Month: July 2016 | Page 3

12 July, 2016

EVERYBODY LOVES A GOOD STORY…

Last week, prime minister Narendra Modi, expanded the Union Cabinet, and 19 new ministers were inducted into it.

The swearing in of the new ministers happened at 11AM in the morning and did not hold any surprises. But a late evening announcement spelling out the change in ministries of existing ministers, had its share of surprises.

Smriti Irani, the youngest cabinet minister in the present Cabinet, was moved from Human Resources Development to Textiles. Jayant Sinha, the minister of state for finance was moved to the Civil Aviation ministry. Both these moves were surprises and were a step down for the ministers.

But it took the social media no time to come up with explanations for these moves and give a positive spin to the entire thing.

So, Irani, apparently had been moved to the textiles ministry because she could have a big role to play in the 2017 Uttar Pradesh elections. While people suggested that Sinha was basically paying for the outbursts of his father, former finance minister, Yashwant Sinha, against the Modi government. Some others suggested that his wife is an investor and there is a conflict of interest.

There are multiple issues that come up here. If people were so sure that Irani being moved from a high profile ministry to a low-profile one, why didn’t they talk about it earlier? If they knew that this was a possibility, they could have at least speculated about it, before the decision was made.

Coming up with explanations after something has happened is an excellent example of hindsight bias. As Jason Zweig writes in The Devil’s Financial Dictionary: “Hindsight bias [is] the mechanism in the human mind that makes surprises vanish. Once you learn what did happen, your mind tricks you into believing that you always knew that it would happen.”

Psychologist Daniel Kahneman explains the phenomenon through the example of a football match. As he writes in Thinking, Fast and Slow: “Imagine yourself before a football game between two teams that have the same record of wins and losses. Now the game is over, and one team trashed the other. In your revised model of the world, the winning team is much stronger than the loser, and your view of the past as well as of the future has been altered by the new perception.”

An excellent example of this is all the explanatory articles that were published after Iceland recently beat England in the Euro Cup football tournament.

The reason this happens is that the human mind wants explanations for surprises. And if there are no explanations it comes up with explanations. As Duncan J Watts writes in Everything is Obvious—Once You Know the Answer: “Whenever something interesting, dramatic, or terrible happens—Hush Puppies become popular again, a book by an unknown author becomes an international best seller, the housing bubble bursts, or terrorists crash plans into the World Trade Center—we instinctively look for explanations.”

This is precisely what happened when Irani and Sinha were demoted. In Sinha’s case, that his wife is an investor has always been known. So that leads to the question why was he moved now? If the reason was conflict of interest, that was true from the day he became minister.

Hence, things that appear to us explanations are basically just stories that we tell ourselves and others, in order to come up with an explanation. As Watts writes: “The result is that what appear to us to be causal explanations are in fact just stories—description of what happened that tell us little, if anything, about the mechanisms at work. Nevertheless, because these stories have the form of causal explanations, we treat them as if they have predictive power.” This is clearly not the case.

Nevertheless, at the end of the day, everybody loves a good story, especially when one does not know the real reason behind why something happened. And that is precisely what happened in the aftermath of Irani and Sinha being demoted from high profile ministries to non-descript ones.

The column originally appeared in the Bangalore Mirror on July 12, 2016

12 July, 2016

Mr Stiglitz, India’s Obsession with Inflation is Correct

Joseph Stiglitz, a Nobel prize winning economist, had some advice for Indian policymakers last week. Speaking in Bangalore, Stiglitz said: “Excessive focus on inflation almost inevitability leads to higher unemployment levels and lower growth and therefore more inequality.”

The point that Stiglitz was making is that the government of India should spend more than it currently plans to. Further, the Reserve Bank of India(RBI) should cut interest rates further and encourage people to borrow and spend more. Of course, all this extra spending will lead to some inflation, with more money chasing the same quantity of goods and services. But that will be a small price to pay for economic growth. This economic growth will lead to lower unemployment and in the process lower inequality.

This is precisely the kind of argument that was made during the Congress led United Progressive Alliance(UPA) regime, to justify the high rate of inflation that prevailed between 2008-2009 and 2013-2014.

The trouble is that there is enough evidence that suggests otherwise. Over the last five to six decades, countries which have grown at a very fast pace, have had very low rates of inflation.

As Ruchir Sharma writes in The Rise and Fall of Nations—Ten Rules of Change in the Post-Crisis World: “The miracle economies like South Korea, Taiwan, Singapore, and China, which saw booms, lasting three decades or more, rarely saw inflation accelerate to a pace faster than the emerging market average. Singapore’s boom lasted from 1961 to 2002, and during that period inflation averaged less than 3 percent.”

The same is the case with China. As Sharma puts it: “In China, the double digit GDP growth of the last thirty years was accompanied by an average inflation of around 5 percent, including an average rate of around 2 percent over the decade ending in 2010. China saw a brief surge in inflation in 2011, and economic growth in the People’s Republic has been slumping steadily since then.”

The point is very clear, inflation is not good for economic growth. There is enough evidence going around to show that. The same can be said in the Indian case as well, when the inflation surged between 2008-2009 and 2013-2014. It ultimately led to economic growth collapsing.

Year	Inflation (in %)	Economic Growth (in %)
2007-2008	6.2	9.32
2008-2009	9.1	6.72
2009-2010	12.37	8.59
2010-2011	10.45	8.91
2011-2012	8.39	6.69
2012-2013	10.44	4.47
2013-2014	9.68	4.74

In 2007-2008, inflation was at 6.2 per cent and the economic growth came in at 9.32 per cent. In the aftermath of the financial crisis that started in 2008-2009, the union government increased its expenditure in the hope of ensuring that the economic growth did not collapse.

The government expenditure budgeted for 2008-2009 was at Rs 7,50,884 crore. The final expenditure for the year was at Rs 8,83,956 crore, which was around 17.8 per cent higher. The expansive fiscal policy led to inflation, which in turn led to lower economic growth in the years to come.

The increased government spending led to high inflation in the years 2009-2010 and 2010-2011, but at the same time it also ensured that economic growth continued to stay strong in the aftermath of the financial crisis. Nevertheless, high inflation ultimately caught up with economic growth and it fell below 5 per cent during 2012-2013 and 2013-2014.

The point being that extra spending and lower interest rates leading to inflation might help bump up economic growth in the short-term, but over the longer term it clearly does not help. What made the situation even worse was that RBI did not get around to raising interest rates as fast as it should have.

As Vijay Joshi writes in India’s Long Road—The Search for Prosperity: “Since fiscal policy was expansive, the job of demand-side inflation control was left to the RBI. Given the strength of both demand and cost-push forces, monetary policy would have had to be tough to be effective. Put bluntly, the RBI muffed it. It took a softly-softly approach to raising interest rates. While this may perhaps have been understandable because it feared hurting investment and growth, it is surely no surprise that inflation proved to be persistent.”

High inflation also leads to a situation where the household financial savings fall. This is precisely how things played out in India. Between 2005-2006 and 2007-2008, the average rate of household financial savings stood at 11.6 per cent of the GDP. In 2009-2010, it rose to 12 per cent of GDP. By 2011-2012, it had fallen to 7 per cent of the GDP. In 2014-2015, the ratio had improved a little to 7.5 per cent of GDP.

Household financial savings is essentially a term used to refer to the money invested by individuals in fixed deposits, small savings schemes of India Post, mutual funds, shares, insurance, provident and pension funds, 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.

A fall in household financial savings happened because the real rate of return on deposits entered negative territory due to high inflation.

This led to a situation where savers have moved their savings away from deposits and into gold and real estate. As RBI governor Raghuram Rajan said in a June 2016 speech: “In the last decade, savers have experienced negative real rates over extended periods as CPI has exceeded deposit interest rates. This means that whatever interest they get has been more than wiped out by the erosion in their principal’s purchasing power due to inflation. Savers intuitively understand this, and had been shifting to investing in real assets like gold and real estate, and away from financial assets like deposits.”

If a programme like Make in India has to take off, low household financial savings cannot be possibly a good thing. This hasn’t created much problem in the recent past, simply because bank lending to industry has simply collapsed. Banks (in particular public sector banks) are not interested in lending to industry because industry has been responsible for a major portion of bad loans in the last few years.

But sooner or later, this situation is going to change. And then the low household financial savings ratio, will have a negative impact and push interest rates up. In this scenario, it is important that inflation continues to be under control and the real rates of return on deposits continue to be in positive territory. That is the only way, the household financial savings ratio is likely to go up.

As Joshi puts it: “In today’s world of low inflation, India’s long-run inflation target should certainly be no higher than 4 or 5 per cent a year.” And that is something both the RBI as well as the union government should work towards achieving and maintaining.

The column originally appeared in Vivek Kaul’s Diary on July 12, 2016

8 July, 2016

What the Govt Should Do and What It Shouldn’t

The government of India over the years, at least in theory, has tried to make the lives of its citizens comfortable, by trying to deliver various goods and services at a subsidised rate.

And it has failed miserably at it. The leakage is extremely high i.e. much of the stuff the government wants to deliver gets stolen before it reaches the individuals it is meant for.

54% of the wheat that the government distributes through the public distribution system gets siphoned off. So does 15% of the rice and 48% of the sugar.

And the stealing doesn’t end at rice and wheat. 40% of fertilizer, 46% of kerosene and 24% of cooking gas is also stolen.

The government suffers from what economists call a principal-agent problem. As Vijay Joshi writes in India’s Long Road—The Search for Prosperity: “The government…suffers from a ‘principal-agent problem’. Its functionaries (legislators, bureaucrats) may pursue their own agendas rather than act in the public interest. They may shirk their duties or feather their own nests.”

While politicians and high-level bureaucrats are a part of the government, they are not the ones that people of this country deal with on a regular basis. The people deal with low level officials, from clerks at the local transport authority who won’t lift a finger without being bribed to the shopkeepers running the public distribution system, throughout the country.

And the incentives of these individuals are not in line with the public interest. Hence, there is pilferage and the subsidies that are meant for the people of this country never reach them.

This leads to a lot of money being spent by the government getting wasted. It leads to the government having to incur a higher expenditure than it would have if things reached the people they were meant for.

It also leads to an active black economy, where everything that is stolen from the public distribution system, is sold in the open market, at a higher price.

So what is the way around this? Should the government stop subsidising the people of this country and in the process save the money that gets wasted? Not really.

As Joshi writes: “There is a crucial distinction to be made between on the one hand the state paying for goods and services and on the other hand the state producing goods and services. For example, ‘food security’ may be thought of in common usage as a ‘public good’. However, even if it is agreed that the state should pay for food security, it does not follow that the state should carry out the task of actually delivering food to people.”

The fact that the government tries to deliver rice, wheat, sugar, kerosene, cooking gas, etc., to people, leads to the principle-agent problem and all the corruption that follows. So what is the way out? As Joshi writes: “The state could enable the poor to buy food in the market, at market prices, by transferring purchasing power to them directly in the form of cash or food vouchers. A system along these lines may be more effective in reaching poor people, and also less corrupt. This example is not chosen at random: it is highly relevant to the problems facing India’s public distribution system(PDS) for food delivery.”

Such a system is already available in case of cooking gas. It’s called Pahal. In this case, the subsidy amount on a cooking gas cylinder is paid directly into the bank account of the individual, instead of the cylinder being sold at a lower subsidised price, as was the case earlier.

In late June, 2016, the finance secretary Ashok Lavasa, told PTI that the government had saved Rs 14,872 crore by paying the subsidy amount directly into the account of people, instead of trying to deliver the cooking gas cylinder at a subsidised amount. The government has been able to save money by being able to bring down the cooking gas cylinders being sold in black.

As the Economic Survey of 2015-2016 points out: “The Pahal scheme has been a big success. The use of Aadhaar has made black marketing harder, and LPG leakages have reduced by about 24 per cent with limited exclusion of genuine beneficiaries.”

The real benefit to the government and the citizens will come when the government is able to implement the cash transfer programme (or what it calls direct benefit transfer) to other areas, where the leakages are high. For this to happen, citizens need to have Aadhaar cards and these cards need to be linked to savings bank accounts.

A lot of progress has been made in the issuance of Aadhar cards. As the Economic Survey points out: “The current government has built on the previous government’s support for the Aadhaar program: 210 million Aadhaar cards were created in 2015, at an astonishing rate of over 4 million cards per week. 975 million individuals now hold an Aadhaar card – over 75 percent of the population and nearly 95 per cent of the adult population.”

An Aadhaar card is necessary in order to identify the right beneficiary. This helps in eliminating bogus identities, through which people claim subsidies. But for the government to be able to transfer money to individuals, the Aadhaar card needs to be linked to a bank account.

As of June 2016, the 22.3 crore bank accounts had been opened under the Jan Dhan Yojana. This is a huge jump from 5.3 crore bank accounts from September 2014. Nevertheless, a lot still needs to be done on this front. As the Economic Survey points out: “Despite Jan Dhan’s record-breaking feats, basic savings account penetration in most states is still relatively low – 46 per cent on average and above 75 per cent in only 2 states (Madhya Pradesh and Chattisgarh).”

The Economic Survey was published in February 2016. Given that some time has elapsed since then, the figures quote above would have improved since then. What also does not help is the fact that only 27 per cent of villages have a bank within a distance of 5 kilometres. This means that last mile connectivity is a problem.

This essentially means that if the government moves to cash transfers immediately in a whole host of areas, chances of people being left out because they do not have a bank account, are high. This needs to be set right in the years to come. Of course, it is easier said than done.

The savings from such a system, if and when it is in place, will be huge. As Nitin Gadkari, the road transport and highways minister recently said: “If bogus claims are removed from scholarships, pension, subsidies, ration cards and other schemes and these are linked to Jan Dhan Yojna and Aadhar, it will result in savings of Rs 1 lakh crore to the exchequer.” For all the leakages that happen, Gadkari might just be right.

The column originally appeared in Vivek Kaul’s Diary on July 8, 2016

7 July, 2016

Why Modi Govt’s Latest Spin on Black Money Doesn’t Make Much Sense

Late last week it was reported that the amount of money held by Indians in Swiss Banks has come down. After the news came out, it was said that this reflects the success of the Narendra Modi government’s policy on black money.

As The Economic Times reported: “India’s drive against black money seems to have yielded some results with the latest Swiss National Bank (SNB) data showing a sharp decline in Indian deposits in 2015, the year New Delhi enacted a tough law.” The Press Trust of India, reported the Revenue Secretary Hasmukh Adhia as saying that the “the data indicated the government’s steps to recover black money were in the right direction.”

Sambit Patra, the national spokesperson of the Bhartiya Janata Party claimed the same on Twitter, when he tweeted: “What #ModiGovt has done against Black Money!!-India slides to 75th slot on Swiss bank money list.”

But as we shall see, this is nothing more than marketing spin.

For a tax haven, Switzerland is very open about the total amount of money that has come from different countries and is with Swiss Banks. The Swiss National Bank has been declaring this data for a long time. Take a look at the following table. This shows the total money that Indians have in Swiss banks.

Year	Indian money in Swiss banks (in Swiss francs)
1996	1219270
1997	1645899
1998	1755948
1999	1994423
2000	1509321
2001	1950674
2002	1847011
2003	2205132
2004	3961827
2005	4197215
2006	4987822
2007	2923209
2008	1585004
2009	1391268
2010	1657736
2011	2025072
2012	1344162
2013	1952712
2014	1776099
2015	1206709
Source: Swiss National Bank

So Indian money in Swiss banks in 2015 stood at around 1.207 billion Swiss francs. This is the lowest in 20 years. So doesn’t that make it an achievement for the Modi government? Doesn’t it mean that the Modi government’s crackdown on black money has been successful? Not really.

The advantage of looking at data across a very long period of time is that it doesn’t bluff. As we can see from the above table, Indian money in Swiss banks peaked in 2006, when it was at around 4.99 billion Swiss francs. The trend has been largely downward since then. In fact, the biggest fall in absolute terms came between 2006 and 2007. In 2007, Indian money in Swiss banks fell to 2.92 billion Swiss francs.

Back then Narendra Modi was the chief minister of Gujarat and Manmohan Singh was the prime minister of India. So does that mean Manmohan Singh did better than Narendra Modi? The answer again is no. In fact, the Indian money in Swiss banks fell dramatically between 2007 and 2008, and even between 2011 and 2012. All these times, Manmohan Singh was the prime minister.

The total amount of Indian money in Swiss banks coming down doesn’t indicate the success of India’s politicians in tackling black money. Black money is essentially money which has been earned but on which tax has not been paid. Firstly, not all Indian money in Swiss banks is necessarily black money. Individuals are allowed out to take some money out of the country, every year.

Take a look at the data carefully. The total amount of Indian money in Swiss banks started to fall in 2006. Since then, the amount has largely had a downward trend and is now at a 20-year low. In fact, 2005-2006 was the time when the Indian economy was really taking off. The stock market as well as the real estate market were both doing well.

What the initial fall clearly indicates is that a lot of black money that had left India simply came back to India. In fact, the Finance Ministry’s White Paper on black money published in 2012, makes this point: “The two topmost sources of the cumulative inflows from April 2000 to March 2011 are Mauritius (41.80 per cent) and Singapore (9.17 per cent). Mauritius and Singapore with their small economies cannot be the sources of such huge investments and it is apparent that the investments are routed through these jurisdictions for avoidance of taxes and/or for concealing the identities from the revenue authorities of the ultimate investors, many of whom could actually be Indian residents, who have invested in their own companies, though a process known as round-tripping.”

A similar sort of round-tripping also happens in the stock market through an instrument known as participatory notes (PNs). As the White Paper points out: “Investment in the Indian Stock Market through PNs is another way in which the black money generated by Indians is re-invested in India. PNs or overseas derivative instruments (ODIs) are issued by FIIs [foreign institutional investors] against underlying Indian securities, which can be equity, debt, derivatives, or even indices. The investor in PNs does not hold the Indian securities in her/his own name. These are legally held by the FIIs, but s/he derives economic benefits from fluctuation in prices of the Indian securities, as also dividends and capital gains, through specifically designed contracts.”

Hence, the fall in Indian money held in Swiss bank accounts simply indicates that a significant part of this money has come back to India. Further, between 2005 and 2011, the real estate market was going great guns. Hence, it is safe to say that a lot of black money which would have otherwise left the country, continued to stay in India and found its way into real estate. This is now reflected in the lakhs of home which have been bought and lie locked all across the country.

It also needs to be pointed out here that since 2008, after the start of the financial crisis, the fixed income returns in Western financial markets have been very low. That is another explanation of why a lot of black money may not have left India.

Further, there is this huge misconception that people have, that all the black money in the world goes to the Swiss banks. While this was correct until a few decades back, this isn’t true anymore. The world now is full of tax havens. There are around 70 tax havens all over the world and the black money that has left the shores of India can be almost anywhere in the world. It need not necessarily be in Switzerland.

While Switzerland was the original tax haven where people who did not want to pay tax in their home countries, took their money to, things have changed since the 1980s. New tax havens like Singapore, the Bahamas, Luxembourg, Hong Kong etc., have emerged over the years.

As Gabriel Zucman writes in The Hidden Wealth of Nations—The Scourge of Tax Havens: “In all these tax havens, private bankers do the same things as in Geneva: they hold stock and bond portfolios for their foreign customers, collect dividends and interest, provide investment advice as well as other services, such as the possibility of having a current account that earns little or nothing. And, thanks to the limited forms of cooperation with foreign tax authorities, they all offer the same service that is in high demand: the possibility of not paying any taxes on dividends, interest, capital gains, wealth, or inheritances.”

Further, many tax havens are not open about their data, as Switzerland has been over the years. In fact, it is safe to say that the focus of the Indian government on black money over the last few years, may have made people move their money from Switzerland into other tax havens.

Hence, the point is that Indian money in Swiss banks falling, doesn’t really mean that the Modi government’s black money policy is working. If it was the success it is being made out to be then many more people would have declared the black money they have overseas, during the compliance window offered between June and September, last year.

Taking advantage of the compliance window 638 declarants declared assets and income of Rs 4,147 crore in total. This meant that the government was able to collect around Rs 2,488 crore (60% of Rs 4,147 crore) as tax revenues. This obviously is an extremely low amount.

The column was originally published in Vivek Kaul’s Diary on July 7, 2016

6 July, 2016

BLACK MONEY AND HOW IT ENGENDERS INEQUALITY

In the last month’s edition of the mann ki baat programme, the prime minister Narendra Modi encouraged the citizens to declare the black money they have, pay a fine and get done with it.

Between June 1 and September 30, the government of India, is running a compliance window which allows citizens with black money to declare it to the government, pay a tax of 30%, a surcharge of 7.5% and a fine of 7.5%. This comes with the promise that for “those who voluntarily declare to the government their assets and their undisclosed income…the government will not conduct any kind of enquiry.” As Modi put it: “not once will it be asked as to from where all this wealth came and how it was acquired.”

It remains to be seen how successful this compliance window eventually turns out to be. But the fact of the matter remains that black money continues to remain a huge bane for the Indian society. The Modi government likes to distinguish between the black money that has left the Indian shores and the black money that continues to remain in India.

In the last two years it has been extremely aggressive about reclaiming black money that has left the Indian shores, but the same aggression has been missing when it talks about reclaiming the domestic black money. In fact, the total tax on domestic black money for those wanting to declare it, has been set at 45 per cent. In case of foreign black money this was 60 per cent.

One school of thought is that black money that remains in the country benefits the country in some ways. Let’s consider a politician who has black money. He invests it in a real estate project of a builder. The builder builds homes and sells it. In the process, infrastructure is created. At the same time, jobs are created as well. Further, real estate has a multiplier effect as well. It leads to demand for cement, bricks, steel, glass, and so on. So a lot of people benefit because of domestic black money, if it is invested.

The trouble is that this is just one part of the argument. A lot of homes that have been built using black money lie unsold. The builders are not willing to cut prices because they don’t want their investors to lose out. The investors in many cases happen to be politicians, who have put their ill-gotten wealth to use. This keeps real estate prices high.

Further, many homes that have been sold also, have been kept locked and not been given out on rent. This for the simple reason that rental laws in this country suck, and are loaded completely in favour of the tenant. Also, the current rental yield (rent divided by the market price) is around 2-3%. And at that rate, many landlords feel that renting out home is a risk not worth taking. Hence, many new homes that have been bought are kept locked. A home that is locked is of no use to anyone.

Also, a basic point that people miss is that black money is basically money on which tax has not been paid. When tax is not paid to the government, the government’s tax collections go down. This means that the government gets those who cannot avoid paying tax, to pay more tax. As Arun Kumar writes in The Black Economy in India: “This makes the latter [i.e. those who cannot avoid paying income tax] feel that injustice is being done to them.”

So the government gets those who are paying tax to pay more tax (let’s say by imposing a cess or increasing the rate of tax) or the government simply borrows more. Usually it does both. If the government borrows more, then the chances of interest rates going up, also go up. This again hurts those who are paying tax, more than it hurts others.

In this way, the prevalence of black money leads to more inequality in the society and that is obviously not a good thing.

The column originally appeared in the Bangalore Mirror on July 6, 2016