Month: January 2015 | Page 3

21 January, 2015

No more Rajagopals

R Gandhi, one of the deputy governors of the Reserve Bank of India (RBI), gave a very interesting speech titled Indian PSU Banking Industry: Road Ahead in Kolkata last week.
As a part of the speech he presented a table (a part of which is reproduced below) which shows how public sector banks (PSBs) are lagging behind their new generation private sector counterparts, on all parameters.

		Public sector banks		New generation private sector banks
Year	2012	2013	2014	2012	2013	2014
Return on Equity	16.55	15.31	9.71	15.38	16.81	17.06
Return on Assets	0.9	0.8	0.5	1.63	1.76	1.83
Net Profit Margin	9.25	8.27	5.4	15.34	15.8	16.68
Net Interest Margin	2.84	2.64	2.48	3.22	3.46	3.56
Staff Expenses / Total Income	10.74	10.48	10.99	8.97	8.39	7.96
Source: Reserve Bank of India

The new generation private sector banks generate better returns for their shareholders, operate at better margins and surprisingly even have a lower staff cost as a proportion of the total income they make, in comparison to public sector banks.
While one expects these banks to have done better than public sector banks, when it comes to returns to shareholders as well as operating margins, one did not expect them to have lower staff expenses as a proportion of their total income. That indeed is a major surprise.
There are multiple reasons for this difference in performance. First and foremost, private banks do not have to deal with political pressure to make loans to favoured individuals and companies.
Take the case of Lanco Infratech, a company, whose founding chairman Lagadapati Rajagopal was a member of the last Lok Sabha from the Congress party. This company, as on March 31, 2014, had total loans amounting to a whopping Rs 34,877 crore. Against this the company had an equity of only Rs 1,457 crore, meaning a debt equity ratio of 24:1.
To put in a simple way, the situation is similar to you and I approaching a bank for a home loan for a home priced at Rs 50 lakh. The bank agrees to give us a home loan of Rs 48 lakh and we need to put in only Rs 2 lakh from our end(which is essentially what equity is) to buy the home. This would mean a personal debt equity ratio of 24:1.
Of course, no bank would do this and would ask for a downpayment of at least 20% of the home price or Rs 10 lakh in this case. But public sector banks did not operate in a similar way when it came to giving out loans to crony capitalists. Crony capitalists got away without putting much of their own money at risk.
And the public sector banks are paying for the same now. The financial stability report released by the Reserve Bank of India (RBI) late last month put the stressed advances of public sector banks at 12.9% of their total loans. For private sector banks the same number was at 4.4%.
The financial stability report further points out that: “Among bank groups, exposure of public sector banks to infrastructure stood at 17.5 per cent of their gross advances as of September 2014. This was significantly higher than that of private sector banks (at 9.6 per cent) and foreign banks (at 12.1 per cent).” It is well known that many crony capitalists in India operate in the infrastructure sector. The higher exposure to this sector has led to higher stressed advances as well.
Interestingly, the government conveyed to the public sector banks at a recent retreat in Pune that it would not interfere in their commercial decisions. “The banks/financial institutions should take all commercial decisions in the best interest of the organization without any fear or favour,” the government said.
If the government sticks to this decision the performance of public sector banks is bound to improve in the days to come. India does not need any more Lanco Infratechs and its Rajagopals. As RBI governor Raghuram Rajan put it in a recent speech, India is “a country where we have many sick companies but no “sick” promoters.” If public sector banks need to do well this needs to be corrected in order to ensure that big business does not take them for a ride in the years to come.
It needs to be pointed out here that employees of public sector banks are selected through highly competitive exams and they are not any lesser than their private sector counterparts. Hence, they have the ability required to figure out which loans to give and which to avoid, if they are allowed to operate on their own without any political interference.
Nevertheless, public sector banks need to put a proper performance appraisal system in place, something that their private sector counterparts already have. As RBI deputy governor Gandhi said in his speech: “The Performance Appraisal System (PAS) needs a complete revamp. Currently the PAS makes no meaningful distinction between individuals for identifying or deploying talent, skills and / or specialisation; nor does it guide determining compensation.”
In fact, stock options play a very important role in retaining and motivating managerial talent to perform better at new generation private sector banks. The government needs to seriously take a look at introducing stock option plans linked to performance, in public sector banks as well.
Further, the government currently owns 25 public sector banks (which includes the State Bank of India and its five associates). There is no reason as to why the government should own 25 banks. It is time that the government got around to selling at least 15 of the smallest banks. That would leave five big banks and SBI and its associates.
The money thus generated could be used to fund a part of the public infrastructure that India badly requires. This topic is a political hot potato and sooner the government starts work on it, the better it is going to be for it.
This will also save the government from another major headache. The PJ Nayak committee report released in May 2014, estimated 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.”
This is not exactly a small amount and by selling 15 banks this won’t totally be government’s headache any more. Further, by concentrating on the largest banks, the government can ensure that these banks are better capitalized in the days to come and can strongly work towards government’s projects like financial inclusion.

(Vivek Kaul is the author of the Easy Money trilogy. He can be reached at [email protected])

The article originally appeared in the Daily News and Analysis on Jan 20, 2015

21 January, 2015

The RBI cannot revive Indian real estate

Vivek Kaul

Raghuram Rajan took over as the governor of the Reserve Bank of India (RBI) in September 2013. Since then, real estate companies and associations that represent these companies have been asking (i.e. putting it politely) for a repo rate cut. The repo rate is the interest rate at which RBI lends to banks and acts as a benchmark for the interest rate at which banks borrow money and in turn, the interest rate at which they lend. Every time Rajan did not cut the repo rate, real estate companies and associations representing them, put out statements in the media saying how high interest rates were hurting the sector and were the main reason why people were not buying homes that were being built. Hence, when the RBI decided to cut the repo rate last week, the real estate companies had a reason to rejoice. Take a look at this statement made by Rohit Raj Modi, President of the Confederation of Real Estate Developers’ Associations of India (CREDAI) in the National Capital Region: “We have been raising the concerns of developers over higher rates from the government. We are happy that RBI has taken a step by cutting the rates. We expect that this will encourage banks to ease their home loan rates…This will help developers to expedite their projects which were otherwise facing fund crunch. Home buyers’ dreams of owning a home would also get a boost as we expect an accelerated purchase cycle(The emphasis is mine).” The most important part of the statement is the last sentence which I have italicized. Modi, who represents the real estate developers in and around Delhi feels that a 25 basis cut in the repo rate by the RBI will lead to more people buying homes. This is a sentiment echoed by Rajiv Talwar, DLF group executive director. As Talwar told the PTI: “The move would definitely encourage buyers now to invest in new homes.” [interestingly, Talwar uses the word invest and not buy]. I wonder where this confidence comes from. The real estate story has gone beyond interest rates and EMIs for a while now. People are not buying real estate simply because it is too expensive. It has been priced way beyond what they can afford. Take a look at the following table. The weighted average price of a flat in Mumbai is Rs 1.34 crore. The average per capita income of a Mumbaikar is Rs 1.97 lakh. This means that it takes 68 years of average per capita income to buy a flat in the Mumbai Metropolitan Region. For Bangalore, the number is at 81.5 years. This is a little difficult to believe. The average income of Bangalore is Rs 1.08 lakh. The number is very low in comparison to the average income of other cities considered in the table. The reason for it is that 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 and hence, drag down the overall number.

City	Weighted Average Price of a Flat	Per Capita Income	Years	Inventory
Mumbai Metropolitan Region	Rs 1.34 crore	Rs 1.97 lakh	68 years	50 months
National Capital Region	Rs 75 lakh	Rs 2.31 lakh	32.5 years	83 months
Bangalore	Rs 88 lakh	Rs 1.08 lakh	81.5 years	41 months
Pune	Rs 58 lakh	Rs 1.83 lakh	31.7 years	23 months
Hyderabad	Rs 75 lakh	Rs 1.46 lakh	51.4 years	38 months

Source: Liases Foras and state government documents

What this table clearly tells us is that Indians are not buying homes to live in primarily because homes are priced way beyond what is affordable. This becomes clear at the massive inventory numbers being reported (as can be seen from the table). “Months inventory denotes the months required to clear the stock at the existing absorption pace. A healthy market maintains 8 months of inventory,” points out Liases Foras, a real estate rating and research firm in a report.
The following table shows very clearly that the months inventory across major cities is way over the healthy level of eight months and high price is the only possible explanation for it.

City	Inventory	Number of times healthy inventory of 8 months
Mumbai Metropolitan Region	50 months	6.25
National Capital Region	83 months	10.375
Bangalore	41 months	5.125
Pune	23 months	2.875
Hyderabad	38 months	4.75

One criticism of this piece of analysis which I can immediately see coming is that the average income of a city hides all kinds of variations. So, for a city like Mumbai it would also take into account the incomes of people who live in slums. And these people should not be considered because they cannot afford the flats being built. The point is that no one stays in a slum by choice. People stay in a slum because they cannot afford proper housing. Another point that I would like to make here is that when such analysis is carried out in developed countries they consider the ratio of weighted average price of a home and disposable income. I had to make do with average income primarily because I could not find any disposable income data for Indian cities (I would be grateful to anyone who could lead me to such data, if it exists). Nevertheless we can make an assumption that around 40% of income is disposable income (I guess that is on the higher side, but let’s just go with it and see how the numbers work out. Also, I am leaving Bangalore out of the calculation for reasons already explained). The following table shows how crazy the situation actually is.

City	Weighted Average Price of a Flat	Per Capita Income	Disposable Income	Years
Mumbai Metropolitan Region	Rs 1.34 crore	Rs 1.97 lakh	Rs 78,800	170
National Capital Region	Rs 75 lakh	Rs 2.31 lakh	Rs 92,400	81.2
Pune	Rs 58 lakh	Rs 1.83 lakh	Rs 73,200	79.2
Hyderabad	Rs 75 lakh	Rs 1.46 lakh	Rs 58,400	128.4

Assuming that disposable income is 40% of average income it would take 170 years of disposable income to buy a flat in Mumbai. Hyderabad comes in second at 128.4 years. In fact, in a recent article in the Business Standard columnist Bhupesh Bhandari made a similar point when he wrote: “According to one study, it will take an Indian with the average per capita income 580 years to buy a top-end property in Mumbai, compared to 65 years in Hong Kong, 62 years in Paris and 47 years in New York.” So, the real estate companies and media reports may keep blaming high interest rates for people not buying homes, but that isn’t really the case. Edelweiss Capital expects the RBI to cut the repo rate by further 100-125 basis points by March 2016. I can say this with confidence that unless real estate prices fall, even with such a massive cut in the repo rate (which is likely to lead to lower home loan rates) home sales won’t pick up. I can also say with confidence that the real estate companies will continue blaming the RBI. But RBI clearly does not have a solution to this problem.

The column originally appeared on www.equitymaster.com as a part of The Daily Reckoning on Jan 19, 2015

21 January, 2015

Why Raghuram Rajan finally cut the repo rate

Vivek Kaul

“I have never run a full marathon, and my wife will not let me run one…She says that’s tempting fate.” – Raghuram Rajan in an interview to The New York Times

I am not an early riser. These days with no full time job, I rarely wake up before 10 AM. Yesterday was not any different and by the time I woke up, I had already got a few messages on WhatsApp from friends and ex-colleagues informing me that Raghuram Rajan, governor of the Reserve Bank of India (RBI), had finally cut the repo rate.
Repo rate is the rate at which RBI lends to banks and acts as a sort of a benchmark to the interest rates that banks pay for their deposits and in turn charge on their loans. Rajan cut the repo rate by 25 basis points(one basis point is one hundredth of a percentage) to 7.75%.
For the past few months there was tremendous political pressure on the governor to cut the repo rate. So what prompted Rajan to finally cut it? “To some extent, lower than expected inflation has been enabled by the sharper than expected decline in prices of vegetables and fruits since September, ebbing price pressures in respect of cereals, and the large fall in international commodity prices, particularly crude oil…Weak demand conditions have also moderated inflation excluding food and fuel, especially in the reading for December,” Rajan said in a statement released early morning yesterday.
The massive crash in crude oil price has contributed to lowering inflation to some extent. But more than that it has helped save precious foreign exchange spent on importing oil. As, Urjit Patel, one of the deputy governors of the Reserve Bank of India (RBI), recently explained “The dramatic fall in oil prices is a boon for us. It saves, on an annualised basis, around US$ 50 billion, roughly, one-third of our annual gross POL (petroleum, oil and lubricants) imports of about US$ 160 billion.”
The fall in the price of crude oil as I have pointed out in the past, has also ensured that the government’s fiscal deficit hasn’t gone totally for a toss. Even with the massive fall in crude oil prices the fiscal deficit for the period April to November 2014 was at 99% of the annual target. Now imagine where the fiscal deficit would have been if this fall in crude oil price had not happened.
On December 2, 2014, the day the Fifth Bi-Monthly Monetary Policy Statement for the last year was released, the Rajan led RBI had kept the repo rate unchanged. The price of the Indian basket of crude oil on December 2, 2014, had stood at $70.08 per barrel. By January 14, 2015, the price of the Indian basket of crude oil had fallen by a massive 38.1% to $43.36 per barrel.
This was a huge change from the time of the last monetary policy statement was released around six weeks back. Clearly, Rajan and the RBI, like almost all other experts, did not see this massive fall in oil price coming.
If that had been the case, the RBI would have cut the repo rate last month itself. As The New York Times reports: “Mr. Rajan also defended his decision not to lower interest rates at his last monetary policy review in December. While oil prices had already fallen considerably by then, he said there was no way to foresee the abrupt plunge that followed.”
The RBI expects the oil prices to continue to remain low. “Crude prices, barring geo-political shocks, are expected to remain low over the year,” the central bank said yesterday.
Another reason which led to the RBI cutting interest rates in between meetings are the falling inflation expectations (or the expectations that consumers have of what future inflation is likely to be).
As per the previous Reserve Bank of India’s Inflation Expectations Survey of Households, the inflationary expectations over the next three months and one year were at 14.6 percent and 16 percent. In the latest inflation expectations survey released yesterday, these numbers have crashed to 8.3% and 8.9% (See chart that follows). “ Households’ inflation expectations have adapted, and both near-term and longer-term inflation expectations have eased to single digits for the first time since September 2009,” Rajan said. This would have been another reason which led the Rajan led RBI to an inter-meeting cut in the repo rate.

Trends in Inflation Perceptions and Expectations

In the statement released on December 2, 2014, RBI had hinted that rate cuts would start in early 2015. “If the current inflation momentum and changes in inflationary expectations continue, and fiscal developments are encouraging, a change in the monetary policy stance is likely early next year, including outside the policy review cycle,” the statement had said.
And that is precisely what the Rajan led RBI has done. It had also said that: “The Reserve Bank has repeatedly indicated that once the monetary policy stance shifts, subsequent policy actions will be consistent with the changed stance.” What this meant in simple English is that once the RBI was convinced that inflation has been brought under control it would cut interest rates rapidly.
Crisil Research expects the RBI to “ cut rates by 50-75 basis points over the next fiscal (i.e. 2015-2016).”
Analysts Chetan Ahya and Upasana Chachra of Morgan Stanley are more bullish. They said in a research note released yesterday: “We believe that this is a beginning of a big rate cut cycle. We expect a further 125bps rate cuts over the next 12 months, cumulative 150bps in this cycle (compared with our earlier forecast of 50bps rate cuts). We expect a further rate cut of 25bps in the next monetary policy review on Feb 3.”
Personally, I don’t think Rajan will cut the repo rate on February 3. He will wait for the government to present the annual budget and then decide further course of action. As he said in yesterday’s statement: “Key to further easing are data that confirm continuing disinflationary pressures.” This means that if inflation keeps falling or remains stable, the RBI will cut the repo rate more in the days to come.
As Crisil Resarch pointed out in a research note yesterday: “Retail inflation has stayed within 5% and core inflation [non food-non fuel inflation] continues to decline. Core inflation fell to 5.5% from 5.8% in November, the lowest recorded since the beginning of the new CPI series in 2012. Current momentum suggests inflation could fall below the RBI’s target of 6% by March 31, 2015. Wholesale price index based inflation (WPI) has hit the rock-bottom, coming at 0% in November and 0.11% in December…In addition, the fall in WPI is accompanied by a mirroring decline in the CPI index, something that was missing in 2009. This points to the sustainability of the current disinflationary trend, and strengthens the case for lower policy rates.”
Nevertheless Rajan also said that “also critical would be sustained high quality fiscal consolidation.” As Crisil Research pointed out: “The speed of the cuts will hinge on continued fiscal consolidation, and measures to improve the potential of the economy so that higher GDP growth does not set off fresh price fires.” And that is something to watch out for.
And to decide whether “fiscal consolidation” is happening Rajan would have to wait for the government to present its budget. Another reason why a rate cut is unlikely on February 3 is that no key economic data points are to be released between now and then.

Postscript: Economist Surjit Bhalla told Reuters yesterday that : “If there is a deal between Rajan and Jaitley, that’s very very positive…Monetary and fiscal policy should be coordinated.” This isn’t the best way to approach the issue, for the simple reason that politicians want interest rates to remain low all the time.
Alan Greenspan, the former chairman of the Federal Reserve of the United States, recounts in his book The Map and the Territory that in his more than 18 years as the Chairman of the Federal Reserve, he did not receive a single request from the US Congress urging the Fed to tighten money supply and thus not run an easy money policy.
In simple English, what Greenspan means is that the American politicians always wanted low interest rates. India is no different on that front. The current finance minister Arun Jaitley has made several comments in the recent past asking the RBI to cut the repo rate. The previous finance minister P. Chidambaram was no different.
To conclude, it is well worth remembering 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.”

The column originally appeared on www.equitymaster.com as a part of The Daily Reckoning on Jan 16, 2015

16 January, 2015

Raghuram Rajan no longer a rate cut virgin, but 25 bps amounts to little

Vivek Kaul

Raghuram Rajan is no longer a virgin—he has just announced his first repo rate cut as the governor of the Reserve Bank of India (RBI). Rajan cut the repo rate by 25 basis points (one basis point is one hundredth of a percentage) to 7.75% and in the process took everybody by surprise. Repo rate is the rate at which the RBI lends to banks.
“To some extent, lower than expected inflation has been enabled by the sharper than expected decline in prices of vegetables and fruits since September, ebbing price pressures in respect of cereals and the large fall in international commodity prices, particularly crude oil. Crude prices, barring geo-political shocks, are expected to remain low over the year. Weak demand conditions have also moderated inflation excluding food and fuel, especially in the reading for December. Finally, the government has reiterated its commitment to adhering to its fiscal deficit target,” Rajan said in a statement explaining why the RBI had chosen to cut the repo rate.
Most economists and analysts who follow the moves of the RBI had been saying that a rate cut would come only after the budget was presented in the month of February. “I am very surprised because it goes against the whole current governor’s philosophy that monetary policy should be predictable. It shows the governor is very pragmatic and can look at his own position and can change,” NR Bhanumurthy, Economist, National Institute of Public Finance and Policy told Reuters. Since taking over in September 2013, Rajan has raised the repo rate multiple times to rein in inflation and to protect the crashing rupee. Nevertheless, increases in the repo rate are boring. They only spell gloom and doom. As interest rates go up, corporates don’t invest and you and I don’t borrow to spend, making things a tad unexciting.
Repo rate cuts on the other hand are fun—look at the smiles that have come back on the faces of business news anchors for one. The Sensex has also rallied big time. And as I write this, it is up 622.28 points or 2.3% from yesterday’s close. The government bond yields fell sharply.
The bankers are all happy. And so are the corporates. At least, that’s how things are being portrayed in the media in general and on television in particular. Don’t be surprised tomorrow morning to read newspapers with headlines “your home loan EMIs are ready to fall,” and how real estate companies expect home sales to pick up again.
Or to put it in a language that everybody understands these days: “acche din aane waale hain”. “It will provide some fillip to the economy both directly and indirectly,” Arvind Subramanian, Chief Economic Adviser to the ministry of finance said.
Finance minister Arun Jaitley, who over the last few months has vociferously been demanding a RBI rate cut said “[the rate cut] will put more money in hands of consumers. [It will be] positive for the Indian economy will help revive investment cycle.”
These are fairly simplistic statements. Just because the RBI has cut interest rates by 25 basis points does not mean that corporates and consumers will start borrowing.
As John Kenneth Galbraith points out in The Economics of Innocent Fraud: “If in recession the interest rate is lowered by the central bank, the member banks are counted on to pass the lower rate along to their customers, thus encouraging them to borrow. Producers will thus produce goods and services, buy the plant and machinery they can afford now and from which they can make money, and consumption paid for by cheaper loans will expand.” This is the logic that has been offered by both Subramanian and Jaitley.
But things play out a little differently in the real world. “The difficulty is that this highly plausible, wholly agreeable process exists only in well-established economic belief and not in real life. The belief depends on the seemingly persuasive theory and on neither reality nor practical experience. Business firms borrow when they can make money and not because interest rates are low,” Galbraith points out.
So, corporates are not just going to start borrowing and investing because the repo rate has been cut by 25 basis points. As Bhanumurthy told Reuters: “I don’t think it will have too much impact because investment is not dependent on interest rates alone.” Further, the Indian corporates are heavily leveraged and they are really in no position to borrow more. Banks have already lost too much lending to them and will be very careful lending more.
What about consumers? Will they borrow and spend more? Here it is important to go back again to what Galbraith writes in The Affluent Society: “Consumer credit is ordinarily repaid in instalments, and one of the mathematical tricks of this type of repayment is that a very large increase in interest brings a very small increase in monthly payment.” And vice versa—a large cut in interest rate decreases the monthly payment by a very small amount.
I have often made this argument in the past, nevertheless its worth repeating here. An individual decides to take a car loan of Rs 4.25 lakh at 10.5%, repayable over a period of five years. The monthly payment or the EMI on this loan amounts to Rs 9,134.9. Now let’s say the RBI decides to cut the repo rate by 25 basis points.
The bank decides to pass on this rate cut to the consumers (something that doesn’t always happen) and cuts the car loan rate by 25 basis points to 10.25%. The EMI now falls to Rs 9082.4 or Rs 52.5 lower. If the cut is 50 basis points as is being speculated on television channels right now, the EMI will fall by around Rs 105. Is someone going to go buy a car just because the EMI has fallen by a little over Rs 50 or Rs 100? I am sure it takes a lot more than that. For loans of lower denominations the difference in EMIs will be even lower.
What about home loans? In that case there is some fall in EMIs, but the basic problem with real estate is that its way too expensive and unless a big fall in price happens, people are not going to buy homes, even if the EMIs come down significantly.
So what does that leave us with? Not much. Monetary policy impact is over-rated. There are many other factors that need to go right for the economy to be up and running again.
The expectation is that Rajan will cut continue to cut rates in the days to come. Shubhada Rao, Chief Economist, YES Bank told Reuters: “We are expecting 50 basis point rate cut between now and June.”
Rajan in his statement said: “Key to further easing are data that confirm continuing disinflationary pressures.” This means that if inflation keeps falling, RBI will cut the repo rate more. Nevertheless Rajan also said that “also critical would be sustained high quality fiscal consolidation.”
This is where things get interesting. What Rajan is essentially saying is that he is waiting for next financial year’s budget to see what sort of fiscal deficit number does the government come up with. Fiscal deficit is the difference between what a government earns and what it spends.
While, the finance ministry mandarins have taken great pains to say that this year’s fiscal deficit target is sacrosanct, no such statements have been made regarding the next year.
In the Mid Year Economic Analysis, Subramanian wrote that: “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.” This has led to a situation where banks aren’t interested in lending and corporates aren’t interesting in investing.
In order to get around this problem Subramanian suggested 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.”
If this were to be implemented it would mean more government spending and a higher fiscal deficit. Higher government spending typically leads to a prospect of high inflation as more money chases the same volume of goods and services. This is something that Rajan will keep a lookout for before deciding to continue with the repo rate cuts.
To conclude, for monetary policy to drive private investments and consumer spending, interest rates need to come down by a huge margin (at least around 300-350 basis points). A 25 basis point cut really amounts to nothing.

The column originally appeared on www.firstpost.com on Jan 15, 2015

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

16 January, 2015

Yesterday, once more: Will LIC come to govt’s rescue again?

On January 13, 2015, the ministry of finance declared the indirect tax collection numbers for the period April to December 2014. And they aren’t looking very impressive.
The government managed to collect Rs 3,77,648 crore during the period, in comparison to Rs 3,54,049 crore it had managed to collect during the same period last year. This is a jump of 6.7%. Indirect taxes include excise duty, customs duty and service tax.
The trouble is that the indirect tax collection target for this financial year is Rs 6,24,902 crore. The total amount collected in the last financial year stood at Rs 5,19,520 crore. Hence, it was assumed that the indirect tax collection would grow by 20.3% from what was achieved last year.
What this tells us clearly is that the growth of the indirect tax collections is nowhere near what it was assumed to be. In the first nine months of the year, the government has managed to collect only 60.6% of the year’s target, meaning that 39.4% of the target still remains to be collected in the last three months of the financial year. Also, unlike direct tax, the collection of indirect taxes is not totally skewed towards the end of the year.
In a report titled Will the Government Meet the Fiscal Deficit Target for F2015? analysts Chetan Ahya and Upasana Chachra of Morgan Stanley point out that “tax collection picks up seasonally toward the end of the fiscal year, with direct tax collection between December and March at 51.4% of total (five-year average) and indirect tax collection at 42% of total.”
So, between December and March, in the last five financial years, the government managed to collect 42% of the indirect tax target set for the year. This time around it needs to collect 39.6% of the annual target between January and March, which will be a tough ask indeed.
It needs to be pointed out here that during the last five years, the economic growth for a significant part of the period was greater than 8%. Currently, the economic growth is around 5%. Hence, indirect tax collections will slowdown to that extent.
Take the case of excise duty. In the first nine months of the financial year the government managed to collect Rs 1,19,719 crore of excise duty, a jump of just 1.6% in comparison to the last financial year. When the budget was presented the government had assumed that excise duty collection will jump by 15.4% during the course of the year.
The government has increased the excise duty on petrol and diesel thrice since October 2014. The third increase came on January 1, 2015, and hence, the excise duty collected because of this increase are not a part of the just released indirect tax data.
The higher excise duty on petrol and diesel is expected to boost the indirect tax collections between January and March 2015 by Rs 14,600 crore, write Ahya and Chachra.
At the same time the “removal of excise SOPs for autos and consumer goods sectors from December 31 [is]expected to add ~Rs 2,400 crore between January and March,” feel the Morgan Stanley analysts.
But even this will not help the government meet its excise duty target of Rs 2,07,110 crore. Taking into account average collections over the last five years and this year’s indirect tax collections it is highly unlikely that the government will be able to meet its indirect tax target for this year. My guess is that it will fall short of the target by around 8-10%.
This gap will amount to Rs 50,000-60,000 crore (~ 8-10% of indirect tax target of Rs 6,24,902 crore). How will the government fill this gap? One way as I have often pointed out in the past will be to cut expenditure. A recent newsreport in the Business Standard points out that “on an average, key ministries, including those of agriculture, rural & urban development, and infrastructure, might see cuts of up to 20 per cent in Plan allocation compared to the FY15 Budget estimates.” This can’t be good news in an environment where corporate investment is slow due to excessive debt levels.
The government will also force public sector units to shell out higher dividends as it had done last year as well. The dividends from public sector units were supposed to contribute Rs 29,870.12 crore to last financial year’s budget. Ultimately the government ended up collecting Rs 43,074.58 crore. This year’s target is Rs 27,815.10 crore. The actual number this year will also be considerably higher.
What adds to the troubles of the government is the fact that it looks highly unlikely to meet the disinvestment target as well. Disinvestment of shares in public sector units was expected to bring in Rs 43,425 crore. Until now only Rs 1,700 crore has come in through this route. Now news coming in suggests that bankers are having a tough time lining up investors for the shares of companies that the government wants to disinvest.
The Economic Times reports that: “Bankers are finding it tough to convince foreign investors to commit money in the proposed share sale as the government is yet to implement reforms that it had promised while marketing the issues previously.”
Whenever such a situation has arisen in the past, where the market is not ready to buy shares of public sector companies, the government has forced the Life Insurance Corporation (LIC) of India to come to its rescue by buying these shares.
The money invested by LIC is essentially the hard earned savings of millions of people and it is not fair to use it to help bail out the government all the time. From the looks of it something similar seems to set to happen this year as well, which is clearly not good news.
What does not help the government is the fact that it has very little time left to carry out the disinvestment. For reasons, which only the government can best explain, there has been barely any activity on the disinvestment front over the last six months and only now things are looking to pick up. But it may be a case of too little too late.

The column originally appeared on www.equitymaster.com as a part of The Daily Reckoning on Jan 15, 2015