Tag: Arun Jaitley | Page 18

5 January, 2015

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

Vivek Kaul

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

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

Source: www.cga.nic.in

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

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

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

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

22 December, 2014

Arun Jaitley’s Rs 1,05,084 crore problem does not deserve a clean chit

Vivek Kaul

Spoiler alert: For those who have not watched PK there is at least one spoiler ahead.

One of the advantages of not being employed is that one can still go and watch a movie when it releases on a Friday morning. And that is what I do from time to time, when all the reading and the writing starts getting to me.
So, this Friday I ended up watching an early morning show of Rajkumar Hirani’s PK, on the day of its release. A friend who works the film industry had already told me who or what PK was. So, I wasn’t really interested in finding that out, like a lot of people are. But I did enjoy watching the movie, given that it tackles a very difficult subject of religion, god and godmen and what they mean to each one of us, in a very upfront manner.
The most surreal moment in the movie is when after a bomb blast, the immortal words written by Sahir Ludhianvi, set to tune by Khayyam and sung by Mukesh, from the movie Phir Subah Hogi, start playing: “Aasman pe hai khuda aur zameen pe hum. Aaj kal wo is tarf dekhta hai kum”.
I don’t know if the finance minister Arun Jaitley was able to watch PK over the weekend, but if he did, he would be definitely complaining that the “economic god” seems to have abandoned him and his government.
On Friday i.e. December 19, 2014, the ministry of finance released the Mid-Year Economic Analysis for this financial year. On page 6 of this report is a very interesting table. As per this table the government has overestimated the tax revenues this year to the extent of Rs 105,084 crore. This has primarily happened due to two reasons, the report says.

Estimating the Revenue Over-Projection in the Union Budget 2014-15

Source: Ministry of Finance

Notes: a) Budgeted GDP for 2013-14 is Rs 1,28,76,653 crore assuming a growth rate of 13.4 per cent whereas the actual GDP is Rs 1,25,58,711 crore @ 10.6 per cent growth rate achieved so far in 2014-15.
b) In the year 2010-11, there was an accelerated upward trend in the gross tax revenue majorly due to an increase in the growth rate of corporation tax, customs duties and union excise duties and also on account of dismal performance of tax revenue collections in the preceding years.
c) The year 2013-14 witnessed a downward trend in indirect tax collections.
1. Computed as the ratio of average growth rate of tax revenues to average growth rate of nominal GDP during 2008-09 to 2013-14. Alternative sample periods could be considered for computing historical buoyancy. A longer sample risks including periods where significant changes occurred in the tax base and rates. The sample chosen, although short and restricted to the post-crisis period, has the virtue of not having witnessed significant policy changes.
2. Computed as ratio of growth rate of tax revenues in 2013-14 (Provisional Actuals) to budgeted growth rate of nominal GDP in 2014-15.
3. Computed as the product of difference between historical and budget 2014-15 buoyancy, the actual GDP growth rate for 2014-15 and the tax collections in 2013-14 (Provisional Actuals).
4. Computed as the product of difference between the budgeted GDP growth rate and the actual GDP growth rate for 2014-15, the historical buoyancy and tax collections in 2013-14 (Provisional Actuals).
5. For Customs duty, buoyancy has been computed as the ratio of growth rate of import duty collections to growth rate of imports.

The first reason is the overestimation due to growth optimism. In the budget it was assumed that the nominal GDP for the current financial year would grow by 13.4 per cent to Rs 1,28,76,653 crore. Nevertheless, the actual growth between April and September 2014(the first six months of the financial year) was at only 10.6%, which means a nominal GDP of Rs 1,25,58,711 crore.
The taxes collected ultimately are also a function of how fast an economy grows. Given that the economy has grown at 10.6%, the taxes collected are lower in comparison to a situation where the economy had grown at 13.4% assumed in the budget. The short fall due to this overestimation is expected to be Rs 27,079 crore.
The second reason is the overestimation of the tax buoyancy. The report defines tax buoyancy as the ratio of revenue growth to the growth in the corresponding base, typically nominal GDP. So what does that mean in simple English? It essentially refers to a situation where the amount of taxes collected is expected to increase at a much faster rate in response to the growth in nominal GDP. That hasn’t turned out to be the case.
The nominal GDP as mentioned earlier was expected to grow at 13.4%. The total taxes collected by the government were expected to grow 16.9%. During the first six months of the financial year the total taxes collected actually grew by 5.1%. The short fall due to this overestimation is expected to be at Rs 78,005 crore.
Hence, the total shortfall in tax collections is expected to be at Rs 1,05,084 crore. Within this “the optimism was greater in relation to indirect taxes than for direct taxes”. Hence, direct taxes may have been overestimated to the extent of Rs 36,108 crore, whereas indirect taxes may have been overestimated to the extent of Rs 68,796 crore.
Interestingly, in a piece I wrote last week I had said that the indirect tax collections will be lower by Rs 68,496 crore, against the amount that has been estimated in the budget. The number is very close to the number that the half yearly economic analysis report has come up with.
Other than the lower tax collections, the government’s other big problem was the fact that subsidy payments from the last financial year had been postponed to this financial year. As the report points out: “In addition, the budget was strained by a legacy effect, reflecting the excess carryover of subsides from the past. This amount is difficult to quantify precisely but could range from 0.3 to as much as 1 percent of GDP.”
Hence, the report goes on to point out that: “Therefore, evaluating the fiscal performance this year should take account of the legacy costs and the ambitious targets that were inherited. They were ambitious because of optimistic revenue projections, of unanticipated moderation in inflation (the consumer’s gain being the Government’s loss), and also because of below-potential growth.”
In an era of clean chits, this is an attempt by the finance minister Arun Jaitley to give himself and his government a clean chit. Nevertheless, the situation is not as simple as it is made out to be. When Jaitley presented the first budget of the current government on July 16, 2014, he had an opportunity to correct the “so called” optimistic assumptions that the previous finance minister P Chidambaram had built into the interim budget presented earlier.
However, Jaitley had accepted these optimistic assumptions as a challenge. As he had said during the course of his speech: “ Considering that we had two years of low GDP growth, an almost static industrial growth, a moderate increase in indirect taxes, a large subsidy burden and not so encouraging tax buoyancy, the target of 4.1 per cent fiscal deficit is indeed daunting. Difficult, as it may appear, I have decided to accept this target as a challenge. One fails only when one stops trying.”
Back then Jaitley had an opportunity to work with a more realistic set of numbers and present a more realistic total tax number, than what was presented. Now that he and his government have failed on that front it is hardly fair to blame ambitious targets that were inherited.
What was a challenge in July has now become an effort to pass the buck. As far as subsidies that were passed on are concerned, it is not as if Jaitley and his team did not know about them. They could have budgeted properly for these subsidies.
This government had an opportunity to start on a clean slate. And they chose not do that.
The trouble is that how will the government fill this gap of Rs 1,05,000 crore in its budget. In fact, the gap might be even higher given that the disinvestment target of Rs 58,425 crore looks unachievable. Only Rs 1,700 crore has been collected through this route until now.
As I have mentioned in the past, the only way for the government to fill such a massive gap in the budget is by cutting “asset creating” plan expenditure. This is a strategy that was followed by the previous government as well. In 2013-2014, the plan expenditure target was Rs 5,55,322 crore. The final expenditure came in at Rs 4,75,532 crore or around Rs 80,000 crore lower.
A similar exercise will have to repeated this year as well. The trouble is that in an environment where private investment is not growing much, if the government expenditure is also slashed, it will have a negative impact on economic growth.
Suggestions have started coming in that the government should forget about the fiscal deficit target for this year and continue spending money. But would this be a good strategy to follow? The previous government cranked up public spending in the aftermath of the financial crisis. For a couple of years India grew at near double digit rates, when the rest of the world was slowing down.
But this splurge came back to haunt us in the form of high interest rates, high inflation and a substantial fall in financial savings. I will write on detail on this issue in tomorrow’s column. Watch this space.

The column originally appeared on www.equitymaster.com as a part of The Daily Reckoning, on Dec 22, 2014

17 December, 2014

Foreign investors exit Russia lock, stock and barrel: Rouble crisis has lessons for India

Vivek Kaul

The Russian rouble has been in trouble of late. The value of the currency crashed from 55 roubles to a dollar as on December 11, 2014, to nearly 73 roubles to a dollar as on December 16, 2014. Since then the currency has recovered a little and as I write this around 67 roubles are worth a dollar.
What caused this? A major reason for this has been the fall in the price of oil by 50% in the last six months. As I write this the Brent Crude Oil quotes at slightly less than $60 to a barrel. The Brent Crude price dropped below $60 per barrel only this week.
The Russian government is majorly dependant on revenues from oil to meet its expenditure. The money that comes in from oil contributes around half of the revenues of the government and makes up for two-thirds of the exports.
As The Economist points out: “The state owns big stakes in many energy firms, as well as indirect links via the state-supported banks that fund them.” Given this excessive dependence on oil, Russia needs the price of oil to be in excess of $100 per barrel, for the government expenditure and income to be balanced.
As Javed Mian writes in the Stray Reflections newsletter dated November 2014: “Today, Russia needs an oil price in excess of $100 a barrel to support the state and preserve its national security.” The Citigroup in a report puts the break-even cost of the Russian government budget at an oil price of $105 per barrel. The oil price, as we know, is nowhere near that level.
The rouble lost 10% against the dollar on December 15 and another 11% on December 16. Why did this happen? Foreign investors are exiting Russia lock, stock and barrel. The Russian central bank recently estimated that capital flight could touch $130 billion this year.
The foreign investors are selling their investments in roubles and buying dollars, leading to an increase in demand for dollars vis a vis roubles. This has led to the value of the rouble crashing against the dollar.
The Russian central bank has tried to stem this flow by buying the “excess” roubles being dumped on to the foreign exchange market and selling dollars. It is estimated that on December 15, 2014, it sold around $2 billion to buy roubles.
But even this did not help prevent the worse rouble crash since 1998. This forced the Russian central bank to raise the interest rate by 650 basis points (one basis point is one hundredth of a percentage) to 17%. Despite this overnight manoeuvre, the rouble continued to crash against the dollar and fell by 11% on December 16.
The Russian central bank has spent more than $80 billion in trying to defend the rouble against the dollar this year and is now left with reserves of around $416 billion. The question is will these reserves turn out to be enough?
Russian companies and banks have an external debt of close to $700 billion. Of this around $30 billion is due this month and another $100 billion over the course of next year, writes Ambrose Evans-Pritchard in The Telegraph.
He also quotes Lubomir Mitov, from the Institute of International Finance, as saying that any fall in reserves below $330bn could prove dangerous, given the scale of foreign debt and a confluence of pressures. “It is a perfect storm. Each $10 fall in the price of oil reduces export revenues by some 2 percent of GDP. A decline of this magnitude could shift the current account to a 3.5 deficit,” Mitov told Evans-Pritchard.
This has implications for Russia on multiple fronts. With oil revenues falling, the Russian economy will contract in 2015. Before raising the interest rates to 17%, the Russian central bank had said that the economy could contract by 4.7% because of oil prices falling to $60 per barrel.
Also, inflation which before this week’s currency crisis was at 9.1%, could go up further. As The Economist points out: “Russian shopkeepers have started to re-price their goods daily. Less than two weeks ago one dollar could be bought with 52 roubles; on December 16th between 70 and 80 were needed. Shops defending their dollar income need a price rise of 50% to offset this.”
Further, so much money leaving Russia in such quick time, the country may also have to think of implementing capital controls.
The revenue projections of the Russian government have gone totally out of whack. The Financial Times reports that two weeks back, the Russian president Vladmir Putin, “ signed the federal budget for 2015-17 — which is still based on forecasts of 2.5 per cent annual gross domestic product growth, 5.5 per cent inflation and oil at $96 a barrel.” These assumptions will have to junked.
Putin might also might have to go slow on the aggressive military strategy that he has been following for a while now As Mian points out: “Russia is the world’s 8th-largest economy, but its military spending trails only the US and China. Putin increased the military budget 31% from 2008 to 2013, overtaking UK and Saudi Arabia, as reported by the International Institute of Strategic Studies.”
Whether this happens remains to be seen. Nevertheless, the Russian crisis has led to financial markets falling in large parts of the world. As I write this the BSE Sensex is quoting at around 26,700 points having fallen by around 1800 points over the last two weeks.
So, what are the lessons in this for India? The first and foremost is that foreign investors can exit an economy at any point of time, once they finally start feeling that the economy is in trouble. They may not exit the equity market all at once but they can exit the debt market very quickly.
This is something that India needs to keep in mind. From December 2013 up to December 15, 2014, the foreign institutional investors have invested Rs 1,63,523.08 crore (around $25.7 billion assuming$1=Rs63.6) in the Indian debt market. This is Rs 44,443 crore more than what they have invested in the stock market.
Even if a part of the money invested the debt market starts to leave the country, the rupee will crash against the dollar. This is precisely what happened between June and November 2013 when foreign institutional investors sold debt worth Rs 78,382.2 crore.
When they converted these rupees into dollars, the demand for dollars went up, leading to the rupee crashing and touching almost 70 to a dollar. It was at this point of time that Raghuram Rajan in various capacities, first as officer on special duty at the Reserve Bank of India (RBI) and later as RBI governor, helped stop the crash.
This is a point that the finance minister Arun Jaitley needs to keep in mind and drop the habit of asking Rajan to cut interest rates, almost every time that he speaks in public. Rajan knows his job and its best to allow him and the RBI to do things as they deems fit. Further, Rajan and RBI are more cued into what is happening internationally than perhaps any of the politicians can ever be.
Also, one reason that foreign institutional investors have invested so much money in the Indian debt market is because the returns on government debt are on the higher side vis a vis other countries. If the RBI were to cut the repo rate (or the rate at which it lends to banks) these returns will come down and this could possibly lead to the exit of some money invested by foreign investors in India’s debt market. And that would not be good news on the rupee front.

The article originally appeared on www.FirstBiz.com on Dec 17, 2014

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

15 December, 2014

How ITC can help fix the fiscal deficit

Vivek Kaul

So this column should complete my trilogy on the fiscal position of the government (You can read the previous two pieces here and here).
Late last week, the ministry of finance declared the total amount of indirect taxes collected during the period April to November 2014. The collections have been shown in the following table, which makes for a very interesting reading.
The indirect tax collections during the month of November 2014 grew by 19.4%, in comparison to November 2013. But between April and November 2014 the number grew by only 7.1%, in comparison to the same period last year.

Tax Head	(Rs. in crores)		% Growth	April to November		% Growth
	Nov 2013	Nov 2014	% Growth	2013-14	2014-15	% Growth
Customs	13137	17185	30.8	111844	123308	10.2
Central Excise*	13544	14952	10.4	102988	102762	(-) 0.2
Service Tax	10224	11923	16.6	91982	102592	11.5
Total	36905	44060	19.4	306814	328662	7.1

Source: Press Information Bureau

The indirect tax collection target for this financial year is at Rs 6,24,902 crore. The total amount collected last year stood at Rs 5,19,520 crore. Hence, it was assumed that the indirect tax collection would grow by 20.3% from what was achieved last year.
This assumed growth in indirect tax collections is turning out to be extremely optimistic. The growth in collections for the first eight months of the year, as can be seen from the above table, has been only 7.1%. In fact, the collection of excise duty has fallen by 0.2%.
There are several reasons why assuming a more than 20% growth in indirect taxes was unrealistic to start with. The annual budget had assumed that the nominal gross domestic product (GDP) for this financial year would grow by 13.4% to Rs 12,876,653 crore.
Ultimately, the indirect taxes that can be collected are also a function of the economic growth. If the economy is expected to grow 13.4% (nominal), how can indirect taxes can be assumed to grow by more than 20%?
There was this basic disconnect to start with. A similar mistake was made in the 2013-2014 as well. It was initially assumed that indirect taxes of Rs 5,65,003 crore would be collected. The final number came in at Rs 5,19,520 crore, which was 8% lower.
In fact, the indirect tax collected in 2013-2014 grew by 9.5% in comparison to 2012-2013, when the number had stood at Rs 4,74,483 crore. So, if the growth in indirect taxes last year was 9.5%, assuming a growth of 20.3% in this year’s number was being highly optimistic to start with.
And all that optimism seems to be going against the government now. The growth in indirect taxes in the first eight months of the year has been at 7.1%. If the same growth continues through the remaining four months of the financial year, the government will end up with a total collection of Rs 5,56,406 crore, or around Rs 68,496 crore lower (Rs 6,24,902 crore minus Rs 5,56,406 crore) lower than what had been estimated at the time the budget was presented.
Even if the government manages to increase the collections in the remaining part of the year by 10% in comparison to last year’s target, it will manage to reach only Rs 5,71,472 crore or Rs 53,430 crore (Rs 6,24,902 crore minus Rs 5,71,472 crore) lower than this year’s target.
While this mistake can’t be corrected, it is important to ensure that the same mistake is not made in the next budget, which will be presented in February 2015.It is important to look at the assumptions that have been used by bureaucrats that were used to make these overtly optimistic projections. As an editorial in The Financial Express points out: “One of the first things Jaitley needs to do is to get the chief economic advisor to relook the tax model the ministry uses.”
Further, this is clearly not a good sign for the government. It will make it even more difficult to control the burgeoning fiscal deficit, which for the first seven months of the financial year (April to October 2014) stood at 89.6% of the annual target.
So, what can the government do to meet its fiscal deficit target of Rs 5,31,177 crore or 4.1% of the GDP? As I had explained in the column that appeared on December 12, 2014, the government will start slashing its “asset creating” capital expenditure. This is obviously not good for the economy.
But there is something else that the government can do. Through the Specified Undertaking of the Unit Trust of India(SUUTI), the government owns shares in ITC and L&T worth Rs 46,970 crore (Using the closing prices as on December 12, 2014, and the shareholding pattern valid as on September 30, 2014).
The shares in ITC are worth Rs 35,479 crore. There is no real reason that the government should be owning shares in ITC. (To read the complete argument click here). There is nothing strategic about the cigarettes, hotels, paper and retail businesses, in which ITC operates. But the government continues to hold on to stake.
Economist Surjit Bhalla offered a reason in a recent column when he wrote: “A suggested explanation for the Indian government (read that as politicians and IAS bureaucrats, plus others) not selling Ashoka or ITC is that they gain enormously from “kickbacks” in the form of discounted or free rooms, or discounted or free dinners, or discounted or free marriage parties.”
In fact, the government can even get a premium to the current market price by selling its SUUTI stake in ITC to the United Kingdom based BAT, which had been trying to raise its stake in ITC for many years. Nevertheless, what the previous government did in April 2010 was to ban all foreign direct investment(FDI) in cigarette industry, citing health reasons. If FDI was banned in the cigarette industry because cigarettes are bad for health, why is the government holding on to its stake in ITC then?
The current government has an opportunity in setting this right and sell the stake that it owns in ITC through SUUTI to whoever is willing to pay the highest price. For the period of three months ending September 30, 2014, ITC made a total operating profit of Rs 3583.26 crore. Of this the cigarettes business contributed Rs 2882.06 crore.
Why should a government own stake in a company which still makes a little more than 80% of its operating profit from selling cigarettes is a question worth asking, even though we may not get an answer for it.

The article originally appeared on www.equitymaster.com as a part of The Daily Reckoning, on Dec 15, 2014

12 December, 2014

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

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

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

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