Month: October 2015 | Page 5

7 October, 2015

Of Jaitley, black money and much ado about nothing

In May earlier this year, the Parliament passed the Undisclosed Foreign Income and Assets (Imposition of New Tax) Act. After the passage of this Act, also known referred to as the black money Act, the government offered a compliance window.

This window allowed those with undisclosed foreign assets and income to declare them, pay a tax of 30% and a penalty of 30%. The window was closed on September 30, 2015.

Taking advantage of the compliance window 638 declarants declared assets and income of Rs 4,147 crore in total. This meant that the government will be able to collect around Rs 2,488 crore (60% of Rs 4,147 crore) as tax revenues. This means around Rs 3.9 crore of tax and penalty will be collected on an average from every declarant.

For all the hype and hoopla that has happened around black money in the last one year, this is barely peanuts. The tax and the penalty need to be paid to the government by December 31, 2015.

The annual report of the ministry of finance for 2014-15 has some interesting data points that need to be mentioned here. The total number of assesses in 2013-2014 had stood at 4.7 crore. These includes individuals, families, trusts and corporates. What this clearly tells us is that not many Indians pay income tax.

Hence, as a result every year a significant amount of black money on which tax is not paid is generated.

And given this, a collection of Rs 2,488 crore is basically a bad joke especially once you take into account the tremendous amount of political capital that the Narendra Modi government has spent on the black money issue.

Having said that, this should hardly come as a surprise to the government given that the black money recovery skills of the Income Tax department are nothing to write home about. As the ministry of finance annual report points out: “The Income Tax Offices throughout the country continued their drive against tax evaders. During the financial year 2014-15 (upto 30.11.2014), 2068 (provisional) search warrants were executed leading to the seizure of assets worth Rs 538.23 Crore (provisional). During the financial year (upto 30.11.2014), 1174 surveys (provisional) were conducted which yielded a disclosure of undisclosed income of Rs 4673.11Crore (provisional).”

So, once Rs 2,488 crore is looked at from the point of the numbers mentioned in the above paragraph, it doesn’t look so dreadful. The basic point here is that the black money recovery skill of the Income Tax department has been very poor.

There could be several reasons for this. Corruption. Incompetence. Not enough people. Or simply the fact that the crooks are always one step ahead of those who are supposed to catch them.

Long story short—people who have a large amount of black money know fully well the competence level of the income tax department and their ability to recover black money from those who have it.

Once we take this factor into account, the finance minister Arun Jaitley’s comment that those who declared their black money to the government could “sleep well,” can be categorised as an empty rhetoric and nothing more.

In fact, after the flop-show, Jaitley seems to have discovered that the bulk of the black money is within India. “The bulk of black money is still within India,” he wrote on his Facebook page. I have been saying this on various media platforms over the last few months.

A lot of this domestic black money has made its way into real estate over the years. As a report on black money brought out by the business lobby FICCI in February 2015 points out: “The Real Estate sector in India constitutes for about 11 % of the GDP of Indian Economy, as these transactions involve high transaction value. In the year 2012-13, Real Estate sector has been considered as the highest parking space for black money.”

What has this government (or any other for that matter) done to target the black money that has made its way into the real estate sector? Absolutely nothing. In fact, the surprising thing is that sector continues to operate more or less without any regulator despite constituting 11% of the Indian GDP.

A simple explanation for this is the fact that bulk of the ill-gotten wealth of politicians is in the real estate sector. And given that no government wants to disturb the status-quo.

A recent report in The Economic Times points out that: “Doctors, engineers and former senior managers who used to work overseas — these professionals formed the biggest chunk of those who made use of the 90-day grace period for the declaration of unaccounted wealth.” Politicians did not come out of the closet to declare their black money. And politicians, as I pointed out earlier, have their black-money in real estate.

Black money has also made its way into the stock market through the anonymous p-note route. P-notes are derivative instruments issued by foreign institutional investors (FIIs) to investors to invest in the stock market as well as the debt market without registering with the regulator i.e. the Securities and Exchange Board of India.

What this means is that FIIs issue p-notes to investors whose identities are not known to the Indian regulator. Now compare this to the KYC that any Indian has to carry out in order to invest in a mutual fund, open a bank account or get a credit card. The world is definitely not a fair place.

The investments coming into India through the p-note route were at Rs 2.72 lakh crore as on February 2015. A major portion of this money came in through Cayman Islands, Mauritius and Bermuda. As a recent report in Business Today magazine points out: “Cayman Island with a population of less than 55,000 routed investment worth Rs 85,000 crore.”

Hence, p-notes are possibly being used to re-route black money generated in India into the Indian stock as well as debt market.

The last time government tried banning p-notes in 2007, the decision did not go down well with the FIIs. The government had to withdraw the ban. Having said that, as the Business Today report points out: “since 2007, the market regulator tightened the noose, and their share in FII investments came down from 50 per cent in 2007 to 11 per cent in February 2015.”

Nevertheless, even 11% is a big number. The question is will the government ban p-notes? The answer is no. The stock markets are anyway edgy these days and the government needs to raise Rs 69,500 crore during the course of this year. And for that it needs a strong stock market.

Over and above this, there are operators running “black ka white” schemes as well, points out columnist Debashis Basu in a recent column in the Business Standard. Basu writes that not much has been done on this front either.

To conclude, people in decision making positions know what the problem is. They also know what the solutions are. They choose to talk a lot about it, without doing much about it.

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

The column originally appeared on SwarajyaMag on October 7, 2015

6 October, 2015

Why we buy lottery tickets

The funny thing about memories is that we remember what we remember. And those memories may not always be a true reflection of how things may have originally happened. What we live with are our versions of how things may have really happened. And this we tell ourselves is the truth.

One abiding memory that I have from my childhood is that of my father buying lottery tickets. I don’t remember how often he did it. Neither do I remember how long he did it for. But I do remember that there was a time when he used to buy lottery tickets regularly. And in my version of this memory, I remember him beaming on days he used to buy a lottery ticket. He looked genuinely happy on those days.

And all these years later, I wonder why he smiled on the days he bought a lottery ticket, given that he never really won anything. Of course, I did not understand the reason back then, but now with some understanding of why people behave in a certain way, I do.

As John Kay writes in Other People’s Money: “A lottery ticket, which millions of people buy each week, is a wager. Cynics have advised that you would do well to buy your ticket at the last minute, because otherwise the probability that you will die before the draw is greater than the probability that you will win the headline prize.”

Jokes apart, why do individuals actually buy lottery tickets, given that the probability of winning the big-prizes on offer on any lottery, is very low. Only a few people out of the millions who buy lottery tickets regularly, are likely to win the top prize.

Psychologist Daniel Kahneman explains this in Thinking, Fast and Slow: “The possibility effect…explains why lotteries are very popular. When the top prize is very large, ticket buyers appear indifferent to the fact that their chance of winning is minuscule.”

The point being that unless you buy a lottery ticket you have no chance of winning. As Kahneman points out: “A lottery ticket is the ultimate example of the possibility effect. Without a ticket you cannot win, with a ticket you have a chance, and whether the chance is tiny or merely small matters little. Of course, what people acquire with a ticket is more than chance to win; it is the right to dream pleasantly of winning.”

And that I guess explains my father’s beaming face every time he bought a lottery ticket. In fact as Kahneman puts it: “Buying a ticket is immediately rewarded by pleasant fantasies…The actual probability is inconsequential; only the possibility matters.”

In fact, promoters, companies and governments (as is the case in India and other parts of the world) which sell lottery tickets, understand this fact very well. As Kay writes: “Promoters have learned through experience how to design an attractive lottery product. A few very large prizes establish the dream. A large number of very small prizes encourage customers to maintain the belief that ‘It could be you’.”

This structure of the lottery also explains why people keeping going back to buying tickets even though their chance of winning the big prize is close to zero. As Kay points out: “When lottery patrons lose, as they mostly do, they can sustain the dream by promising themselves that they will buy a ticket again next week. ‘It could be you’ was the well-judged slogan with which Britain’s national lottery was launched.”

So, the story and the hope of winning a big lottery continues among millions of people all over the world. And it is hope which makes a dull and dreary life, liveable at the end of the day. If that means buying a lottery ticket, then so be it.

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

The column originally appeared in the Bangalore Mirror on Oct 7, 2015

6 October, 2015

Are banks finally pulling the plug on real estate?

The Reserve Bank of India (RBI) puts out the sectoral deployment of credit data every month. These numbers tell us how much banks have lent to different sectors.

The latest set of numbers released by the RBI point out that lending to commercial real estate grew by just Rs 7,153 crore or 4.5% between August 22, 2014 and August 21, 2015. Commercial real estate includes loans to builders.

This, when the overall lending by banks grew by Rs 4,67,509 crore or 8.2%. Hence, the lending to real estate by banks grew at a much slower rate than the overall lending carried out by banks, over the last one year.

How did things stand in August 2014? Between August 23, 2013 and August 22, 2014, the overall lending of banks had grown by Rs 5,28,173 crore or 10.2%. In comparison the lending to commercial real estate by banks had grown by 17.3% or Rs 23,318 crore during the period. Hence, the lending to real estate banks between August 2013 and August 2014 had grown at a much faster rate than the overall lending by banks. That is clearly not the case now.

In fact, between August 2013 and August 2014, banks lent Rs 23,318 crore or nearly 3.3 times the Rs 7,153 crore that they have lent between August 2014 and August 2015. Hence, new lending to commercial real estate by banks has slowed down considerably.

What is interesting is that during the course of this financial year the overall lending to commercial real estate by banks has actually gone down. Between March 20, 2015 and August 21, 2015, the lending to commercial real estate has fallen by Rs 975 crore or 0.6%.

This should put further pressure on builders as far as their finances are concerned and push them more towards lowering prices of unsold homes.

In the recent past a spate of private equity/venture capital funds have invested in real estate companies as well as projects. This is now being offered as one of the reasons as to why the real estate prices won’t fall in the time to come. It is being said that money from private equity/venture capital funds will keep real estate companies going for a while.

There are multiple questions that needs to be answered here. The first question is, why are these funds investing in Indian real estate? John Kay explains this in his book Other People’s Money—Masters of the Universe or Servants of the People?

In the aftermath of the financial crisis, the central banks of the Western world have printed a huge amount of money. Some of this money has been diverted into asset markets and financial markets all around the world, driving up their values. At the same time, the markets have been going up and down in the same direction at the same time. They have become highly correlated in comparison to the past.

As Kay writes: “The resulting common volatility of security prices has provoked a search for ‘alternative assets’ which would not be correlated with existing portfolios. Traditionally ‘alternatives’ were investments such as gold, art, vintage cars and fine wines: but these exist only in limited quantities. And as investor interest in them grew, their prices became increasingly correlated with those of mainstream assets.”

This, perhaps explains why private equity and venture capital funds are interested in investing in Indian real estate. They believe that returns are not highly correlated to other asset classes.

The next question is how many real estate companies have got money from these funds? The answer is not many. It is worth remembering here that thousands of companies operate in the Indian real estate space all over the country. And once this is taken into account, the number of companies getting venture capital/private equity funding is essentially insignificant.

Further, at what prices are these funds buying into real estate companies or real estate projects. There is not much clarity on this front. It is safe saying here that the prices at which they are buying projects must be at a significant discount to the so called “market price” of real estate. So, in that sense there has been a price correction. The question is at what price will these companies sell these homes?

Meanwhile, the simplistic belief that a cut in home loan interest rates will revive the sector continues. As Sumeet Abrol of Grant Thorton India told The New Indian Express: “High interest rates and inflated prices were the major problems. Now one is resolved.” Really? The RBI cut the repo rate or the rate at which it lends to banks by 50 basis points (one basis point is one hundredth of a percentage) to 6.75%. In response the country’s largest bank, the State Bank of India, cut its base rate or the minimum interest rate a bank charges its customers, by 40 basis points to 9.3%.

This meant that the interest rate on home loans should have fallen by 40 basis points as well. Nevertheless, the interest rate on an SBI home loan will fall by only 20 basis points. Why is that? Earlier, the bank gave out home loans to men at five basis points above its base rate. To women, it gave out home loans at the base rate. Now it has decided to give out home loans to men at 25 basis points above the base rate. In case of women it is 20 basis points.

Hence, interest rate on a man taking an SBI home loan will be now be 9.55% (9.3% base rate plus 25 basis points). Earlier, the interest rate was 9.75%. This means a fall in interest rate of 20 basis points.

This means a fall in EMI of a little over Rs 13 per lakh of a home loan. Data from the National Housing Bank shows that in 2013-14, the average home loan size in India was Rs 18-19 lakh. I couldn’t find more recent data. Hence, we can assume that the average home loan size for banks would be around Rs 20 lakh now.

The housing finance company, HDFC, gives out average home loan size data every three months, along with its quarterly results. As on June 30, 2015, the average home loan size of HDFC stood at Rs 23.4 lakh.

Given this, an average home loan of Rs 20 lakh for the Indian banking system is a good number to work with. This means that the EMI on an average Indian home loan would fall by Rs 260 (Rs 13 multiplied by 20). So, will that lead to more people buying homes? Or was that stopping people from buying homes in the first place? I don’t think I need to answer that.

As Abrol of Grant Thorton India put it: “Real growth will be triggered only when builders are ready to cut property prices. If a revival is to happen in the sector, prices which were artificially moved up in the recent past in some areas, should come down to realistic levels.”

QED.

(The column originally appeared on The Daily Reckoning on October 6, 2015)

6 October, 2015

Why the Bihar poll matters for stock markets: A BJP win will allow stockbrokers to sell ‘ache din’ again

The assembly elections in the state of Bihar are scheduled to happen across five phases between October 12, 2015, and November 7, 2015. The constituents of the stock market are closely following the run up to these elections like they had followed the run up to the Lok Sabha elections last year.

While the stock market following the Lok Sabha elections is but natural, why is it following the run up to the assembly elections in Bihar? Bihar is the poorest state in India as measured by the per capita income. Data released by the Ministry of Statistics and Programme Implementation shows that for 2014-2015, the per capita income of the state was Rs 36,143. This was the lowest among the states and union-territories, which had declared their per capita income when the data was published in July earlier this year.

During 2013-2014, the per capita income of the state was at Rs 31,199, the lowest among all states and union-territories. The state of Uttar Pradesh came in second from the bottom at Rs 36,250. This when the per capita income of Bihar has grown at greater than 15% in each of the last three financial year’s.

Data from the India Brand Equity Foundation points out that the per capita income of the state is around 43% of the Indian per capita income. The gross domestic product (GDP) of the state is around 3.25% of the Indian GDP, even though the state has more than 8% of India’s population.

The installed power capacity of the state is 2759.8 MW, which is around 1% of the total capacity in India. Over and above this, given the many years of lawlessness and the lack of electricity that the state has faced, it barely has an industry.

Data from the ministry of finance shows that the state has 26 public private partnership projects. This is less than 2% of the 1409 projects all across India. The India Brand Equity Foundation points out that the “total FDI for Bihar and Jharkhand combined during the period from April 2000 to May 2015 stood at US$ 59 million.” On this my guess is that even this miniscule amount would have gone more to Jharkhand than Bihar.

The state barely contributes to the Indian GDP, has virtually no industry and almost no FDI is going into the state. In this scenario why is the stock market worried about Bihar? As Shankar Sharma, Vice Chairman and Managing Director of First Global recently told Business Standard: “Bihar election is important from the context of whether the Modi government still enjoys popular mandate or not.”

And how will that help the stock market? A win in Bihar for the Bhartiya Janata Party(BJP) led coalition will allow the stock brokers to sell the Narendra Modi “ache din aane waale hain” story all over again to foreign investors as well as Indian investors.

As Philip Tetlock and Dan Gardner write in Superforecasting—The Art and Science of Forecasting: “The one undeniable talent that talking heads have is their skill at telling a compelling story with conviction, and that is enough.”

Stock market investors love a good story and Narendra Modi in control is a compelling story that can ‘still’ be sold with some conviction by stock brokers. What works for it is the fact that it has already been sold once between September 2013 and May 2014, in the run up to the last Lok Sabha elections. The BSE Sensex ran up 33% between September 2013 and May 26, 2014, when Narendra Modi was sworn in as the prime minister of the country.

This was purely a sentiment based rally based around a compelling story that was well sold. The stock brokers are hoping to repeat this in the time to come. The trouble is that unlike the last Lok Sabha election this election remains too close to call. Hence, up until now, various opinion polls have swung both ways. Some have suggested that the BJP led alliance will win, whereas others have suggested that Lalu Prasad Yadav + Nitish Kumar + Congress (or the Grand Alliance) will win. Let’s see which way things swing.

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

The column originally appeared on Firstpost on Oct 6, 2015

1 October, 2015

Ajit Gulabchand: The man who built Bandra-Worli sea-link needs lessons in basic economics

Ajit Gulabchand, the chairman and managing director of Hindustan Construction Company (HCC) said in an interview yesterday: “a 50 basis points (bps) rate cut is welcome, but it is insufficient. …I expected at least 300 bps but if not that, 200 bps as an initial cut to create the impact that is necessary.” Among other things, Gulabchand is famous for having built the Bandra-Worli sea-link in Mumbai.

Gulabchand was reacting to the Reserve Bank of India’s decision to cut the repo rate by 50 basis points (one basis point is one hundredth of a percentage) to 6.75%. Repo rate is the rate at which the Reserve Bank of India (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.

While industrialists are used to being unreasonable, this is among the most irresponsible statements I have come across from an industrialist, in a while. Allow me to explain.

Central banks do not take extreme steps unless it’s an emergency. When was the last time you heard a big central bank dropping rates by 300 basis points at one go? Or even 200 basis points? Or even 100 basis points for that matter?

So, central banks work in a step by step process and not in a random manner. The question is why is Gulabchand sounding so desperate? The answer can be found out from his profit and loss account statement.

The operating profit (or earnings before interest taxes depreciation and amortisation) of HCC excluding its other income, for the period of April to June 2015 stood at Rs 161.8 crore. The total amount of interest that the company paid on its debt during the same period was at Rs 167 crore.

Hence, the interest coverage ratio of the company is less than one. The interest coverage ratio is calculated by dividing the interest on debt that a company pays during a period by its operating profit. An interest coverage ratio of less than one essentially shows that the company is not making enough money to be able to pay the interest on its debt. And that is not a good situation to be in.

What this basically means is that HCC has taken on more debt than it should have. In this scenario Gulabchand is desperate for the interest costs of the company to go down. The total debt of the company as on March 31, 2015, stood at Rs 5,011 crore. On this the company paid an interest of Rs 651.1 crore during the course of April 2014 to March 2015.

This means an effective interest rate of 13% (Rs 651 crore as a proportion of Rs 5,011 crore). If the interest rates fall by 300 basis points, HCC’s effective rate of interest will come down to 10%, assuming that the banks totally pass on the cut to the borrowers.

At 10%, the interest outflow for HCC would be Rs 501.1 crore (10% of Rs 5,011 crore). This is Rs 150 crore lower than the amount the company paid as interest during the period April 2014 to March 2015. And this is a huge amount given that the profit after tax of HCC during the period was Rs 81.6 crore.

So, it’s understandable why Gulabchand is desperate for significantly lower interest rates. The same logic holds true for a spate of other corporates who are deep in debt and are having a tough time servicing their debt. And given half a chance they talk about lower interest rates.

The question nonetheless is can India afford interest rates which are 300 basis points lower than they currently are. Let’s do a little thought experiment here.

The repo rate before the RBI cut it by 50 basis points was at 7.25%. Let’s say instead of cutting the repo rate by 50 basis points, the RBI had cut it by 300 basis points, as Gulabchand wanted it to. Let’s further assume that banks passed on this cut (I know I am being unreasonable here, but just humour me for a moment). They cut deposit interest rates by 300 basis points and they cut lending rates by 300 basis points as well.

What would happen here? Given that the repo rate would fall to 4.25%, we would have a situation where deposit rates would suddenly fall around 5%. So far so good.

In the monetary policy statement released yesterday the RBI expects consumer price inflation is to reach 5.8% in January 2016. So we will have a scenario where interest on fixed deposits are in the region of 5% and the inflation is at 5.8%. This will mean a negative real return on the fixed deposits, as the rate of inflation will be greater than the interest being offered on fixed deposits. And that will not be a good thing.

Take a look at the accompanying chart. The green line represents the consumer price inflation. The red line represents the average rate of interest at which the government borrows.

As can be seen from the chart, between 2007-08 and 2013-2014, the consumer price inflation was greater than the average interest rate at which the government borrowed. The rate of interest at which the government borrows is the benchmark for all other kinds of loans and deposits.

As can be seen from the chart, the government managed to borrow at a rate of interest lower than the rate of inflation between 2007-08 and 2013-14. And if the government could raise money at a rate of interest below the rate of inflation, banks couldn’t have been far behind.

Hence, the interest offered on fixed deposits by banks and other forms of fixed income investments was also lower than the rate of inflation. The inflation was consistently greater than 10% during the period, whereas the fixed deposit rates ranged between 8-10%.

And this had negative consequences, as household financial savings fell. Household financial savings is essentially a term used to refer to the money invested by individuals in fixed deposits, small savings scheme, mutual funds, shares, insurance etc. A major part of household financial savings in India is held in the form of bank fixed deposits and post office small savings schemes.

The household financial savings have fallen from 12% of the GDP in 2009-10 to 7.5% in 2014-15. The number was at 7% in 2012-2013. This happened because the rate of return on offer on fixed income investments (like fixed deposits, post office savings schemes and various government run provident funds) was lower than the rate of inflation.

This led to people moving their money into investments like gold and real estate, where they expected to earn more. It also led to a huge proliferation of Ponzi schemes in several parts of the country.

Hence, the money coming into fixed deposits and post office income schemes slowed down leading to a situation where household financial savings fell. This, in turn, led to high interest rates. As mentioned earlier the effective rate of interest that Gulabchand’s HCC paid on its debt during the period between April 2014 and March 2015, was 13%.

If the household financial savings are to be rebuilt, the rate of interest on offer to depositors has to be significantly greater than the rate of inflation. A major reason why household financial savings have risen between 2012-2013 and 2014-2015 has been because the rate of interest on fixed income investments has been higher than the rate of inflation.

In fact, the RBI governor Raghuram Rajan has often talked about a real rate of interest of 1.5-2% on fixed income investments (i.e. fixed deposit interest rates are higher than the rate of inflation by 1.5-2%). This is a very important factor that needs to be kept in mind by the RBI while deciding on interest rates.

The basic point is that the interest rates are not just about corporates and borrowing, they are also about savers. If people don’t save enough through fixed deposits and other fixed income investments, the rate of interest is going to go up.

And in order to ensure that people save enough and do not divert their money into other investments, it is important that the rate of interest on offer on fixed income investments continues to be significantly higher than the rate of inflation.

This also ensures that over the long term interest rates will remain at more reasonable levels. Meanwhile, if that means that the corporates are hurt, then so be it.

The column originally appeared on The Daily Reckoning on Oct 1, 2015