SUUTI

Happy new year folks: The govt has increased excise duty on petrol and diesel again!

light-diesel-oil-250x250Dear Reader,

While you, me and everybody else was busy celebrating the new year, the government quietly increased the excise duty on petrol and diesel, again. This increase was announced on January 1, 2016 and came into effect from the next day.

This is the seventh increase in the excise duty on petrol and diesel since November 2014. Also, the government has increased the excise duty thrice in quick succession over the last two months (between November 6, 2015 and now). Since November 2014, the excise duty on unbranded petrol has gone up by Rs 6.53 per litre, with latest increase being of 37 paisa per litre. This is a massive jump of 544%.

During the same period the excise duty on unbranded diesel has gone up by Rs 6.37 per litre or 436%, with the latest increase of Rs 2 per litre. In the process, the government has captured a major part of the fall in oil prices.

On November 11, 2014, when the excise duty on petrol and diesel was increased by the Narendra Modi government for the first time, the price of the Indian basket of crude oil was at $79.11 per barrel. As on December 31, 2015, the price of the Indian basket of crude oil stood at $32.9 per barrel, a massive fall of 58.4% since November 2014.

In the same period the price of petrol and diesel in Mumbai has fallen by only 3.6% and 9.9% respectively. What this tells us loud and clear is that the government has captured most of the fall in oil prices, without passing on the benefit to end consumers. The surprising thing here is that there has been no protest on this, either from the opposition parties or the citizens.

There are a number of issues that crop up here. First comes the question, why is the government doing this? In fact, there is a clear trend in the government increases of the excise duty on petrol and diesel. In 2014-2015, the last financial year, the increases came on November 11, 2014, December 2, 2014 and January 1, 2015. These increases were in the period close to the annual budget which is presented in end February.

The same trend is playing out this time as well. The three recent increases have come on November 6, 2015, December 16, 2015 and January 1, 2016. In the run up to the budget which will be presented in end February 2016, the government is sprucing up its finances. Estimates suggest that the three recent increases will bring in an extra Rs 10,000 crore into the coffers of the government.

In the budget presented in February 2015, the government had targeted a fiscal deficit of Rs 5,55,649 crore or 3.9% of the gross domestic product(GDP). Fiscal deficit is the difference between what a government earns and what it spends.

It is important to figure out how this calculation was carried out. In 2014-2015, the nominal GDP was at Rs 12,653,762 crore. Nominal GDP is essentially GDP which hasn’t been adjusted for inflation. It was assumed that during 2015-2016, the nominal GDP would increase by 11.5% to Rs 14,108,945 crore. A fiscal deficit of Rs 5,55,649 crore amounts to 3.9% of this projected GDP of Rs 14,108,945 crore.

So there are two things that the government needs to keep track of here. The absolute fiscal deficit as well as the nominal GDP. The trouble is that the nominal GDP hasn’t grown at the projected rate. The nominal GDP for the first six months of the financial year (April to September 2015) has grown by only 8.2% instead of the projected 11.5%. And this has thrown the fiscal deficit calculations of the government for a toss.

As the Mid-Year Economic Analysis released in December 2015 points out: “It is true that the decline in nominal GDP growth relative to the budget assumption will pose a challenge for meeting the fiscal deficit target of 3.9 per cent of GDP. Slower-than-anticipated nominal GDP growth (8.2 percent versus budget estimate of 11.5) will itself raise the deficit target by 0.2 percent of GDP.”

In order to ensure that it meets the fiscal deficit target, the government has increased the excise duty on petrol and diesel thrice in the last three months. On November 6, 2015, when the first of the three increases came in, the price of the Indian basket of crude oil was at $45.07 per barrel. Since then it has fallen to $32.9 per barrel, a fall of 27%. Hence, every time there has been a fall in oil prices, the government has moved in and increased the excise duty.

What this tells us is that on the finance front, the government has essentially turned out to be a one-trick pony. The easy money that the government has managed to raise from falling oil prices has led to a situation where it has totally given up on all other measures to spruce up its revenues as well as cut its expenditure.

The loss making public sector units continue to operate as they had in the past. The government continues to own stakes in companies like ITC, Axis Bank and L&T, worth thousands of crore.

The irony is that the government spends a lot of money in telling people that consumption of tobacco is injurious to health and at the same owns a 11.17% stake in ITC through the Specified Undertaking of the Unit Trust of India. How do the finance minister Arun Jaitley and prime minister Narendra Modi explain this dichotomy? (Like P Chidambaram and Manmohan Singh before them).

Jaitley has also talked about a stable tax regime in the past to woo foreign investors to invest in India. How about offering the same stable tax regime to the Indian consumer as well?

The Indian economy as well as the government finances have benefitted a lot during the course of this year due to falling oil prices. Sajjid Chinoy, chief economist at JP Morgan India, has estimated that lower oil prices gave a 1.3 percentage points boost to growth in the last four quarters.

The question is will this continue? If it doesn’t, does the government have a Plan B in place?

What will happen once oil prices start to rise? How will the government finance its expenditure? Will the government be able to maintain the excise duty that it is currently charging on petrol and diesel and allow their respective prices to rise? If the government raised excise duty in an era of falling oil prices, it is only fair that it cuts excise duty when oil prices are going up?

To conclude, falling oil prices have made the Modi government lazy on the revenue raising front. And that is clearly not a good sign as we enter 2016.

The column originally appeared on The Daily Reckoning on January 4, 2016.

How ITC can help fix the fiscal deficit

ITC

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

2013-14

2014-15

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

Please cut our losses

narendra_modiVivek Kaul  

The investment industry suddenly got into an overdrive in the aftermath of the Narendra Modi-led Bhartiya Janata Party (BJP) winning a majority in the 16th Lok Sabha on its own. Both Indian and foreign stock brokerages immediately upped their Sensex/Nifty targets and categorically stated that the Indian stock market is ready for its next big bull run. Of the many targets bandied around, the most optimistic target was that of Sensex touching 35,000 points by the end of December 2015. It currently quotes at around 24,200 points.
Now, every bull run has a theory behind it. What is the theory behind this bull run? The investing community is of the opinion that the new Modi government will take measures to set the Indian economy back on track. But that is nothing more than hope and hope alone can’t  go a long way.
In the noise of the elections what everybody seems to have forgotten is that the Indian economy is still in a bad shape. The gross domestic product (GDP) numbers that were released on May 30 showed that economic growth, as measured by the growth in GDP for the year ending March 31, 2014, stood at 4.7 per cent. It was the second straight year of less than 5 per cent economic growth. Rather worryingly, the manufacturing sector contracted by 0.7 per cent during the course of the year.
Setting this right will be a major long-term challenge for the Modi government. Economic history clearly shows that countries which have moved from being developing to developed at a fast rate have done so by creating jobs in the manufacturing sector. That hasn’t happened in India as yet.
When it comes to short term challenges, the fiscal deficit remains one of the bigger challenges. Fiscal deficit is the difference between what a government earns and what it spends. The fiscal deficit during the rule of the Congress-led UPA government burgeoned big time. In the interim budget presented in February, the then finance minister, P. Chidambaram, claimed to have brought it down to Rs 5,24,539 crore or 4.6 per cent of the GDP. Numbers later released by the Controller General of Accounts suggest that the fiscal deficit for the year ending March 31, 2014, came in a little lower at Rs 5,08,149 crore.
But this was primarily achieved by cutting down on the asset creating planned expenditure and by not recognising’certain’expenses which in total amounted to more than Rs 1,00,000 crore (their recognition was postponed to this financial year, i.e. the year starting April 1, 2014). This primarily includes oil, food and fertiliser subsidies. This anomaly needs to be set right. More than anything, the Government of India should not be indulging in what is a clear accounting fraud. One of the basic tenets of accounting is to recognise expenditure during the period it is incurred. In the short run, if this leads to the actual expenditure of the government shooting up, then so be it.
The government can, instead, look at encashing some low-hanging fruit. SUUTI (Specified Undertaking of the Unit Trust of India) holds shares of bluechip companies like ITC and L&T which are worth around Rs 42,400 crore currently. SUUTI was formed in the aftermath of the Unit Trust of India going bust in early 2000s. These shares can be sold to help shore up the government revenues.
Over and above this, the BSE PSU Index has gone up by 36 per cent since the beginning of this year. What this means is that the government can use this opportunity to sell shares it owns in a host of public sector units (PSUs). Take the case of Coal India Ltd. There is no reason that the government has to own 89.65 per cent of the company. Even at a significantly lower stake, it can retain the management control of the company.
Along similar lines, the government needs to bring down its stakes in public sector banks (PSBs). Currently, India has 27 PSBs. Why does the government need to run 27 banks? There is clearly no logic to it. A lot of money can be raised by selling shares of PSBs. Money can also be raised by quickly selling telecom spectrum. The last auction which happened in February 2014 fetched the government close to Rs 61,000 crore. There are a whole host of loss making PSUs which are sitting on a lot of land in premier locations. This land needs to be monetised.
It needs to be pointed out that trying to meet regular expenditure by selling assets is not the best idea going around. It is like you and me trying to meet our regular expenditure by selling things that we own. It may be necessary sometimes in the short run. What can also be done is that some of the money coming in through the sale of assets can be used to set up an infrastructure fund. The allocation to this fund can be increased over the years, and this money can be used to boost the physical infrastructure across the country.
Other than trying to raise revenues, the government should also try and limit its losses. Air India, which has constantly been losing money, either needs to be shut down or just sold off (assuming we can find a buyer for it).
Many analysts and experts want the government to cut down on expenditure allocated towards programmes like NREGA and the Food Security Scheme. This may really not be possible given that the BJP had voted to legislate them.
But what the government can easily do is to get the Food Corporation of India (FCI) to go slow on its purchases of rice and wheat. Currently, FCI has double the stocks than what it actually needs. Going slow on purchases can really help control the government expenditure. It will also help to control food inflation, given that more rice and wheat will land up in the open market.
To conclude, the economic scenario remains a huge challenge for the new Modi government, but to get going it can cash in on the low-hanging fruit.
This article originally appeared in The Asian Age/Deccan Chronicle dated June 4, 2014

(Vivek Kaul is the author of the Easy Money trilogy. He can be reached at [email protected])

SUUTI money belongs to UTI investors and not to the government

unit_trust_of_indiaVivek Kaul 
The Specified Undertaking of Unit Trust of India (SUUTI) has appointed three merchant bankers for the sale of 23.58% stake that it holds in Axis Bank, the third largest private sector bank in the country. As of January 21, 2014, the value of this stake works out to around Rs 13,157 crore. This sale will help the government control its burgeoning fiscal deficit. Fiscal deficit is the difference between what a government earns and what it spends.
But the question is does this money really belong to the government? In order to answer this question we need to go back more than ten years and understand why SUUTI was formed in the first place. By 2001, several assured return schemes as well as Unit Scheme-64 (US-64) of the Unit Trust of India (UTI), were in a mess. The government had to come to the rescue of the investors.
In the wake of the crisis, UTI assured unit holders having 5,000 or less units that their units would be redeemed any timebetween 1 August 2001 and 31 May 2003. The incentive to hold on was the promise of Rs 12 for every unit worth Rs 10, if it wasredeemed in May 2003. The assets of UTI were divided into UTI-I and UTI-II. The government took responsibility for UTI-I, to which US-64 and all theassured return schemes of UTI were transferred. UTI-I came to be known as SUUTI and UTI-II became UTI Mutual Fund.
SUUTI continued to repurchase units of US-64 even after May 2003. The first 5000 units were bought back at the rate of Rs 12per unit and the remaining at the rate of Rs 10 per unit. Alternatively, investors were offered 6.75% tax-free US-64 bonds maturing in five years, in lieu of their investments.
Of course, the investments that had been made by the assured returns schemes as well as US-64 were transferred to SUUTI. These investments included stocks like Axis Bank (or what was then known as UTI Bank), L&T and ITC.
Now given that the government rescued the investors in the scheme, shouldn’t it be cashing on the shares owned by SUUTI? The argument is not as straight-forward as that. A lot of investors who invested in UTI were essentially retail investors. They parked their hard earned money into the scheme on the understanding that UTI was a government undertaking.
The government, instead of managing the scheme well turned it into a Ponzi scheme. Take the case of US-64, the flagship scheme of UTI. US-64 was launched on July 1, 1964. It was designed to be a balanced fund sort of scheme, which invested both in shares as well as debt securities. But things started to change from 1993, once the government started disinvesting its stakes in public sector enterprises. These shares were offloaded by the government on to UTI and other government owned financial institutions.
In June 1987, debt securities formed nearly 64% of the corpus of the scheme. By June 2000, this had dropped to 26%. Hence, US-64 became an equity scheme from being a balanced scheme. Interestingly, a lot of the investment in equity went into shady companies. US-64 also accumulated a lot of investments in the so called K-10 stocks, which were being rigged by Ketan Parekh.
Other than making bad investments, US-64 was also paying dividends way beyond what it could afford. In its first year of operation US-64 had paid a divided of 6.1%. It gradually rose to around 10% by 1979-1980. By 1990-1991 this had gone up to 19.5%. This reached 26% in 1992-93, staying there for the next few years.
With the dividend payouts going up dramatically, the income of the scheme also needed to continually keep going up, in order to ensure that UTI could continue maintaing such high dividend levels. UTI had built up very high reserves as it retained a certain percentage of its income and did not give out its entire income left after accounting for expenses as dividend to the unit holders every year.
So UTI dipped into its reserves to continue paying a dividend of 26%, till 1995-1996 because it did not want to lower its dividends. Over the years the dividends paid out were larger than the income of the unit trust. It made up for the difference by dipping into its reserves. But it soon ran out of reserves as well. The next thing it did was that it started to use the money that the new investors brought into US-64 to pay the dividends.
US-64 thus degenerated into a Ponzi scheme, where money being brought in by the new investors was being used to pay off the older investors. On September 30, 1998, a shocked investing public came to know that the reserves of US-64 had turned negative by Rs 1098 crore. On 28th February 2001, UTI managed funds amounting to Rs.64,250 crore or more than 13% of themarket capitalization of the Bombay Stock Exchange. It was around this time that some serious bungling seemed to have taken place. UTI accumulated substantial holdings in what came to be known as the K-10 stocks. These were companies in whichleading stockbroker Ketan Parekh had made big investments. While Parekh withdrew from these stocks, UTI continued to holdonto them. In a private placement exercise, UTI picked up 3.45 lakh shares of Cyberspace Infosys at a price of Rs 930 when themarket price was Rs 1100. The price of the stock later fell to Rs.11.
UTI also accumulated significant stakes in unlisted entertainment and media companies, acquired at prices between Rs 250 andRs 500 per share. This again seemed to be an attempt to mirror Ketan Parekh’s strategy. After moving out of K-10 stocks, Parekhtook a fancy for the stocks of unlisted media and entertainment companies. Most of these companies put their Initial Public Offer(IPO) plans on hold, blocking UTI’s exit route.
This was the final nail in the coffin of US-64 and UTI, and the government had to come to its rescue. As Dhirendra Kumar writes in a column on www.valueresearchonline.com “The government supposedly mounted this rescue and gave the poor investors something. However, the fact that the investors lost out was not their fault. These weren’t people who invested in some shady Ponzi scheme. They trusted the Government of India and invested in that magnificent institution called the Unit Trust of India. Effectively, the government ran UTI to the ground, bought back the assets of its victims for a pittance by offering them a Hobson’s choice, and is now ready to make a killing by selling off those assets when the equity markets are much higher.”
Given this, the profits that the government is now likely to make by getting SUUTI to sell the stake that it holds in Axis Bank, actually belongs to the investors of the assured return schemes and US-64 of UTI.
The article originally appeared on www.firstpost.com on January 22, 2014
(Vivek Kaul is a writer. He tweets @kaul_vivek)