Analysis

Dear Modi sarkar, what about domestic black money?

narendra_modi
The Lok Sabha passed the Undisclosed Foreign Income and Assets (Imposition of New Tax) Bill, 2015 or the foreign black money Bill, yesterday. The ministry of finance 2012 white paper on black money defines black money as: “any income on which the taxes imposed by government or public authorities have not been paid.” The wealth that has been accumulated in this way “may consist of income generated from legitimate activities or activities which are illegitimate per se, like smuggling, illicit trade in banned substances, counterfeit currency, arms trafficking, terrorism, and corruption,” the white paper goes on to suggest.
Of course this wealth that has been accumulated through tax evasion has “neither been reported to the public authorities at the time of their generation nor disclosed at any point of time during their possession.”
Some portion of this black money over the years has managed to escape the Indian shores and has been invested abroad. An estimate made by Washington-based research and advocacy group Global Financial Integrity in a report titled Illicit Financial Flows from Developing Countries: 2003-2012, suggests that around $439.6 billion of black money left the Indian shores, between 2003 and 2012. Through the foreign black money Bill the government is attempting to get this money back.
Also, given the penal provisions of the Bill, an attempt is being made to ensure that in the days to come, citizens pay tax on their income, instead of accumulating it as black money and then transferring it abroad.
As the finance minister Arun Jaitley put it yesterday: “All those who keep money outside — time is running out for them as the world is moving to an automatic information exchange and soon, when that is available, they will be penalised for their action.”
And what are these penalties like? The Bill states that undisclosed foreign income as well as assets will be taxed at the rate of 30%, without allowing for any exemptions or deductions which are allowed under the Income-Tax Act, 1961. This will be accompanied by a penalty equal to three times the amount of tax. Hence, the tax and penalty on undisclosed overseas income as well as assets can amount to as much as 120% (30% + 90%). Further, the amount of tax to be paid on foreign assets will be computed on the basis of its current market price and not the price at which it was bought.
Nevertheless, there is a way out of this. After the Bill becomes an Act, the government will offer a short compliance window, which will allow those with undisclosed foreign assets and income to declare them, pay a tax of 30% and a penalty of 30%.
The Bill also has a provision which allows the government to charge a penalty of Rs 10 lakh for the inaccurate disclosure of foreign assets, along with a rigorous imprisonment of six months to seven years, the first time around. Second and subsequent offences are punishable with fines of Rs 25 lakh to Rs 1 crore and a rigorous imprisonment three to 10 years.
On the face of it, the Bill seems like an honest attempt to crack down on black money that has already left the country and that might leave the country in the days to come. But there are several questions that crop up here.
Why is a short compliance window being offered? It makes the taxpayers who have been honestly declaring their foreign income as well as assets till date, look a tad stupid. Just because someone is willing to pay a fine of 30% and declare his foreign assets, does that make his less guilty? Or is this another tax amnesty scheme in disguise being offered by the government?
Further, why is there a distinction being made between domestic and foreign black money? The definition of black money in the ministry of finance white paper does not make any distinction between black money in the country and black money that has left the shores. Ultimately, almost all black money originates in the country, when people earn an income and do not pay a tax on it. So why is this artificial distinction being made? Why couldn’t the government have come up with a law which covered both domestic as well as foreign black money? Its now been in office for close to one year.
The answer perhaps lies in the way political funding works in this country. An analysis carried out by the National Election Watch and Association of Democratic Reforms reveals that during the period 2004-2005 and 2011-12, the total income of the national political parties was Rs. 4,899.46 crores. The Congress party declared the highest income of Rs 2,365.02 crores. It was followed by the Bhartiya Janata Party which declared an income of Rs 1,304.22 crores.
Between 2004-05 and 2011-12, there were two Lok Sabha elections(in 2004 and 2009) and multiple state assembly elections. It doesn’t take rocket science to come to the conclusion that the amount of donations declared by the political parties were clearly not enough to fight so many elections.
Within 90 days of completion of the General Elections, political parties are required to submit their election expenditure to the Election Commission of India. The National Election Watch and Association of Democratic Reforms has analysed this expenditure for the last Lok Sabha election and it makes for a very interesting reading. This expenditure statement contains the “details of the total amount received as funds in the form of cash, cheques and demand drafts and the total amount spent under various heads.”
The total amount of funds collected by national political parties for the 2014 Lok Sabha election was at Rs 1158.59 crores. This was 35.5% higher than the funds collected for the 2009 Lok Sabha elections. The total declared expenditure of the national political parties was Rs 1308.75 crore, up by 49.4% from 2009.
Now compare this to an estimate made by the Centre for Media Studies in March 2014. It estimated that around Rs 30,000 crore would be spent during the 16th Lok Sabha elections which happened in April and May 2014. Of this amount, the government would spend around Rs 7,000-8,000 crore to conduct the elections. The remaining amount of around Rs 22,000-23,000 crore would be spent by the candidates fighting the elections.
Of course, national political parties are not the only parties fighting elections. Nevertheless, the difference between the officially declared expenditure and the ‘real’ expenditure to fight elections, is huge. Where does this money come from? The domestic black money essentially finances political parties and in the process elections in India. And given this, no government(and political party) can really go after it. Meanwhile, they will keep talking about foreign black money.

Moral of the story—You don’t kill the goose that lays golden eggs.

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

The column originally appeared on DailyO on May 12, 2015

Black money in our backyard

narendra_modi
Getting black money from abroad has been one of the pet issues of the Narendra Modi government. Black money is essentially money on which taxes have not been paid.
Estimates made by Global Financial Integrity in a report titled Illicit Financial Flows from Developing Countries: 2003-2012, suggest that around $439.6 billion of black money left the Indian shores, between 2003 and 2012.
India is ranked number fourth (behind China, Russia and Mexico) when it comes to the total amount of black money leaving a developing country. The interesting thing nonetheless is that the quantum of money leaving India has increased dramatically during the Congress led UPA years.
In 2003, around $10.18 billion left the country. By 2012, this had jumped by more than 9 times to $94.8 billion. Interestingly, the number in 2009 was at $29 billion. This clearly tells us that the second term of the Congress led UPA which started in May 2009 was fairly corrupt.
Also, the amount of money leaving China grew by 3.9 times between 2003 and 2012. In case of Russia the increase was 3 times, whereas in case of Mexico the increase was 1.6 times. Hence, the jump in the Indian case was clearly the most.
The $439.6 billion that has left the country works out to around 23% of the Indian GDP of $1.88 trillion in 2013. Given this, it is a large amount of money and hence, the Modi government’s interest in getting this money back, seems justified.
While things may always be possible, what we need to look at is whether they are probable. And the answer in this case is no. Conventional wisdom has it that all this money is lying in Swiss banks. But that is an incorrect assumption to make.
There are around 70 tax havens all around the world. Given this, the money that has left Indian shores could be anywhere. Tax havens are unlikely to cooperate with the Indian government in helping it get back the black money stashed abroad. The economies of many tax havens run on black money.
So does that mean the government should give up on its pursuit of black money? Of course not. It should concentrate on the black money that is stashed in India.
There are no clear estimates of the total amount of black money in India. As per a confidential report submitted to the government by the National Institute of Public Finance and Policy (NIPFP) in December 2013, the black money economy could be three fourths the size of the Indian economy. This report was accessed by The Hindu in August 2014.
There are other estimates which are not so big. Nevertheless, what we know for sure is that only around 2.9% of Indians pay income tax. In fact, former finance minister P Chidambaram in his February 2013 budget speech had said that India had only 42,800 people with a taxable income of Rs 1 crore or more.
Now compare this with the fact that around 30,000 luxury cars are sold in India every year. Both Audi and Mercedes sold more than 10,000 cars in India in 2014. A February 2015 report brought by business lobby FICCI makes a similar point.
The report estimates that the number of dollar millionaires(i.e. with assets of Rs 6 crore or more) in India in 2014 stood at around 2.27 lakhs, up from 2.14 lakh in 2013. But the number of taxpayers with a taxable income of more than a crore is less than 50,000.
What this tells us clearly is that there is widespread tax evasion in the country. This tax evasion continues to generate a lot of black money, a major part of which continues to remain country. This is the black money that the government should be going after.
Information technology can play a huge part in this. In fact it already is. As the FICCI report cited earlier points out: “The Integrated Taxpayer Data Management System is a data mining tool implemented by the I-T department that is used for detection of potential cases of tax evasion. The tool assists in generating a 360-degree profile of the high net-worth assesses.” The government should work towards making this tool even more robust by building in more data into it, in the days to come.
Further, it has to get cracking on the real estate sector where the maximum amount of black money is invested. This black money generates more black money. Going after the biggest property dealers of the National Capital Region, where most black money changes hands, might be a good starting point.
The question is will this government (or for that matter any government) go after domestic black money, given that it finances almost every political party in the country. Now that is something worth thinking about.

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

The column originally appeared in the India Today magazine dated May 18, 2015

The Make in India lesson I learnt when I bought a television set

make in indiaVivek Kaul

Yesterday’s edition of The Times of India had a very interesting newsreport. As per the newsreport: “Data available with the Bureau of Indian Standards (BIS) shows that over 60% of the recently registered products are “Made in China.””
These include products like mobile phones, printers, power adapters, notebooks, tablets and so on. What this tells you clearly is that a vast majority of electronic products that we buy in India are not made in India, but in China.
Interestingly, the last time I bought a television set few years back, it came with a weird looking plug—something that I had never seen before. It wouldn’t fit into the electrical socket at home. It took a helpful neighbour to solve the problem. He told me that I would need a converter to fit the plug into the socket. The converter cost me Rs 25 and left me wondering that why did a company which sold a product worth Rs 15,000 inconvenience its customers for something worth Rs 25? Maybe marketing professionals can throw some light on that.
Last year when I bought a smart phone a similar experience awaited me. But this time around I was prepared and as soon as the smart phone was delivered at home (I had ordered it online), I went out and bought a converter, which cost Rs 20 this time around.
As you must have figured out by now, dear reader, both the products were made in China. Not just technology products which are made in China are flooding the Indian market. There are other products as well. As The Times of India newsreport referred to earlier points out: “There are a vast majority of goods — from electricity bulbs and thermometers to Ganesha and Laxmi idols — where the government is yet to have domestic standards resulting in unregulated entry of Chinese product.” Even Rakhis are now made in China. Indeed, this has been a worrying trend for sometime now.
The reason for this is fairly straightforward—no country has gone from developing to developed without the expansion and success of its manufacturing sector. As Cambridge University economist Ha-Joon Chang writes in Bad Samaritans—The Guilty Secrets of Rich Nations & the Threat to Global Prosperity: “History has repeatedly shown that the single most important thing that distinguishes rich countries from poor ones is basically their higher capabilities in manufacturing, where productivity is generally higher, and more importantly, where productivity tends to grow faster than agriculture and services.”
And the Indian manufacturing sector cannot flourish with products being made in China. For a while there was great hope that India does not need to go through a manufacturing revolution to pull its citizens out of poverty. And that the information technology led services revolution would do that trick. But services by their very design have certain limitations.
As Chang writes: “There are certainly some services that have high productivity and considerable scope for further productivity growth—banking and other financial services, management consulting, technical consulting and IT support come to mind. But most other services have low productivity and, more importantly, have little scope for productivity growth due their very nature (how much more ‘efficient’ can a hairdresser, a nurse or a call centre telephonist become without diluting the quality of their services?).”
So, where does that leave us? Over the last few years the education infrastructure that has been built to feed trained individuals into the services sector has been huge. As Akhilesh Tilotia writes in The Making of India: “An analysis of the demand-supply scenario in the higher education industry shows significant capacity addition over the last few years: 2.4 million higher education seats in 2012 from 1.1 million in 2008.” In 2016, India will produce 1.5 million engineers. This is more than the United States (0.1 million) and China (1.1 million) put together.
The number of MBAs between 2012 and 2008 has also jumped to 4 lakh from the earlier 1 lakh. As Tilotia writes: “India faces a unique situation where some institutes(IITs,IIMs, etc.) are intensely contested while a large number of the recently-opened institutes struggle to fill seats…With most of the 3 million people wanting to pursue higher education now having an opportunity to do so, the big question that should…be asked…are all these trained personnel required? Our analysis seems to suggest that India may be over-educating its people relative to the current and at least the medium-term forecast requirement of the economy.”
What this means is that a large number of people going in for higher education will find it difficult to find jobs which are commiserate with the kind of money they have paid for their education, after they pass out. And they will not be the only ones having a tough time. India is adding nearly 13 million people to the workforce every year. And enough jobs are not being created.
This is something that the latest economic survey points out: “Regardless of which data source is used, it seems clear that employment growth is lagging behind growth in the labour force. For example, according to the Census, between 2001 and 2011, labor force growth was 2.23 percent (male and female combined). This is lower than most estimates of employment growth in this decade of closer to 1.4 percent. Creating more rapid employment opportunities is clearly a major policy challenge.”
And these rapid employment opportunities will be created only if more and more products are made in India and not China. For products to be made in India, major labour reforms need to happen. A report in The Indian Express seems to suggest that the government is working on this front. It is planning to make amendments to the Industrial Disputes Act, 1947. The government is also planning to: “codify the Central labour law architecture wherein the labour ministry plans to merge all 44 Central legislations into four codes on labour laws — one each on wages, industrial relations, social security and safety & welfare. Apart from industrial relations and wages, other codes are likely to be released during the course of the year.”
Let’s see how far is it able to go with this. 

The column originally appeared on The Daily Reckoning on May 6,2015

With QE 4 around the corner, the stock market will rally

3D chrome Dollar symbolVivek Kaul

The post financial crisis world is a weird one—the world’s biggest economy doesn’t do well and the stock market rallies in another part of the world.
The gross domestic product(GDP) of United States grew by 0.2% for the period January to March 2015. This was an advance estimate released by the Bureau of Economic Analysis. The second estimate is scheduled to be released on May 29, later this month.
The BSE Sensex rose by 479.28 points or 1.77% to close at 27,490.59 points yesterday (May 4, 2015). A possible explanation lies in the fact that the bad economic growth number might force the Federal Reserve of United States, the American central bank, to go in for another round of money printing or quantitative easing (QE), as the economists like to call it.
As Albert Edwards of Societe Generale writes in his latest research note: “The US economy is struggling and the Fed will ultimately re-engage the QE spigot.” The Federal Reserve has already carried out three rounds of money printing, with the last round better known as QE III ending in October 2014.  Until October 2014, the Federal Reserve had been printing money and pumping money into the financial system by buying government bonds and mortgaged backed securities.
The idea was to flood the financial system with money by buying bonds and drive down interest rates. At lower interest rates, people were more likely to borrow and spend money. This would help businesses and in turn, the overall economy. While this happened to some extent, what also happened was that institutional investors borrowed money at low interest rates and invested them in financial markets all over the world. This led to stock market rallies all over the world.
With the US GDP growing by just 0.2%, it is more than likely that the Federal Reserve will go back to its tried and tested strategy of printing money in the days to come. This round of money printing will be referred to as QE IV. What makes the situation more than likely is the fact that even a 0.2% economic growth is overstated. This is primarily because it includes a huge inventory build up. Inventory essentially refers to goods which are being produced but not being sold.
Inventories during the period January and March 2015 went up by $110.3 billion. They had risen by $80 billion during the period October to December 2014. An increase in inventory adds to the GDP. Nevertheless what it also means is that there will be production cuts in the months to come, which in turn will pull the GDP down.
Edwards of Societe Generale estimates that without this unprecedented rise in inventories, “GDP would rather have declined by some 2½%!” Economists at Bloomberg estimate that: “inventory rise added 74 basis points to growth, which means that final sales (GDP ex-inventories) actually contracted (-0.5 percent).” One of the reasons for this rise in inventory is the strong dollar, which has led to imports flooding the United States.
Another reason put forward by American economists for the build up of inventory is the more than usual ‘snowy’ winter in large parts of the United States. Nevertheless as Edwards argues: “Sales are declining on a year on year basis, but we are assured this is due to the cold weather. But if it is not, and sales do not surge in coming months, then the economy is heading into recession as the inventory sales ratio has now reached levels that will necessitate savage cutbacks in production.”
What also does not help is a slowdown in consumer spending. During the period January and March 2015, consumer spending rose by 1.9%. It had grown by 4.4% in the period October to December 2014.
The next meeting of the Federal Open Market Committee (FOMC) of the Federal Reserve is scheduled on June 16-17, 2015. It had been suggested earlier that the FOMC will start raising the federal funds rate in June. The federal funds rate is the interest rate at which one bank lends funds maintained at the Federal Reserve to another bank, on an overnight basis and acts as a sort of benchmark for short and medium term loans. Federal funds rate is currently in the range of 0-0.25% and is likely to continue staying in that range.
With the US economic growth collapsing during the first three months of the year, there is no way the FOMC will start raising the federal funds rate in June. What this also means is that money will continue to be available at low interest rates for institutional investors to borrow and invest in financial markets all over the world. The Sensex rising by around 480 points yesterday was an indication of the same.
Also, one of the things that I have learnt in the post financial crisis world is that central banks seem to have come around to the belief that the only economic weapon they have to get economic growth going again is to print money. Given this, QE IV might well be on the cards in the days to come. And this means foreign institutional investors will continue to invest money in Indian stocks.
All I can say as of now is stay tuned and watch this space. 

The column appeared on The Daily Reckoning on May 5, 2015.

Yellen does a Greenspan, talks about “irrational exuberance” in the stock market

yellen_janet_040512_8x10Vivek Kaul

Janet Yellen, the chairperson of the Federal Reserve of the United States, said yesterday: “equity market valuations at this point generally are quite high…There are potential dangers there.” This is the strongest statement that Yellen has made against the rapidly rising stock markets in the United States and other parts of the world.
In February earlier this year Yellen had said that the stock prices where “somewhat higher than their historical average levels.” In March, she had followed this up by saying that the stock market valuations were “on the high side”.
Central bank governors don’t say things just like that on the stock market, like the stock market analysts tend to do. When a central bank governor makes his view public on the stock market, the idea is to temper down the expectations of stock market investors in some way.
Take the case of a speech that Alan Greenspan, who was the Chairperson of the Federal Reserve between 1988 and 2006, gave on December 5, 1996. In this speech Greenspan said: “Clearly, sustained low inflation implies less uncertainty about the future, and lower risk premiums imply higher prices of stocks and other earning assets. We can see that in the inverse relationship exhibited by price/earnings ratios and the rate of inflation in the past. But how do we know when irrational exuberance[emphasis added] has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade.”
Greenspan was essentially saying that the stock market level might have run way ahead of the kind of earnings that were being generated by companies. And hence there was an “irrational exuberance”.
Greenspan recalls in his autobiography The Age of Turbulence that at the end of the speech, he wondered whether people would understand what he was trying to get at. They sure did.
The Japanese stock market, which had opened by the time Greenspan finished his speech, reacted instantly. The Nikkei index dropped 3.2 percent. The Hang Seng in Hong Kong dropped 2.9 percent. The DAX in Germany went down four percent and so did the FTSE 100 in London.
The next day, when the stock markets in the United States opened for trading, the Dow Jones Industrial Average, America’s premier stock market index, was down 2.3 percent. The NASDAQ Composite Index, where most of the technology companies listed, was down 1.8 percent at opening.
By the close of trading, NASDAQ Composite Index was down 0.9 percent and had recovered half of its losses. When the stock market opened for trading again on December 9, 1996, after the weekend, it was back trading at the levels it had been at before Greenspan made the “irrational exuberance” speech.
Various explanations have been offered over the years as to why the stock market investors chose to ignore what Greenspan had said and continued to stay invested in the dotcom bubble. One is that Greenspan did not immediately back his speech with the concrete action of raising interest rates. This argument is not totally correct because Greenspan did raise interest rates a couple of months later, although he did not do anything immediately. The second reason given is that by the time Greenspan raised the red flag, the market was already irrationally exuberant. It had already formed a mind of its own and was in no mood to listen. As the economist Ravi Batra writes in Greenspan’s Fraud: “The lure of free lunch is so powerful that it clouds our vision. For once Greenspan had offered words of wisdom, but in doing so he lost his audience. The master bartender wanted his customers to sober up. They wanted more: whiskey, champagne, rum, just bring it on.”
The stock market needed a little more than just one Greenspan speech to sober up. A series of interest rate hikes might just have done the trick. But this can only be said with the benefit of hindsight. Nobody likes to spoil a party that is on. Greenspan too was human, and he did not want to be a killjoy.
So what is it that we can learn when we compare Greenspan’s warning with those made by Yellen in the recent past. Yellen’s warnings on the stock market like that of Greenspan might also have come a little late in the day. But unlike Greenspan who just made one warning and then more or less kept quiet, till the dotcom bubble burst in 2000, Yellen has come up with a series of warnings. If she keeps saying the things she has been the investors will eventually take her seriously. The only question is when.
Further, just talking about stock market being overvalued won’t help. If Yellen has to rein in the stock market then the Federal Reserve also needs to start raising the interest rates. The trouble is that with the American gross domestic product(GDP) growing by just 0.2% between January and March 2015, Yellen and the Fed are not really in a position to start raising interest rates.
In fact, what makes the economic situation even more worse than it actually looks is the fact that even a 0.2% economic growth is overstated. This is primarily because it includes a huge inventory build up. Inventory essentially refers to goods which are being produced but not being sold.
Inventories during the period January and March 2015 went up by $110.3 billion. They had risen by $80 billion during the period October to December 2014. An increase in inventory adds to the GDP. Nevertheless what it also means is that there will be production cuts in the months to come, which in turn will pull the GDP down. Albert Edwards of Societe Generale estimates that without this unprecedented rise in inventories, “GDP would rather have declined by some 2½%!” He also said in a recent research note that: “The US economy is struggling and the Fed will ultimately re-engage the QE spigot.” QE or quantitative easing is the technical term that economists use for a central bank printing money and pumping that money into the financial system to keep interest rates low.
Until October 2014, the Federal Reserve had been printing money and pumping money into the financial system by buying government bonds and mortgaged backed securities. The idea was to flood the financial system with money by buying bonds and drive down interest rates. At lower interest rates, people were more likely to borrow and spend money. This would help businesses and in turn, the overall economy. While this happened to some extent, what also happened was that institutional investors borrowed money at low interest rates and invested them in financial markets all over the world. This led to stock market rallies all over the world.
Hence, while Yellen might keep making statements about the stock markets being overvalued, she needs to back it up with some concrete action(like raising interest rates) for investors to take her seriously.
The trouble is Yellen can’t raise interest rates. At least, not in near future. Given the American economic growth scenario, an era of low interest rates and easy money is likely to continue in the days to come. And what this means is that BSE Sensex just might go back to rallying despite the recent fall.

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

The column originally appeared on Firstpost on May 7, 2015