Winter and Money Printing are Coming to India, In a Few Months

The Controller General of Accounts publishes the state of government finance at the end of every month. This data is published with a gap of one month. Hence, on 31st August, the data as of 31st July, was published.

This data, not surprisingly, doesn’t make for a good reading. The fiscal deficit, the difference between what a government earns and what it spends, for the period April to July 2020 stood at Rs 8.21 lakh crore. The fiscal deficit that the government had plans to achieve during the course of the current financial year (2020-21) stands at Rs 7.96 lakh crore. Hence, at the end of July, the actual fiscal deficit of the government was 103.1% of the budgeted one.

But given the state we are in this is hardly surprising. Nevertheless, there are several reasons to worry. Let’s take a look at it pointwise.

1) Tax collections have collapsed. Between April and July 2020, the gross tax revenue, which brings in a bulk of the money for the central government and which it shares with the state governments, is down 29.5% to Rs 3.8 lakh crore, in comparison to the same period in 2019.

Let’s look at the different taxes collected by the government between April and June this year and the last year.

They all fall down


Source: Controller General of Accounts.

 

As can be seen from the above chart, the collections of all major taxes are down big time.

Take the case of central goods and services tax. (GST) or the part of GST that ends up with the central government. During April to July 2019, the total collections of the central GST had stood at around Rs 1.41 lakh crore. During the same period this year the collections have fallen by 34% to Rs 92,949 crore. Other taxes have fallen along similar lines.

The fall in GST collections is a reflection of a massive slowdown in consumption. A slowdown in consumption ultimately reflects in a slowdown in income of individuals as well as incomes of companies. Ultimately, one man’s spending is another man’s income.

But there is something that the above chart does not show, the excise duty collections of the central government. They are up year on year by 23.8% to Rs 67,895 crore. This despite the fact that the consumption of petroleum products between April and July is down 22.5% in comparison to 2019.

So, how have excise duty collections gone up? The central government has increased the excise duty on petrol from Rs 22.98 per litre to Rs 32.98 per litre. The excise duty on diesel has been raised from Rs 18.83 per litre to Rs 31.83 per litre. Also, a substantial part of this duty is a cess, leading to a situation where the central government does not have to share the revenue earned through the cess with the state governments.

In the process, the central government has captured a bulk of the fall in oil prices.

2) As mentioned earlier, the central government needs to share a part of the money it earns with state governments. Between April and July it shared Rs 1.76 lakh crore with states, against Rs 2 lakh crore, during the same period last year. This is 12% lower, during a time when the states are at the forefront of fighting the covid-epidemic.

The ability of the state governments to raise taxes, after having become a part of the goods and services tax system, is rather limited. Take the case of petrol and diesel. The central government has raised excise duty by such a huge extent that the state governments aren’t really in a position to raise the value added tax or the sales tax on petrol and diesel, which they are allowed to charge, without having to face political repercussions for it.

3) The central government has more ways of raising money than the states. One such way is disinvestment of its stakes in public sector enterprises. This year the government plans to earn a whopping Rs 2.1 lakh crore through this route. The original plan included the plan to sell Air India. Whether that happens in an environment where the airlines business has been negatively rerated in the aftermath of covid, remains to be seen.

The other big disinvestment plan was that of the government selling its stake in the Life Insurance Corporation of India through an initial public offering. There are one too many regulatory hurdles that need to be removed, before a stake in India’s largest insurance company can be sold to investors. Long story short, it looks highly unlikely that the government will get anywhere near earning Rs 2.1 lakh crore this year, through the disinvestment front.

Having said that, the government can always resort to some accounting shenanigans, like getting one public sector enterprise to buy another, and pocketing that money. This is likely to happen in the second half of the year.

Over and above this, the government earns a lot of money from the dividends that it earns from public sector enterprises as well as banks and financial institutions. The target for this year is around Rs 1.55 lakh crore. Public sector banks will continue to remain on a weak wicket through this year, hence, their ability to pay dividends is rather limited.

The only way the government can make good this target is by raiding the balance sheet of the RBI for money. Also, the government is likely to raid the cash balances of public sector enterprises which have them, by asking them to pay special dividends.

4) The money that gets invested into various small savings schemes, which includes schemes like Post Office Savings Account, National Savings Time Deposits ( 1,2,3 & 5 years), National Savings Recurring Deposits, National Savings Monthly Income Scheme Account, Senior Citizens Savings Scheme, National Savings Certificate ( VIII-Issue), Public Provident Fund, KisanVikas Patra and Sukanya Samriddhi Account, net of the redemptions, is a revenue entry into the government budget.

This time it has been assumed that the government will get Rs 2.4 lakh crore through this route. Between April and July, Rs 38,413 crore or just 16% of the targeted money has come in. Last year, during the same period, 38% of a much lower target of Rs 1.3 lakh crore had been achieved. Clearly, this target is also going to be missed.

5)  Of course, the government understands this and which is why in early May it increased its borrowing target from Rs 7.8 lakh crore to Rs 12 lakh crore, by more than 50%. The government borrows money to finance its fiscal deficit.

What this means is that the government wants to at least keep the fiscal deficit to around Rs 12 lakh crore. The question is will that happen? Gross tax revenues are already down 30%. Of course, as the economy keeps opening up, this number will look better. Having said that, even if tax revenues are down by 15% as of the end of the year, we are looking at a shortfall of Rs 2.5 lakh crore for the central government. The other big entries of disinvestment and the net-revenue from small savings schemes, are also looking extremely optimistic in the current situation.

Even if the government achieves a fiscal deficit of Rs 12 lakh crore and the economy shrinks by around 10% this year, we will be looking at a central government fiscal deficit of 7% against the targeted 3.5%.

In this scenario, it is now more than likely that the RBI will resort to direct financing of government expenditure by printing money and buying government bonds. The government sells bond to finance its fiscal deficit.

This isn’t to say that the RBI hasn’t printed money this year. It has. But it has chosen to operate through the primary dealers. But the mask might come off in in the time to come and the RBI might decide to buy bonds directly from the government.

Winter and money printing are coming to India, in a few months.

 

There’s a Basic Disconnect in Trump’s Plan to Make America Great Again

donald trumpThis is the third and the final column in the series, where I explain that Donald Trump’s idea of making America great again, by imposing tariffs, is not going to work.

Dear Reader, before you start reading this column, it perhaps makes sense to read the two columns published before this, in order to get a complete perspective on the topic. (You can read the columns here and here).

In today’s column we will take a look at how Trump’s entire idea of driving up exports while driving down imports, is contradictory to say the least. Let’s start by looking at Figure 1, which basically plots the trade deficit of the United States over the years.

Figure 1: US trade deficit (in $ million) 

Trade deficit is a situation where the imports of a country are more than its exports. We can see that the United States has run a trade deficit with the rest of the world over the last four decades. The trade deficit peaked between 2004 and 2008, fell for a few years after that, and started going up again.

The American trade deficit came down in the years 2009 and 2010, and these were years when the American economy and the global economy, were both not doing well. Now let’s take a look at Figure 2, which basically plots the exports and imports of the United States over the last four decades.

Figure 2: 

Figure 2 makes for a very interesting reading. The exports and the imports curves of the United States, move more or less in the same way. This basically means that when imports go up, exports also go up and vice versa. Why is that the case? The reason for this is very straightforward. The United States is the largest market in the world. When it imports stuff, it pays dollars to other countries, which are exporting stuff to the United States. These countries can then use these dollars to pay for American exports.

Hence, if Trump keeps going ahead with imposing more tariffs on imports into the US, as he has suggested for a while, he will deny other countries an opportunity to earn “enough” dollars through which they can pay for their imports from the US, which are basically the exports for the US. The larger point being that it is not possible to increase American exports and decrease American imports at the same time. This is the simplistic plan that Trump has to make America great again and there is a basic disconnect at the heart of it. Also, any such plan will have a negative international impact.

Now let’s take a look at Figure 3, which basically plots the American trade deficit with one country, and that is China.

Figure 3: 

Figure 3 clearly shows that the American trade deficit with China has gone up dramatically over the years. The Chinese imports help keep inflation low in the United States. They also help keep interest rates low, as the dollars earned by the Chinese, have over the years found their way back into the United States and are invested in American treasury securities and other debt securities. This foreign demand for American financial securities has helped keep interest rates low in the US. Over and above this, there is another major point that arises here. Take a look Figure 4. It plots the overall trade deficit of the United States, along with the trade deficit that the country runs with China.

Figure 4: 

Figure 4 tells us very clearly that over the years, the trade deficit with China has formed a greater proportion of the overall trade deficit run by the United States. In 2017, the trade deficit with China formed nearly 66% of the overall trade deficit.

Much has been said about the fact that Trump is basically not thinking about the long-term, but is trying to beat down American trading partners into giving American companies better terms. The trouble is that the bulk of the American trade deficit is with China and unless Trump takes on China, the gains of his so called policy are going to be very low.

Of course, it is not easy to bully China, given that other than helping maintain a low inflation and low interest rates in the US, the Chinese also own more than a trillion dollars of American government treasury securities and if push comes to the shove, it can use these treasury securities, as a bargaining tool.

Also, the current Chinese regime is turning more and more authoritarian and is unlikely to take to any bullying by the US, lightly. The only way America can become great again on the industrial front is, if it is able to compete with the products being produced internationally, both on the price as well as the quality front.

The column originally appeared on Equitymaster on March 16, 2018.

Trump’s Trade Wars Will Hurt Dollar’s Exorbitant Privilege

donald_trump_by_gage_skidmore_2
Dear Reader, we would suggest that before you start reading this column, you read the column published yesterday. In yesterday’s column we saw how the tariffs unleashed by the US President Donald Trump will hurt America, instead of making it great again. Reading this column, before you read today’s column, will give you a complete perspective on the issue. This is the second in a series of three columns on the issue. The third column will appear on Thursday.

The American dollar is at the heart of the global financial system as it has evolved. The reasons for this are historical.

By 1944, it was clear that the Allied forces are going to win the Second World War. In July 1944, they gathered at the Mount Washington Hotel, Bretton Woods, New Hampshire in the US, to design a new financial system for the world. Europe had been totally destroyed during the course of the war and even countries like Britain and France were in a bad shape despite being on the winning side. European countries were in no position to negotiate. And so, the American dollar was placed at the heart of the financial system that evolved at Bretton Woods.

The US was ready to convert dollars into gold at the rate of $35 for one ounce (31.1 grams) of gold. This came to be known as the Bretton Woods Agreement. It made the
American dollar the premier international currency of choice, as it was the only currency that could be converted into gold.

This ensured that over a period of time countries moved to carrying out their international trade primarily in American dollars. It also ensured that countries held their foreign exchange reserves in dollars because dollar was the only currency which could be converted into gold.

This structure that emerged gave the American dollar an exorbitant privilege. While the rest of the world had to earn these dollars by exporting stuff, the United States could simply print them and buy all the stuff that it needed. This has been one of the primary reasons why United States, over the decades, has turned into a big buyer of things. All the American buying drives global demand.

Given that the dollar became the international trading and reserve currency, the oil cartel OPEC (Organization of the Petroleum Exporting Countries), also sold the oil that it produced, in dollars. This was one more reason for the world to buy and sell stuff in dollars. Every country did not produce the total oil it consumed, and in order to import enough oil to fulfil its consumption needs, it needed dollars. The only way to earn these dollars was to price its exports in dollars.

In fact, the Saudi Arabia led OPEC continuing to price oil in dollars, is one of the major reasons why dollar continues to be the major reserve as well as trading currency of the world. Even the Americans recognise this fact.

As Nassim Nicholas Taleb writes in his new book Skin in the Game—Hidden Asymmetries in Daily Life: “It is clear since the attack on the World Trade Center (in which most of the attackers were Saudi citizens) that someone in that nonpartying kingdom had a hand—somehow—in the matter. But no bureaucrat, fearful of oil disruptions, made the right decision—instead, the absurd invasion of Iraq was endorsed because it appeared to be simpler.”

So, dollar due to various reasons is the international currency in which people and countries want to deal with. As George Gilder writes in The Scandal of Money—Why Wall Street Recovers But the Economy Never Does: Today it [i.e. the dollar] handles more than 60 percent of world trade, denominates more than half the market capitalization of world stocks, and partakes in 87 percent of global currency trades.”

Given this, over the years, countries have accumulated huge dollar reserves. A significant chunk of these reserves have been earned by exporting stuff to the United States.  The United States is the biggest economy in the world. It accounts for nearly one-fourth of the world’s GDP. By virtue of this, it is also the world’s biggest market, where China, Japan and countries from South- East Asia sell their goods and earn dollars in the process.

It is also the world’s biggest consumer of oil and consumes nearly a fourth of the global oil production. This meant that oil-rich states such as Saudi Arabia could sell oil to it and thus earn dollars in the process.

The dollars earned by other countries haven’t stayed in the vaults of their central banks. They have been invested in American treasury securities and other debt securities. Treasury securities are basically financial securities issued by the American government to finance its fiscal deficit, which is the difference between what a government earns and what it spends. Take a look at Figure 1. It basically plots the foreign investment in American treasuries over the last 40 years.

Figure 1:

Source: Board of Governors of the Federal Reserve System (US)

 

The foreigners currently own more than $6 trillion of American government treasury securities. This along with the easy money policy initiated by the Federal Reserve of the United States, in the aftermath of the financial crisis that broke out in September 2008, has ensured that the interest that the US government pays on these securities has been around 2% per year, over the last five years.

The interest paid on the US treasury securities sets the benchmark for other loans in the American financial system (or for that matter any other financial system) because lending to the government is deemed to be the safest form of lending. Over and above this, the foreigners have invested close to $3.3 trillion in other American debt securities.

This inflow of dollars into the United States has kept interest rates low. These low interest rates have kept the American consumption story going to some extent. As the American stand-up comedian George Calrin once said: “Consumption is the new national pastime. People spending money they don’t have on things they don’t need, money they don’t have so they can max out their credit cards… And they didn’t like it when they got it home anyway.”

Donald Trump’s tariff policy will attack at the heart of this model. Countries earn dollars by exporting stuff to the United States and other parts of the world. These dollars then find their way back to the United States where they are invested in treasury and other debt securities, and help maintain low interest rates.

If Trump and America shut out the American market to other countries, the countries exporting stuff to the US (Japan, China, South Korea, Taiwan, and a whole host of other countries), will not earn as many dollars as they currently are. And if they don’t earn enough dollars, the likelihood of them continuing to invest in American debt securities, is very low. This will mean that the interest rates in the United States will start to rise. This is something that the country which is currently going through an early stage of economic recovery, cannot really afford.

Further, the other countries might also start to try and price their exports in currencies other than the dollar, as well. China has been working towards this for quite a while. Trump’s decision to introduce tariffs might just be the final push that the country needs.
If countries start pricing their exports in non-dollar currencies, Trump’s plan to impose tariff will hurt the exorbitant privilege that the dollar has enjoyed over the years.

In fact, in the third and final column in this series, which will appear on Thursday, we will see why Trump’s plan of trying to increase American exports while shrinking its imports, is essentially contradictory in nature.

The column originally appeared on Equitymaster on March 13, 2018.

Trump’s Trade Wars Aren’t Going to Make America Great Again

donald trump
Donald Trump’s campaign slogan while fighting the American presidential elections, was to ‘Make America Great Again’. On March 1, 2018, a little over a year after taking over as the 45th president of the United States, Trump announced a 25% tariff on steel and a 10% tariff on aluminium.

The question is, how does this fit into Trump’s plan to make America great again? Trump plans to drive up exports and drive down imports. By driving down imports through tariffs, the American consumer will be forced to buy stuff produced within the country. This will encourage domestic industry and in turn create jobs. By driving up exports, again domestic industry will be encouraged and this will create jobs. QED.

Now only if it was as simple as that. The trouble is that most politicians while making economic decisions look at only the first order effects of their decisions. In the current case this basically means that the steel tariff of 25%, will also allow the American domestic steel industry to compete.

As of now the American steel industry cannot compete simply because it cannot produce steel at a price at which steel can be imported into the United States. The tariff of 25% will make imported steel costlier and in the process allow American steel companies to compete. And this will create jobs. At least that is what Trump and his advisers who have helped him to arrive at this decision, hope for.

This is the first order effect of Trump’s decision which looks just at the impact of the tariff  on the American steel producers. As Henry Hazlitt writes in Economics in One Lesson: “Those who favour it [i.e. tariffs] think only of the interests of the producers immediately benefitted by the particular duties involved. They forget the interests of the consumers who are immediately injured by being forced to pay these duties.”

Hazlitt is talking about the first order effect of Trump’s decision which benefits American steel companies and the second order effect of Trump’s decision which hurts American companies consuming steel.

Steel (either imported or produced in America) is bought by other American companies. It is used as a major component while making buildings, tools, ships, automobiles, machines, appliances, and weapons. Other than weapons, the United States cannot do without the other things listed in the last sentence.

On second thought, given the American obsession with guns, neither can the country do without weapons.

Steel is also used as a major input into building physical infrastructure.

While the tariff on steel will make American steel producers viable, it will make steel more expensive for American steel consumers, as they will have to pay more for steel. This increase in cost will be passed on to the end consumers. So, everything from cars to appliances to homes will cost more. The end consumer only has so much money going around. Hence, he or she may not buy the stuff he has been planning to, due to higher prices. If he does so, his expenses will have to increase or he will have to balance his overall expenses, by cutting down on his other expenditure.

As Hazlitt writes: “The added amount which consumers pay for a tariff protected article leaves them just that much less with which to buy all other articles. There is no net gain to industry as a whole.” This is a very basic point which politicians encouraging any sort of protectionism don’t seem to get.

The tariffs will impact the overall sales of other American businesses, which might in turn fire people to maintain their profitability. It’s just that it is not possible to exactly quantify these job losses and loss of business.

As Hazlitt writes: “It would be impossible for even the cleverest statistician to know precisely what the incidence of the loss of other jobs had been—precisely how many men and women had been laid off from each particular industry, precisely how much business each particular industry had lost—because consumer had to pay more [for steel in this case].”

The news agency Reuters has a story on how 780 workers of the Novolipetsk Steel will lose their jobs. The company imports two million tonnes of steel slabs per year from its Russian parent company. It then rolls these slabs into sheets for various American companies, ranging from Home Depot to Harley Davidson to Caterpillar.

The customers of this steel company now need to be ready to accept a 25% increase in the price of steel. If they do, the company survives. If they don’t, then the company will have to start firing workers. This is the second order effect of a tariff, which is not very clear up front.

If these companies accept a 25% increase it will only be in a situation where they can’t source the steel they need from a cheaper source. Further, it will lead to a rise in the price of their end product, depending on what proportion steel forms of their total inputs.

Also, it is worth remembering here, that if America can impose tariffs on its imports, other countries can do the same on their imports, hurting American exports. In fact, this is precisely how things played out in the aftermath of the First World War, when America tried to protect its domestic industry through tariffs. In return, other countries imposed tariffs on their imports and this led to the start of the global trade war, hurting American exports.

Hence, driving down imports, while trying to drive up exports, is sort of contradictory. There are many other aspects to this, which we shall see in tomorrow’s column.

The Economist estimates that steel and aluminium accounted for around 2% of the total American imports of $2.4 trillion, last year. This formed around 0.2% of the American GDP. Given this, currently the level of protectionism unleashed by the American president is very small. But the level of rhetoric that Donald Trump has unleashed around the issue, it doesn’t seem that he is going to stop just at this. This also becomes clear from the fact that on March 6, 2018, Gary Cohn, the chief economic adviser of Trump, quit.

We will return to this discussion in tomorrow’s column.

The column originally appeared on Equitymaster on March 12, 2018.