पापा कहते थे बड़ा नाम करेगा, कोई इंजीनियर का काम करेगा?

papa kehte hain

An education entrepreneur, I used to once know, liked the idea of offering MBA courses at various price points.

If someone can afford to pay Rs 1 lakh, we should charge him Rs 1 lakh. If someone can afford to pay Rs 7 lakh, we should charge him Rs 7 lakh,” was the basic argument he used to make (I am paraphrasing here).

His justification for it was fairly straightforward. “Hindustan Lever Ltd (now Hindustan Unilever Ltd) sells Lifebuoy. It also sells Lux,” he used to offer as a way of explanation of different price points.

And he wasn’t just a speaking type. He acted on what he said and had different business schools offering an MBA at various price points. Another peculiar feature of this entrepreneur was that he opened and shutdown business schools depending on how good the economy and in turn, his business was looking.

So, if he felt, that in the coming years, the demand for business school education would drop, he would not hesitate in shutting down a few business schools as well. That way he had a control over costs and at the same time there were no seats going around vacant in the years to come.

Now imagine what it did to the morale of students who had just passed out? Having studied at a business school, which had already shut down. Of course, the entrepreneur wasn’t running a charity, he was simply running a business which was responding to supply and demand, like every other business does.

And that is how he operated, until he had a run-in with the education authorities and had to scale down his operations dramatically.

Having said that he had a reasonably good record in shutting-down business schools just before the demand for business school education fell. At least, that is what the old-timers who had worked with him for a long period of time, used to say. This primarily was a function of the fact that most of his business schools operated out of a few floors of rented buildings and did not have a campus, so to speak.

The same cannot be said about many entrepreneurs who in the last few years set up engineering colleges, to cash in on what they thought was an education boom. But as happens in case of many bubbles, by the time the supply of the new engineering seats hit the market, the demand for engineers had already started to slowdown and in the years to come things only became worse.

Given the fact, that many of these engineering colleges were set up by politicians, the All India Council for Technical Education(AICTE) went easy on approving these institutions. For politicians, establishing engineering colleges, on cheap government land, was a good way of putting their ill-gotten black money to use.

Also, once the college was in place, the hope was that the management quota seats, would keep bringing in the black money. Hence, education made for a great business model. The key assumption here was that the demand for engineers in information technology companies would keep exploding. Of course, the model also worked on the assumption that an engineering degree would continue to be aspirational for the middle class and the lower middle class households.

And all this made for an excellent business model, or so people thought. Nevertheless, this wasn’t rocket science exactly and many people had figured it out, including, you, me and our mothers. It’s just that we didn’t have the money or the political connections to execute it, like the politicians did.

As Philippa Halmgren writes in Signals—How Everyday Signs Can Help Us Navigate the World’s Turbulent Economy: “Whenever the majority of the population seeks to pursue the same idea at the same time, it usually ends in tears. It is a sure sign of trouble when 85 per cent of business school graduates want a job in the financial markets.”

And it is a sure sign of trouble when many politicians want to set up engineering colleges and many prospective students want an engineering degree which gets them a job in an information technology company.

The number of engineering seats exploded from around 5 lakh in 2005-2006, to 10 lakh in 2009-2010 and to more than 15 lakh, currently. India produces more engineers than the United States and China, put together. Given this, it isn’t surprising that many of these engineering seats are going vacant.

Take the case of Maharashtra which has 1.35 lakh engineering seats. Newsreports point out that around 51,000 seats went vacant this year. That is around 38 per cent of the total seats. In Tamil Nadu, close to 1.19 lakh seats in engineering colleges found no takers. Tamil Nadu has the highest number of engineering seats in the country at around 2.79 lakh. Maharashtra comes in second.

In Karnataka, another state, known for its obsession with the engineering degree, 15,561 engineering seats found no takers. I can go on state by state, but the results will nonetheless remain the same. There is a surfeit of engineering seats across the country.

In fact, as the government recently told the Lok Sabha, “overall there is surplus capacity in the engineering sector with 8,44,328 seats remaining vacant in 2014-15.” The surplus capacity does not mean that the competition to get into an engineering college has become any easier.

While, the number of seats may have exploded, the number of good colleges continues to be few and far between. In fact, various studies over the years have found that a majority of Indian engineering students are unemployable. A recent study carried out by Aspiring Minds found that 80 per cent of the engineers who graduated in 2015, were unemployable.

This isn’t surprising given that starting an engineering college by acquiring the land and putting up buildings, is the easiest part of the job. What an engineering college (or for that matter any college) requires are good teachers. And there is a clearly a huge shortage of even half-decent teachers going around.

Having taught and studied at private colleges (MBA and journalism) I can vouch for the fact that they are extremely poor pay masters, once we take into account the kind of fee that they charge to their students.

There have been gainers out of the entire process as well. And these are the information technology companies. With the number of engineering colleges exploding, the starting salaries in these companies has more or less remained the same, over the last few years.

Also, the AICTE after allowing the establishment of all these colleges has now plans of shutting them down. As Anil Sahasrabudhe, chairman of the All India Council of Technical Education (AICTE), told Mint in September 2015:We would like to bring it down to between 10 lakh and 11 lakh (one million and 1.1 million) from a little over 16.7 lakh now.”

And that is how government institutions operate. First they create the problem and then they think they will be able to solve it, by simply shoving it away. The good thing is, at least in one area in India, the market is doing a good job of cleaning up the mess that prevailed.

The column was originally published in Vivek Kaul’s Diary on August 17,2016

Of Retirement Savings and Weight Loss



Given that on most days I write stuff on economics and finance, one query I regularly get tends to be from senior citizens.

They basically want to know how can they go about increasing their monthly income, given that their current income was proving to be insufficient to meet their needs, because of high inflation.

This is a tricky question to answer. One cannot ask a senior citizen to start investing in stocks, in the hope of earning a better return, and in the process a higher income. That would be an irresponsible thing to do.

Further, most senior citizens generate a regular income by investing in fixed deposits and post office savings schemes. There’s only so much these schemes pay at any given point of time and one cannot do anything about that.

Corporate fixed deposits pay better, but then one has to be careful about which corporate one is investing with. And given the low financial literacy
of most Indians, such a recommendation is best avoided.

So what does that leave us with? Nothing really. In case of many senior citizens, the monthly income is simply not enough because they haven’t gone around saving as much as they should have for retirement.

There can be many reasons for this. Right from not earning enough, to too many expenses when it comes to getting kids educated and married. In some cases, family emergencies and responsibilities for the extended family take away whatever has been saved.

Nevertheless, in many cases it is simply a case of not saving regularly, even though the earnings are reasonable enough. The reasons for this can vary, from sheer laziness to the fact that regular investing is boring or the fact that the individual has been taken for a ride a few times.

I have tried to motivate some of my friends as well as family to invest regularly, and met with failure regularly on that front. This behaviour is something that the American social psychologist Kurt Lewin studied extensively. His solution for it was also a fairly straightforward change of focus.

As Thomas Gilovich and Lee Ross write in The Wisest One in the Room—How You Can Benefit from Social Psychology’s Most Powerful Insights: “When people try to change someone’s behaviour, they typically try to give the person a push in the desired direction: They promise rewards or issue threats. They hire motivational speakers to get their employees to take more initiative; they offer their kids money to get grades; they give impassioned speeches about the importance of eating right, avoiding wasteful spending, or practicing safer sex.”

But these impassioned pleas don’t work many times. And this is where Lewin’s simple insight about change of focus comes in. What Lewin meant by this was that instead of trying to increase motivation, a much better strategy is to identify and then go about eliminating the obstacles that stand in the way of the desired behaviour.

As Gilovich and Ross point out: “Lewis insight applies broadly. To produce change, smooth the path or open a clear channel that links good intentions to effective action. Having difficulty saving money? Set up an automatic deduction plan. Having trouble losing weight? Empty your cupboard of tempting foods. Want your son to spend less time playing computer games and more time reading? Start him out with graphic novels and comic books.”

In the context of putting together a reasonably big retirement corpus this means investing regularly in tax efficient financial instruments. This means investing in fixed deposits to build a retirement corpus (or for that matter any corpus) is a bad strategy because the interest earned is taxable. But investing regularly in financial instruments like mutual funds (through systematic investment plans) and public provident fund (which allows investors to invest up to 12 times in a year) is a great way of building up a corpus.

Once you invest regularly for a longish period of time, only then does the power of compounding come into play. And that remains the only way to accumulate a big enough corpus for retirement for a middle class Indian.

The column originally appeared in the Bangalore Mirror on August 17, 2016

Why Do People Still Have Deposits in Indian Overseas Bank and UCO Bank?


That we are financially illiterate nation is a given. But even with this disclaimer I am sometimes amazed at how lackadaisical people are when it comes to their money.

Take the case of two public sector banks: a) Indian Overseas Bank b) UCO Bank. Recently, both the banks declared results for the three-month period ending June 30, 2016. As of June 30, the bad loans of Indian Overseas Bank amounted to 20.48 per cent. And that of UCO Bank were at 17.19 per cent.

This basically means that close to one-fifth of the loans given by these banks have not been repaid. The question is how do these banks or for that matter any bank, give loans? A bank raises deposits and then gives out those deposits as loans.

Of course, if the loans of a bank are not being repaid, it’s chances of returning deposits are also low. At least, that is how things should work in theory. But that is not the case primarily because everyone knows that a government is not going to let a public sector bank go bust. (Actually, the government won’t let even a private sector bank go bust, but that is a story we will leave for another day).

And this explains why people still have their money deposited with these banks. Take the case of Indian Overseas Bank. As on June 30, 2016, the total deposits with the bank stood at Rs 2.18 lakh crore, in comparison to Rs 2.32 lakh crore a year earlier. Now that is a fall of 5.85 per cent.

This drop is extremely marginal when one takes into account the fact that the bad loans of the bank have more than doubled during the same period. As on June 30, 2015, the bad loans of the bank had stood at 9.40 per cent of its total advances. What this clearly tells us is that the smart money has started to move out of the bank. But the bulk of the lot continue to hold on to their deposits in the bank.

How do things look for UCO Bank? I couldn’t find the deposits of the bank as on June 30, 2016, and hence, have worked with March 31, 2016, numbers, which are good enough to make the point I am trying to make.

As of March 31, 2016, the total deposits of UCO Bank were at Rs 2.07 lakh crore, down from Rs 2.14 lakh crore from a year earlier. This is a meagre fall of 3.4 per cent. During the same period, the bad loans of the bank have jumped from 6.76 per cent to 15.43 per cent.

While the investors in the stocks of these banks have realised the true situation that these banks are in, the same cannot be said about the depositors. The explanation for this is fairly straightforward. Most depositors do not keep track of the state of the bank they have deposited their money in, especially if it happens to be a public sector bank.

The de facto assumption is that money deposited in a public sector bank is safe, which it is. Nevertheless, if at all there is trouble, there might be transitional problems and during that period liquidity of these deposits might be an issue.

Also, for all the risk that depositors are taking on by investing in these banks, what is the extra return that they are earning? The interest on fixed deposits of UCO Bank for a period of one year or more vary between 7.25 per cent and 7.5 per cent. The interest rates on fixed deposits of Indian Overseas Bank for a similar period vary between 7 per cent and 7.25 per cent.

The State Bank of India, the largest public sector bank, offers interest rates between 7 per cent and 7.5 per cent, for fixed deposits of one year or more. Hence, the State Bank of India offers more or less the same interest rate as Indian Overseas Bank and UCO Bank, do.

At the same time, it is a much safer bank to have your deposits in given that its bad loans as on June 30, 2016, stood at 6.49 per cent of its total advances. They had stood at 4.29 per cent as on June 30, 2015.

So, the bad loans of State Bank of India are lower than that of both Indian Overseas Bank as well as UCO Bank. At the same time, they have gone up at a much slower pace. In case both Indian Overseas Bank and UCO Bank, the bad loans have more than doubled over the last one year. This is clearly not the case with State Bank of India.

Hence, even those depositors who like to hold their deposits in government owned banks, the State Bank of India, is a much safer bet. Also, it is the biggest government bank and the government has the most interest in keeping it going.

The only place human beings are known to be rational are in theoretical economics. In real life they clearly not. The above example clearly shows us that. The reasons of people holding on to deposits in Indian Overseas Bank and UCO Bank can be multiple

The first, is that they don’t know that the banks are in a bad shape. The second, is that they do know that banks are in a bad shape, but they also know that government banks don’t fail. The third, is that they have always had their deposits in these banks and are friendly with the people who run the branch they have their deposits in.

Nevertheless, none of these reasons is a rational one because the fixed deposits of these two banks do not pay a higher rate of return for the extra risk that the people are taking on.

The column originally appeared in Vivek Kaul’s Diary on August 16, 2016

What Mainstream Media DID NOT TELL YOU About GST

On August 3, 2016, the Rajya Sabha, the upper house of Indian Parliament, finally passed the 122nd Constitutional Amendment Bill for the introduction of the Goods and Services Tax(GST).

The passing of the Bill will be looked at as an important achievement for the Modi government. Also, credit must be given to the Modi government for reaching out to the opposition and getting almost everyone on board (excluding the AIADMK party) to get the Bill passed in the Rajya Sabha.

To be honest, I didn’t think this would happen and which is what I had said in my past pieces. Nevertheless, the Bill could have been passed during the period 2009-2014, if the Bhartiya Janata Party, which is in power right now, hadn’t opposed it as vehemently as it did.

The television and the print media have gone totally gaga about the whole thing. If you were watching any television channel after the GST Bill was passed on August 3, you would think, looking at the excitement of the anchors, that the Indian per capita income had just crossed that of the United States.

The excitement of the mainstream media notwithstanding there is a lot that remains to be done for a Goods and Services Tax to become a reality. Here is what needs to happen on the legislative front:

a) The Constitutional Amendment Bill will first go back to the Lok Sabha in order to clear the amendments made to it in the Rajya Sabha. The Lok Sabha had earlier passed the Bill in May 2015. This should be fairly straightforward given that the Bhartiya Janata Party led National Democratic Alliance has the required numbers in the lower house of the Indian Parliament.

b) After this is done, 15 or more states will have to ratify the Constitutional Amendment Bill.

c) Then 29 states and two union territories will have to pass their own GST Bills.

d) The Parliament will have to pass the actual GST Act and the interstate GST Act, which will specific the structure of the tax and enable its collection.

As of now this seems doable given that the two Acts that need to be passed by the Parliament need a simple majority of more than 50 per cent and not two-thirds majority as was the case with the GST Constitutional Amendment Bill. Nevertheless, this will take time and when things take time, it is always possible that political parties change their mind.

Further, the GST Constitutional Amendment Bill will lead to the creation of the GST Council comprising of the finance minister of the union government, who will be its Chairperson, as well as the finance ministers of state governments. The GST Council will essentially go about setting the tax rates.

Before we go any further, it is important to understand what GST exactly is, and how will it help improve India’s taxation system.

What is GST?

India currently has many indirect taxes. Indirect tax is essentially a tax on goods as well as services and not income or profits, for that matter. India currently has a plethora of indirect taxes both at the state government level as well as the union government level. The GST will subsume many of these taxes. It hopes to have one indirect tax for the whole nation and this will convert the country into one unified common market.

The GST or value added tax(VAT), as it is known in other parts of the world, is already present in large parts of the world, as can be seen from the following chart.

Goods and Services Tax in India

How do things stand in India as of now?

Up until now, the Constitution empowers the Union government to levy an excise duty on manufacturing. Let’s take the case of a company which manufactures cars. It needs to pay an excise duty to the union government on every car that it manufactures. The current rate of excise duty is 12.5 per cent on small cars. While, the company pays this tax to the government, it ultimately recovers it from the end consumer who buys the car.

The union government can also levy a customs duty on exports as well as imports. Further, the constitution allows, the Union government to levy a service tax on the supply of services, which the state governments can’t.

On the other hand, the State governments are allowed to levy a value added tax(VAT) or a sales tax on the sale of goods. This division has essentially led to a multiplicity of taxes.

As the Report of the Select Committee of the Rajya Sabha on the 122nd Amendment Bill of the Indian Constitution presented in July 2015 points out: “This exclusive division of fiscal powers has led to a multiplicity of indirect taxes in the country. In addition, central sales tax (CST) is levied on inter-State sale of goods by the Central Government, but collected and retained by the exporting States. Further, many States levy an entry tax on the entry of goods in local areas.”

This multiplicity of taxes has led to an inherently complicated indirect tax structure. As the Select Committee Report points out: “Firstly, there is no uniformity of tax rates and structure across States. Secondly, there is cascading of taxes due to ‘tax on tax’. No credit of excise duty and service tax paid at the stage of manufacture is available to the traders while paying the State level sales tax or VAT, and vice-versa. Further, no credit of State taxes paid in one State can be availed in other States. Hence, the prices of goods and services get artificially inflated to the extent of this ‘tax on tax’.”

Let’s understand this through an example

Let’s take the case of a dealer in one state buying goods from another state worth Rs 1,00,000. As the goods are moving from one state to another, on this, he has to pay a central sales tax of Rs 2,000 (2 per cent of Rs 1,00,000). His effective purchase price works out to Rs 1,02,000. On this he builds a margin of Rs 8,000 and his sales price works out to Rs 1,10,000.

When he sells this good, the state sales tax (or the value added tax) will be charged on Rs 1,10,000. If the tax rate is 5 per cent, then it will work out to Rs 5,500 (5 per cent of Rs 1,10,000). This means that the final price of the good would be Rs 1,15,500 (Rs 1,10,000 + Rs 5,500).

In this case, the state sales tax is also being paid on the central sales tax of Rs 2,000 that has already been paid. Central sales tax paid while purchasing goods from one state is not available as an input tax credit while selling the goods in another state. This leads to a cascading effect as tax on tax needs to paid. In this case the cascading effect is Rs 100 (5 per cent of Rs 2,000 of central sale tax). This ultimately gets built into the price of goods, making them more expensive than they should be.

What are the practical implications of this?

The cascading effect and the fact that the indirect taxes already paid in one state cannot be deducted while paying indirect taxes in another state makes many Indian businesses uncompetitive. The Report on theRevenue Neutral Rate and Structure of Rates for the Goods and Services Tax (GST) (or better known as the Arvind Subramanian Committee Report) has an excellent example.

As the report points out: “Consider a simple example, where intermediate goods produced in Maharashtra go to Andhra Pradesh for production of a final good which in turn is sold in Tamil Nadu. Effectively, the goods will face an additional tax of 4 per cent, which will reduce the competitiveness of the goods produced in Andhra Pradesh compared with goods that can be imported directly to say Chennai from South and East Asian sources.”

This basically happens because goods move between states twice and a 2 per cent central sales tax has to be paid each time. As mentioned earlier, tax paid in one state cannot be deducted while paying more indirect taxes in another state. This essentially means that a programme like Make in India cannot take off in many cases.

What are the other implications?

Other than central sales tax, state governments levy entry taxes as well. These can be like octroi in order to fund a local municipal body or otherwise. These taxes are collected while goods are entering the state or a town. This explains to a large extent why trucks in India move as slowly as they do. This essentially drives up logistical costs.

As the Subramanian Committee report points out: “One study suggests that, for example, in one day, trucks in India drive just one-third of the distance of trucks in the US (280 kms vs 800 kms). This raises direct costs (wages to drivers, passed on to firms), indirect costs (firms keeping larger inventory), and location choices (locating closer to suppliers/customers instead of lowest-cost location in terms of wages, rent, etc.). Further, only about 40 per cent of the total travel time is spent driving, check points and other official stoppages take up almost one-quarter of total travel time. Eliminating check point delays could keep trucks moving almost 6 hours more per day, equivalent to additional 164 kms per day – pulling India above global average and to the level of Brazil. So, logistics costs (broadly defined, and including firms’ estimates of lost sales) are higher than the wage bill or the cost of power, and 3-4 times the international benchmarks.”This will be possible if GST becomes the order of the day. The entry taxes will be subsumed under GST. This will lead to a dismantling of check posts at state borders and there will be no need for trucks to be held up.

Around 72 per cent of Indian freight moves through roads. Hence, eliminating check posts will lead to a faster movement of goods through the length and breadth of the country. Crisil Research estimates that “eliminating delays at check posts will yield additional savings of 0.4-0.8% of sales [of companies].”

While, the state governments are yet to agree to removal of border check posts, as and when this happens, it will be one of the bigger benefits of the GST. If it doesn’t, it will make GST a little less useful.

What will GST do about all this?

The GST will subsume multiple indirect taxes. Take a look at the following table. It points out the indirect taxes which will come under GST and indirect taxes which won’t.

GST TAX table

While GST plans to subsume many indirect taxes it does leave out several taxes as well. Hence, in that sense GST is not a one nation one tax that it is being made out to be.

How will GST work?

The GST will take the cascading effect of tax on taxes out of the equation. It will allow input tax credit for indirect taxes that have already been paid irrespective of what kind of indirect taxes have been paid and where they have been paid.

Take a look at the following table:

Basic Information/Kind of TaxManufacturerWholesalerRetailerTotal
A. Transactions (exclusive of tax)
1. Sales6008001,2002,600
2. Purchases06008001,400
3. Value-added (A1-A2)6002004001,200
4. Tax on sales (10% of A1)6080120260
5. Tax on purchases (10% of A2)06080140
6. Net tax liability (B4-B5)602040120
7. Tax on retail sales (10% of A1/R)120120

Source: Professor Mukul Asher of the Lew Kuan Yew School of Public Policy, National University of Singapore

There are three levels in the above table- the manufacturer, the wholesaler and the retailer. Let’s start with the manufacturer who sells a product for Rs 600 to a wholesaler. He does not purchase any inputs and makes everything in house (I know this is an unrealistic assumption, but it just keeps the Maths a little simple).

On this, the manufacturer pays a tax at the rate of 10% which amounts to Rs 60. The wholesaler sells the product for Rs 800. On this he has to pay a tax at the rate of 10 per cent. This amounts to Rs 80, but he also gets credit for Rs 60 indirect tax which the manufacturer has already paid. Hence, his tax outflow amounts to Rs 20.

The retailer finally sells the product for Rs 1,200. On this he pays tax at the rate of 10%. This amounts to Rs 120. But he gets credit for Rs 80 (Rs 60 paid by the manufacturer and Rs 20 paid by the wholesaler). Hence, he actually pays a tax of Rs 40. In this way, there is no cascading effect and all the tax that has already been paid is taken into account.

What this also tells us is that GST is a destination based tax and will finally accrue to the government once the final customer has bought the good or the service. This explains why parties that rule states like Bihar and Uttar Pradesh have come out in its support. While these states may not have a large industrial base, they do have consumers.

How does all this help?

The GST has a self-policing feature built into it. As the Subramanian Committee report points out: “To claim input tax credit, each dealer has an incentive to request documentation from the dealer behind him in the value-added/tax chain. Provided, the chain is not broken through wide ranging exemptions, especially on intermediate goods, this self-policing feature can work very powerfully in the GST.”

As Crisil Research points out: “Since input tax credit will be available for all taxes paid earlier in the value chain, firms would require evidence of compliance from the preceding links to claim set-offs. Thus, they would prefer sourcing inputs from compliant firms. This could increasingly bring unorganised players under the tax net, thereby reducing their price competitiveness vs. organized players.” This will be one of the biggest benefits from the GST over the long-term as it will make the entire system more transparent.

This could also bring down the price competitiveness of unorganised players as they will have to go legitimate in order to keep their business going. This will increase their costs and could help the more organised players, who already have a strong information technology infrastructure in place. The following table shows the proportion of unorganised players sector wise.

GST Sector table

But there might be some starting troubles on this front. The onus is on the customer to prove that all the suppliers in the value chain have paid their share of taxes, if he wants to take the input tax credit. This is as per Section 16(11)(c) of the Act. Basically what the section says is that if a supplier has not furnished proper returns or made the correct payment, then the customers of the supplier cannot avail of the input tax credit. And if it has been given, it will be reversed.

What will be the rate of tax?

This is something that the GST council headed by the finance minister needs to decide on. The Subramanian Committee has basically recommended four rates of taxes. A rate of 2 to 6 per cent for precious metals. A low rate on goods of 12 per cent. A standard rate on goods and services between 16.9 per cent to 18.9 per cent. And a high rate on goods at 40 per cent.

It is important that the GST council chooses a reasonable rate of tax. The unweighted OECD average rate for GST was 19.1 per cent in 2014 and 18.7 per cent in 2012. The recommendation of the Subramanian committee of a standard rate of 16.9 per cent to 18.9 per cent is in line with the OECD average.

Given the current rate of service tax is 15 per cent (including the cesses), a tax rate of 16.9-18.9 per cent is likely to make services expensive in the short run. This basically means that stuff on which you pay service tax (from your mobile phone bills to your credit card bills) is likely to become more expensive.

Crisil Research expects inflation as measured by the consumer price index is likely to go up by 60 basis points in the short-term. This will be in line with global evidence where inflation does go up in the short-term wherever good and services tax is actually implemented.

The trouble is that the rate of inflation is already looking up. Also, by the time GST becomes the order of the day, the next Lok Sabha elections will be around one to two years away. Will the government be willing to take on this risk? In the run up to the Lok Sabha elections the rate of inflation as measured by the consumer price index anyway goes up, as the government increases subsidy spends.

Why states like the idea of GST?

The state governments have come around to the idea of GST primarily because it allows them to tax services, which isn’t the case as of now. The GST being adopted has a dual structure with both the union government as well as the state governments levying a GST. Both the central GST and the state GST will be levied on every transaction of supply of goods and services, happening within a state. The taxes will not be levied on exempted goods and services.

As Crisil Research points out: “Multiple exemptions exist under the present tax system – the Centre has ~300 items exempted from central excise duty, while the States (together) have ~90 items exempted from VAT. These will be merged into a Final synchronized exemption list under the GST regime.”

It needs to be mentioned here that longer the list of exempted goods and services, higher the standard rate of GST will have to be. Given this, the government will have to limit exemptions if it wants a proper GST.

Other than central and state GST, there will be an interstate GST for transactions happening between states and it will be collected by the union government. The interstate GST will be roughly equal to the central GST plus the state GST. Input tax credit will be available on interstate GST. The following chart shows how the interstate GST will work.

IGST Model

What are the potential areas of conflict?

The former finance minister P Chidambaram of the Congress party has been talking about a standard GST rate of 18 per cent. The Kerala finance minister Thomas Isaac has remarked that capping the 18 per cent rate is too low. Other finance ministers have said the same thing.

A report in The Times of India suggests that Isaac has recommended a standard rate of 22-24 per cent, in order to ensure that states do not lose out on revenue. The situation as of now seems to suggest a standard rate of 20 per cent or more, will be arrived at.

To this Arvind Subramanian, chief economic adviser to the ministry finance said that a standard rate of “higher than 18-19% will stoke inflation”. This is primarily because the tax on services which is currently at 15 per cent will see a huge jump.

It remains to be seen what rate the GST council comprising of state finance ministers and the union finance minister come around to.

R Jagannathan writing for Firstpost makes this point in the context of small cars. An excise duty of 12.5 per cent is levied on small cars. Then there is the state level sales tax or value added tax of 12.5-14.5 per cent. The union budget this year added a one per cent infrastructure cess on cars. Over and above all this, some cities charge an octroi as well.

Hence, we are talking about an effective tax rate of around 28 per cent. If the standard rate of GST is 18-19 per cent then prices of small cars will come down. Crisil Research expects that the prices of small cars to come down by about 10 per cent.

But this is assuming that state finance ministers come around to the idea of 18 per cent standard rate of GST. As Jagannathan asks: “Why would any sensible finance minister at Centre or states reduce this to 18 percent?”This will continue to remain a tricky issue given that states need to subsume a whole host of taxes into the GST and are likely to demand (in fact they are already demanding) a standard rate of 20 per cent or more.

Also, there is the question of how will states compensate municipal corporations for taxes that are subsumed into the GST. Take the case of octroi. The Brihanmumbai Municipal Corporation makes a lot of money through octroi. If GST were to become the order of the day, the octroi will be subsumed into it.

As R Jagannathan writes in a column on Huffington Post India: “The Mumbai Municipal Corporation’s Octroi collections annually are in the range of Rs7,000-8,000 crore. Will GST collections in Maharashtra be enough to finance this revenue loss?” This is a question worth asking.

Further, the GST system as it has been envisaged will need a solid information technology backbone. This information technology system will essentially lead to a lot of lower level bureaucracy, which runs India’s indirect tax system, becoming useless. (Think of all those employees manning check posts on state borders for one).

While, the government does not fire employees, a move to GST will lead to the income from corruption for the lower level bureaucracy coming down. And this is unlikely to go down well with them. They, as always, remain in a position to create problems.

Also, in a recent interaction with a few economists, I was told that the state level bureaucracy remains unprepared for implementing the GST. The fact that GST is a destination based tax and not an origin based one, which is one of its core points, remains unclear to many of them.

The fiscal deficit conundrum

For the first five years, the union government will compensate the states for the loss of revenue arising because of GST. This is the known unknown that can really create a problem. If the compensation demands from states are more than what is expected, the fiscal deficit of the central government can shoot up. Fiscal deficit is the difference between what a government earns and what it spends.

In this scenario, achieving the fiscal deficit target that finance minister Arun Jaitley has set for the government will become difficult. In the budget speech made in February 2015, Jaitley had said that the government will achieve a fiscal deficit of 3.5% of GDP in 2016-17; and 3% of GDP in 2017-18. Running up a higher fiscal deficit will have its own set of repercussions.

What are the advantages of GST?

As we have already seen GST is basically a self-policing system and makes the entire system more transparent. The Subramanian Committee report points out that the GST “is a stark example of a tax believed to facilitate enforcement through a built-in incentive structure that generates a third party reported paper trail on transactions between firms, which makes it harder to hide the transaction from the government.”

This basically ensures that the tax collected by the government goes up. As analysts Saurabh Mukherjea, Ritika Mankar Mukherjee and Sumit Shekhar of Ambit Capital point out: “Cross-country evidence suggests that the introduction of GST boosts the tax-to-GDP ratio by 1-2% points.” The analysts feel that GST will boost tax collection in India by bringing the unorganised sector which accounts for 59 per cent of India’s economy, under the purview of taxation.

While the rate of inflation is initially expected to go up, over the longer term, the inflation does come down as the cascading effect of indirect taxes is done away with and the cost of doing business comes down.

As the Ambit Cpital analysts point out: “Whilst the introduction of a single GST helped reduce inflation in New Zealand as well as Canada, inflation rose moderately in Australia and Thailand. However, the increase in inflation in Australia as well as Thailand was driven by unique factors such as domestic supply constraints. After adjusting for these factors, inflation in these two countries too was lower post GST implementation.”

And what about the GDP?

The finance minister Arun Jaitley has said in the past that GST is likely to push up the Indian GDP growth by 1 to 2 per cent. “This (GST) has the potential to push India’s GDP by one to two per cent,” Jaitley had said in April 2015. Jaitley’s statement was probably made on the basis of a December 2009 report brought out by National Council of Applied Economic Research(NCAER). In this report NCAER said that other things remaining the same the implementation of GST is likely to push up India’s GDP “somewhere within a range of 0.9-1.7%”.

The evidence on GST increasing GDP growth (or economic growth) is at best sketchy. As the Ambit Capital analysts point out: “Whilst it is difficult to assess the impact of GST on economic growth (as GDP growth is affected by a range of variables), cross-country evidence suggests that there is no clear evidence that the introduction of GST necessarily leads to higher GDP growth. Although the introduction of a single GST limits inefficiencies created by a heterogeneous taxation system, there is little evidence that it helps boost GDP growth rates.”

To conclude, there are many good things about the GST. Nevertheless, it is not a done deal yet and a few major issues remain, which will continue to test the Modi government in the days to come. Also, it is not the be all and end all, that the media is making it out to be. It is just one of the factors that will set India right in the years to come.

This column originally appeared in Vivek Kaul’s Diary on August 5, 2016

Postscript: I will be taking a break from writing the Diary and will be back after August 15. Here is wishing everybody a Happy Independence Day in advance.

Some New Old Lessons in Real Estate


Yesterday (August 1, 2016), the Mumbai edition of The Times of India had a very interesting piece of news.

A bungalow on Nepean Sea Road (one of the poshest areas in South Mumbai), built in 1904, is on sale. The bungalow was last sold in 1917, for a little over Rs 1 lakh. In the recent past, similar properties in vicinity have been sold for Rs 400 crore, or so reports The Times of India.

Imagine, something bought for something as little as Rs 1 lakh being sold for Rs 400 crore. That is exactly what I was told by a friend who called me after he read the news. “See, this is why I keep saying property is the best form of investment. Nothing beats it,” he said. “Such huge returns make real estate such a fantastic form of investment,” he added for good measure.

I was groggy having just woken up, so just heard him out.

A little while later having read the news, I figured out that my friend had fallen for what I call the fallacy of absolute numbers in real estate.

The trouble is that whenever real estate is sold, we tend to look at absolute numbers. “You know, my grandfather bought this house a long time back for a few lakhs and now it’s worth a few crores.” That kind of stuff.

No one bothers to calculate the real rate of return. We just look at absolute numbers and conclude that real estate is a fantastic form of investment. But that is not the right way.

Let’s look at the Nepean Sea Road bungalow with which I started this piece. It was a bought for around Rs 1 lakh and is now worth Rs 400 crore. The value has gone up by around 40,000 times in 99 years. Doesn’t that sound fantastic? It surely does.

Nevertheless, what is the rate of return? The rate of return is 11.3 per cent per year. Over a period of 100 years, a return of 11.3 per cent per year, is very good. But a return of 11.3 per cent per year, sounds nowhere as sexy as the value of the bungalow going up by 40,000 times.

But they are one and the same thing. Further, in an Indian case, comparisons cannot be made, given that data for other forms of investment for such a long period of time, are simply not available.

Also, the question is would you buy real estate now, if it promises you a rate of return of 11.3 per cent per year, over a period of time? In most cases, the answer will definitely be no, given the hassles that come with owning real estate.

Also, there are other mistakes that are made while evaluating real estate returns. Over a period of 100 years a lot of money would have gone into maintaining the house as well as paying those who maintain it. Further, property taxes would have been paid as well. Given that, such expenditure is regular in nature, nobody keeps a record of it, and hence, is not taken into account while calculating the rate of return on a property. This is a basic mistake that keeps getting made all the time.

Also, most people while selling property tend to deal in black and hence, they don’t take into account the fact that a tax needs to be paid on a house being sold. Real estate returns are not tax-free though you can take inflation into account while determining the cost of purchase of a house.

Once we take these factors into account, the real rate of return on property can rarely be calculated and given this people tend to go with absolute numbers. And when we look at absolute numbers it is easy to come to the conclusion that property is the best form of investing.

In this particular case one needs to take into account the fact that the property is based on the Nepean Sea Road, one of the toniest neighbourhoods in Mumbai as well as India. Hence, there will be some premium for it.

Similar properties in not so tony neighbourhoods would not have given this kind of return.

In the India that we live in, there is a danger of the builder disappearing, and the home being built not being delivered. In that situation you will have to continue to pay the rent of the home that you are living in, along with the EMI on the home loan that you have taken in order to buy the house.

If you haven’t taken on a home loan, then your savings are stuck in an asset that isn’t giving you any return really.

More than the money, the stress that comes with an uncompleted home and the builder disappearing with the money, is extremely huge. I have seen a number of such examples among my friends and family, and believe me it’s simply not worth the trouble. It’s amazing to see so many builders get away after not delivering homes on time. There are those who disappear with the money as well. It’s still more amazing to see people believing homes are the best investment.

Another factor that most people don’t realise while buying property as an investment is that the timing the investment is very important. If you had bought property any time during the period 2002 and 2009, and sold it by now, you would have made good money. There is no doubt about it.

But if you had bought property post 2010 onwards, and if you take into account, the cost of maintenance (which needs to be paid every month in most building societies these days), property tax, EMI interest, or loss of interest on the amount invested in the property, etc., chances are your returns would be in single digit territory. In many cases, the returns will be flat. And if you start taking inflation into account, then the value of the home, would have actually gone down in real terms.

But the human brain is not used to dealing with so many factors at the same time. In the simplistic world of the human brain, investing in property continues to be a good form of investing and will continue to be so because it tends to look at absolute numbers and not the real returns.

The column originally appeared in Vivek Kaul’s Diary on August 2, 2016