Category: BJP | Page 4

7 January, 2015

Coal India: India’s biggest industrial strike in 38 years that no one is talking about

The unions of Coal India, the company which produces nearly 80% of the coal produced in India, have gone on a five day strike, starting January 6, 2015. The strike is supported by the five leading trade unions in the country, including the Bhartiya Janata Party backed Bhartiya Mazdoor Sangh (BMS).
The Press Trust of India reports that the strike is the biggest industrial action seen in any sector since 1977. It is also the biggest strike in the history of Coal India. Interestingly, the unions had boycotted a meeting called by coal minister Piyush Goyal last week.
The unions are essentially protesting the disinvestment and restructuring of Coal India. They also don’t like the idea of the government selling coal blocks to private parties. D Ramanandan, President of All India Coal Workers’ federation, told The Times of India that “The protests will not stop till the commercialization of coal blocks is not stopped”.
Long story short, the protesters want Coal India in particular and coal production in general to continue to be government owned in every way and keep private companies as far as possible. Nevertheless, the following table makes for a very interesting reading.

Name of the Coal India subsidiary	Number of employees (as on Dec 1, 2014)	Coal production between April and September 2014 (in million tonnes)
Mahanadi Coalfields	22,245	55.029
South Eastern Coalfields	69,012	54.367
Northern Coalfields	16,418	29.718
Central Coalfields	45,722	21.593
Western Coalfields	50,557	17.82
Bharat Coking Coal	57,184	16.106
Eastern Coalfields	69,739	15.967
North Eastern Coalfields	2,064	0.14

Source: www.coalindia.in

The table lists the eight coal producing subsidiaries of Coal India (the company has a ninth subsidiary called Central Mine Planning Design Institute, which does not mine coal). The North Eastern Coalfields produces a minuscule amount of coal and hence, can be left out of the analysis.
One look at the table will tell you that the two best performing companies of Coal India are Mahanadi Coalfields and Northern Coalfields.
For the period April to September 2014, Mahanadi Coalfields managed to produce 55.029 million tonnes of coal. As of December 1, 2014, it had an employee strength of 22,245.During the course of 2013-2014 it produced 114.34 million tonnes of coal or nearly one fourth of the coal that was mined by Coal India.
In case of Northern Coalfields the employee strength was 16,418. The coal produced amounted to 29.718 million tonnes. In 2013-2014, it produced 72.11 million tonnes of coal or around 15.6% of the total coal produced by Coal India.
It is also clear from the table that the company with the most number of employees, Eastern Coalfields, also produces the least amount of coal. The company with the third largest number of employees, Bharat Coking Coal, comes in second from the bottom when it comes to coal production. In 2013-2014, Eastern Coalfields produced just 36.25 million tonnes or 7.8% of the coal produced by Coal India. The same was the case with Bharat Coking Coal, which employed 17% of total Coal India employees but produced only 7.4% of coal that was produced.
The trend is clear here. Companies with fewer employees are producing more coal. The only exception to this is South Eastern Coalfields, which with 69,012 employees produced 54.367 million tonnes of coal during the first six months of this financial year.
Why is this the case? Why are companies with fewer employees producing more coal? The answer lies in the fact that companies which are producing more coal with fewer employees are outsourcing the excavation of coal. Also, the coal mines of Northern Coalfields are highly mechanised.
Another reason why Eastern Coalfields has a lower productivity is because it has many underground mines. In fact, during the first six months of this financial year, the company produced around 22.1% of its coal underground. The same stands true for Western Coalfields as well, which mined nearly 20.9% of its coal underground.
The overall number in case of Coal India was at 8%. Of the total of 210.74 million tonnes produced by Coal India between April to September 2014, 16.953 million tonnes was mined underground. The remaining coal was excavated from open cast mines.
This is an important point because the technology used to mine coal from underground mines is still very labour intensive and that to some extent explains the lower productivity of both Eastern as well as Western Coalfields.
Having said that companies like Eastern Coalfields and Bharat Coking Coal also have stronger trade unions (Eastern Coalfields is head-quartered at Sanctoria in West Bengal and Bharat Coking Coal at Dhanbad in Jharkhand, but right on the West Bengal border). This is another major reason which explains why these companies employ so many people to produce very little coal in comparison to other subsidiaries.
Nevertheless, outsourcing has made an inroad in the low productivity companies of Coal India as well. The contractual expenses of Eastern Coalfields have risen by 117% between 2009-2010 and 2013-2014. How does this compare with Coal India as a whole? The contractual expenses of Coal India in 2013-2014 stood at Rs 7812.71 crore, a rise of around 48% from 2010-2011. The annual report of the company points out that the contractual expenses have increased mainly due increased volume of contractual operations.
In simple English, more and more excavation of coal is being outsourced, even in a company like Eastern Coalfields, and this is something that the unions need to be more worried about than the government selling coal blocks to private companies.
It also needs to be pointed out here that the best performing companies of Coal India have huge operating margins. Mahanadi Coalfields earned a total revenue of Rs 12,033 crore during 2013-2014, with an operating profit of Rs 5429.08 crore, which means an operating margin of 45.1%. Interestingly, the company had an operating margin of 51.3% in 2012-2013. Northern Coalfields had an operating margin of of 40.1% in 2013-2014, having fallen from an operating margin of 54.2% that the company had earned in 2012-2013.
These companies should not be subsidiaries of Coal India. They should be allowed to operate on their own. Currently, these companies have a certain “command area” beyond which they cannot operate. Hence, Mahanadi Coalfields cannot operate a coal mine in the command area of Eastern Coalfields, even though the company is more productive at mining coal. These limitations need to be done away with for the simple reason that it will create more competition within the sector.
A recent report in the Business Standard newspaper suggests that the Suresh Prabhu-led ‘Advisory group for integrated development of power, coal and renewable energy’ “has quashed the idea of restructuring Coal India.” Nevertheless, the report does talk about empowering the subsidiaries of Coal India.

“(The) subsidiaries may be given adequate delegation of power, capital expenditure and operational flexibility, along with commensurate accountability, so that their dependence on CIL for decision making does not hamper fulfilment of targets set out for them,” the newsreport in Business Standard pointed out.
This is a good step forward. Ideally, the government should breakdown Coal India and let its subsidiaries operate on their own. Given that it does not want to do that, this is the next best step.
To conclude, India has the third largest coal reserves in the world of 301.56 billion tonnes as per estimates of the Geological Survey of India. But we still import a huge amount of coal.
Coal India produced 323.58 million tonnes of coal in 2004-2005. In 2013-2014, it produced 462.42 million tonnes of coal. The rate of production has increased at an average annual rate of 4.05%. During the same period, the total amount of coal imports has increased from 28.95 million tonnes to 171 million tonnes, at an average annual rate of 21.8%. What this clearly tells us is that India needs more coal. Not more Coal India.
The sooner the government realizes this, the better the energy scenario in the country is likely to be.

The column originally appeared on www.equitymaster.com as a part of The Daily Reckoning, on January 7, 2015

5 January, 2015

Jaitley needs to be realistic while making budget projections for 2015-2016

Vivek Kaul

The fiscal deficit of the government of India for the period April to November 2014 stood at Rs 5,25,134 crore or 98.9% of the annual target of Rs 5,31,177 crore (4.1% of the GDP). Fiscal deficit is the difference between what a government earns and what it spends.
As can be seen from the accompanying table this is the second highest fiscal deficit during the first eight months of the financial year since 1997-1998. Also, the level is way higher than the average fiscal deficit of 73.64% between 1997 and 2013.

Period	% of the annual target
April to November 2014	98.90%
April to November 2013	93.90%
April to November 2012	80.40%
April to November 2011	85.60%
April to November 2010	48.90%
April to November 2009	76.40%
April to November 2008	132.40%
April to November 2007	63.80%
April to November 2006	72.80%
April to November 2005	74.70%
April to November 2004	51.50%
April to November 2003	61.00%
April to November 2002	61.50%
April to November 2001	68.00%
April to November 2000	57.80%
April to November 1999	80.60%
April to November 1998	75.80%
April to November 1997	66.70%

Source: www.cga.nic.in

As far as the total expenditure of the government is concerned it has gone up by only 5% in comparison to the same period in 2013. The major reason for the high fiscal deficit lies in the fact that the total revenues of the government for the period April to November 2014 have grown by 7.8%. The budget presented by finance minister Arun Jaitley in July 2014 had assumed that revenues would grow by 15.6%.
Hence, the revenue growth has been half of the projected level. Things are even worse when it comes to the taxes collected by the government. It was assumed that total tax collected by the government would grow by 16.9% in 2014-2015 in comparison to the same period during the last financial year. The actual growth between April to November 2014 was just 4.3%. The projections made by Jaitley and his team have gone for a toss totally, even after taking into account the fact that the government earns a substantial portion of its tax income during the last quarter of the financial year.
The Mid Year Economic Review which was published in late December 2014 stated that the tax collections will fall short by close to Rs 105,084 crore or around 0.84% of the GDP.
The learning from this is that Jaitley and his team need to be realistic with the projections they make for the next financial year’s budget, which is due next month. There is no point in assuming a very high growth rate in revenues, as was the case this year, and hence, understating the fiscal deficit number for the next financial year.

What these numbers also clearly tell us is that there is no way the government can meet the fiscal deficit target that it set for itself in July, unless it changes course. It doesn’t take rocket science to figure out that there are two things that the government can basically do—cut expenditure and increase revenues.
As far as government expenditure is concerned as I have pointed out in the past the expenditure is categorised into two categories—plan and non-plan. Non-plan expenditure makes up for around 68% of the total expenditure of the government in 2014-2015.
Interest payments on debt, pensions, salaries, subsidies and maintenance expenditure are all non-plan expenditure. As is obvious a lot of non-plan expenditure is largely regular expenditure that cannot be done away with. The government needs to keep paying salaries, pensions and interest on debt, on time. Hence, slashing this expenditure to meet the fiscal deficit target is easier said than done.
What is interesting is that while presenting the budget Jaitley had assumed that non-plan expenditure would grow by 9.4% during the course of the financial year. At the same time he had assumed that plan expenditure would grow by 20.9%.
Jaitley had increased the allocation of plan expenditure by close to Rs 1,00,000 crore to Rs 5,75,000 crore. Planned expenditure is essentially money that goes towards creation of productive assets through schemes and programmes sponsored by the central government. In an environment where the highly indebted private sector is going slow on investment, the government should be spending more on asset creation.
Nevertheless, the government will now ago about slashing plan expenditure big time between January and March 2015. From the looks of it, the government has already started going slow on this front. The plan expenditure between April and November 2014 grew by a minuscule 0.9%.
My broad guess is that Jaitley will cut plan expenditure by around Rs 1,00,000 crore to Rs 4,75,000 crore to keep it at the last year’s level. And this can’t be good news in an environment of slow growth. This is what the previous finance minister Chidambaram did in 2012-2013 and 2013-2014. In 2012-2013, he had budgeted Rs 5,21,025 crore towards plan expenditure. The final expenditure came in 20.6% lower at Rs 4,13,625 crore. In 2013-2014, the plan expenditure was budgeted at Rs 5,55,322 crore. The final expenditure came in 14.4% lower at Rs 4,75,532 crore.
There several other areas where Jaitley will have to copy Chidambaram as well. A recent report in the Business Standard points out that: “Jaitley was likely to ask PSU chiefs to use their cash piles to either boost public investment or partly offset the expected shortfall in tax receipts.”
Chidambaram had done something similar last year by getting public sector companies to pay high dividends. Coal India in particular announced a total dividend of Rs 18,317.46 crore. Of this, a lion’s share of Rs 16,485 crore went to the government. Over and above this, the government also collected Rs 3,100 crore as dividend distribution tax from the company.
Something similar seems to be in the works this year as well. In another report Business Standard had pointed out that public sector units were sitting on cash of close to Rs 2,00,000 crore. Coal India with Rs 54,780.2 crore was right on top. Getting these companies to pay high dividends is essentially an accounting shenanigan where money will be moved from one arm of the government to another.
Jaitley like Chidambaram will also have to postpone payments to the next financial year. Chidambaram postponed more than Rs 1,00,000 crore of payments in order to meet the fiscal deficit target that he had set for the last government. It is highly likely that the same thing might happen again.
A recent report in The Financial Express points out that: “The Food Corporation of India’s (FCI) procurement operations could come to a halt by February unless it is paid a good part of its outstanding dues of a record Rs 58,000 crore soon.” The corporation which buys rice and wheat directly from farmers is currently running on three short-term bank loans of Rs 20,000 crore , on which it is paying an interest of 11.28%.
The report further points out that “The food ministry has requested the finance ministry for Rs 1.47 lakh crore (including Rs 92,000 crore budgeted for FCI’s MSP functions and overall food subsidy arrears from previous years) in the current fiscal.” This looks highly unlikely and which means some expenditure that has to be paid for will get postponed to the next financial year.
What this means is that Jaitley will have to resort to every trick that Chidambaram had resorted to, in order to ensure that he meets the fiscal deficit target. The finance ministry has been vociferous in the recent past regarding achieving the target. The minister of state for finance Jayant Sinha recently said: “We are considering all options (cutting expenditure). We are very confident that we will be able to achieve fiscal deficit target of 4.1 per cent in the current fiscal year.”
Let’s see how things pan out on this front. The Daily Reckoning will keep a close watch.

Postscript: In my last column I had suggested that the prime minister Narendra Modi should give an assurance to public sector banks that the government won’t meddle with their work. Newsreports suggest that the prime minster told the same to a bankers retreat in Pune on Saturday. As he said: “There is a difference between political intervention and political interference… there will never be any phone call from the PMO…But as we are working in a democratic system… there will be intervention as and when required.” If followed this will be a great move.

The column originally appeared on www.equitymaster.com as a part of The Daily Reckoning on January 5, 2015

12 December, 2014

High price not EMIs: Dear Jaitley, here is why Indians are not buying homes

Sometimes I wonder if the finance minister Arun Jaitley has ever heard of Abraham Maslow. Maslow was an American psychologist who among other things also came up with the law of the instrument, which is better known as Maslow’s hammer.
As Maslow put it: “I suppose it is tempting, if the only tool you have is a hammer, to treat everything as if it were a nail.”
The idea was also put forward by the American philosopher Abraham Kaplan, when he said: “Give a small boy a hammer, and he will find that everything he encounters needs pounding.”
What the idea essentially tries to communicate is the habit of using the one tool for all purposes. In Jaitley’s case this tool seems to be a cut in the “repo rate”, or the rate at which the Reserve Bank of India (RBI) lends to banks.
In the recent past, he has asked the RBI to cut the repo rate time and again. Once the RBI starts cutting the repo rate, banks will start cutting the interest rates at which they give loans, the belief is.
At lower rates people will borrow and spend more and the Indian economy will grow at a much faster rate. For Jaitley its all about lower interest rates. “Now time has come with moderate inflation to bring down the rates. If you bring down the rates, people will start borrowing from banks to pay for their flats and houses. The EMIs will go down,” he said yesterday.
The statement was essentially a continuation of the pressure that Jaitley has been trying to build on the RBI to cut the repo rate. But will it make any difference?
Let’s try and understand this through an example of an individual trying to buy a home in Mumbai. In a recent research report the real estate research firm Liases Foras had pointed out that the weighted average price of a flat in Mumbai was Rs 1.34 crore.
I had written a piece around this data in early November showing how expensive flats in Mumbai and other cities were vis a vis the average income of people in living in those cities. One criticism that came in was that the weighted average price arrived at was on a higher side because the data had taken only premium projects into account.
There is enough anecdotal evidence to suggest that is not the case. Nevertheless let’s take that into account and assume that the actual weighted average price of a flat in Mumbai is 75% of the price that Liases Foras had arrived at.
This works out to around Rs 1 crore. Let’s say an individual decides to buy such a flat and takes on a home loan to do so. A bank would normally give around 80% of the market price of a house as a home loan. So, the individual takes a loan of Rs 80 lakh (80% of Rs 1 crore) to be repaid over a period of 20 years. The remaining Rs 20 lakh he puts from his savings.
The RBI governor Raghuram Rajan in a recent speech said that the average interest rate on a home loan these days was 10.7%. Let’s assume that the individual borrows at the average interest rate. The EMI on this loan works out to Rs 80,948.
Let’s say the interest rate on the home loan comes down by 50 basis points (one basis point is one hundredth of a percentage) to 10.2%. The EMI on this loan works out to Rs 78,265 or Rs 2,683 lower.
If the interest rates are cut by 100 basis points and the interest rate on the home loan falls to 9.7%, the EMI will fall by around Rs 5,330. So, will an individual who has the ability of making a downpayment of Rs 20 lakh and taking on a home loan of Rs 80 lakh, buy a home simply because the EMI is Rs 2,683-5,330 lower?
An individual who has the ability to take on a home loan of Rs 80 lakh must be making around Rs 1.65 lakh per month(as per the home loan eligiblity calculator available on www.hdfc.com). And that is clearly a lot of money. Only a small set of individuals make that kind of money, even in a city like Mumbai.
The same exercise can be repeated for other cities as well, and the results will remain the same. The larger point is that the fact that Indians are not buying homes has got nothing to do with high interest rates and EMIs and everything to do with the fact that homes are atrociously expensive. And instead of asking the RBI to cut interest rates, Jaitely should be looking at ways through which home prices can be brought down to more reasonable levels.
He could start with ensuring that better data on real state is available to the people of this country.
Currently, the National Housing Bank has the Residex index, which gives some idea of the prevailing price trends across various cities. But the information is not up-to-date enough to be of much use. As of now, the data is available only up to June 2014. Also, the data is declared every three months. Something of this sort should be declared on a monthly basis.
Further, anyone trying to buy a home essentially has no data that he can look at to figure out what the prevailing price trend is. Typically, he has to go with what the brokers tell him. And brokers are not normally thinking about the best interests of the individual trying to buy a home.
For starters, the government could try and aggregate the stamp duty data from the twenty biggest cities in India. This will tell us the average price at which “homes” are “supposedly” being sold. Along with that the number of transactions being registered will give us some idea of what the demand situation is.
Of course, given the black money transactions that happen in real estate, the average price that we get through this route may not be totally correct. Nevertheless, this is not a bad starting point. Further, in order to cut down on black money transactions the government needs to ensure that the circle rate is close to the prevailing market value in any area.
A property when it is sold needs to be registered at the actual transaction value or the prevailing circle rate, whichever is higher. The stamp duty needs to paid on this value. Typically, the market rate tends to be much higher than the prevailing circles rate. This essentially leads to a situation where transactions are declared at the circle rate and not the market rate, ensuring that a significant part of the transaction happens in black. It also leads to lower tax collections for the government.
Further, in areas where the difference between the market rate and the circle rate is high attract a lot of black money. As Anuj Puri chairman and country head, Jones Lang LaSalle India, told Mint in September 2014, “Reduction in the gap between circle and market rates means that the region becomes less attractive for those who are seeking to offload unaccounted-for funds, and more attractive for genuine buyers.”
These are the steps that Jaitley should be thinking about instead of asking the RBI to cut interest rates almost every time he speaks.

The article appeared originally on www.FirstBiz.com on Dec 12, 2014

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

11 December, 2014

As tax collections slow down, govt fiscal deficit shoots to its highest level in 16 years

Vivek Kaul

The Controller General of Accounts declares the fiscal deficit number at the end of every month. The cycle works with a delay of month. So, at the end of November 2014, the fiscal deficit for the first seven months of the financial year (April to October 2014) was declared.
The fiscal deficit for this period stood at a rather worrying 89.6% of the annual target of Rs 5,31,177 crore. Fiscal deficit is the difference between what a government earns and what it spends.
One reason the fiscal deficit is number is so high is because the government’s expenditure is spread all through the year, whereas it earns a substantial part of its income only towards the end of the year. But even keeping that point in mind, the fiscal deficit for the first seven months of this financial year is substantially high than it usually has been in the years gone by.
For the period April to October 2013, the fiscal deficit had stood at 84.4% of the annual target for that year. In fact, the accompanying table shows us that the fiscal deficit for the first seven months of this financial year has been the highest over the last sixteen years.

Period	Fiscal deficit as a proportion of the annual target
April to Oct 2014	89.60%
April to Oct 2013	84.40%
April to Oct 2012	71.60%
April to Oct 2011	74.40%
April to Oct 2010	42.60%
April to Oct 2009	61.10%
April to Oct 2008	87.80%
April to Oct 2007	54.50%
April to Oct 2006	58.60%
April to Oct 2005	60.90%
April to Oct 2004	45.20%
April to Oct 2003	56.00%
April to Oct 2002	51.50%
April to Oct 2001	54.50%
April to Oct 2000	45.70%
April to Oct 1999	72.20%
April to Oct 1998	67.00%

Source: www.cga.nic.in

Also, I couldn’t look for data beyond 1998, given that it wasn’t available online. The table makes for a very interesting reading. The fiscal deficit level up to October 2007 was under control. It took off once the government decided to crank up expenditure to meet its social obligations.
Further, the average fiscal deficit for the first seven months of the year between 1998 and 2013 stood at 61.75% of the annual target. Hence, the number for this year at 89.6% of the annual target, is very high indeed.
Why has this happened? The income of the government during the period has gone up by only 5.3%. The budget presented in July earlier this year assumed that the income would grow by 15.6% in comparison to the last financial year.
The collection of direct as well as indirect taxes has been significantly slower than what was assumed. The direct taxes (corporation and income tax primarily) were assumed to grow at 15.7% in comparison to the last financial year. They have grown at only 5.5%.
The indirect taxes (customs duty, excise duty and service tax) were supposed to grow at 20.3%. They have grown by only 5.9%. In fact, within indirect taxes, the collection of customs duty has fallen by 1.7%.
What this clearly tells us is that the finance minister Arun Jaitley made very aggressive assumptions when it came to growth in tax collection and will now have a tough time meeting the numbers.
What makes the situation worse is the fact that Jaitley’s predecessor, P Chidambaram, had made the same mistake. In fact, in 2013-2014, Chidambaram had projected a total gross tax collection of Rs 12,35,870 crore. The final collection stood around 6.2% lower at Rs 11,58,906 crore. Given this, Jaitley could have avoided falling into the same trap and worked with a more realistic set of numbers. But then those projections wouldn’t have projected “acche din”, the plank on which the Bhartiya Janata Party had fought the Lok Sabha elections.
Even with such a huge fall in tax collections, Chidambaram managed to beat the fiscal deficit target that he had set by essentially pushing expenditure of more than Rs 1,00,000 crore into the next financial year (i.e. the current financial year 2014-2015).
Chidambaram essentially ended up passing on what was his problem to Jaitley. Jaitley cannot do that because he will continue to be the finance minister (or someone else from the BJP government will).
So what can Jaitley do if he needs to meet the fiscal deficit target of Rs 5,31,177 crore or 4.1% of GDP that he has set? The first thing that will happen and is already happening is that the plan expenditure will be slashed. The plan expenditure for the first seven months of the year fell by 0.4% to Rs 2,66,991 crore.
This was the strategy followed by Chidambaram as well in 2013-2014. The plan expenditure target at the time of the presentation of the budget was at Rs 5,55,322 crore. The actual number came in 14.4% lower at Rs 4,75,532 crore. This is how a major part of government expenditure was controlled.
The government expenditure is categorised into two kinds—planned and non planned. Planned expenditure is essentially money that goes towards creation of productive assets through schemes and programmes sponsored by the central government.
Non-plan expenditure is an outcome of planned expenditure. For example, the government constructs a highway using money categorised as a planned expenditure. But the money that goes towards the maintenance of that highway is non-planned expenditure. Interest payments on debt, pensions, salaries, subsidies and maintenance expenditure are all non-plan expenditure.
As is obvious a lot of non-plan expenditure is largely regular expenditure that cannot be done away with. The government needs to keep paying salaries, pensions and interest on debt, on time. These expenses cannot be postponed. Hence, the asset creating plan expenditure gets slashed.
The second thing that the government is doing is not passing on the benefit of falling oil prices to the consumers. It has increased the excise duty on petrol and diesel twice, since deregulating diesel prices in October.
The third thing the government will have to do is to get aggressive on the disinvestment front in the period up to March 2015. The disinvestment target for the year is Rs 58,425 crore. But until now the government has gone slow on selling shares that it owns both in government and non-government companies because of reasons only it can best explain.
The recent sale of shares in the Steel Authority of India Ltd(SAIL) was pushed through with more than a little help from the Life Insurance Corporation of India and other government owned financial firms. This is nothing but moving money from one arm of the government to another arm. It cannot be categorised as genuine disinvestment.
This is something that Chidambaram and the UPA government regularly did in order to meet the disinvestment target. Despite this they couldn’t meet the disinvestment target in 2013-2014. The government had hoped to earn Rs 54,000 crore but earned only Rs 19,027 crore.
Also, selling assets to fund regular yearly expenditure is not a healthy practice. If at all the government wants to sell its stake in companies, it should be directing that money towards a special fund which could be used to improve the poor physical infrastructure throughout the country. Right now, the money collected through this route goes into the Consolidated Funds of India.
In the months to come we could also see the government forcing cash rich companies like Coal India (which has more than Rs 50,000 crore of cash on its books) to pay a special interim dividend to the government, as was the case last year.
This is the way I see things panning out over the next few months. Nevertheless, the proper thing to do would be to put out the right fiscal deficit number, instead of trying to use accounting and other tricks to hide it.
The first step towards solving a problem is to acknowledge that it exists.

The article originally appeared on www.equitymaster.com as a part of The Daily Reckoning, on Dec 11, 2014

21 November, 2014

What Arun Jaitley can learn from marketers and real estate agents

Vivek Kaul

I need to confess at the very start that I should have written this column a few days back. But more important things happened and this idea had to take a back seat. Nevertheless, as they say, it’s better late than never.
So, let’s start this column with two examples—one borrowed and one personal. The idea behind both the examples is to illustrate two concepts from behavioural economics—contrast effect and anchoring.
In the book The Paradox of Choice: Why More is Less, Barry Schwartz discusses an example of a high-end catalog seller, who was selling an automatic bread maker for $279. As he writes “Sometime later, the catalog seller began to offer a large capacity, deluxe version for $429. They didn’t sell too many of these expensive bread makers, but sales of the less expensive one almost doubled! With the expensive bread maker serving as anchor, the $279 machine had become a bargain.”
Essentially, there are two things that are happening here. The buyer first gets “anchored” on to high price of the deluxe version of bread maker which is priced at $429. After this the contrast effect takes over. The bread maker priced at $279 seems cheaper than the deluxe version and people end up buying it.
As John Allen Paulos writes in A Mathematician Plays the Stock Market “Most of us suffer from a common psychological failing. We credit and easily become attached to any number we hear. This tendency is called “anchoring effect.””
And once an individual is anchored on to a number, he then tends to compare it with other numbers that are thrown at him. Marketers exploit this very well. As Schwartz points out “When we see outdoor gas grills on the market for $8,000, it seems quite reasonable to buy one for $1,200. When a wristwatch that is no more accurate than one you can buy for $50 sells for $20,000, it seems reasonable to buy one for $2,000. Even if companies sell almost none of their highest-priced models, they can reap enormous benefits from producing such models because they help induce people to buy cheaper ( but still extremely expensive) ones.”
This was the borrowed example. Now let me discuss the personal example. Sometime in May 2006, I was suddenly asked to leave the apartment that I lived in because the landlord had not been paying the society charges for a very long time. And thus started the search for another apartment to rent. Affordable apartments in Central Mumbai tend to be in buildings that are not in best shape.
Given this, real estate agents use a trick where they try and exploit the contrast effect. The first few apartments that they show are in a really bad shape. After having done this they show an apartment which is slightly better than the ones shown earlier, but the rent is significantly higher.
The attractiveness of the apartment shown later is increased significantly by showing a few “run down” apartments earlier.
The idea behind sharing these two examples was to explain the idea of anchoring and contrast effect. I hope both these concepts are clear by now. Now let me move on to real issue that I want to talk about in this column.
On November 18, the finance minister Arun Jaitley said in a speech “Inflation, especially food inflation, has moderated in the last few months and global fuel prices have also come down. Therefore, if RBI, which is a highly professional organisation, in its wisdom decides to bring down the cost of capital, it will give a good fillip to the Indian economy.”
In simple English, Jaitley, as he has often done in the past, was asking the Reserve Bank of India (RBI) to cut the repo rate. Repo rate is the interest rate at which RBI lends to banks. The idea is essentially that at lower interest rates, people will borrow and spend more, and companies will invest and expand. This will lead to faster economic growth. While this sounds good in theory, as I had argued a few days back, it isn’t as simple it is made out to be.
One argument offered by those asking the RBI to cut interest rates is that inflation as measured by the consumer price index has fallen to 5.52% in October 2014. It was at 6.46 % in September 2014 and 10.17% in October 2013.
Nevertheless, is inflation really low? Or are Jaitley and others like him who have been demanding an interest rate cut just becoming victims of anchoring and the contrast effect?
The inflation figure of greater than 10% which had been prevalent over the last few years is anchored into their minds. And in comparison to that an inflation of 5.52% does sound low. Hence, the contrast effect is at work here.
Further, it is worth remembering that this so called low inflation has been prevalent only for a few months. Chances are that food prices might start rising again. The government has forecast that the output of kharif crops will be much lower than last year and this might start pushing food prices upwards all over again. Also, recent data showsthat vegetable and cereal prices have started rising again because of the delayed monsoon.
Central banks of developed countries typically tend to have an inflation target of 2%. In the recent past they have been unable to meet even that number. Large parts of the world might now be heading towards deflationary scenario, where prices will fall.
In October, the consumer price inflation in China stood at 1.6%, well below the targeted 3.5%. Also, in January earlier this year the Report of the Expert Committee to Revise and Strengthen the Monetary Policy Framework set up by RBI had recommended that the Indian central bank should set an inflation target of 4%, with a band of +/- 2 per cent around it .
The committee had said “transition path to the target zone should be graduated to bringing down inﬂation from the current level of 10 per cent to 8 per cent over a period not exceeding the next 12 months and 6 per cent over a period not exceeding the next 24 month period before formally adopting the recommended target of 4 per cent inﬂation with a band of +/- 2 per cent.”
Once, these factors are taken into account, the latest inflation number of 5.52% as measured by the consumer price index, isn’t really low, even though it seems to be low in comparison to the very high inflation that had prevailed earlier. But as explained this is more because of anchoring and the contrast effect at work.
Also, as I had written earlier, more than anything people still haven’t come around to the idea of low inflation, given that inflationary expectations(or the expectations that consumers have of what future inflation is likely to be) continue to remain on the high side.
As per the Reserve Bank of India’s Inflation Expectations Survey of Households: September – 2014, the inflationary expectations over the next three months and one year are at 14.6 percent and 16 percent. In March 2014, the numbers were at 12.9 percent and 15.3 percent. Hence, inflationary expectations have risen since the beginning of this financial year.
If inflationary expectations are to come down, then low inflation needs to be prevail for some time. Just a few months of low inflation is not enough. As RBI governor Raghuram Rajan had said in a speech in February this year “ the best way for the central bank to generate growth in the long run is for it to bring down inflation…Put differently, in order to generate sustainable growth, we have to fight inflation first.”
Rajan is trying to do just that, and it’s best that Jaitley allows him to do that, instead of demanding a cut in interest rates every now and then.

The article appeared originally on www.equitymaster.com on Nov 21, 2014