Equitymaster

Kaala Dhandha Gore Log – Why politicians are not serious about black money

kaala dhandhaVivek Kaul

Sometime in the mid 1980s, I vaguely remember spending a few days with my family, in one of the many small coal producing towns that dot what is now known as the state of Jharkhand. As was common in those days, we had hired a VCR and had decided to go on a movie watching spree.
One of the movies on the list was Kaala Dhandha Gore Log. The movie was directed by Sanjay Khan. That is the only bit about it that I still remember. I don’t know why, but I found the title of the movie very fascinating and was really looking forward to watching it.
But the adults in the family threw a spanner in the works and banned us “kids” from watching the movie, without really going into the reasons for it. Around three decades later I can speculate as to why we weren’t allowed to watch the movie.
I guess the movie must have had a few scenes with the heroine mouthing the most famous cliché of the eighties,“mujhe bhagwan ke liye chhod do,” or it must have had songs we now call “item numbers”.
Those were days when cable television hadn’t come to India (that would happen only in late 1991, early 1992). Middle class India still hadn’t discovered The Bold and the Beautiful or Santa Barbara for that matter, two shows that went a long way in Indian parents becoming a lot more liberal in deciding what their kids could watch on television.
For some reason the title of the movie has always stayed in my mind, and I have speculated now and then, on its possible storyline. As the title of the movie suggests, the story could possibly be about businesses run by white people (meaning foreigners) which throw up black money.
Three decades later, reel life seems to have turned into real life. There is a great belief in this country that all of the black money generated over the years is now with foreigners. It has been transferred into foreign banks operating out of tax havens. The prime minister Narendra Modi has promised to get the money back.
In an earlier piece I had explained why getting this money back is not a feasible proposition, even though it might sound possible. And a better thing to do would be to simply concentrate on unearthing all the black money that is there in the country. I had also said that a lot of black money which has gone abroad over the years is possibly now being round-tripped to India, given that the chances of earning a good return are better in India.
Nevertheless, there are two questions that arise here? First, why has the black money problem been allowed to become so huge? Second, will the politicians choose to do anything about it? Let me answer the second question first.
Political analyst Mohan Guruswamy shared some very interesting data in a recent column in The Asian Age. Between 2004-05 and 2011-12, national political parties collected Rs 435.87 crore as donations. Of this the Bhartiya Janata Party received Rs 192.47 crore from 1,334 donors and the Congress Rs 172.25 crore from 418 donors.
Corporates made 87% of these donations. Interestingly, over and above this, the parties received donations from unknown contributors as well. The Congress party received a total of Rs 1,185 crore in three financial years (2007-08, 2008-09, 2009-10) and the BJP received around Rs 600 crore during the same period.
It is worth remembering that in the period between 2004-05 and 2011-12, there were two Lok Sabha elections and many elections to state assemblies. It doesn’t take rocket science to come to the conclusion that the amount of donations declared by the political parties were clearly not enough to fight so many elections.
In fact, a study carried out by Centre for Media Studies in March earlier this year estimated that around Rs 30,000 crore would be spent during the 16th Lok Sabha elections which happened in April and May 2014. Of this total, the government would spend around Rs 7,000-8,000 crore to conduct the elections through the Election Commission and the home ministry.
The remaining amounts would be spent by the candidates contesting the elections and the political parties they belonged to. Candidates standing for Lok Sabha elections are allowed to spend only Rs 70 lakhs for fighting an election in bigger states. For other states, the amount varies from anywhere between Rs 22 lakh to Rs 54 lakh.
These amounts are peanuts when it comes to fighting elections. Even candidates from major political parties fighting state level elections spend more money than this. Candidates stay within these limits officially, but political parties spend much more money outside the set limits, during the course of campaigning.
What this tells us clearly is that political parties have got access to funding beyond what they have declared in the public domain. This money that comes to them is black money. This black money can possibly be the money that politicians have accumulated through corruption or money handed over by crony capitalists looking at possible favours in the days to come.
Hence, a crackdown on black money within the country would lead to the major source of funding for political parties and politicians being impacted. Guruswamy put it very aptly in his column when he said “Their own taps will run dry.”
Now, let me try and answer the first question, which was that why has the black money problem been allowed to become so huge? Why has it been left unattended for so many decades? As Daron Acemoglue and James A Robinson write in Why Nations Fail—The Origins of Power, Prosperity and Poverty “Political institutions determine economic institutions…Extractive political institutions concentrate power in the hands of a narrow elite and place few constraints on the exercise of power. Economic institutions are then often structured by this elite to extract resources from the rest of the society. Extractive institutions thus naturally accompany extractive political institutions. In fact, they must inherently depend on extractive political institutions for their survival.”
So what does this mean in the Indian context? It means that the Income Tax department, which is supposed to be unearthing the black money in this country, is corrupt because the politicians running this country are corrupt. The way the economic incentives of politicians have evolved has led to a situation wherein they simply cannot become active in cracking down on black money.
It explains why only 3.5 crore individuals out of a population of 120 crore pay income tax in this country.
To conclude, the question worth asking is, what will it take for politicians of this country get serious about unearthing black money?

The column originally appeared on www.equitymaster.com on Nov 14, 2014

The sucker flag is up, as the retail investor is back into the stock market

Vivek Kaul

It’s morally wrong to allow a sucker to keep his money – W C Fields

The Indian retail investor is a sucker. He invests when the markets are high and he gets out when the markets are low. Don’t believe me? Look at the table that follows.
This table shows the net inflows(total inflows minus total outflows) into equity mutual funds in India during the course of a financial year. As can be seen in 2007-2008 equity mutual funds saw a net inflow of Rs 40,782 crore. This was the time when the stock market was on fire. In early January 2008, the Sensex almost touched 21,000 points. It had started the financial year at around 12,500 points.

earInflows/Outflows in/from
equity mutual funds (in Rs Crore)
2007-200840,782
2008-20091,056
2009-2010595
2010-2011-13,405
2011-2012264
2012-2013-12,931
2013-2014-7,627
2014-2015 (from April 1,2014 to October 31 2014)39,217

Source :Association of Mutual Funds in India


And when the party was on the retail investor couldn’t have been far behind. He poured money into equity mutual funds. In January 2008, equity mutual funds saw a net inflow of Rs 12,717 crore. The stock market started to fall from mid January onwards. In fact, the Sensex fell from 21,000 points to 17,500 points in a matter of a few days.
So, the good things came to an end pretty soon. Over the next few years, the faith of the retail investor in the stock market came down dramatically and inflows into equity mutual funds almost dried down. In 2010-2011, the outflows from equity mutual funds reached Rs 13,405 crore. The trend continued in 2012-2013 and 2013-2014 as well.
What these data points clearly show us is that the retail investor poured money into the stock market at high levels and got out only once the market started to fall. The opposite of the buy low, sell high, strategy that the stock market experts keep talking about. But what else do you expect from a sucker.
Nevertheless, things seem to have started to change again. The retail investor seems to be back into the stock market. This financial year (between April and October 2014) has seen a net inflow of Rs 39,217 crore into equity mutual funds. And if things go on as they currently are, the year might see the highest inflow into equity mutual funds ever.
This is not surprising given that the Sensex has rallied by close to 25% between April and October 2014 to reach almost 28,000 points. And this has got the suckers interested in the stock market all over again.
In fact, the Indian retail investor isn’t the only sucker going around. Maggie Mahar in her book Bull!—A History of the Boom and Bust, 1982–2004, makes a similar point about American investors during the dotcom bubble.
Between 1982 and 1996, the Dow Jones Industrial Average gave positive returns in 12 out of the 14 years. In eight of the 12 years that the Dow had given positive returns, the absolute return had been 20 percent or more. This led to more investors entering the stock market.
The number of investors in the stock market increased, as many middle class investors made their first jump into the stock market. Wealthier Americans already owned stocks. Nearly three-fourths of those having financial assets of $500,000 or more had made their first investment in stocks sometime before 1990. Some 33 percent of the households with financial assets of $25,000 to $100,000 bought their first stock or invested in a mutual fund that in turn invested in stocks between 1990 and 1995. But 40 percent of those owning financial assets in the range of $25,000 to $99,000, and 68 percent of those with financial assets of less than $25,000 made their first purchase after January 1996.
So, the American retail investor started taking interest in technology stocks only after January 1996, and by that time the dotcom bubble was well and truly on. A similar sort of dynamic was visible in the real estate bubble that followed, when a large number of individuals started taking loans to buy homes that they wanted to flip, only by 2005-2006, when the bubble was at its peak.
Economic theory tells us that more often than not, higher prices dampen demand and lower prices increase demand. But when the stock market witnesses a bull run, investors do not behave like normal consumers.
As Mahar puts it in Bull! “In the normal course of things, higher prices dampen desire. When lamb becomes too dear, consumers eat chicken; when the price of gasoline soars, people take fewer vacations. Conversely, lower prices usually whet our interest: color TVs, VCRs, and cell phones became more popular as they became more affordable. But when a stock market soars, investors do not behave like consumers. They are consumed by stocks. Equities seem to appeal to the perversity of human desire. The more costly the prize, the greater the allure.”
This is something that every investor should try and remember.
What these examples show is that the retail investor tends to enter a market only once its done well for a while. In the process he or she ends up making losses or limited gains.
Let’s compare this to a situation of an investor who had invested regularly in the stock market over the years, through a systematic investment plan.
Let’s consider the Goldman Sachs Nifty BeES fund for this exercise. This particular fund is essentially an exchange traded index fund and invests in stock that constitute the Nifty index. A regular monthly investment in this fund from September 2007 till November 2014, would have yielded a return of 14.10% per year. During the same period the Nifty has given a return of around 9.15% per year, barely matching the rate of inflation.
What is the point of investing in the stock market over the long term, if you can’t even beat the rate of inflation?
Now let’s say you had started investing in January 2008, when the stock market was at a then all time high level and continued to invest in the Nifty BeES till date. The returns on the systematic investment plan would be 14.84%. During the same period the Nifty gave a return of 4.5% per year. Some savings accounts would have given more return than that.
Moral of the story: Successful stock market investing can be simple and boring at the same time.
To conclude, retail investors entering the stock market in droves has been a clear sign of the market nearing its high levels, in the past. Is that the case this time around as well? This remains a difficult question to answer given that foreign investors are the ones really driving the Indian stock market.
As long as Western central banks maintain low interest rates, these investors can borrow money at low interest rates and invest them in financial markets all over the world, including India. Given this, the retail investor entering the market right now may not turn out to be suckers at the end of the day.
But the same cannot be said about the retail investors still waiting in the wings.
Stay tuned.

Disclosure: The basic idea for this column came after reading this piece in the Business Standard

The column originally appeared on www.equitymaster.com on Nov 13, 2014

Of foreign investors, China and the Hotel California song

china

In response to the last column a reader wrote in on Twitter saying “shudder to think what would happen [to the stock market] if FIIs[foreign institutional investors] packed their bags and left.” Since the start of the financial crisis in September 2008 and up to October 2014, the FIIs have made net purchases (gross purchase minus gross sales of stocks) close to Rs 2.76 lakh crore in the Indian stock market. During the same period, the domestic institutional investors(DIIs) made net sales of Rs 95,219 crore.
The FIIs have continued to bring in money even during the course of this year. Between January and November 10, 2014, they had made net purchases of stocks worth Rs 65,751.25 crore. During the same period, the DIIs had made net sales of stocks worth Rs 30,136.32 crore.
Over and above this, the FIIs own around 26% of the BSE 100 stocks. Deepak Parekh in a recent speech estimated that after excluding promoter shareholding and the retail segment, which do not have too much liquidity, FIIs dominate close to 70% of the stock market.
What all these numbers clearly tell us is that the foreign investors run the Indian stock market. But that we had already established in the last column. In this column we will try and address the question as to what will happen if foreign investors packed their bags and left? The simple answer is that the stock market will fall and will fall big time. The foreign investors control 70% of the stock market and if they sell out, chances are there won’t be enough buyers in the market.
Nevertheless, the foreign investors also know this, so will they ever try getting out of the Indian stock market, lock, stock and barrel? This is where things get a little tricky.
Let’s try and get deeper into this through a slightly similar situation in a different financial market. Over the years, the United States(US) government has spent much more than it has earned and has financed the difference through borrowing. As on November 7, 2014, the total borrowing of the United States government stood at $ 17.94 trillion dollars. The US government borrows this money by selling financial securities known as treasury bonds.
A little over $6 trillion of treasury bonds are held by foreign countries. Within this, China holds bonds worth $1.27 trillion and Japan holds bonds worth $1.23 trillion. Even though the difference in the total amount of treasury bonds held by China and Japan is not much, China is clearly the more important country in this equation.
Why is that the case? James Rickards explains this in great detail in Currency Wars—The Making of the Next Financial Crisis. The buying of treasury bonds by the Japanese is not as centralized as is the case with China, where the People’s Bank of China, the Chinese central bank, does the bulk of the buying. In the Japanese case the buying is spread among the Bank of Japan, which is the Japanese central bank, and other institutions like the big banks and pension funds.
The United States realizes the importance of China in the entire equation. Right till June 2011, China bought American treasury bonds through primary dealers, which were essentially big banks dealing directly with the Federal Reserve of the United States. But since then things have changed. The treasury department of the US (or what we call finance ministry in India) has given the People’s Bank of China, a direct computer link to its bond auction system.
Also, there is a great fear of what will happen if the Chinese ever decide to get out of US treasury bonds, lock, stock and barrel. It will lead to a contagion where many investors will try getting out of the treasury bonds at the same time, leading to a fall in their price.
A fall in price would mean that the returns on these bonds will go up, as the US government will continue paying the same interest on these bonds as it had in the past. Higher returns on the treasury bonds will mean that the interest rates on bank deposits and loans will also have to go up.
This can lead to a global financial crisis of the kind we saw breaking out in September 2008. Nevertheless, the question is will China wake up one fine day and start selling out of US government bonds? For a country like China, which holds treasury bonds worth $1.27 trillion, it does not make sense to wake up one day and start selling these bonds. This as explained earlier will lead to a fall in bond prices, which will hurt China as the value of its investment will go down. China has invested the foreign exchange that it earns through exports, in treasury bonds.
As on September 30, 2014, the Chinese foreign-exchange reserves stood at close to $3.89 trillion. Hence, nearly one third of Chinese foreign-exchange reserves are invested in US treasury bonds. Given this, it is highly unlikely that China will jeopardise the value of these foreign-exchange reserves by suddenly selling out of treasury bonds.
What China has done instead is that since November last year its investment in US treasury bonds has been limited to around $1.27 trillion. Also, some threats work best when they are not executed.
Hence, when it comes to the Chinese and their investment in treasury bonds, the situation is best expressed by the Hotel California song, sung by The Eagles: “You can check out any time you like, but you can never leave.”
Now let’s get back to the FIIs and their investment in the Indian stock market. Isn’t their situation similar to the Chinese investment in US treasury bonds? If they ever try to exit the Indian stock market lock, stock and barrel, it is worth remembering that they control nearly 70% of the market. When foreign investors decide to sell there won’t be enough buyers in the market. Hence, stock prices will fall big time, leading to foreign investors having to face further losses on the massive investments that they have made over the years.
Given this, are the Chinese in the US and foreign investors in India in a similar situation? Does the Hotel California song apply to foreign investors in India as well? Prima facie that seems to be the case. But there is one essential difference that we are ignoring here.
Nearly one third of Chinese foreign-exchange reserves are invested in US treasury bonds. Hence, China has a significant stake in the US treasury bond market. The same cannot be said about foreign investors in India’s stock market, at least when we consider them as a whole.
As Deepak Parekh said in a recent speech “India ranks among the top 10 global equity markets in terms of market cap. However, India accounts for just 2.4% of the global market capitalization of US $64 trillion.” Given this, in the global scheme of things for foreign investors, India does not really matter much.
Hence, if a sufficient number of them feel that they need to exit the Indian stock market, they will do that, even if it means that they have to face losses in the process. As mentioned earlier, in the global scheme of things, these losses won’t matter. Also, a lot of money brought into India by the FIIs has been due to the “easy money” policy run by the Federal Reserve of the United States and other Western central banks.
These central banks have printed money to maintain interest rates at low levels. The foreign investors have borrowed money at low interest rates and invested in the Indian stock market. Once these interest rates start to go up, it may no longer make sense for them to stay invested in India. Of course, it is very difficult to predict when will that happen.
Nevertheless, it is worth remembering what Steven Pinker writes in his new book The Sense of Style—The Thinking Person’s Guide to Writing in the 21st Century: “It’s hard to know the truth, that the world doesn’t just reveal itself to us, that we understand the world through our theories and constructs, which are not pictures but abstract propositions.”
And whatever I have written in today’s column is my abstract proposition. Hence, the question still remains: Will foreign investors ever sell out of the Indian stock market, lock, stock and barrel? 

Sensex at 28,000: Will the real Indian stock market investor please stand up?

bubbleVivek Kaul

I have cooked my own food for over 12 years now. Over the years, as boredom from cooking on a daily basis has set in, the quality of what I cook has deteriorated. These days the food I cook is just about edible.
Given this, I like to watch some mindless television while eating. This ensures that I don’t pay attention to what I am eating and as a result, don’t end up cribbing to myself. What works best in this scenario, especially during lunch time, are business news channels.
If you are the kind who still watches them, you would know that a major part of the day on these channels is spent in trying to figure out which way the stock market is headed. The anchors of these channels talk to so called “experts” who give their “gyan” on why they feel the market moved the way it did, and which way they think it’s headed in the future.
More often than not these experts are optimistic and keep telling us that the market is only going to go up from here. Nevertheless, as you and I know that is not how things always turn out. It is especially interesting on days the markets rise, to see these experts thump their chests and tell the viewers “I told you so!”
The reasons for their optimism vary from day to day. It can be low inflation on one day and the hyperactive Modi government on another. On days they run out reasons they like to tell us the “India growth story is still intact”. Come rain or sunshine, these experts always have their reasons ready. And that makes it great fun to watch.
(I have to confess here that I have this recurring dream where I have been invited to a studio of a business channel and am asked “Mr Kaul, which way do you think the stock market is headed?” And I look write into the eyes of the anchor and tell her “Mam, it’s headed only one way and that’s up”.
“Why do you say so?” she asks, with her eyebrows fluttering. And I reply: “The whole country of the system is juxtaposition by the haemoglobin in the atmosphere because you are a sophisticated rhetorician intoxicated by the exuberance of your own verbosity.”)
Jokes apart, these experts especially the Indian ones, never really tell us the real reason behind the Indian stock market going up.
Between April 2007 and October 2014, the foreign institutional investors(FIIs) made a net purchase(gross purchase minus gross sales of stocks) of Rs 2.06 lakh crore in the Indian stock market. During the same period the domestic institutional investors(DIIs) made net sales of Rs 22,715 crore.
Things get more interesting once we look at the numbers between September 2008 (the month the current financial crisis started) and October 2014. During this period, FIIs have made a net purchase of Rs 2.76 lakh crore. In the same period, the DIIs made net sales of Rs 95,219 crore. These data points tell us very clearly who is really driving up the Indian stock market. In the aftermath of the financial crisis breaking out in September 2008, the developed nations of the world led by the United States and United Kingdom carried out quantitative easing or printed money and pumped it into their respective financial systems, to keep interest rates low.
This was done in the hope that at low interest rates people would borrow and spend more, and all the spending would help revive economic growth. What happened instead was that large financial institutions managed to borrow money at low interest rates and invested it in financial markets all over the world. This has driven up stock markets all over the world, including the BSE Sensex.
The inflow of foreign money has been particularly strong this year. As Abhishek Saraf and Abhay Laijawala of Deutsche Bank Market Research point out in a recent report “On a year to date basis too, India has witnessed the highest FII inflows into equities at ~US$14billion.”
This has helped the Sensex rally by more than 33% since the beginning of this year. But the interesting thing is that DIIs have continued to stay away. Since the beginning of this year they have made net sales of Rs 27,241.5 crore.
Nevertheless, October 2014 has been an exception to this, with the DIIs making a net purchase of Rs 4,103 crore. This is for the first time since August 2013, when the net purchase of the DIIs was higher than that of the FIIs. In fact, FIIs made net sales of Rs 1683 crore during the course of the month.
The question to ask here is why have the DIIs not invested anywhere as much as the FIIs have in the years since the financial crisis broke out. The answer lies in the fact that DIIs (primarily insurance companies and mutual funds) ultimately invest money they collect from the retail investors.
The retail investors had bailed out of the stock market lock, stock and barrel, in the aftermath of the financial crisis. They haven’t returned since. A major reason for the same was the fact that insurance companies sold expensive unit linked insurance plans (or Ulips) to retail investors.
Many agents promised investors that their money once invested in the stock market would double in three years. That clearly did not happen, and individuals who had bought Ulips essentially went around footing the bill for the high commissions that insurance companies paid their agents. And this ended up giving the stock market a bad name.
Also, many retail investors started entering the stock market only in late 2007, when the market was already at a very high level and ended up making losses. As Deepak Parekh said in a speech last week in Mumbai “Retail investors tend to enter stock markets on the highs and lose confidence on the lows.”
Further, DIIs represent only the indirect participation of the retail investor in the stock market. What about the direct participation? This is very minuscule. As Parekh pointed out “On the retail side, the picture is grimmer. Direct participation of retail investors in Indian capital markets is 1.4% of the population compared to China at 9.4%, UK at 16% and US at 18%.” Or as maverick investor Shankar Sharma once told me during the course of an interview “The Sensex is just a two square mile phenomenon — Fort to Nariman Point. That is about all that is interested in the Sensex.”
Parekh in his speech estimated that after excluding promoter shareholding and the retail segment, which do not have too much liquidity, FIIs dominate close to 70% of the market. What this clearly tells is that it is the FIIs have used the “easy money” provided by the central banks of Western countries to drive the Indian stock market, and, in turn, have benefited the most from it as well. This has also helped the BSE Sensex cross the level of 28,000 points more than a few times in the recent past.
Given this, the next time you see an Indian expert trying to give you reasons on why the stock market is rallying, try and tell this to yourself: “he knows not what he is talking for he is on television.”
To conclude the question to ask here is whether it is time to allow big provident funds like the employee provident fund, the government provident fund and the coal mines provident fund to invest a part of their corpus in the stock market? This will be one way of ensuring that some regular Indian money also keeps coming into the stock market and foreign investors are not the only ones to benefit. And that is something worth thinking about.

The article originally appeared on www.equitymaster.com on Nov 11, 2014

Why Indian politicians need to read Charles Dickens and Anand Bakshi

Charles_Dickens_1858The writing of very few writers survives across generations. Charles Dickens is one of them. In his book David Copperfield one of the characters Mr Micawber says: “Annual income twenty pounds, annual expenditure nineteen nineteen six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.”
This is something that Indian politicians should be reading and imbibing. If reading Dickens is something that they don’t like, they can try listening to the song aamdani atthani kharcha rupaiya o bhaiyya na poocho na poocho haal natija than than gopal. This song is from the 1968 movie Teen Bahuraniyan. Given that most of the Indian politicians are “old,” they will definitely relate better to this song from the time when they were young, than to Dickens.
The moral in both what Dickens and Anand Bakshi (who was the lyricist for the aamdani atthani kharcha rupaiya song) wrote is that when you spend more than you earn there is trouble ahead. This basic lesson is something that the Indian government (and most other governments around the world) has not understood over the last ten years.
The government has constantly spent more than it has earned and run a fiscal deficit. Indeed, the situation continues to remain worrying on this front, even during the course of this financial year. Data released by the Comptroller General of Accounts(CGA) shows that during the first six months of 2014-2015(i.e. the period between April 1, 2014 and March 31, 2015), the government ran a fiscal deficit of Rs 4,38,826 crore or around 83% of the targeted fiscal deficit of Rs 5,31,177 crore, set at the time of the budget. The number was at 76% during the course of the last financial year.
One reason for this is the fact that the expenditure of the government is front loaded whereas its income is not. Hence, six months into the financial year, the fiscal deficit is not equal to 50% of the annual target.
Between April and September 2014 the total income of the government has risen by only 6.6% in comparison to the same period last financial year. The targeted growth in income in the budget is at 12.6%.So, the income has not grown as fast as it is supposed to grow. On the expenditure front things look a tad better. Between April and September 2014, the total expenditure has risen by 6.6%. The targeted growth in expenditure is at 7.8%.
In fact, with oil prices coming down the oil under-recoveries suffered by the oil marketing companies will come down. For a very long period of time oil marketing companies were selling diesel at a price at which they did not recover their cost of producing it. Cooking gas and kerosene continue to be sold at a price below their cost of production.
The government compensates these companies for their under-recoveries. This pushes up the expenditure of the government and hence, its fiscal deficit.
Kaushik Das and Taumir Baig economists at Deutsche Bank Research expect the under-recoveries for this financial year to be at Rs 85,300 crore against around Rs 1,40,000 crore, during the last financial year. This calculation was made in early October and oil prices have fallen further since then. As seems likely oil prices will continue to remain low in the short run and this will help the government contain its expenditure towards oil under-recoveries.
Nevertheless, before you uncork that bubbly, there are some other points that need to be considered. Around Rs 50,000 crore of food subsidies remain unpaid. In case of fertilizer subsidies pending bills amount to Rs 38,000 crore. This should largely neutralize the gains on account of oil prices falling. The previous finance minister P Chidambaram had pushed the payment of more than Rs 1,00,000 crore of subsidies into the current financial year, in order to ensure that he met his budget targets.
Also, there are other long term concerns on the fiscal front. The public sector banks are in a mess. They will need regular infusions of capital from the government, if they need to continue to function. This is a ticking time bomb which no one seems to be talking about. In fact, the Report of The Committee to Review Governance of Boards of Banks in India (better known as the PJ Nayak committee) released in May 2014, goes into the substantial detail regarding this issue. It estimates that between January 2014 and March 2018 “public sector banks would need Rs. 5.87 lakh crores of tier-I capital.”
The report further points out that “assuming that the Government puts in 60 per cent (though it will be challenging to raise the remaining 40 per cent from the capital markets), the Government would need to invest over Rs. 3.50 lakh crores.”
Where is this money going to come from? In fact, there has been very little activity on this front from the government during this financial year. As and when the government allocates money towards this, its expenditure will go up again. The other option is to let the private sector take over some of these banks. But that is a political minefield and also the money required for the capital infusion is not small change exactly.
Another long term issue on the fiscal front are the recommendations of the seventh finance commission which will come into force in 2016. As happened in the case of the sixth finance commission, the salaries of government employees will go up again. This will lead to a greater expenditure for the government and in turn, a higher fiscal deficit.
Immediately after the seventh finance commission recommendations are implemented, state government employees all across the country will ask for hikes as well. The state governments, as has been the case in the past, will be happy to oblige, even though they don’t have the money for it. This will mean that the total government borrowing (states + centre) will shoot up and crowd out the private sector borrowing and push up interest rates, which have only recently started to fall. These are issues that the government needs to tackle if it hopes that interest rates continue to fall.
In fact, during the course of the last financial year, the fiscal deficit crossed its annual target in January 2014. Something similar will happen this year. Nevertheless, by the time March 2015 comes, the government would have managed to bring back the fiscal deficit to the targeted level. This is because tax collections shoot up during the last three months of the year. Further, the government will go in for disinvestment of its holdings in public sector companies at that point of time. This year the government has targeted an income of Rs 58,400 crore through the disinvestment of shares. This seems to have become standard practice over the years. But the danger here is that shares once sold cannot be resold. But the expenditure they are financing is more or less permanent.
To conclude, it is important that the government looks at increasing its income, if it hopes to finance its ever burgeoning expenditure efficiently. In other words, it has to follow the advise of both Charles Dickens and Anand Bakshi.
In order to that the government has to look at increasing the number of income tax payers for one. Currently, only 3.5 crore individuals out of a population of 120 crore pay the income tax. A quick implementation of goods and services tax regime will also help. Hence, the government needs to tackle the black money economy in India seriously. The question is will get around to doing that?

The article originally appeared on www.equitymaster.com on Nov 7, 2014