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

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

Jaitley may end up doing a Chidambaram to meet fiscal deficit target

P-CHIDAMBARAMVivek Kaul 

In yesterday’s column I had explained how the fiscal deficit of the government of India between April and October 2014 was at its highest level since 1998. Fiscal deficit is the difference between what a government earns and what it spends.
This despite the fact global oil prices have been falling for a while now. This has not helped the government primarily because like his predecessors the current finance minister Arun Jaitley also assumed a low oil subsidy number at the time he presented the budget in July 2014.
When the previous finance minister P Chidambaram presented the budget for the financial year 2013-2014, he assumed that Rs 65,000 crore would be spent towards oil subsidy. The actual number came in at Rs 85,480 crore, which was 31.5% higher.
This has been standard operating procedure for finance ministers over the years, where they start with a low oil subsidy number at the beginning of the year and end up spending much more by the time the year ends. What this does is that it makes the fiscal deficit number look more respectable at the time the budget is presented.
Jaitley did the same thing as his predecessor by assuming that oil subsidy for the year would work out to Rs 63,426.95 crore. This despite the fact that subsidies worth Rs 35,000 crore which were to be paid in 2013-2014, had been postponed to this financial year. So, in effect Jaitley only had a little more than Rs 28,400 crore to play around with on the oil subsidy front.
Oil prices started falling a few months back. This wasn’t known at the time the budget was presented in July earlier this year. In the budget it was assumed that oil prices
would average at $110 per barre during the course of this financial year. As on December 10, 2014, the price of the Indian basket of crude oil stood at $63.16 per barrel.
Given that, Jaitley assumed a lower number to start with, the government is not going to benefit on the fiscal deficit front, due to a fall in oil prices. As Neelkanth Mishra and Ravi Shankar of Credit Suisse write in a recent research note titled
2015 Outlook: Growth at any price?: “The…budgeted amount for fuel subsidies (Rs 63,400 crore, 0.5% of GDP)…may not change much for financial year 2014-2015, as Rs35,000 crore of the oil subsidy is already spent.”
The analysts also wrote that there won’t be much change in the fertiliser subsidy amount of close to Rs 73,000 crore, as well. Mishra and Shankar write that “it will be difficult for the government to reduce food subsidies”.
Given this, Jaitley isn’t really in a position to cut down subsidies. What he will have to do is to start cutting down on plan expenditure, like Chidambaram had done. As I had explained in yesterday’s piece, the government expenditure is categorised into two kinds—planned and non planned. Planned expenditure is essentially money that goes towards creation of productive assets through schemes and programmes sponsored by the central government.
Non-plan expenditure is an outcome of planned expenditure. For example, the government constructs a highway using money categorised as a planned expenditure. But the money that goes towards the maintenance of that highway is non-planned expenditure. 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. These expenses cannot be postponed. Hence, the asset creating plan expenditure gets slashed.
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.
This helped Chidambaram to cut down on the overall government expenditure majorly. Jaitley will have to do something similar, if he wants to achieve the fiscal deficit target of Rs 5,31,177 crore or 4.1% of GDP, that he has set.
As economists Taimur Baig, and Kaushik Das of Deutsche Bank Research write in a recent research note titled
India 2015 Outlook: Turning the cycle and structure around: “The government’s 2014-2015 fiscal deficit target of 4.1% of GDP will likely be achieved, but by cutting capital expenditure for the third straight year in a row. We estimate that the government will have to cut capital expenditure by at least Rs 70,000 crore…to make up for the significant shortfall in tax collection and disinvestment target.”
Supporters of Jaitley say that Chidambarm left him with unpaid bills of more than Rs 1,00,000 crore. Fair point. But Jaitley knew about this at the time he presented the budget. So, what stopped him from taking these unpaid bills into account while presenting the budget earlier this year?
If he had done that he wouldn’t have been able to present a fiscal deficit number of Rs 5,31,177 crore or 4.1% of GDP. The number would have been much higher. Nevertheless, that would have been the real fiscal deficit number, instead of the unrealistic and fictional number that was presented at the time of the budget. It is not surprising that Jaitley will have a tough time in meeting this number.
As I said in yesterday’s piece, the first step towards solving a problem is acknowledging that it exists. Jaitley and the BJP had an excellent opportunity to do this. And they let that go.
Another reason for the government to worry is the disinvestment target of Rs 58,400 crore. With basically three months left for the financial year to get over, the disinvestment of shares that the government owns in government and non-government companies has barely started.
As Baig and Das point out: “We expect the government to rely on disinvestments as a key source of revenue to reduce the fiscal deficit, but as seen from this year’s experience, there is no guarantee that such a strategy would work. Further, trade union activism could come in the way of the government pursuing an aggressive disinvestments/privatization agenda, which then will likely put pressure back on expenditure compression (particularly capital expenditure) to achieve the headline fiscal deficit target.”
Also, what does nothelp is the fact that growth in tax collections is nowhere near what had been assumed initially. The direct taxes (corporation and income tax primarily) were assumed to grow at 15.7%, in comparison to the last financial year. They have grown at only 5.5% between April and October 2014.
The indirect taxes (customs duty, excise duty and service tax) were supposed to grow at 20.3%. They have grown by only 5.9%
The situation clearly does not look good. And given that finance ministers do not like to miss targets they set, it is more than likely that Jaitley will now do a Chidambaram and slash asset creating plan expenditure majorly in the months to come. In fact, the plan expenditure for the first seven months of the financial year fell by 0.4% to Rs 2,66,991 crore.
As the old French saying goes: “
plus ça change, plus c’est la même chose. The more things change, the more they remain the same.

The article originally appeared on www.equitymaster.com as a part of The Daily Reckoning, on Dec 12, 2014

As tax collections slow down, govt fiscal deficit shoots to its highest level in 16 years

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

The Controller General of Accounts declares the fiscal deficit number at the end of every month. The cycle works with a delay of month. So, at the end of November 2014, the fiscal deficit for the first seven months of the financial year (April to October 2014) was declared.
The fiscal deficit for this period stood at a rather worrying 89.6% of the annual target of Rs
5,31,177 crore. Fiscal deficit is the difference between what a government earns and what it spends.
One reason the fiscal deficit is number is so high is because the government’s expenditure is spread all through the year, whereas it earns a substantial part of its income only towards the end of the year. But even keeping that point in mind, the fiscal deficit for the first seven months of this financial year is substantially high than it usually has been in the years gone by.
For the period April to October 2013, the fiscal deficit had stood at 84.4% of the annual target for that year. In fact, the accompanying table shows us that the fiscal deficit for the first seven months of this financial year has been the highest over the last sixteen years. 

PeriodFiscal deficit as a proportion of the annual target
April to Oct 201489.60%
April to Oct 201384.40%
April to Oct 201271.60%
April to Oct 201174.40%
April to Oct 201042.60%
April to Oct 200961.10%
April to Oct 200887.80%
April to Oct 200754.50%
April to Oct 200658.60%
April to Oct 200560.90%
April to Oct 200445.20%
April to Oct 200356.00%
April to Oct 200251.50%
April to Oct 200154.50%
April to Oct 200045.70%
April to Oct 199972.20%
April to Oct 199867.00%

Source: www.cga.nic.in

Also, I couldn’t look for data beyond 1998, given that it wasn’t available online. The table makes for a very interesting reading. The fiscal deficit level up to October 2007 was under control. It took off once the government decided to crank up expenditure to meet its social obligations.
Further, the average fiscal deficit for the first seven months of the year between 1998 and 2013 stood at 61.75% of the annual target. Hence, the number for this year at 89.6% of the annual target, is very high indeed.
Why has this happened? The income of the government during the period has gone up by only 5.3%. The budget presented in July earlier this year assumed that the income would grow by 15.6% in comparison to the last financial year.
The collection of direct as well as indirect taxes has been significantly slower than what was assumed. The direct taxes (corporation and income tax primarily) were assumed to grow at 15.7% in comparison to the last financial year. They have grown at only 5.5%.
The indirect taxes (customs duty, excise duty and service tax) were supposed to grow at 20.3%. They have grown by only 5.9%. In fact, within indirect taxes, the collection of customs duty has fallen by 1.7%.
What this clearly tells us is that the finance minister Arun Jaitley made very aggressive assumptions when it came to growth in tax collection and will now have a tough time meeting the numbers.
What makes the situation worse is the fact that Jaitley’s predecessor, P Chidambaram, had made the same mistake. In fact, in 2013-2014,
Chidambaram had projected a total gross tax collection of Rs 12,35,870 crore. The final collection stood around 6.2% lower at Rs 11,58,906 crore. Given this, Jaitley could have avoided falling into the same trap and worked with a more realistic set of numbers. But then those projections wouldn’t have projected “acche din”, the plank on which the Bhartiya Janata Party had fought the Lok Sabha elections.
Even with such a huge fall in tax collections, Chidambaram managed to beat the fiscal deficit target that he had set by essentially pushing expenditure of more than Rs 1,00,000 crore into the next financial year (i.e. the current financial year 2014-2015).
Chidambaram essentially ended up passing on what was his problem to Jaitley. Jaitley cannot do that because he will continue to be the finance minister (or someone else from the BJP government will).
So what can Jaitley do if he needs to meet the fiscal deficit target of Rs 5,31,177 crore or 4.1% of GDP that he has set? The first thing that will happen and is already happening is that the plan expenditure will be slashed. The plan expenditure for the first seven months of the year fell by 0.4% to Rs
2,66,991 crore.
This was the strategy followed by Chidambaram as well in 2013-2014. The plan expenditure target at the time of the presentation of the budget was at Rs 5,55,322 crore. The actual number came in 14.4% lower at Rs 4,75,532 crore. This is how a major part of government expenditure was controlled.
The government expenditure is categorised into two kinds—planned and non planned. Planned expenditure is essentially money that goes towards creation of productive assets through schemes and programmes sponsored by the central government.
Non-plan expenditure is an outcome of planned expenditure. For example, the government constructs a highway using money categorised as a planned expenditure. But the money that goes towards the maintenance of that highway is non-planned expenditure. 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. These expenses cannot be postponed. Hence, the asset creating plan expenditure gets slashed.
The second thing that the government is doing is not passing on the benefit of falling oil prices to the consumers. It has increased the excise duty on petrol and diesel twice, since deregulating diesel prices in October.
The third thing the government will have to do is to get aggressive on the disinvestment front in the period up to March 2015. The disinvestment target for the year is Rs 58,425 crore. But until now the government has gone slow on selling shares that it owns both in government and non-government companies because of reasons only it can best explain.
The recent sale of shares in the Steel Authority of India Ltd(SAIL) was pushed through with more than a little help from the Life Insurance Corporation of India and other government owned financial firms. This is nothing but moving money from one arm of the government to another arm. It cannot be categorised as genuine disinvestment.
This is something that Chidambaram and the UPA government regularly did in order to meet the disinvestment target. Despite this they couldn’t meet the disinvestment target in 2013-2014. The government had hoped to earn
Rs 54,000 crore but earned only Rs 19,027 crore.
Also, selling assets to fund regular yearly expenditure is not a healthy practice. If at all the government wants to sell its stake in companies, it should be directing that money towards a special fund which could be used to improve the poor physical infrastructure throughout the country. Right now, the money collected through this route goes into the Consolidated Funds of India.
In the months to come we could also see the government forcing cash rich companies like Coal India (which has more than Rs 50,000 crore of cash on its books) to pay a special interim dividend to the government, as was the case last year.
This is the way I see things panning out over the next few months. Nevertheless, the proper thing to do would be to put out the right fiscal deficit number, instead of trying to use accounting and other tricks to hide it.
The first step towards solving a problem is to acknowledge that it exists.

The article originally appeared on www.equitymaster.com as a part of The Daily Reckoning, on Dec 11, 2014

RBI keeps repo rate at 8%: Lower interest rates are not a solution to slow economic growth

ARTS RAJANVivek Kaul

Ramachandra Guha in a wonderful essay titled An Anthropologist Among Marxists writes about what he calls a “possibly, apocryphal anecdote.” As he writes “When Indira Gandhi was assassinated, her ashes were sent to different cities to allow public homage. When her ashes lay lay in Calcutta’s Government House they were visited one evening by the state’s finance minister. In the previous year this man had delivered no less than two hundred and sixty-two speeches on the discrimination against West Bengal in the release of funds from the central treasury. As the minister came out of the Government House, he was asked how he felt when confronting the mortal remains of his most resolute political opponent. He replied in character: Centre Kom Diye Che (the centre has again given us less than our rightful share).”
In another essay titled
Political Leadership Guha writes “Jyoti Basu’s government, it was said, began every discussion on federalism with the words, “Centre kom diye che.
The communists who ruled West Bengal for more than three decades liked to blame all the problems of the state on the central government, which they felt did not give the state a fair share of the funds.
Dear Reader, if you are wondering why am I talking about West Bengal and its politics in a piece which has the term “interest-rates” in the headline, allow me to explain. Over the last few years, everyone from politicians to businessmen to bankers have called for interest rates to be cut as a solution for reviving economic growth in India. The assumption is that at lower interest rates people will borrow and spend more and that will lead to economic growth.
In that sense, these individuals are not very different from the communist politicians of West Bengal for whom “
Centre kom diye che” was an explanation for all the problems of the state. Along similar lines, individuals calling for a cut in interest rates seem to believe that higher interest rates are a major reason for the slowdown in economic growth, and a cut can really get people borrowing and spending all over again.
The former finance minister P Chidambaram was a major propagator of this belief. His successor Arun Jaitley has carried of where Chidambaram left. Other than the politicians, bankers have also regularly asked the Reserve Bank of India (RBI) to cut interest rates.
Today with the RBI deciding to keep the repo rate unchanged at 8% in the fourth bi-monthly monetary policy, the interest-rate-
wallahs will be at it again. Repo rate is the rate at which the RBI lends to banks.
The RBI had its reasons for not changing the repo rate. As it pointed out in a statement “Since June, headline inflation has ebbed…The most heartening feature has been the steady decline in inflation excluding food and fuel…to a new low. With international crude prices softening and relative stability in the foreign exchange market, some upside risks to inflation are receding. Yet, there are risks from food price shocks as the full effects of the monsoon’s passage unfold, and from geo-political developments that could materialise rapidly.”
Nevertheless, over the next few days you will see bankers, real estate company owners, industry lobbies and possibly even the finance minister Jaitley, wondering why the RBI did not cut the repo rate, to get lending going again.
The most recent occasion when the interest-rate-wallahs came out in the open was when the bankers asked the RBI to cut the repo rate, after the growth in bank loans fell to a five year. As on September 5, 2014, the one year growth in bank loans stood at 9.7%. During the same time last year the number was at a significantly higher 17.9%.
The belief as explained earlier is that at lower interest rates people will borrow more. But as the American baseball coach Yogi Berra once famously said “In theory there is no difference between theory and practice. In practice there is.”
Lower interest rates do not always lead to more borrowing and revival of economic growth. An excellent example of this is what has happened in the aftermath of the financial crisis that broke out in September 2008. Western central banks brought down interest rates to very low levels in the hope that people will borrow and spend more, and help revive economic growth. But that did not happen. All it did was lead to many stock market bubbles all over the world.
Closer to home let’s take a look at car sales. The sales have revived from May 2014, after having continuously fallen for nine months. In August 2014, car sales grew by 15.16%, in comparison to the same period last year. This has happened without much change in interest rates. Why is that the case? Let’s try and understand this through a simple example. Let’s assume that an individual takes a car loan of Rs 4 lakh to be repaid over a period of five years at an interest rate of 10.5%. The EMI on this loan works out to around Rs 8,598.
Let’s say that interest rates were to come down by a massive 100 basis points (one basis point is one hundredth of a percentage)to 9.5%, all at once. At this interest rate, the EMI would work out to around Rs 8,401 or around Rs 200 lower than the earlier EMI. Now how many people will go and buy a car just because the EMI is now lower by Rs 200?
Anyone who has the ability to repay an EMI of Rs 8,401 can also repay an EMI of Rs 8,598. Hence, what people look at while taking on a loan is their ability to service the EMI. This involves at looking at factors like job prospects, the prospects of the company the individual works for and some idea of how he expects the broader economy to do. A major reason for the revival in car sales has been the election of Narendra Modi as the prime minister of India.
People have bought his election slogan “
acche din aane waale hain” and hence, have taken on car loans and bought cars because for now they believe that their future will be better than their past. Interest rates have had no role to play in the revival of car sales.
Let’s consider real estate next. Here again the belief is that if interest rates are cut people will borrow and buy homes. This logic again doesn’t really hold. Home prices are now way beyond what an average Indian can afford. Let’s consider the city of Mumbai.  
A July 2014 report in The Times of India quotes Pankaj Kapoor of property research firm Liases Foras as saying “In Mumbai, the average cost of a flat is Rs 1.2 crore.”
An estimate made by Forbes puts the average income of a Mumbaikar at $5900 or around Rs 3.54 lakh (assuming $1 = Rs 60) per year. This means it would need nearly 34 years of annual income (Rs 1.2 crore divided Rs 3.54 lakh) for an average Mumbaikar to buy a home in this city currently. What this tells us very broadly that homes in Mumbai are very expensive. Similar calculations done for other parts of the country are most likely to show similar results.
Hence, the point is that homes in most parts of the country are now much more expensive than what most Indians can afford. Given this, lower EMIs because of lower interest rates aren’t going to help much. The real estate market has priced itself out.
This was the demand side of things. Now let’s look at what the economists call the supply side. Investments made by corporates have fallen rapidly over the last few years. As Sanjeev Sanyal of Deutsche Bank Market Research writes in a research report titled
India 2020: The Road to East Asia and dated September 2014, “Gross Fixed Investment by the private corporate sector dropped from a peak of 14.3% of GDP in 2007-08 to 8.5% of GDP in 2012-13 (and likely even lower in 2013-14) with investments in machinery and equipment being particularly hit.”
The interest-rate-
wallahs would like us to believe that this fall in investment has primarily been because of the high interest rates that have prevailed over the last few years. Nevertheless is that really the case? As Rahul Anand and Volodymyr Tulin write in an IMF Working Paper dated March 2014 and titled Disentangling India’s Investment Slowdown “Our results suggest that real interest rates account for only one quarter of the explained investment downturn. However, we find that standard macro-financial variables (interest rates, external demand, relative prices, global financial market volatility and others) do not fully explain the recent investment slump. Finally, using the new measure of economic policy uncertainty, the results suggest that heightened uncertainty and deteriorating business confidence have played a key role in the recent investment slowdown.”
Hence, if the current government really wants to get corporate investment going it needs to bring in a lot of much delayed structural reform. Also, it is worth remembering here that a some of the major business groups in India have already borrowed a lot of money and are having tough time paying interest on the debt they already have. Hence, where is the question of borrowing more?
Further, it also needs to be remembered that financial savings in India have fallen dramatically over the last few years. The latest RBI annual report points out that “the household financial saving rate remained low during 2013-14, increasing only marginally to 7.2 per cent of GDP in 2013-14 from 7.1 per cent of GDP in 2012-13 and 7.0 per cent of GDP in 2011-12…the household financial saving rate [has] dipped sharply from 12 per cent in 2009-10.”
Household financial savings is essentially the money invested by individuals in fixed deposits, small savings scheme, mutual funds, shares, insurance etc. The household financial savings were at 12% of the GDP in 2009-10. Since then, they have fallen dramatically to 7.2% in 2013-14. A major reason for the fall has been the high inflation that has prevailed since 2008.
The rate of return on offer on fixed income investments(like fixed deposits, post office savings schemes and various government run provident funds) has been lower than the rate of inflation. This has led to people moving their money into investments like gold and real estate, where they expected to earn more. If the household financial savings number has to go up the rate of interest on offer on fixed income investments needs to be higher than the rate of inflation. Only recently has the consumer price inflation fallen to levels below the rate of return available on fixed income investments. This situation has to be allowed to persist if the financial savings of India are to increase.
To conclude, calling for lower interest rates on almost every occasion is not a solution to anything. It is time the interest-rate-
wallahs understand this.

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

Vinod Rai has had the last laugh on Coalgate. Here’s why

Inclusive Governance: Enabling Capability, Disabling Resistance

Vivek Kaul

In an interview with the Business Standard in September 2013, Jairam Ramesh was asked why the Congress party was losing ground so badly in urban India. “Because of the bhumihar from Ghazipur,” Ramesh replied. He was referring to the former Comptroller and Auditor General (CAG) of India, Vinod Rai, who had retired from his post in May 2013. The CAG in a series of reports had exposed the wrongdoings of the government.
As Rai writes in
Not Just an Accountant—The Diary of the Nation’s Conscience Keeper “Jairam Ramesh was a regular visitor to the CAG headquarters for discussions on the audit of the national rural employment guarantee programme. His discussions did indeed lend value. In one of the conversations with me, he asked why N.K.Singh, the Rajya Sabha MP representing the Janata Dal(United), used to refer to me not only as a bhumihar but as a ‘bhumihar from Ghazipur’. I told him I did know what it meant.” Rai further writes that even his caste was brought into prominence, “and this after sixty-seven years of independence.”
Ramesh’s quip against Rai was a part of a series of statements made by leaders of the Congress party to discredit him. This after, the CAG had meticulously gone about exposing wrongdoings of the government in the telecom, coal, sports and aviation sectors.
Manish Tewari, the Congress leader who can speak on just about anything, said that the “R-virus has infected the Indian growth story. The R-virus stands for a phenomenon were responsible individuals decide to become loose cannons.” On another occasion Tewari said “When individuals decide to go rogue, institutions suffer. That possibly has the most detrimental effect on the India growth story.” Sharad Pawar, who is a part of the UPA, and was the food and agriculture minister in the UPA government said “CAG has taken certain decisions that have created a different atmosphere in the country… I haven’t seen anything like this in the forty-five years of my career as a politician.” Montek Singh Ahluwalia, the deputy chairman of the Planning Commission, went on to claim that “untrained staff [is] auditing CAG reports.” The business lobby ASSOCHAM even went to the extent of releasing advertisements which said that CAG reports were sending wrong messages. The advertisement went on to state “The CAG’s conclusions over the 57 coal block allotment appear to have been arrived at without taking all facts into consideration. Only one of the 57 blocks has gone into production.”
The then finance minister P Chidambaram even went to the extent of saying that the government had faced no loss from giving away coal blocks free to private and public sector companies. “If coal is not mined, where is the loss? The loss will only occur if coal is sold at a certain price or undervalued,”Chidambaram had said.
In order to understand this statement we need to go back to the early 1990s. The government at that point of time realized that enough coal was not being produced. The Coal Mines(Nationalisation) Act was amended with effect from June 9, 1993. This was done largely on account of the inability of Coal India Ltd (CIL), which produces most of India’s coal, to produce enough coal.
The coal production in 1993-94 was 246.04 million tonnes, up by 3.3% from the previous year. This rate was not going to increase any time soon as newer projects had been hit by delays and cost over-runs, as still often happens in India. As the 
Economic Survey of 1994-95 pointed out “As on December 31, 1994, out of 71 projects under implementation in the coal sector, 22 projects are bedevilled by time and cost over-runs. On an average, the time over-run per project is about 38 months. There is urgent need to improve project implementation in the coal sector.”
The idea, as the Economic Survey of 1994-1995 pointed out, was to “encourage private sector investment in the coal sector, the Coal Mines (Nationalisation) Act, 1973, was amended with effect from June 9, 1993, for operation of captive coal mines by companies engaged in the production of iron and steel, power generation and washing of coal in the private sector.”
The amendment to the Coal Mines (Nationalisation) Act 1973 allowed companies which were in the business of producing power and iron and steel, to own coal mines for their captive use. Hence, the coal that these companies produced in these mines was to be used to feed into the production of power and iron and steel. Any excess coal was to be handed over to the local subsidiary of the Coal India Ltd.
Between 1993 and 2011, 195 coal blocks were given away for free to public and private sector companies for captive use. Most of these free coal blocks were given away between 2004 and 2011. Nevertheless even by 2011-2012, these coal blocks produced only 36.9 million tonnes of coal. This amounted to around 6.8% of the total production of 539.94 million tonnes during the course of that year.
And because very little coal was being produced in these captive mines, this led Chidambaram and the industry lobby Assocham to put forward the argument that since coal was not being mined how did the government face any losses? This was a really stupid argument to make. The government handed over a natural asset free to private and public sector players. They, in turn, were not able to mine coal from it quickly enough. How does that mean that the government did not face any losses? It does not change the fact that coal blocks were essentially handed over for free.
As Rai puts it in his book: “I thought any prudent and concerned industry body would have questioned the urgency to allot when the allottees had not even commenced mining. But then, since every person who wanted to display his loyalty to the government was hastening to take potshots at the CAG, why not an industry body?”
Interestingly, Manmohan Singh explained the inability of the private coal producers to start producing coal quickly enough by saying “it is true that the private parties that were allocated captive coal blocks could not achieve their production targets. This could be partly due to the cumbersome processes involved in getting statutory clearances.”
This Rai says is a defeatist argument. As he writes “This does appear to be a defeatist argument; if the government is aware that the processes are cumbersome and accords the process urgency, it is incumbent on the government to take steps to ensure speedy clearances.”
The CAG came in for heavy criticism for coming up with a loss figure of Rs 1,86,000 crore for these coal blocks being given away free by the government. In his book, Rai explains with great clarity how this number was arrived at. The CAG worked with most conservative estimates while coming up with this number. While calculating the loss the CAG did not take into account the coal blocks given to the public sector companies. Only blocks given to private sector companies were taken into account.
The total geological reserves of the coal blocks given away for free amounted to around 44.8 billion tonnes. The total amount of coal in a block is referred to as geological reserve. But not all of it can be extracted. Open cast mining of coal typically goes to a depth of around 250 metres below the ground whereas underground mining goes to a depth of around 600-700 metres. Beyond this, it is difficult to extract coal.
The portion of the geological reserves that can be extracted are referred to as extractable reserves. The CAG worked with fairly conservative estimates on this front as well. Typically extractable reserves are around 80-95% of geological reserves. As Rai writes “Audit based its computation on [the] conservative estimate of 73 million tonnes for every 100 million tonnes given in the GR [geological reserve]…Can audit be faulted if its computation was based on a conservative estimate of 73 per cent?…The extractable reserves…based on the aforementioned method, was found by the CAG to be 6282.5 million tonnes, which is mentioned in the report.”
So only 6282.5 million tonnes of the 44.8 billion tonnes of geological reserves was assumed as extractable reserves while calculating the losses of the government due to giving away coal blocks for free.
After establishing the extractable reserves the CAG needed to establish the price at which this coal could be sold as well as the cost of production of this coal. For establishing the price at which the coal cold be cold, the CAG considered three possible options.
“The first was by imports. The average import price of non-coking coal sourced from Indonesia during 2010-2011 was Rs 3,678 per tonne (Indonesia supplied most of our non-coking coal imports). The second source was the coal sold in e-auction by Northern Coalfields Limited, a subsidiary of CIL [Coal India Ltd] based in Singrauli. The third and major source of coal supply in the country was that which was mined and supplied by CIL. Audit utilized the only creditable data available in the public domain—that of CIL. CIL is regularly audited by the CAG, so its accounts and other details can be taken as authentic. From the audited accounts of 2010-2011, the average sales price of all grades of coal sold by CIL was taken as Rs 1,028 per tonne. This was the most conservative price too,” writes Rai.
After this, the cost of production of coal needed to be established. For this, the CAG again went back to CIL, which produces most of the coal in the country. As Rai writes “The average cost of coal mined by CIL was found to be Rs 583 per tonne. The MoC has indicated, after due verification, that the financing cost ranged from Rs 100 to Rs 150 per tonne. To be on the safe and conservative side, audit assumed it to be at Rs 150. Thus, while the average sale price was Rs 1,028, the average cost was Rs 583 plus Rs 150, namely Rs 733,” writes Rai.
Manmohan Singh later criticized this calculation by saying “the cost of production of coal varies significantly from mine to mine even for CIL due to varying geo-mining conditions, method of extraction, surface features, number of settlements, availability of infrastructure etc.”
By taking the average cost of production these are exactly the factors that CAG was taking into account. And this left Rs 295 per tonne (Rs 1028 minus Rs 733) as the financial benefit. So Rs 295 of financial benefit per tonne was multiplied with 6282.5 million tonnes of extractable reserves and a loss figure of close to Rs 1,86,000 crore was arrived at.
As you can clearly see the most conservative estimates had been used to arrive at a loss number. If the CAG had not used these conservative estimates it could have easily put out a much bigger number for these losses.
Another criticism that the CAG came in for was that the loss calculation did not take the concept of net present value(NPV) into account. “Even if discounting had been done to arrive at the NPV, we would have possibly projected an annual increase of 10 per cent in cost/sale price, and we would then have discounted, at, say, a discount factor of 10 per cent. We would have got to an NPV of financial gain of Rs 2.40 lakh crore, at 11 per cent of Rs 1.86 lakh crore and at 12 per cent of Rs 1.49 lakh crore. There is no substantial difference. Hence, why all the ire?”
In the end, Vinod Rai has had the last laugh. The Supreme Court in a recent decision deemed the allocation of coal blocks to be illegal. And for those who are still not convinced about the way Rai operated as the CAG, it is time they read his book.
The article appeared on www.FirstBiz.com on Sep 16, 2014

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