Modinomics, meet the industrial slowdown!

narendra modi
The Prime Minister, Shri Narendra Modi addressing the Nation on the occasion of 71st Independence Day from the ramparts of Red Fort, in Delhi on August 15, 2017.

The index of industrial production (IIP) figures declared earlier this week, portray a worrying picture of the overall Indian economy. The IIP is a measure of industrial activity in the country.

For the month of July 2017, the IIP grew by 1.2 per cent in comparison to July 2016. In June 2017, it had contracted by 0.2 per cent. While, there has been some improvement month on month, the overall trend of the IIP growth has been down for a while. Take a look at Figure 1, which basically plots the IIP growth (or contraction for that matter) over the last four years.

Figure 1:

As is clear from Figure 1, for more than a year now, the overall trend of IIP growth in the country has been downward. This is a clear indication of a slowdown in the growth of industrial activity.

One of the ways through which IIP is measured is referred as economic activity based classification. As per this method, manufacturing accounts for 77.6 per cent of the IIP. And if things for overall IIP have been bad, they have been worse for manufacturing. Take a look at Figure 2, which basically plots the growth (and contraction) in manufacturing over the last four years.

Figure 2:

Source:  Ministry of Statistics and Programme Implementation.

What does Figure 2 tell us? The manufacturing scene in the country doesn’t look great. In July 2017, manufacturing grew by just 0.1 per cent, after having contracted by 0.5 per cent in June 2017. This is a trend that was also visible in the gross domestic product (GDP) data released in late August 2017. Let’s take a look at Figure 3, which plots the growth rates of industry and manufacturing using GDP data, over the last four years.

Figure 3:

Figure 3 clearly tells us that the growth in industry and manufacturing as per the GDP data is at a four-year low. For the period April to June 2017, industry and manufacturing grew at 1.6 per cent and 1.2 per respectively, in comparison to the same period last year.

What does this mean for the overall economy? Industry has formed around 29-31 per cent of the GDP over the years. The fact nearly one-third of the economy is barely growing should be a big reason for worry. This will impact economic growth in both direct and indirect ways. If one-third of the economy barely grows, overall economic growth is bound to slowdown. That is the direct impact.

What about the indirect impact? In order to understand this, we need to figure out how many people actually work for industry. In 2009-2010, the industry as a whole employed around 9.9 crore individuals. Analysts, Nikhil Gupta and Madhurima Chowdhury, who work for stock brokerage Motillal Oswal, in a recent research note using data from the 2014-2015 Annual Survey of Industries, state: “Over the past 35 years, employment in Indian industrial sector has grown at an average of ~2%.” The actual figure is 1.9 per cent per year.

Hence, employment in the industrial sector tends to rise at the rate of 1.9 per year on an average. Using this, we can conclude that by March 2017, the total number of people working in industry would stand at around 11.3 crore. Further, the average Indian family has 5 people. Given this, around 55 crore individuals in a population of 130 crore or around 42 per cent of the population depend on income from industry, in one way or another. An if the industry is barely growing, these people will go slow on their consumption and other expenditure, and in the process slowdown overall economic growth. This is the indirect impact.

Why is this happening? The economic slowdown initiated by demonetisation is basically continuing. It is worth remembering that first and foremost is a medium of exchange. It is a token to carry out economic transactions. When you take 86.4 per cent of the currency in circulation out of an economy, where 80 to 98 per cent of the consumer transactions (in volume, and depending on which data source you take) is carried out in cash, economic transactions are bound to slowdown. And ultimately this is reflecting in the manufacturing data.

If there is slowdown in consumption, there is a bound to be a slowdown in manufacturing. If people are not buying stuff at the same pace as they were in the past, there is no point in companies increasing production like they were in the past.

The irony is that this crisis the Modi government brought upon us. Indeed, this is very worrying in a country where one million individuals are entering the workforce every month. That makes it 1.2 crore, a year. If the growth in industrial sector slows down to the level that it currently has, how will any jobs be created for these youth.

And that is a question worth asking.

The column originally appeared in Newslaundry on September 14, 2017.


4 Things Modi Could Have Done Instead of Demonetisation


The decision to demonetise Rs 500 and Rs 1,000 notes when it was first announced was to tackle black money and fake currency. As the ministry of finance press release accompanying the decision said: “High denomination notes are known to facilitate generation of black money”.

What the Modi government was essentially saying is that it is easier to store black money in the form of high denomination notes. Having demonetised Rs 500 and Rs 1,000 notes, the government decided to launch a Rs 2,000 note, going precisely against its own statement.

The assumption was that people had stored black money in their homes in the form of cash. And by demonetising Rs 500 and Rs 1,000 notes, these notes would be rendered useless. Holders of black money in the form of currency would deposit it into banks and post offices, for the fear of generating an audit trail. Demonetised currency can be deposited into banks and post offices up to December 30, 2016. This money will be credited into the bank account or the post office savings account.

Things haven’t turned out like that. By December 6, 2016, close to 75 per cent of the demonetised currency had already made it back into the banks. Government officials are now saying that they expect almost all the demonetised currency to come back to the banks.

What this essentially means is that those who had black money in the form of cash have managed to get it converted into currency which continues to be legal tender. The hope now is that the government will use information technology to identify people who have deposited their black money into banks, tax them and raise some money in the process.

To what extent this happens remains to be seen. Nevertheless, if the idea was to attack black money in India, there are four things that the Modi government could have done, instead of demonetising high denomination notes and disrupting the entire economy. This would have hit at the heart of the nexus between politicians and builders, which thrives on black money.

1) Stop cash donations to political parties: Currently, political parties need to declare a donation only if it is greater than Rs 20,000. In 2014-2015, 55 per cent of the donation of the national political parties came from those making donations of Rs 20,000 or lower. Hence, the details of these donors are unknown.

If citizens are expected to share their identity with the bank or the post office while depositing their demonetised notes, why should donors of political parties be allowed to hide behind an archaic law, is a question worth asking. This needs to change.

2) Political parties should be brought under Right to Information(RTI): This is currently not the case. If the political parties are brought under the ambit of RTI, they will have to function in a much more transparent way in comparison to what they do now. This would mean keeping proper records of where the funds to finance them are coming from.

3) Real estate should be brought under the Goods and Services Tax(GST): If real estate is brought under GST, builders if they want to claim input tax credit must request documentation from all the suppliers and the contractors that they work with. This will hopefully start cleaning up the real estate business as more and more builders will have to operate through legitimate means. Once they stop using cash in dealings with their suppliers, their proclivity to ask for cash from their customers will also go down.

4) Slash stamp duty rates on real estate transactions: This is one reason why the real estate sector is at the heart of black money. If stamp duties across states are reduced and brought to realistic level, the tendency of people to under-declare the value of real estate transactions will come down. Hence, the proportion of cash transactions will come down.

These four moves would have hit at the heart of the generation of black money. What the government chose to do instead was to demonetise Rs 500 and Rs 1,000 notes, and throw the entire country in a huge disarray.

The column originally appeared in Bangalore Mirror on December 14, 2016


#EPFnotax: Six reasons why taxing EPF was a stupid idea in the first place


Fostering Public Leadership - World Economic Forum - India Economic Summit 2010

The Narendra Modi government has decided to withdraw their plan to tax the corpus accumulated by investing in the Employees’ Provident Fund(EPF). As the finance minister Arun Jaitley said in the Lok Sabha today: “In view of representations received, the government would like to do a comprehensive review of this proposal and therefore I withdraw the proposal.”

This is a sensible decision to withdraw what was basically a very stupid idea at multiple levels.

a) The finance minister Arun Jaitley in his budget speech had said that only 40% of the corpus accumulated by investing in EPF would be tax free. This would apply on investments made after April 1, 2016.

The entire 100% accumulated corpus could be made tax free by investing 60% of the corpus in annuities. Annuities are essentially policies sold by insurance companies which can be used to generate a regular income.

The trouble is that most annuities in India give a return of around 5-7%. Given this, they remain a bad way to invest a large corpus. Even investing in a long term fixed deposit can give you a better return.

Some savings bank accounts also pay more than the returns that can be generated by investing in annuities. The annuities in their current are essentially nothing but a rip-off and anyone in their right mind would stay away from investing in them.

Then there is the Senior Citizens Savings Scheme, which allows a senior citizen to invest up to Rs 15 lakh. The scheme pays an interest of 9.3%per year. Given that better returns are available elsewhere, why force people to invest 60% of their provident fund corpus into annuities paying 5-7% per year.

b) Also, the change applied only to private sector employees with a salary of greater than Rs 15,000. This meant that the government employees investing in the General Provident Fund (GPF) or employees of public sector companies investing in other recognised provident funds, could withdraw 100% of their accumulated corpus and need not have paid any income tax on it.

Why was the change proposed only for private sector employees? Why was this distinction made on the basis of the employer? If the idea was to tax, the tax should have applied to everyone and not just the private sector employees.

In the way things had been proposed, a private sector employee making Rs 16,000 per month would have had to pay a tax on the accumulated corpus. A government employee need not have done anything like that. How is that fair and equitable?

c) The government has defended this move on the logic of moving towards a “pensioned society”. As the clarification issued by the ministry of finance a few days back pointed out: “The purpose of this reform of making the change in tax regime is to encourage more number of private sector employees to go for pension security after retirement instead of withdrawing the entire money from the Provident Fund Account.”

Why was only the private sector encouraged to move towards a pensioned society? Also, what about those people who are earning less than Rs 15,000 per month. Their need for a regular income after retirement is even greater than those making more money.

d) Also, why make only EPF and other recognised provident funds taxable at maturity. Why leave out the Public Provident Fund? Shouldn’t self-employed professionals who invest in PPF to possibly accumulate a retirement corpus, also be encouraged to become a part of the pensioned society?

e) The government also planned to tax the principal amount invested in the EPF. How fair is this? While calculating capital gains for investments made in stocks or real estate, the principal amount is not included. Also, investments made in real estate and debt mutual funds get indexation benefits, where the impact of inflation is taken into account while calculating the cost of purchasing the asset. This brings down the capital gains on which income tax is paid.

Further, there is no tax on long-term capital gains made on stocks and equity mutual funds. Taking all this into account, how fair was it to decide to tax EPF? Why leave out the investing modes of the rich and decide to tax the middle class EPF?

f) Further, it needs to be realised that different people have different needs. As Jaitley said in the Lok Sabha today: “”Employees should have the choice of where to invest. Theoretically such freedom is desirable, but it is important the government to achieve policy objective by instrumentality of taxation. In the present form, the policy objective is not to get more revenue but to encourage people to join the pension scheme.”

For that to happen there are so many other things that need to be set right. People use their retirement corpus for various things. They use the money to get their children married, educated and so on. While the government may look at this as something that shouldn’t be done but at times there is no option.

Sometimes emergency medical costs are also met out of withdrawing out of the corpus accumulated by investing in the EPF. In a country where there is almost no insurance for the old, how fair is to deny them access to the EPF corpus by deciding to tax it?

What all these points clearly tell us is that the Modi government clearly introduced the idea of taxing the EPF corpus in a hurry. There is clearly more thinking needed on it. Also, several things need to change before such a tax is introduced. And these changes are not going to happen any time soon.

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

The column originally appeared on Firstpost on March 8, 2016

Modi Government Wants To Tax Your Provident Fund And That’s Bad News


Arun Jaitley’s third budget had little to offer for the salaried middle class in particular and the middle class in general. But there was a huge negative point which perhaps no one saw coming.

The Employees Provident Fund(EPF) and other recognised provident funds are a huge mode of saving for the salaried middle class. Up until now the EPF worked on exempt-exempt-exempt or the EEE principle. The money invested in this investment is tax free, the interest earned is tax free and so is the corpus earned on maturity.

What does this mean? As Sandeep Shanbhag, Director, Wonderland Consultants, a tax and investment advisory explains: “In EEE tax saving effected is permanent in nature. This means that once the tax is saved for that particular year, it is saved, per se. When the invested amount matures, it is tax-free.”

Nevertheless, Jaitley has proposed to bring EPF and other recognised provident funds under the exempt-exempt-tax or the EET principle. As Jaitley said during his budget speech: “I propose to make withdrawal up to 40% of the corpus at the time of retirement tax exempt in the case of National Pension Scheme.

In case of superannuation funds and recognized provident funds, including EPF, the same norm of 40% of corpus to be tax free will apply in respect of corpus created out of contributions made after 1.4.2016.”

Before getting into the details of what Jaitley means by this, let’s first try and understand what EET means. As Shanbhag puts it: “When the EET system is put into place, permanent tax saving won’t be possible. This is because, by making an investment, you will reduce the same from your income thereby lowering the tax liability. However, when the amount matures, it would be taxable in that year.”

This essentially means that under the EET system, the money invested in EPF and other recognised provident will be tax-free, the interest earned will be tax-free, but the accumulated corpus will be taxed. Hence, as Shanbhag puts it: “Therefore, this is a deferment of tax and not saving of tax. In other words, you will defer (postpone) the payment of tax depending upon the lock-in of your tax saving investment. However, some time or the other, the investment will mature. At that time, tax will be levied.”

Let’s try and understand this through an example. Let’s say you invest Rs 50,000 every year into EPF, starting from April 1, 2016.

The amount invested can be deducted while calculating the taxable income. Every year the interest earned on this would be tax free. Let’s at the end of 20 years, you earn an average return of around 8.7% per year. This means you would have accumulated around Rs 24.73 lakh. Under the EEE principle this amount is totally tax-free.

Under the EET principle this amount will be taxable. How much tax will you have to pay? Jaitley said during his speech that 40% of the corpus will be tax free.

This means 40% of Rs 24.73 lakh or Rs 9.89 lakh will be tax free. Tax will have to be paid on the remaining Rs 14.84 lakh, if this amount is withdrawn. This amount will be taxed according to the prevailing income tax laws at that point of time.

The question everyone is asking is, why is Jaitley or actually the government doing this? A few years back, the government launched the new pension scheme (NPS). This scheme follows the EET principle.

Up until now, 40% of the maturity corpus of NPS had to be compulsorily used to buy immediate annuities. These are essentially insurance policies which help earn a regular income. The remaining 60% of the corpus could be withdrawn. Nevertheless, an income tax needs to be paid on it.

Jaitley in his budget essentially removed this prevailing discrepancy between NPS at one end and EPF and recognised provident funds, on the other. Now on, 40% of the maturity corpus of the investments made on or after April 1, 2016, can be withdrawn and no tax needs to be paid on it. The remaining 60% will be taxed if you withdraw the amount. The same principle applies for other recognised provident funds as well.

Further, if you use 60% of the money to buy immediate annuities, to generate a regular income, you don’t have to pay any tax on it. Even with this, this is a very anti-salaried/middle class move. This is primarily because of the fact that people use their provident funds to get their children educated as well as married.

They even use it to buy a home after retirement. If they want to do something along these lines, they will have to withdraw money and pay income tax on it.

Also, at the end of the day, it is also about letting the individual decide what he wants to do with her or her money. The immediate annuities currently available in the market do not generate returns which are comparable to other investment avenues like simply investing the money in a fixed deposit or buying tax free bonds, for that matter. Hence, to that extent this is a sub-optimal solution for those who know what to do with their money.

Further, why has Jaitley and indeed the government left out maturing amounts paid on insurance policies and tax saving mutual funds, is a question worth asking. These investment avenues continue to follow the EEE principle. Why is there this discrimination?

If Jaitley and the government do not withdraw this change, all it will do is empower the insurance agents of Life Insurance Corporation and private insurance companies to start another sound of mis-selling to the citizens of this country. And that is not a good thing.

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

The column originally appeared on Huffington Post India on February 29, 2016



The robber barons of India

rober barons

In his latest book Other People’s Money—Masters of the Universe or Servants of the People?, the British economist John Kay talks about the robber barons of the United States, who lived through the late nineteenth and the early twentieth century.

As Kay writes: “The late nineteenth century is described as ‘the gilded age’ of American capitalism. The dominant figures of that era – men such as Henry Clay Frick, Jay Gould, J.P. Morgan, John D. Rockefeller and Cornelius Vanderbilt – are often called the ‘robber barons.’

These robber barons helped build the railroads, oil supply systems and steel mills of the United States. As Kay writes: “They were both industrialists and financers, in varying degrees…But their immense personal wealth was as much the product of financial manipulation as of productive activity.”
Now replace United States with India, and you can see the similarities. While the United States had robber barons in the nineteenth and the early twentieth century, India has had them in the twentieth and the twenty-first century.

The Reserve Bank of India governor explained the finance skills of Indian businessmen in great detail in a speech he made in November 2014. As Rajan said: “The reason so many projects are in trouble today is because they were structured up front with too little equity, sometimes borrowed by the promoter from elsewhere. And some promoters find ways to take out the equity as soon as the project gets going, so there really is no cushion when bad times hit.”

What Rajan was essentially saying here is that many Indian businessmen start a project with very little of their own money invested in it. Further, some of them even manage to tunnel out this small investment as soon as the project starts. This is typically done by over stating the cost of the project, borrowing against the higher number and then tunnelling out a portion of the debt that has been taken on to get the project going.

Also, in the last few years, many Indian businessmen have taken on more bank loans than they could have possibly repaid. They have subsequently defaulted on it or renegotiated the terms, leaving the banks in a lurch. Interestingly, even after defaulting on their loans, they have continued to be in positions of control.

As Rajan said during the course of his speech: “In much of the globe, when a large borrower defaults, he is contrite and desperate to show that the lender should continue to trust him with management of the enterprise. In India, too many large borrowers insist on their divine right to stay in control despite their unwillingness to put in new money. The firm and its many workers, as well as past bank loans, are the hostages in this game of chicken — the promoter threatens to run the enterprise into the ground unless the government, banks, and regulators make the concessions that are necessary to keep it alive.”

And if after all this, the business comes back to health, the businessmen tends to benefit the most. As Rajan said: “The promoter retains all the upside, forgetting the help he got from the government or the banks – after all, banks should be happy they got some of their money back!  No wonder government ministers worry about a country where we have many sick companies but no “sick” promoters.”

These businessmen over the years have survived on essentially manipulating the system (or what we like to call jugaad) and surviving on multiple doles from the government. This is something that Rajan clearly pointed out in a recent speech, where he said: “India must resist special interest pleas for targeted stimulus, additional tax breaks and protections, directed credit, subventions and subsidies, all of which have historically rendered industry uncompetitive, government over-extended, and the country incapable of regaining its rightful position amongst nations.”

But this is easier said than done, given that India’s businessmen have always operated like this. The question is how can this change? Kay has a possible answer in his book Other People’s Money, where he suggests that the United States went from strength to strength after the links between finance and business were loosened.

As he writes: “While the ‘robber barons’ were both financers and businessmen, the leading industrialists of the first half of the twentieth century – men such as Alfred Sloan of General Motors and Harry McGowan of ICI – were primarily businessmen. Their skill was in developing the systems and cadre of professional managers needed to run a modern corporation.”

This is possible if banks go after corporates defaulting on loans with great zeal, which they currently lack. Further, a new class of capitalists needs to flourish.
The Prime Minister Narendra Modi in a recent meeting with India’s biggest businessmen asked them to increase their risk taking appetite. As the president of the Confederation of Indian Industry, a business lobby, told the media after the meeting with Modi: “Prime Minister has said that industry must take risk and increase investments…we must go out and invest.”

The trouble is India’s incumbent businessmen are not the risk taking type. As Dipankar Gupta wrote in a recent column in The Times of India: “Till the 1980s Indian businesses were shielded from foreign competition, and they returned this favour by not introducing a single innovation above street-corner jugaad…Even after liberalisation came to India in the 1990s, this risk aversion among Indian capitalists stayed firm and remained protected by a friendly state. This can best be seen in the advocacy and implementation of the current Public Private Partnership (PPP) model.”

Hence, expecting such businessmen to suddenly start taking risk is a tad absurd. That ain’t happening. So what is the way out? As I said earlier, India needs a new class of capitalists. And for that to happen, as Rajan said the other day, it is important “to improve regulation by focusing on what is absolutely necessary to create a sound business environment.”
The column originally appeared in The Daily Reckoning on Sep 22, 2015