six months of the financial year the total taxes collected actually grew by 5.1%. The short fall due to this overestimation is expected to be at Rs 78,005 crore.

Hence, the total shortfall in tax collections is expected to be at Rs 1,05,084 crore. Within this “the optimism was greater in relation to indirect taxes than for direct taxes”. Hence, direct taxes may have been overestimated to the extent of Rs 36,108 crore, whereas indirect taxes may have been overestimated to the extent of Rs 68,796 crore.
in a piece I wrote last week I had said that the indirect tax collections will be lower by Rs 68,496 crore, against the amount that has been estimated in the budget. The number is very close to the number that the half yearly economic analysis report has come up with.
Other than the lower tax collections, the government’s other big problem was the fact that subsidy payments from the last financial year had been postponed to this financial year. As the report points out: “In addition, the budget was strained by a legacy effect, reflecting the excess carryover of subsides from the past. This amount is difficult to quantify precisely but could range from 0.3 to as much as 1 percent of GDP.”
Hence, the report goes on to point out that: “Therefore, evaluating the fiscal performance this year should take account of the legacy costs and the ambitious targets that were inherited. They were ambitious because of optimistic revenue projections, of unanticipated moderation in inflation (the consumer’s gain being the Government’s loss), and also because of below-potential growth.”
In an era of clean chits, this is an attempt by the finance minister Arun Jaitley to give himself and his government a clean chit. Nevertheless, the situation is not as simple as it is made out to be. When Jaitley presented the first budget of the current government on July 16, 2014, he had an opportunity to correct the “so called” optimistic assumptions that the previous finance minister P Chidambaram had built into the interim budget presented earlier.
However, Jaitley had accepted these optimistic assumptions as a challenge.
As he had said during the course of his speech: “ Considering that we had two years of low GDP growth, an almost static industrial growth, a moderate increase in indirect taxes, a large subsidy burden and not so encouraging tax buoyancy, the target of 4.1 per cent fiscal deficit is indeed daunting. Difficult, as it may appear, I have decided to accept this target as a challenge. One fails only when one stops trying.”
Back then Jaitley had an opportunity to work with a more realistic set of numbers and present a more realistic total tax number, than what was presented. Now that he and his government have failed on that front it is hardly fair to blame ambitious targets that were inherited.
What was a challenge in July has now become an effort to pass the buck. As far as subsidies that were passed on are concerned, it is not as if Jaitley and his team did not know about them. They could have budgeted properly for these subsidies.
This government had an opportunity to start on a clean slate. And they chose not do that.
The trouble is that how will the government fill this gap of Rs 1,05,000 crore in its budget. In fact, the gap might be even higher given that the disinvestment target of Rs 58,425 crore looks unachievable. Only Rs 1,700 crore has been collected through this route until now.
As I have mentioned in the past, the only way for the government to fill such a massive gap in the budget is by cutting “asset creating” plan expenditure. This is a strategy that was followed by the previous government as well. In 2013-2014, the plan expenditure target was Rs 5,55,322 crore. The final expenditure came in at Rs 4,75,532 crore or around Rs 80,000 crore lower.
A similar exercise will have to repeated this year as well. The trouble is that in an environment where private investment is not growing much, if the government expenditure is also slashed, it will have a negative impact on economic growth.
Suggestions have started coming in that the government should forget about the fiscal deficit target for this year and continue spending money. But would this be a good strategy to follow? The previous government cranked up public spending in the aftermath of the financial crisis. For a couple of years India grew at near double digit rates, when the rest of the world was slowing down.
But this splurge came back to haunt us in the form of high interest rates, high inflation and a substantial fall in financial savings. I will write on detail on this issue in tomorrow’s column. Watch this space.

The column originally appeared on as a part of The Daily Reckoning, on Dec 22, 2014

What are the financial markets making out of Janet Yellen’s mumbo jumbo


Vivek Kaul

People who head central banks are not the kind who talk in a language that is easily understood. As Alan Greenspan, the Chairman of the Federal Reserve of the United States, the American central bank, from 1988 to 2006, once said “I guess I should warn you, if I turn out to be particularly clear, you’ve probably misunderstood what I’ve said.”
Nevertheless, things have changed in the aftermath of the financial crisis which broke out in September 2008. Central banks and individuals who head them now tend to communicate a little more clearly than they used to in the past.
Take the case of the Federal Reserve which has been saying for a while now that it will maintain low short term interest rates of between zero to ¼ percent “
for a considerable time”. The financial markets around the world have taken this phrase as good news. It has allowed them to borrow money at low interest rates and invest them in financial markets all over the world.
There is an entire army of people who make a living out of analysing what the Federal Reserve is saying. After the Federal Reserve chose to stop printing money in October 2014, there has been considerable debate among these army of analysts who track the Fed, about what does the phrase “for a considerable time” really mean. They have also asked if the Federal Reserve would remove the phrase when it met in December. And if it did that what would that mean?
The Federal Open Market Committee (FOMC) in the latest monetary policy statement released yesterday said: “Based on its current assessment, the Committee judges that it can be patient in beginning to normalize the stance of monetary policy.” It seemed that the Fed had dropped the phrase “for a considerable time,” which had kept the Fed watchers interested for a considerable period of time.
Interestingly, the statement then went to clarify that the new words did not mean anything different from the earlier phrase. “The Committee sees this guidance as consistent with its previous statement that it likely will be appropriate to maintain the 0 to 1/4 percent target range for the federal funds rate for a considerable time following the end of its asset purchase program,” the latest statement said.
Federal funds rate is the interest rate
at which one bank lends funds maintained at the Federal Reserve to another bank, on an overnight basis. Until October 2014, the Federal Reserve had been printing money and pumping money into the financial system by buying government bonds and mortgaged backed securities. This it referred to as the asset purchase program.
So, the Federal Reserve seems to have removed the phrase “for a considerable time” and reintroduced it as well. As the economist Tim Duy put it:
If you thought they would drop “considerable time,” they did. If you thought they would retain “considerable time,” they did. Everyone’s a winner with this statement.” Nevertheless, this briefly sent Fed watchers into a tizzy after the statement was released. What did the Fed really mean?
Janet Yellen, the Chairperson of the Federal Reserve, clarified this in the press conference that followed the Federal Reserve’s two day meeting.
The statement that the committee can be patient should be interpreted that it is unlikely to begin the normalization process for at least the next couple of meetings,” Yellen said.
What this possibly means is that the Federal Reserve won’t raise the federal funds rate, which acts as a benchmark for short term interest rates at least till April. The Federal Reserve’s first two monetary policy meetings are scheduled in January and March next year.
Interestingly, later on in the press conference Yellen in a way took back this earlier statement when she said: “
The Fed will feel free to make news at meetings even when there isn’t a scheduled press conference.” She also said that “no meeting is completely off the table” for raising interest rates.
All FOMC meetings do not have a press conference scheduled after the meeting ends. The Federal Reserve doesn’t have another press conference scheduled until March 2015. So, at the end of the day Yellen wasn’t really clear in communicating about when the Federal Reserve is likely to start raising the federal funds rate.
In the FOMC statement it was said that the Federal Reserve would be “patient” when it came to raising the federal funds rate. In the press conference Yellen said that the Fed wasn’t likely to raise the federal funds rate in the first two meetings scheduled next year. Then she also said that no meeting is completely off the table when it comes to the question of raising the federal funds rate.
Also, in the meeting Yellen dismissed all the reasons against not increasing the federal funds rate.
So where does all this leave us? Confused? Bloomberg View has a possible answer:
The Fed doesn’t know when it will start to raise interest rates, nor should it have to know, nor should it indulge analysts’ misconceived determination to find out. Interest-rate changes are not, and should not be, on a schedule. They depend entirely on what happens in the economy, and the Fed — like every last one of those analysts — doesn’t know what will happen.”
So why did the Federal Reserve and Janet Yellen indulge in all the mumbo jumbo? As
Bernard Baumohl, The Economic Outlook Group, told The Wall Street Journal: “For a Fed that seeks to introduce more clarity and transparency of its views, they have in fact done the opposite. The tortuous, semantic-conscious language of the statement is really an exercise in obfuscation, one that harkens back to the days of Alan Greenspan.” So “Janet Yellen” managed to do an “Alan Greenspan” yesterday.
Further, like the analysts who track the Federal Reserve, the Fed Chairperson is also not in a position to say: “I don’t know”. Even though Yellen clarified time and again that everything was “data dependent”.
The statement issued by the Fed was vague enough. But in the press conference Yellen said that the Fed would not raise the federal funds rate for the first couple of meetings next year, and then she had to quickly go into damage control mode, to try and make things vague enough again. My theory is that Yellen is trying to get the markets used to the idea of higher interest rates in the days to come, without saying so loud and clear, so that she does end up spooking the markets.
The all important question is how is the market taking it? The financial markets all over the world were worried that the Federal Reserve might increase the federal reserve rate for the first time in eight years since 2006. Now that has not happened. Also, it is likely that the Federal Reserve might not raise rates before April (that was one of the things that Yellen said after all).
Further, the consumer price inflation in the United States for the month of November 2014 came in at 1.3%. The number had stood at 1.7% in October 2014. This is the largest month on month decline in inflation since December 2008. This fall in inflation has largely been due to a massive decline in oil prices over the last six months.
The point here being that a rate of inflation of 1.3% is well below Fed’s inflation target of 2%. As the Federal Reserve’s statement yesterday pointed out: “the Committee will assess progress–both realized and expected–toward its objectives of maximum employment and 2 percent inflation”. If the inflation number continues to be well below 2%, then there is not much chance of the Federal Reserve raising interest rates immediately.
This is the message that the financial markets seem to have taken from the Federal Reserve. The S&P 500, one of the premier stock market indices in the United States, rallied by 2% to close at 2012.89 points yesterday. The Nikkei 225 in Japan is up 2.3% to 17,232 points today. Stocks in Australia were up 1%. The BSE Sensex is currently up around 1% and is quoting at levels of around 27,000 points.
Long story short: The financial markets seem to remain convinced that the easy money will continue at least in the short-term. Yellen, on the other hand is trying to get the markets ready for an interest rate hike next year.

The article appeared originally on on Dec 18, 2014

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