Month: April 2016 | Page 3

21 April, 2016

Why It’s Best to Stay Away from Buying LIC Policies

The Life Insurance Corporation(LIC) of India is India’s biggest insurance company. It is also India’s biggest investment firm.

It is so big that it keeps coming to the rescue of the government now and then, when the government cannot find enough buyers for the financial securities that it wants to sell.

Nevertheless, the question is, how good is LIC when it comes to generating returns on the investments it makes?

Before we figure that out, it is good to point out that LIC is basically an investment firm which also sells insurance. A major portion of the money that it collects as premium from Indians, against the so called insurance policies that it sells, is invested in stocks and bonds (both private as well as government).

The insurance policies that LIC sells are basically investment plans with a dash of insurance. And given that the premium that it collects and in turn invests, should be generating decent returns for the policyholders (actually investors). Of course, the tragedy is that most of these policy holders don’t even know that they are actually investors.

So how do things look? The accompanying table gives us the investment track record of LIC between 2005-2006 and 2014-2015. As is clear from the table the investment record of LIC has been dismal to say the least.

In 2014-2015, the investment firm earned a return of 7% on its investments. The average return on the 10-year government bond during the course of the year was 8.3%. The investment return of LIC was 130 basis points lower than the average return on a 10-year government bond. One basis point is one hundredth of a percentage.

Year	Income from investments (In Rs crore)	Investments (In Rs Crore)	Return (%)	Average returns on 10 year govt bond	Difference
2014-2015	1,35,483	19,462,49	7.0%	8.3%	130 basis points
2013-2014	1,18,097	16.846,90	7.0%	8.4%	140 basis points
2012-2013	1,03,882	14,864,57	7.0%	8.2%	120 basis points
2011-2012	90,267	13,495,32	6.7%	8.5%	180 basis points
2010-2011	77,667	12,665,39	6.1%	7.9%	180 basis points
2009-2010	67,198	10,958,41	6.1%	7.3%	120 basis points
2008-2009	56,583	8,15,484	6.9%	7.6%	70 basis points
2007-2008	47,999	7,56,891	6.3%	7.9%	160 basis points
2006-2007	40,572	6,13,267	6.6%	7.8%	120 basis points
2005-2006	35,479	5,24,017	6.8%	7.2%	40 basis points
Source: LIC annual reports and www.investing.com

[These numbers may not reflect mark-to-market on certain investments and hence the investment income may be higher, though it cannot meaningfully alter the returns.]

In fact, the difference between the average returns on a 10-year government bond during the course of a year and the investment returns of LIC vary between 40 basis points and 180 basis points. This is a huge difference.

The average return on investment for LIC over a period of ten years between 2005-2006 and 2014-2015 has been 6.7%. The average return on a ten-year bond has been 7.9%. The difference between the two returns is 120 basis points.

In fact, the average rate of inflation between 2005-2006 and 2014-2015 was 8.85%. Hence, the average return on investment of LIC was lower than the rate of inflation as well.

What does this tell us about a professional investment firm like LIC? It tells us that LIC is doing a terrible job of managing public money. Any investment firm should be able to generate average returns greater than the returns on government bonds, at least. It should also be able to beat the inflation. In fact, that is what it is paid a fee for. But that doesn’t seem to be happening in case of LIC.

The investment returns of LIC have been consistently lower than the 10-year government bond returns. First and foremost, this tells us that the investment management capabilities of LIC are very bad, given that its investment returns have been 120 basis points lower than returns on a 10-year government bond, over a period of ten years.

Further, LIC would be simply better off by buying government bonds and then holding on to them till maturity, instead of actively trying to manage money. It would probably end up earning higher returns than it currently does.

Second, what this also tells us is that the government is interfering too much in the functioning of the firm and getting it to make investments, which it shouldn’t be making in the normal scheme of things. The government regularly gets LIC to invest in shares of public sector enterprises which other investors are not willing to pick up.

In the recent past LIC has picked up stakes in public-sector banks to help them meet their capital requirements. As a March 29, 2016, news-report in The Indian Express points out: “Since the beginning of 2016, LIC has brought into preferential allotment of as many as six banks, supporting the fund-raising requirement of these banks in turn. Share prices of PSBs on an average have declined close to 11.7% so far this year.”

The public-sector banks are sitting on a huge corporate-debt time bomb. Many corporates they have lent to over the years are currently no longer in a position to repay their loans or have simply siphoned off this money. The question is why is LIC money being invested in these banks? This is because the government wants to continue owning these banks, instead of selling them out.

Also, LIC now owns 21.22% of Corporation Bank, 14.37% of IDBI Bank and 14.99% of Dena Bank. Again, the question, why should an investment firm managing public money be taking on such concentrated risk? In fact, the Securities and Exchange Board of India(Sebi) regulations do not allow a mutual fund to own more than 10% of a company.

Why doesn’t the same rule apply to LIC as well? Like mutual funds LIC is also in the business of managing hard-earned public money.

Unnamed LIC officials in various news-reports justify this buying by saying that they are buying value. Maybe they are, but buying value does not mean betting the house on one stock. When an institution is managing as much money as LIC is, some basic investing principles need to be followed.

Third, it tells us that individuals are better off putting their money somewhere else rather buying LIC policies. What is the point in investing money in order to earn a return of 6-7% on an average? Yes, investing in LIC policies helps people save on tax, but there are better ways of saving tax like the Public Provident Fund(PPF).

Between 2009 and now the returns on PPF have never gone below 8%. In fact, currently the rate of interest on PPF is at 8.1%. As far as an insurance cover is concerned, individuals can look at buying a pure term insurance policy, which just offers insurance against the premium paid.

Fourth, the government needs LIC to finance its fiscal deficit and to keep rescuing the public sector enterprises which aren’t a viable business anymore. Fiscal deficit is the difference between what a government earns and what it spends. LIC helps the government finance its fiscal deficit by buying government bonds and at the same time it also helps the government meet its disinvestment target by buying shares of public sector enterprises which other investors are not interested in. This money helps narrow the fiscal deficit.

In the process, the returns that LIC is able to generate on its investment portfolio get compromised on.

Fifth, when was the last time you saw an article analysing the returns on various LIC policies? Like is the case with other insurance companies, it is not possible to figure out which LIC plan has given what kind of return, over the years. Hence, it is best to stay away from investing in them.

The column originally appeared on Vivek Kaul’s Diary on April 21, 2016

20 April, 2016

Water Shortage: Lack of Water Storage Facilities is the Real Problem

Every week the Central Water Commission (CWC) puts out the total volume of water that it has in 91 storage reservoirs all over the country. These reservoirs have a total storage capacity of around 157.8 billion cubic metres(BCM). This amounts to around 62% of the total storage capacity of 253.4 BCM in the country.

Hence, the data put out by CWC is a good representation of the total water stored in the reservoirs across the country. For the week ending April 13, 2016, the total amount of water stored in these reservoirs stood at 35.8 BCM. Given that the total storage capacity of these reservoirs is around 157.8 BCM, the total amount of water currently available amounts to around 23.3%. This is less than one-fourths of the total storage capacity.

How does the situation look if we were to compare it with the same time last year? As on April 16, 2015, the total amount of water in these 91 reservoirs had stood at 50.9 BCM. This amounted to around 33% of the total capacity of these reservoirs.

Further, the total amount of water currently available is around 70.3% of that was available last year. Hence, the situation has deteriorated since then. This can be explained by the fact that the country has had two bad monsoons.

In 2015, the monsoon rains had stood at 86% of the long period average (LPA). In 2014, the monsoon rains had stood at 88% of the long period average(LPA). Two bad monsoons have essentially ensured that the total amount of water available in the CWC reservoirs is currently very low.

The good news is that this time around the monsoon rains have been predicted to be at 106% of the long period average. Unless, the India Meteorological Department goes badly wrong, the monsoon rainfall is going to be much better than the previous two years. This should help building up the water levels in the CWC reservoirs.

But that is just the short-term solution. The per capita water availability in India has been falling over the years. The average per capita availability of water as per the 2001 census was 1816 cubic meters. This fell to 1545 cubic metres as per the 2011 census. The number must have fallen further by now.

In fact, data from World Bank suggests that in 2014, the renewable internal freshwater resources per capita in India stood at 1,116 cubic metres. This had stood at 1,226 cubic metres in 2007.

As the Economic Survey of 2015-2016 points out: “India has much lower levels of water per capita than Brazil, one of the world’s leading agricultural countries. This constraint is exacerbated because, while Brazil and China use approximately 60 per cent of their renewable fresh water resources for agriculture, India uses a little over 90 per cent.”

So what is the way out of this? The simple answer is creation of more water storage capacity to start with. As Akhilesh Tilotia of Kotak Institutional Equities and author of The Making of India writes in a recent research note titled Dam It: “India’s consumption of water was estimated to be 1,030 BCM per year in 2010 and is expected to rise to 1,498 BCM by 2030E. The current consumption of water would hence be around 1,100 BCM (of which ~80% of the water is used for agriculture and rest is split between housing and industry). For a country that even in a failed monsoon gets 2,640 BCM of rain, servicing a requirement of 1,100 BCM should not ideally be a challenge – so what gives?”

Further, there are rains, other than the monsoon, and then parts of India get snow as well. This leads Tilotia to conclude that India “receives a precipitation of ~4,000 BCM of rains (and snow) every year.”

So the consumption of water stands at 1100 BCM. Even a bad monsoon gets 2640 BCM of rain, so where does the real problem lie? As Tilotia writes: “It should be obvious that if the bulk of rains fall in a few months of the year, the only way to get water through the year is to bank it. There are two ways in which water can be banked: a natural process of water seeping underground which is then pulled out over the course of the year or by holding back the water in artificially created storage areas or dams. As we have noted above, India has the capacity to store only 253 BCM of water (or less than 10% of normal monsoon rains). It is no surprise that we annually find ourselves without water in summers!”

The point being that if India’s water problem needs to be solved, then first and foremost we need to create more water storage capacity to start with.

Further, efficiency of water usage in agriculture also needs to improve. As the Economic Survey points out: “Although water is one of India’s most scarce natural resources, India uses 2 to 4 times more water to produce a unit of major food crop than does China and Brazil (Hoekstra and Chapagain [2008]). Hence, it is imperative that the country focus on improving the efficiency of water use in agriculture.”

This will start to happen once state governments price power for agriculture at the right price, instead of selling it cheap or giving it away free. As the Economic Survey points out: “It has long been recognized that a key factor undermining the efficient use of water is subsidies on power for agriculture that, apart from its benefits towards farmers, incentivises wasteful use of water and hasten the decline of water tables.”

The solutions to the water problem are well known. The question is do the government(s) [state governments as well as the central government] have the political will and the necessary money to go ahead and implement them.

The column originally appeared on the Vivek Kaul’s Diary on April 20, 2016

20 April, 2016

The Magic of Markets

In the early 1990s, the Soviet Union broke up and started making a transition from being a communist economy to a more market focused economy. At this point of time, a British economist named Paul Seabright came visiting.

He had a very interesting experience which Felix Martin recounts in Money—The Unauthorised Biography. The director of bread production of the city of St. Petersburg asked Seabright a very interesting question.

This gentleman was trying to understand how the new system (i.e. a more market focussed economy, which wasn’t like the old system) worked. He asked Seabright, “Please understand that we are keen to move toward a market system … but we need to understand how such a system works. Tell me, for example who is in charge of the supply of bread to the population of London?”

Now anyone who understands how a market works would know that nobody is really in-charge. It works because of the efforts of multiple people trying to further their own interest. As Adam Smith, the original economist, wrote: “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.”

And this best explains how a product is made and makes it to the market. In fact, even the simplest product involves many people working towards their interest and is beyond one individual. As Matt Ridley writes in The Evolution of Everything: “Among the myriad of people who contribute to the manufacture of a simple pencil, from graphite miners and lumberjacks to assembly-line workers and managers, not to mention those who grow coffee that each of these drinks, there is not only person who knows how to make a pencil from scratch.”

A pencil gets made because of the selfish interests as well as cooperation and knowledge of many people. Or let’s take the example of something as simple as ink. As Donald J Boudreaux writes in The Essential Hayek: “Consider the ink. Where does it come from? Its colour comes from a dye made from chemicals that were extracted from roots, berries, or bark. Who found those roots, berries or bark? That person had to know which specific roots, berries or barks to find. Most roots, berries, and bark won’t work. And just how are the colouring chemicals extracted from vegetation? Today the extraction is done through a complex process involving a mix of industrial chemicals and complicated machinery. The dye is then mixed with water, resins, polymers, stabilizers and preservatives.”

This is just one set of expertise required to make ink. Then you require people who can run machines who can extract the colourings. Another group of people to mix the extracted chemicals with other ingredients. Machines run on electricity, so you need electricians to equip the factory with electrical wiring. And so on.

The point being making even simple things is essentially a complicated thing beyond the capabilities of a single individual. As Bordeaux writes: “To make even one vial of the simplest and least-expensive modern ink requires the knowledge and efforts of many, many people…No single person knows more than a tiny fraction of all that there is to know about how to make ink.”

Many people specialise in many areas for a product to be made. And this specialisation leads to economic prosperity as well as innovation. As Ridley writes: “Specialisation, accompanied by exchange, is the source of economic prosperity…Leave people free to exchange ideas and back hunches, and innovation will follow. So too will scientific insight.”

The trouble is most governments do not understand this, given that it is not in their control. And they try to do too many things to create economic prosperity given that governments are meant to do things. What they do not do is to allow specialisation, exchange and innovation, to flourish.

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

The column appeared in Bangalore Mirror on April 20, 2016

20 April, 2016

The PF problem: Why the govt is after your EPF money

The Narendra Modi government has tried initiating a few changes to the way the Employees’ Provident Fund(EPF) operates. And this hasn’t really gone down well with those who have accumulated their savings through EPF.

These moves are in line with what the finance minister Arun Jaitley referred to as “measures for moving towards a pensioned society,” in his February 2016, budget speech.

One such move has been the restriction on the complete withdrawal of EPF. In a notification dated February 10, 2016, the government had specified that an individual investing in EPF can withdraw only his contribution made to the EPF and the interest accumulated thereon, in case the individual is unemployed for a period of at least two months.

Up until now, a 100% withdrawal was possible. In fact, given the way the Employees’ Provident Fund Organisation(EPFO) operated, one could withdraw 100% of the accumulated EPF even at the point of changing jobs. All an individual had to do was to declare that he or she was unemployed.

This loophole has now been plugged in with the introduction of the Universal Account Number(UAN). Earlier, the EPFO could not track the movement of an employee from one job to another, but with UAN that is possible.

In fact, with the new notification, premature withdrawal of 100% EPF corpus would become impossible. Further, the notification also increased the retirement age from 55 years to 58 years.

The change of not allowing to withdraw the full EPF, is in line with what Jaitley had talked about in his budget speech. The idea is to discourage individuals from withdrawing their accumulated EPF corpus. By doing this, the hope is that the individual will have enough money going around when he or she retires.

And at that point of time, the accumulated corpus can be used to generate a regular income after retirement i.e. a pension.

These changes haven’t gone down well with people who contribute to the EPF every month and there have been protests against it. Given this the notification specifying the changes has now been put in abeyance. As the labour minister Bandaru Dattareya told reporters today (April 19, 2016): “The notification will be kept in abeyance for three months till 31 July, 2016. We will discuss this issue with the stakeholders.”

In fact, a PTI news-report also points out that the labour ministry is contemplating allowing withdrawal of 100% of the corpus on grounds like marriage and education of children, purchase of house, serious illnesses etc.

The way the scheme is currently structured, it does not allow a 100% withdrawal for such things. The Section 68K of the Employees’ Provident Fund Scheme 1952, allows for withdrawal of up to 50% of the individual’s contribution and the interest accumulated thereon, “for his or her own marriage, the marriage of his or her daughter, son, sister or brother or for the post-matriculation education of his or her son or daughter.”

As far as medical emergencies are concerned, the amount that can be withdrawn from the EPF should not exceed, the individual’s “basic wages and dearness allowances for six months or his own share of contribution with interest in the Fund, whichever is less.”

News-reports suggest that these limits are likely to be withdrawn in the days to come. If something like that happens, it won’t be good for the society as a whole. The basic idea behind any provident or pension fund is to accumulate enough money so as to be able to live comfortably after retirement.

But if 100% withdrawals are allowed then this will not be possible. Hence, some withdrawals should be allowed, but allowing 100% withdrawals for weddings and education etc., is clearly not a great idea.

This did not matter earlier when people lived in joint families. But in the era of nuclear families and increasing life expectancy, it is important that those retiring from jobs have enough money for themselves.

Further, it needs to be pointed out that the current norms allow 100% withdrawal “on termination of service in the case of mass or individual retrenchment”. Of course, one is quitting the job to become an entrepreneur then a 100% withdrawal is not allowed. But big government schemes cannot be so flexible so as to meet the needs of everyone.

Anyone leaving the country is also allowed to withdraw 100% of the accumulated corpus. Further, those suffering from “total incapacity for work due to bodily or mental infirmity” can withdraw 100% of the corpus. So, the point being that the scheme is flexible “enough”.

Also, as a recent government clarification on the EPF pointed out: “The main category of people for whom EPF scheme was created are the members of EPFO who are within the statutory wage limit of Rs 15,000 per month.”

Hence, for those earning greater than Rs 15,000 per month and looking for the flexibility with their money, should essentially be negotiating with their employers to make a minimum contribution to the EPF and receiving their salaries under other heads.

To conclude, it is safe to say that the Modi government has essentially botched up the entire idea behind a pensioned society. Almost no effort has been made in order to explain the basic idea behind the phrase, which is actually a good one.

For a government which is pretty good at marketing itself that is rather ironical.

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

The column originally appeared in the Bangalore Mirror on April 20, 2016

19 April, 2016

Why Monsoon Still Matters So Much

The stock market wallahs have been excited since April 12, 2016. On that day, the India Meteorological Department(IMD) came up with the forecast for the monsoon season rainfall for 2016. The forecast this time is that the monsoon rainfall during the period July to September 2016 will be 106% of the long period average (LPA), averaged over the country, with a model error of ± 5%. At 106%, this will be an above average monsoon.

The long period average over the country as a whole for the period 1951-2000 is 89 cm. So the question is how good have the IMD’s forecasts been over the last few years? The short answer is—not good.

In 2015, the IMD had forecast a rainfall of 93% of the long period average. The actual rainfall was 86% of the long period average. The actual result was outside the ± 5% model error that IMD works with. When the IMD forecast a rainfall of 93% of long period average, it was essentially forecasting a rainfall of anywhere between 88% and 98% of the long period average.

In 2014, the IMD had forecast a rainfall of 95% of the long term average. The actual rainfall was 88% of the long period average. This was also outside the model error of ± 5%. In 2013, the actual rain was 106% of the long term average, in comparison to a prediction of 98%. This was also outside the model error of ± 5%.

In 2012, the actual rain and the predicted rain were at 92% and 99% of the long period average. This prediction was also outside the model error of ± 5%.

In 2011, the actual rain and the predicted train were at 101% and 98%. This was within the model error of ± 5%. Hence, in the last five years, the IMD has got only one prediction right. This makes one wonder if the stock market wallahs have taken this bad record of IMD at predicting monsoons into account or not. Between April 11, 2016 and April 18, 2016, the BSE Sensex has gone up by around 3.2% in four trading sessions.

The tragic thing is that nearly 70 years after independence from the British in 1947, the country is still so highly dependent on the monsoon season. As Raghuram Rajan, the governor of the Reserve Bank of India, told the Wall Street Journal in a recent interview: “We’re looking for signs of a good monsoon. Unfortunately, India is still somewhat sensitive to monsoons.”

So why is India so dependent on the monsoon season? Data from World Bank suggests that in 2012, only 36.3% of India’s total agricultural land had access to irrigation. This number would have improved since then. Nevertheless, nearly 60% of India’s agricultural land still does not have access to irrigation.

Hence, for water, Indian agriculture is majorly dependent on the monsoon rains. In this scenario, it is important that monsoon rains arrive on time, are well spread over the season and across different parts of the country, which do not have access to irrigation systems.

Once there are adequate rains, the farmers will be able to grow a good crop and then sell it at a good price. (Of course, a good crop does not mean a good price, there are other issues at play as well. But we will leave that for some other day).

The money that they thus earn will be spent on consumer goods, two-wheelers and so on. This will benefit the companies that manufacture these things, along with those who supply the inputs to these companies and so the multiplier effect will work. For example, more two-wheeler sales mean more sales for tyre companies. More tyre sales mean more demand for rubber and so on. The same logic applies to other inputs that go into making a two-wheeler.

At least this is how the stock market wallahs are thinking. But there are a few caveats that need to be made here. First and foremost, as I said earlier in this column, IMD forecasts more often than not have turned out to be wrong in the last few years. But given that they have made a forecast of 106%, unless they go majorly wrong, the rains this year will be better than the last two years. Second, a good crop need not necessarily mean a good price for the farmer. The agricultural markets around the country still don’t function like they should and benefit the trader community more than the farmers.

Third, the agricultural crop that will benefit from the monsoon rains (i.e. the kharif crop) will start hitting the market only in October 2016. Hence, the fillip to consumption (if any) will start happening only around then i.e. in the second half of this financial year.

Over and above this, there is another important point that needs to be made here. Data from the World Bank tells us that in 2014, India’s population was 129.5 crore. The population growth rate in 2014 was at 1.2%. Assuming that the population in 2015 grew at the same rate, the population for 2015 comes in at around 131 crore.

Data from World Bank shows that 50% of India’s population depends on agriculture. Hence around 65.5 crore out of the 131 crore are still dependent on agriculture. Data from the Central Statistics Office(CSO) shows that in 2015-2016, the total contribution of agriculture, forest and fishing to the gross domestic product (at current prices) was Rs 2,082,692 crore.

Hence, the per capita income of every individual dependent on agriculture, forest and fishing, works out to around Rs 31,797 (Rs 2,082,692 crore divided by 65.5 crore).

Now how do things look for the other half which is not dependent on agriculture? Their total contribution to GDP was Rs 101,69,614 crore. Hence, their per capita income works out to Rs 1,55,261 (Rs 101,69,614 crore divided by 65.5 crore).

What these calculations tell us is that in 2015-2016, those not working in agriculture earned nearly 4.9 times those working in agriculture. If we were to use GDP at constant prices (at 2011-2012 prices), the ratio comes to 5.5. Constant prices essentially adjust for inflation.

And this huge differential in per capita income between those who work in agriculture and those who don’t, is India’s single biggest problem. (Of course since I am using averages here, a lot of other issues are getting side-lined, but the broader point remains valid nonetheless).

This also shows the tremendous amount of inequality present in the country between the haves and the have-nots.

Agriculture no longer yields enough to feed the number of people dependent on it. The only solution to this is to improve crop yields (i.e. more production per hectare), ensure that the farmers are able to sell this increased production through a proper market which works and finally, people need to be gradually moved out of agriculture into doing other things.

This is going to be a slow process because people dependent on agriculture simply do not have the required skillset to be moved to do other things, in most cases. Until then we will simply be dependent on monsoon rains.

The column originally appeared in Vivek Kaul’s Diary on April 19, 2016