Equitymaster

Of BJP and Congress: Why governments hate markets

light-diesel-oil-250x250Vivek Kaul

Over the years I have come to the conclusion that governments don’t like markets. Markets are too unpredictable for their taste. And they don’t do what the government wants them to do. They don’t move in directions the government wants them to. In short, markets can’t be controlled. Or to put it even more simply, markets have a mind of their own.
And no government likes that.
Hence, when the diesel price was decontrolled in October earlier this year, I had my doubts about how long will it last. The finance minister Arun Jaitley had said on that occasion “Henceforth, like petrol, the price of diesel would be linked to the market and therefore depending on whatever is the cost involved …the consumers will have to pay.”
At times things sound too good to be true. This was one of those statements. And now only a few weeks later, the government has sideline the market and decided to go about setting the price of petrol and diesel.
Earlier this week on December 2, 2014, the government decided to raise the excise duty on petrol and diesel. This was the second time the government increased the duty in less than a month. The excise duty on petrol was increased by Rs 2.25 per litre and that on diesel by one rupee per litre.
This increase in duty will not be felt at the consumer level. Nonetheless, if the government had not decided to increase the duty it would have meant that consumers would have benefited from a further fall in the price of petrol and diesel. Hence, the government is essentially creaming off the consumer surplus.
This also explains why the price of petrol and diesel in India hasn’t fallen as much as the global oil prices have. And that means the petrol and diesel prices are no longer linked to the market, as Jaitley would have had us believe only a few weeks back. As an editorial in the Business Standard points out: “If the government is forcing the oil marketing companies to set prices according to the dictates of political masters, then it can hardly claim deregulation has happened.”
The government is having a tough time meeting its expenditure and this is a very easy way to raise its income. The fiscal deficit for the first seven months of this financial year (April to October 2014) was at 89.6% of the annual target. Last year during the same period, the number was at 84.4%. Fiscal deficit is the difference between what a government earns and what it spends.
Hence, if the government has to meet its fiscal deficit target it has to increase its income or decrease its expenditure or possibly do both.
An editorial in The Indian Express points out that the two hikes in excise duty, will help the government earn an additional Rs 10,000 crore. This should come as a welcome relief for the government given that estimates now suggest that indirect tax collections will see a shortfall of around Rs 90,000 crore in comparison to what had been assumed at the time the budget was presented in July this year.
The editorial goes on to suggest that instead of increasing the excise duty the government could have levied a cess and collected that money to go towards a specific purpose like a national highway fund. But that hasn’t happened and the increase in the excise duty will just disappear into the consolidated fund of India.
But that’s just one part of the story. Every government has the right to increase or decrease taxes, after taking into account the situation that it is operating in. Nevertheless, if the government had allowed the market to operate, the oil marketing companies would have been allowed to pass on this increase in excise duty to the end consumer. The fact that they haven’t been allowed to do so means that the government is deciding on the price of petrol and diesel.
Further, now that the government has decided to set the price of petrol and diesel, it will be interesting to see what happens when the price of oil starts to go up again (That may not happen immediately with Saudi Arabia looking determined to drive down the price of oil to make US shale oil unviable, but its a possibility nonetheless).
The previous Congress led United Progressive Alliance(UPA) government did not allow the oil marketing companies to sell petrol and diesel at a price which was viable for them.
Instead, the government along with the upstream oil companies like ONGC and Oil India Ltd, compensated the oil marketing companies for their “under-recoveries”. This drove a huge hole into the government finances. The total oil subsidy bill during the period the Congress led UPA government ruled the country was a whopping Rs 8,30,000 crore. This along with other subsidies pushed up the government expenditure and in the process its fiscal deficit.
Once the government was borrowing more, it crowded out other borrowers as there was a lesser amount of money available for others to borrow. This pushed up interest rates. It also led to a rupee crisis between late May and August 2013, when the value of the rupee crashed against the dollar.
It had other repercussions as well. But before we get into that it’s important to repeat what Henry Hazlitt writes in Economics in One Lesson: “We cannot hold the price of any commodity below its market level without in time bringing about…consequences. The first is to increase the demand for that commodity. Because the commodity is cheaper, people are tempted to buy, and can afford to buy, more of it.”
This is precisely what happened in India. The demand for diesel went up because for a very long period of time the government completely delinked diesel prices to international oil prices. Hence, there was a substantial difference between the price of petrol and diesel. This led to a huge market in diesel cars. Given this, rich consumers ended up consuming more than their fair share of diesel.
As Hazlitt writes in this context: “Unless a subsidized commodity is completely rationed, it is those with the most purchasing power than can buy most of it. This means that they are being subsidized more than those with less purchasing power…What is forgotten is that subsidies are paid for by someone, and that no method has been discovered by which the community gets something for nothing.” So, while the rich went around in their diesel cars, the nation ended up with a huge subsidy bill.
Like the Congress led UPA before it, the current BJP led National Democratic Alliance (NDA) has decided to set the price of petrol and diesel and not leave it up to the market. There will be great pressure on the government to hold back the price of petrol and diesel, once oil prices start to go up again. And that as we have seen can be disastrous for the economy. 

The article was published on www.equitymaster.com on Dec 5, 2014

Sensex 4,20,000: Coming in 15 years at a stock market near you

rakesh jhunjhunwalaVivek Kaul

It is that time of the year when stock brokerages forecast their Sensex/Nifty targets for the next year. A few such reports have landed up in my mailbox and the highest forecast that I have come across until now is that of the Sensex touching 37,000 points by December 2015.
I was thinking of writing a piece around these forecasts, until I happened to read an interview in which big bull Rakesh Jhunjhunwala said that he would disappointed if the Nifty doesn’t hit 1,25,000 by 2030.
Nifty currently quotes at a level of around 8,500 points. The logic offered by Jhunjhunwla is very straightforward. He said that the earnings of stocks that constitute the Nifty index will grow by fifteen times over the next fifteen years. And that would take the Nifty to a level which is fifteen times its current level ( actually 15 times 8500 is 1,27,500, but given that Jhunjhunwala was talking in very broad terms let’s not nitpick). Hence, Nifty will be at 1,25,000 by 2030.
How reliable is this forecast? Not very, is a straightforward answer. A period of 15 years is too long a time to make such a specific forecast on the stock market or anything else for that matter. There are many things that can go wrong during the period (or go right for that matter). Hence, such forecasts need to be taken with a pinch of salt and seen as something that has an entertainment value more than anything else.
In matters of forecasts like these it is important to remember the first few lines of Ruchir Sharma’s Breakout Nations – In Pursuit of the Next Economic Miracles: “The old rule of forecasting was to make as many forecasts as possible and publicise the ones you got right. The new rule is to forecast so far into the future that no one will know you got it wrong.” Jhunjhunwala has done precisely that.
If earnings have to grow by 15 times in 15 years, the Indian economy also needs to grow at a breakneck speed. Over a very long period of time, the companies cannot keep growing their profits unless the economy grows as well. For 15% earnings growth to happen, the economy needs to grow at a real rate of 8-10% per year (the remaining earnings growth will come from inflation).
The trouble is that this kind of rapid long term economic growth in countries is an extremely rare phenomenon.
As Sharma points out in Breakout Nations:“Very few nations achieve long-term rapid growth. My own research shows that over the course of any given decade since 1950, only one-third of emerging markets have been able to grow at an annual rate of 5% or more. Less than one-fourth have kept that pace up for two decades, and one tenth for three decades. Just six countries (Malaysia, Singapore, South Korea, Taiwan, Thailand, and Hong Kong) have maintained the rate of growth for four decades, and two (South Korea and Taiwan) have done so for five decades.”
In fact, India and China which have been among the fastest growing countries over the last ten years, were laggards when it come to economic growth. “During the 1950s and the 1960s the biggest emerging markets – China and India – were struggling to grow at all. Nations like Iran, Iraq, and Yemen put together long strings of strong growth, but those strings came to a halt with the outbreak of war…In the 1960s, the Philippines, Sri Lanka, and Burma were billed as the next East Asian tigers, only to see their growth falter badly,” writes Sharma.
Long story short: Rapid economic growth cannot be taken for granted and given this forecasts like Nifty touching 1,25,000 at best need to be taken with a pinch of salt. Indeed, Jhunjhunwala had predicted in October 2007 that the Sensex will touch 50,000 points in the next six or seven years.
Its been more than seven years since then and the Sensex is nowhere near the 50,000 level.
In October 2007, India was growing at a rapid rate. At that point of time it was almost a given that the country would continue to grow at a very fast rate. In fact, this feeling lasted almost until 2011, when the high inflation finally caught up with economic growth and the first set of low economic growth numbers started to come.
Also, Jhunjhunwala and most other stock market experts did not know in October 2007 that more or less a year later, the investment bank Lehman Brothers would go bust, and the world would see a financial crisis of the kind it had never seen since the Great Depression.
The stock market fell rapidly in the aftermath of the crisis. Once this happened the central banks of the world led by the Federal Reserve of the United States, printed and pumped money into their respective financial systems.
The idea was to flood the financial system with money so as to maintain low interest rates and hope that people borrow and spend, and in the process get economic growth going again. That happened to a limited extent. What happened instead was that big financial institutions borrowed money at low interest rates and invested it in financial markets all over the world.
In the Indian case the foreign institutional investors have made a net purchase of Rs 3,19,366.35 crore in the Indian stock market between January 2009 and November 2014. During the same period the domestic institutional investors sold stocks worth Rs 1,27,280.1 crore. The massive financial flows from abroad have ensured that the BSE Sensex has jumped from around a level of 10,000 points to around 28,450 points, during the same period, giving an absolute return of around 185%.
The point being that despite this massive inflow of money from abroad, the BSE Sensex is nowhere near the 50,000 level that Jhunjhunwala had predicted in October 2007. Over the long term a lot of things can go wrong and which is what happened after 2007.
To conclude, let me ride on Jhunjhunwala’s forecast and make my own forecast. Jhunjhunwala has predicted that the Nifty index will touch 1,25,000 points in 2030. This means the Sensex will cross 4,16, 420 points in 2030.
How do I say that? The Sensex currently quotes at around 28,450 points. In comparison, the Nifty is at around 8,500 points. This means a Sensex to Nifty ratio of around 3.33.
Hence, when Nifty touches 1,25,000 points, the Sensex will touch 4,16,420 points (1,25,000 x 3.33). For the sake of convenience let’s just round this off to 4,20,000 points. I know, the world is not so linear. If forecasts were just about dragging a few MS Excel cells, everybody would be getting them right.
But then it is the forecast season and everyone seems to be making one, and given that even I should be making one. And if in 2030 I am proven right, I will search this column and tell the world at large that I said it first way back in late 2014 on The Daily Reckoning.
To conclude, dear reader, remember you read it here first. That’s the trick and I know how it works.

The article originally appeared on www.equitymaster.com as a part of The Daily Reckoning, on Dec 4, 2014 

Rajan and RBI have done their bit, now the ball is in government’s court

ARTS RAJANOne of the laws of forecasting is to publicize the forecasts that you get right. On November 17, 2014, I wrote a piece titled Raghuram Rajan won’t cut interest rates even in Hindi.
In the Fifth Bi-Monthly Monetary Policy Statement released yesterday (December 2, 2014), Raghuram Rajan, the governor of the Reserve Bank of India (RBI), kept the repo rate unchanged. Repo rate is the rate at which the RBI lends to banks.
This was along expected lines. Rajan unlike many other central banks believes in clear communication. As Alan Greenspan, the Chairman of the Federal Reserve of the United States, the American central bank, from 1988 to 2006, once said “I guess I should warn you, if I turn out to be particularly clear, you’ve probably misunderstood what I’ve said.” Rajan does not believe in this school of thought and what he writes and says is normally very clear.
And that’s true about the latest monetary policy statement as well. He lays out very clearly what the Indian central bank is thinking at this point of time.
Let’s look at a few statements that Rajan made in the monetary policy statement. These statements are italicized and what follows is my interpretation of the statements.
“Further softening of international crude prices in October eased price pressures in transport and communication. However, upside pressures persist in respect of prices of clothing and bedding, housing and other miscellaneous services, resulting in non-food non-fuel inflation for October remaining flat at its level in the previous month, and above headline inflation.”
What Rajan means here is that overall inflation(i.e. rate of price rise) has been falling. But the prices of a part of the consumer price index which consists of non food and non fuel items haven’t been falling as fast as the overall inflation has been. Given this, its not yet time for the RBI to cut the repo rate or the rate at which it lends to banks.
“Survey-based inflationary expectations have been coming down with the fall in prices of commonly-bought items such as vegetables, but are still in the low double digits. Administered price corrections, as and when they are effected, weaker-than-anticipated agricultural production…could alter the currently benign inflation outlook significantly.”
Inflationary expectations (or the expectations that people have of what future inflation is likely to be) have been coming down. This means that people expect the rate of price rise to come down in the days to come. Nevertheless, the inflationary expectations are still on the high side, given that they remain in the low double digits.
Further, agricultural production is likely to fall as well. “It is reasonable to expect some firming up of these prices in view of the monsoon’s performance so far and the shortfall estimated for kharif production,” the statement read. This could push up inflation in the days to come. The RBI needs to wait and see how these factors pan out, before deciding to cut the repo rate.
“Inflation has been receding steadily and current readings are below the January 2015 target of 8 per cent as well as the January 2016 target of 6 per cent. The inflation reading for November – which will become available by mid-December – is expected to show a further softening. Thereafter, however, the favourable base effect that is driving down headline inflation will likely dissipate and inflation for December (data release in mid January) may well rise above current levels.”
A large part of the above statement is self explanatory. The Rajan led RBI expects the rate of inflation to have fallen further for November 2014. Nevertheless, a large part of this fall in inflation is because of the favourable base effect feels the RBI. What this means is that inflation in November 2013 was at a high level. This high inflation in November 2013 will make the inflation in November 2014 look small. (For a detailed explanation of the base effect click here). The RBI expects this base effect to go away after November and inflation to rise. Hence, it wants to wait and watch and see how the situation turns out by early next year.
This statement is also important from the point of view of inflationary expectations. They start to come down only once the people see low inflation being maintained for a while. And if inflation actually has to be controlled, the inflationary expectations need to be controlled first.
“ Risks from imported inflation appear to be retreating, given the softening of international commodity prices, especially crude, and reasonable stability in the foreign exchange market. Accordingly, the central forecast for CPI inflation is revised down to 6 per cent for March 2015.”
In this statement the Rajan led RBI acknowledges that one of the reasons for the falling inflation is a fall in oil prices. The RBI also says that it largely expects the inflation not to spike from here but is not totally sure about it. And given that they have revised the inflation number for March 2015 to 6%. Earlier it was at 8%. This statement reaffirms the fact that the RBI wants to wait and watch and be sure that the low inflation environment is here to stay. In short, it doesn’t want to jump the gun.
“With deposit mobilisation outpacing credit growth and currency demand remaining subdued in relation to past trends, banks are flush with funds, leading a number of banks to reduce deposit rates.”
“Some easing of monetary conditions has already taken place. The weighted average call rates as well as long term yields for government and high-quality corporate issuances have moderated substantially since end-August. However, these interest rate impulses have yet to be transmitted by banks into lower lending rates.”
In these statements Rajan points out that interest rates on deposits have fallen despite the RBI not reducing the repo rate. He also acknowledges that RBI plays a limited role in influencing interest rates. Further, the overall rate of loan growth for banks has been falling. Given this, the government and big corporates have been able to raise money at lower interest rates since the end of August 2014.
This quip is aimed at the businessmen who have been asking Rajan to cut interest rates. Further, this slowdown in the loan growth for banks has not transmitted into lower interest rates for everybody as yet. The government and the big corporates are the only ones who have benefited from it.
“The Reserve Bank has repeatedly indicated that once the monetary policy stance shifts, subsequent policy actions will be consistent with the changed stance. There is still some uncertainty about the evolution of base effects in inflation, the strength of the on-going disinflationary impulses, the pace of change of the public’s inflationary expectations, as well as the success of the government’s efforts to hit deficit targets. A change in the monetary policy stance at the current juncture is premature. However, if the current inflation momentum and changes in inflationary expectations continue, and fiscal developments are encouraging, a change in the monetary policy stance is likely early next year, including outside the policy review cycle.”
This is the crux of the monetary policy statement. What Rajan is saying here is that the RBI is still not totally convinced about cutting the repo rate. It doesn’t feel comfortable in declaring that the battle against inflation has been won.
It feels that if the rate of inflation continues to remain low, the inflationary expectations continue to fall and the government is able to meet its fiscal deficit targets, only then would have the RBI achieved what it set out to, after Rajan took over as the governor in September 2013.
Fiscal deficit is the difference between what a government earns and what it spends. The difference is made up through borrowing. If the government borrows more, it pushes up interest rates because it leaves a lower amount for others to borrow.
Once the RBI sees these three factors under control it will start cutting the repo rate and it will do that at a rapid rate. This, the central bank feels is likely to happen early next year. It has also made it clear that once it is convinced about the need to cut the repo rate it will do that without waiting for the days on which monetary policy is scheduled.
The phrase to mark here is “early next year,” which is open ended. Since Rajan has talked about waiting to see if the government is able to maintain its fiscal deficit target, the repo rate cut is likely to happen after the budget is presented in late February.
There are a couple of other points that I would like to make:

a) It was nice to see Rajan stick to his guns and not fall for the pressure to cut interest rates. This, despite the fact that Arun Jaitley went on an overdrive demanding that the RBI cut interest rates. He even met Rajan on December 1.

b) Further, Rajan has always maintained that if inflation is controlled economic growth will follow. As he wrote in the 2008 Report of the Committee on Financial Sector Reforms: “The RBI can best serve the cause of growth by focusing on controlling inflation.”

He repeated the same statement while talking to reporters yesterday. As he said “There is a major misconception in the industry that the RBI is not concerned about growth. The central bank is concerned about growth and the way to sustainable growth is to have a moderate inflation…RBI wants the strongest growth for India that is possible. We’re talking of years of sustainable growth for which you need to fight inflation.”
This statement should go a long way in countering those who had been trying to portray RBI’s efforts at countering inflation in a negative way and trying to hold it wrong for the low growth environment that prevails in the country these days.
In the end, like good central bank governors often do, Rajan acknowledged that there is only so much that the RBI can do. If economic growth has to be revived the government needs to get its act together. As he said towards the end of the monetary policy statement “A durable revival of investment demand continues to be held back by infrastructural constraints and lack of assured supply of key inputs, in particular coal, power, land and minerals. The success of ongoing government actions in these areas will be key to reviving growth.”
The RBI due to its own efforts and with some luck(like oil prices crashing) has brought inflation under some control. Now it’s over to the government.

The article originally appeared on www.equitymaster.com as a part of The Daily Reckoning, on Dec 3, 2014

Warren Buffett’s favourite business book tells us what is wrong with India’s tax system

Warren_Buffett_KU-crop,flip

Vivek Kaul

Business books are soporific. They put me to sleep.
Nonetheless, now and then, one does come across an excellent business book as well. These days I am reading John Brooks’ Business Adventures. The book is a collection of 12 long articles that Brooks wrote for the New Yorker magazine.
In July 2014, Bill Gates wrote a blog titled The Best Business Book I’ve Ever Read. As he put it : “Not long after I first met Warren Buffett back in 1991, I asked him to recommend his favorite book about business. He didn’t miss a beat: “It’s Business Adventures, by John Brooks,” he said. “I’ll send you my copy.” I was intrigued: I had never heard of Business Adventures or John Brooks. Today, more than two decades after Warren lent it to me—and more than four decades after it was first published—Business Adventures remains the best business book I’ve ever read.” This blog by Gates sent the book to the top of the best-sellers lists almost everywhere.
The third chapter of the book is called The Federal Income Tax. Brooks makes several points in the chapter about the income tax system in the United States as it had prevailed in the fifties and sixties. Some of the points I feel are as applicable to the general tax environment in India today as they were in the United States back then.
As Brooks writes in the context of the federal income tax in the United States: “A good deal of the attention given to the income tax is based on the proposition that the tax is neither logical nor equitable. Probably, the broadest and most serious charge is that the law has close to its heart something very much like a lie; that is, it provides for taxing incomes at steeply progressive rates, and then goes on to supply an array of escape hatches so convenient that hardly anyone, no matter how rich, need pay the top rates or anything like them.”
Long story short: The rich were “supposed” to be taxed at a high rate, but at the same time enough loopholes were built into the income tax laws ensuring that they did not pay the highest tax rates in reality.
A similar sort of scenario prevails in India when it comes to the Income Tax Act in particular and taxes in general. Along with the budget every year, the government of India puts out a statement of revenue foregone under the central tax system.
What is the purpose of this system? “The estimates and projections are intended to indicate the potential revenue gain that would be realised by removing exemptions, deductions, weighted deductions and similar measures,” the latest statement of revenue foregone points out.
The deductions, exemptions and other measures lead to a loss of revenue for the government. As can be seen from the accompanying table the revenue foregone for the government during the year 2013-2014 has been estimated to be at Rs 5,72,923.3 crore.

Statement of Revenue Foregone

TaxYear(in Rs crore)
2012-20132013-2014
Corporate Income Tax68,720.076,116.3
Personal Income Tax33,535.740,414.0
Excise Duty209,940.0195,679.0
Customs Duty254,039.0260,714.0
566,234.7572,923.3


A simplistic way of looking at it is that the revenue foregone number is greater than the fiscal deficit of the government for 2013-2014, which stood at Rs 5,42,499 crore.
Nevertheless it needs to be pointed out that the statement of revenue foregone is based on certain assumptions. As the statement points out “ The estimates are based on a short-term impact analysis. They are developed assuming that the underlying tax base would not be affected by removal of such measures….The cost of each tax concession is determined separately, assuming that all other tax provisions remain unchanged. Many of the tax concessions do, however, interact with each other. Therefore, the interactive impact of tax incentives could turn out to be different from the revenue foregone calculated by adding up the estimates and projections for each provision.”
So the revenue foregone figure needs to be looked at with these limitations in mind. Having said that, the government of India is losing out on revenue because of the exemptions and deductions. There is no denying that. As can be seen from the above table corporate India is a major beneficiary of the same, like the rich were in the United States, around the time Brooks wrote about the federal income tax.
Getting back to Brooks, he also points out that laws and the regulations were so vast that the critics thought it was an “undemocratic state of affairs, for only the rich can afford the expensive professional advice necessary to minimize their taxes legally”.
This is what is happening in India as well. Companies have an army of chartered accountants and lawyers, working towards legally minimizing taxes, whereas most individual tax payers find it difficult to afford the services of a good chartered accountant who can help them.
Brooks also talks about the favoured treatment of capital gains. This is something that really helps the rich because they are the ones primarily investing in stocks and bonds. In India short term capital gains on equity gets taxed at 15%. There is no long term capital gains tax on equity i.e. if you buy and then sell a share after one year, you don’t have to pay a tax on the capital gains you make when you sell the shares. Equity mutual funds are treated in a similar way.
In case of debt mutual funds, long term capital gains come into the picture if the investment is held for a period of more than three years. Long term capital gains are taxed at either 10% or 20% with indexation, whichever is lower. Indexation allows inflation to be taken into account while calculating the cost of purchase. This brings down the tax significantly.
Now compare this to the common man’s investment—the humble fixed deposit. In this case the interest earned is taxed at the marginal rate of tax. Why is there a favourable treatment for investing in equity? I have often been told that this is because the investor investing in stocks is taking on more risk than the fixed deposit investor, and hence needs to be encouraged through a favourable tax treatment.
This I guess is “bullshit” (pardon my French!) of the highest order perpetuated by those who invest in equity and do not want to pay any tax on it. The amount of risk that an individual wants to take on with investments, is his or her personal preference and should have nothing to do with the prevailing income tax system. Nevertheless that’s the way things stand. Equity gets preferential tax treatment all over the world.
Other than this, the Indian Income Tax Act has a very interesting provision for those taking on a home loan to buy a home. In fact, the Act encourages people to speculate in real estate. There is no restriction on the number of homes against which you can claim a tax deduction on the interest paid on the home loan to fund the property. Only one of these properties needs to categorized as a self-occupied property. On this self-occupied property, an interest of up to Rs 1.5 lakh can be claimed as a tax deduction.
But this limit does not apply to the remaining homes that an individual may choose to buy. Any amount of interest paid on home loans can be claimed as a deduction as long as a “notional rent” is added to the income.
We all know that these days “rents” are relatively low in comparison to the EMIs that need to be paid in order to repay the home loan. Hence, the interest component tends to be massive during the initial years and helps people with two or more homes, claim huge tax deductions.
In a country where a large number cannot afford to buy a home what is the logic in having a regulation like this one?
The Direct Taxes Code, which is supposed to be replace the Income Tax Act, in its original form simplified the income tax system. In fact, I remember reading a large part of it when it first came out and was very impressed by its simplicity.
But a simple tax code doesn’t benefit those who currently make money out of the Income Tax Act being as complicated as it is. These include chartered accountants, tax lawyers, corporates and the income tax officers. Over the years, the Direct Taxes Code has been revised and from what I am told by those in the know of such things, it has become more or less as complicated as the Income Tax Act currently is.
To conclude, the tax system in India currently favours those who need to pay more taxes. This is something that needs to be addressed in the days to come.

The article originally appeared on www.equitymaster.com on Dec 2, 2014

Why governments, politicians and businessmen hate gold

gold
Yesterday Switzerland voted on whether its central bank should be holding more gold as a proportion of its total assets. Gold currently makes up for around 7% of the total assets of Swiss National Bank, the country’s central bank.
The proposal dubbed as “Save Our Swiss Gold” had called for increasing the central bank’s holding of gold to 20% of its total assets. It was more or less rejected unanimously with nearly 78% of the voters having voted against it.
This proposal was backed by the right-wing Swiss People’s Party and came out of the concern that the Swiss National Bank had sold too much of its gold in the years gone by.
Interestingly, Switzerland was on a gold standard till 1999 and was the last country to leave it. In a gold standard the paper money issued by the central bank is backed by a certain amount of gold held in the vaults of the central bank.
What this means is that the central bank and the government cannot issue an unlimited amount of paper money. The total amount of paper money that can be issued is a function of the total amount of gold that the central bank holds in its vaults.
In April 1933, when the Great Depression was on in the United States, the Federal Reserve of the United States had around $2.7 billion in gold reserves, which formed around 25 percent of the monetary gold reserves of the world. At the same time, the ratio of paper money to gold was at a healthy 45 percent, more than the decreed 35–40 percent. (Source: J.W. Angell, “Gold, Banks and the New Deal,” Political Science Quarterly 49, 4(1934): pp 481–505)
That’s how the gold standard worked.
Getting back to the Swiss vote on gold, other than the Swiss People’s Party, the other parties as well as businessmen were opposed to it. As the Wall Street Journal reports “The initiative was widely criticized by Switzerland’s political and business communities.”
This isn’t anything new. The politicians over the last 100 years have not liked the gold standard because it limits their ability to create money out of thin air. And as far as businessmen are concerned they usually tend to go with what the politicians are saying.
As Raghuram Rajan and Luigi Zingales write in Saving Capitalism from the Capitalists: “The First World War and the Great Depression created great dislocation and unemployment… Workers, many of whom had become politically aware in the trenches of World War I, organized to demand for some form of protection against economic adversity. But the reaction really set in during the Great Depression, when they were joined in country after country by others who had lost out—farmers, investors, war veterans, the elderly.”
The politicians could not do much about it given that most of the world was on the gold standard. And given this, they could not print money and flood the financial system with it. “The gold standard … imposed tight budgetary discipline on governments, which made it difficult for them to intervene much in economic affairs… Politicians had to respond, but such a large demand for protection could not be satisfied within the tight constraints imposed by the gold standard. Hence, the world abandoned the straitjacket of the gold standard… With their ability to turn on or turn off finance, governments obtained extraordinary power,” write Rajan and Zingales.
This explains why governments hate gold.
In 2012, I had the pleasure of speaking to the financial historian Russell Napier. And he made a very interesting point about the rise of democracy and paper money having gone hand in hand. As he put it: “The history of the paper currency system, or the fiat currency system is really the history of democracy… Within the metal currency, there was very limited ability for elected governments to manipulate that currency.”
Napier further pointed out that most people don’t have savings. As he explained: “And I know this is why people with savings and people with money like the gold standard. They like it because it reduces the ability of politicians to play around with the quantity of money. But we have to remember that most people don’t have savings. They don’t have capital. And that’s why we got the paper currency in the first place. It was to allow the democracies. Democracy will always turn toward paper currency and unless you see the destruction of democracy in the developed world, and I do not see that, we will stay with paper currencies and not return to metallic currencies or metallic based currencies.”
With paper currencies around, politicians (even honest ones) feel that they have the ability to bring an economy out of a recession, by getting their central banks to print money and flood the financial system with it, so as to maintain low interest rates.
At low interest rates the hope is that people will borrow and spend more. In a gold standard all this wouldn’t have been possible. But that as we have seen over the last few years has led to other problems.
Having said that, the fundamental problem with paper money, that it can be created out of thin air, remains. Or as Ben Bernanke, the former Chairman of the Federal Reserve of United States, put it in 2002: “The U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost.”
This is what the US government has done with the help of its central bank, the Federal Reserve, over the last few years, largely during the years in which Bernanke was the Chairman.
As on September 17, 2008, two days after the investment bank Lehman Brothers went bust, and the financial crisis well and truly started, the Federal Reserve held US government treasury bonds worth $479.8 billion. Since then, the number has jumped up to $2.46 trillion. Where did the Fed get the money to buy these bonds? It simply printed it. And then it bought bonds to pump that money into the financial system.
In fact, it also printed money to buy bonds other than treasury bonds as well. This was done so as to flood the financial system with money, in the hope of keeping interest rates low, in order to get people to borrow and spend again, and hopefully create economic growth.
While that has happened to a limited extent, financial institutions have borrowed this money at low interest rates and invested this money in large parts of the world chasing returns.
The Fed decided to stop printing money towards the end of October 2014. But now it needs to keep telling the financial markets that it won’t go about withdrawing the trillions of dollars that it has printed and pumped into the financial system, any time soon. We need to see what happens when it decides to start withdrawing all the money it has printed and pumped into the financial system.
To conclude, it is worth remembering what economist Stephen D. King writes in When the Money Runs Out “A central banker who jumps into bed with a finance minister too often ends up with a nasty dose of hyperinflation.”

The article appeared originally on www.equitymaster.com on Dec 1, 2014