Figures seem credible but what about the emphasis?

My budget comment in DNA - the edited version. The unedited view is below.

The budget, as an exercise in accounting credibility, seems better than many in the recent few years. If we were to accept for a moment, the assumption that GDP growth for FY14 will exceed 6% (as forecast by the economic survey), a 15% increase in excise collection, or a 17% increase in corporate tax made in the budget does not appear to be very challenging. Some figures seem optimistic – a 35% increase in service tax, high growth in divestment and dividend income and high telecom license revenues. However, this is nitpicking. Largely, the budget seems to have a reasonably consistent set of assumptions – so where is the nub?

The issue seems to revolve around the question of growth. While it may be credibly argued that the budget is not expected to resolve all policy problems, one usually looks at the budget more from the point of view of the stated goal of the fiscal policy and not just from the prism of numbers. This is where budget fails to provide an inkling of government’s plans to increase growth. Why will growth rate go up – other than because it will?

If resumption of high growth is a major concern and the private sector is not investing, would it not be logical to increase government spend on capex? Instead, we see government reducing capital expenditure in the current year by 22% lower than the budgeted amount. Why the excessive focus on fiscal deficit in a cyclically weak year? The argument that interest rates will go up have been proven to be untrue – we continue to have negative or near zero real interest rates. And, inflation remains high because of government policy of passing on price of its inefficiency to the public.

The economic survey itself is confused on its understanding on interest rates. At one point, the survey states that household savings in financial assets have fallen since inflation reduces attractiveness of financial instruments and suggests that inflation linked bonds should be introduced – a suggestion which the finance minister too takes up. This would imply that interest rates should go UP.

However, the survey promptly then blames high interest rate for lower investment by the private sector. The survey itself admits that private investment is down because of Rs7500bn worth of stalled projects. “Analysis of 20 individual projects (making up 70% of the total cost of the shelved projects) suggests difficulties in land acquisition, coal linkages, and mining bans as major causes.” None of this suggests a problem with interest rates. Presumably, since this seems an implied criticism of government’s inability to frame workable policies, the problem must be laid at that door of monetary policy.

To borrow a term from Paul Krugman, the “confidence fairies” have made their way to India as well. Somehow, unless the fiscal deficit is contained, interest rates will go up – despite evidence to the contrary. So the path to growth remains shrouded in mystery.

Overall corporate earnings growth is likely to be downgraded by a couple of percentage points to accommodate the increase in surcharge and other changes in tax rates proposed. This will likely reduce sensex earnings estimates to below 1400 for FY14. With little likelihood for a rapid reduction in nominal interest or inflation in the near term, markets will continue to be in the grip of global shifts in risk perception. Unless we have more and better policy action following, the outlook for equity in the current year continues to remain subdued.  

Latest market obsession - reforms post Presidential elections

Post the announcement that Pranab Mukherjee was standing down as the finance minister, the equity markets again started factoring in "reform initiatives" by the PM. That this would imply the PM's inability to push his senior colleagues to accept  his recommendations vis a vis their ministries, does not seem to bother the markets. In this context, Swaminathan Anklesaria's column

Don’t expect major reforms from Manmohan as FM

is worth a read.

For those interested in the context of the "reforms" initiated by Dr. Singh in 1991, the video below is a must-watch. Though it features the finance minister of the "other" side, it does give a ring side view of what the situation was in those days. When will the market participants learn? Being bullish is great, but ignoring history ensures that errors are repeated

My Column in DNA Money on Budget Day

This article was written on the budget day in 2012. Two issues I had warned about - the risk of foreign exchange exposure and the dangers of GAAR have since haunted the markets.

Budget 2012: Bus missed, administrative nightmare ahead

Anand Tandon | Saturday, March 17, 2012 

The finance minister’s latest fare offers little to cheer - either for industry, individuals or the market. However, the markets tend to be optimistic.

The introduction of tax relief for equity investments up to Rs50,000 for small investors is being viewed favourably. Whether it will induce investors to invest or not is another matter.

This seems to be a modified equity-linked investment scheme. Along with the exemption of interest on bank deposits up to a limit, it signals a return to ad hoc tax exemptions—something the government was moving away from.
 Individuals will face the prospect of higher and sustained inflation—as service tax and excise increase across most products. There is absolutely no attempt to reduce government spend.

On the contrary, the minister has promised to make available resources for the Food Security Bill—guaranteed to increase expenditure out of proportion and cause sustained inflation. Anyone hoping for a sustained interest rate cut needs to take a deep breath.

Corporate income tax contribution to the government revenue is budgeted to grow 14%— not a challenging assumption. However, higher excise and service tax will potentially reduce growth as companies struggle to pass on cost pressures to the consumer.Incentives for investment remain elusive—growth, if any, is still likely to come from consumption rather than investment.

The opening up of the ECB route for funding domestic infrastructure is likely to create longer-term problems. Bankability of infrastructure projects is a key issue and not so much the source of funds.

With domestic earnings and foreign exchange exposure, the need for careful hedging by borrowing companies cannot be overstated. Given the penchant of the Indian industry to look short term, we are likely to see unhedged exposures leading to demands for increase in user charges when volatile foreign exchange markets are increasing overall cost of borrowers.

Two issues related to taxation have the potential to create long-term growth problems.

One relates to taxation of transactions by overseas companies holding Indian assets. With the Budget allowing a reopening of old cases, the potential for litigation and for an adverse effect on foreign investment is real.

The “GAR” —general anti-avoidance rule—is draconian. Income-tax officers have been handed discretionary powers that are far-reaching. This will seriously complicate tax administration and has the potential to increase corruption manifold.

Other measures such as requirement of tax deduction by purchasers of immovable property can pose administrative nightmares - the devil will lie in the detail.

The decision to increase the cess on up-stream oil companies, potentially reducing post-tax profits by 10%, just a few days after having sold a large chunk of shares in ONGC - and that, too, to LIC should rank as a case of insider-trading of the worst kind.

If this were to be done by shareholders of a private company, it would surely attract a class-action suit. Luckily for the government India is less litigious, and has no precedence of class action of this kind. 
However, this would indeed be a fit case to start.

The best that can be said of this Budget is that the government is unwilling to give a direction on where the economy should head. We will therefore continue to be dependent on foreign flows - which are themselves subject to their own central bank policies.

Currently, the positive for the market even after the performance of the first quarter of this calendar year is that at 14.5x FY13; the market remains relatively “cheap”. This is on current expectations of growth.

A slowdown in China, a serious possibility, can lead to lower commodity prices and help Indian companies.
On the flip side, we may see earnings expectations get muted as taxes bite into consumers.

If global flows were to reduce for any reason, the going can get tough. Keep Draghi and Bernanke’s pictures on the wall of your trading floor and seek their blessings. We seem to have run out of ideas.

Anand Tandon, CEO, JRG Securities

Budgeting for growth - but focus on the hocus

The latest budget of the UPA government cannot be faulted for trying fuel growth through lower taxes in the hands of individuals. At a time when private capital formation has been weak, and most of the growth of the current fiscal has been achieved through higher government spend, lower planned spend by the government has to be replaced by private consumption to keep the wheels of commerce moving.

Pranab da however gives the game away when he says that the budget is a political document. In a world where it has become acceptable for governments to fudge figures on a large scale, a la Greece, India is following suit. An example would clarify. Forecast for GDP growth for FY2009-10 estimates that "real growth" in agriculture is -0.2%. The economic survey states that Kharif crop production is lower by 15% over previous year, sugarcane by 9%, oilseeds by 15% and pulses 8%. To get to a 0.2% de-growth, we not only have to assume that the Rabi crop is normal, but that it is also 15% higher in terms of output. The survey also says "the index of area under rice shows negative growth (sic)". So where is the growth coming from?

Another way to look at this is the computation of "real GDP". The "real" growth is calculated by taking the nominal output and applying the GDP deflator. The deflator is supposed to have the advantage of reflecting the actual consumption basket in the economy (as opposed to a fixed basket used in calculating WPI or CPI). While the CPI in the current year is in double digits, the WPI is less than 2%. The survey uses 3.6% as the deflator.

Now the growth in agri prices is upwards of 18% on an average. However, if one uses 3.6% as the deflator, then a 15% de-growth in real terms, would show up only at a 0.2% de-growth since the price rise would take care of the rest. It appears that we are significantly over-stating the real growth in the economy.

On most parameters except growth, India is no different from Greece. With a fiscal deficit figure in double digits, an internal debt burden of over 80% and unemployment near double digit, the only reason India is not bracketed with the 'PIIGS" and "STUPID"'s is the supposedly higher growth the economy continues to register. When the growth itself is chimera, the consequences may be disastrous. SS Tarapore made the point in his column here.
 
We should ignore the warnings at our own peril.

The Budget Agenda – making India competitive

As the first budget of the new government, the market is looking for the government to set the agenda for the next few years. High fiscal deficit will restrict maneuverability with regard to tax reduction. The popular mandate, as interpreted by the ruling party, is one of continuity of fiscal policy with a bend to offering direct assistance to farmers and the fiscally weak. This limits the ability to reduce expenditure.

The agenda therefore has to focus on improvement in efficiency of expenditure and better tax collection. Besides, steps are needed to reduce of size of government, and bureaucracy to speed growth. Some steps I would look for are:

1. Financial Reporting – remove the obfuscation. The Fiscal Responsibility and Budget Management (FRBM) Act was expected to form the blue print for India to the path of fiscal prudence. Instead, it has led to the government resorting to a policy of smoke and mirrors to hide its inability to manage the budget. Obvious ones include the non-inclusion of fuel subsidy in the budget deficit. The more pernicious ones are reduction of state transfers – with states being asked to approach the market. While this reduces the apparent expenditure of the Central government, it does not actually reflect better fiscal management. What is needed is to:
a) Move to a system of accrual accounting instead of cash accounting. This will help focus policy debate on not only the immediate term issues, but the longer term ones of ballooning pension liabilities, and debt servicing.
b) Reflect all governmental revenues and liabilities through the budget – all non-budgetary items to be avoided – to prepare a true and fair picture of the state of government finances
c) Prepare accounts that are consolidated – which represent the accounts of the state governments as well as the centre
d) A key area of reform has to be to measure all salaries paid by the government and its agencies and by public sector companies on a cost-to-company basis. This will likely throw up interesting information especially when measured against productive output!

2. Establishment of efficiency parameters – for the most part, the budgetary focus is on revenue and expenditure and not on measuring the efficiency of use of the money spent. Most government departments do have review mechanisms. However, these are not transparent – a case in point is the inability of the Ministry of Human Resources to explain where the money collected (as a cess) for secondary education actually goes. Besides, rarely is the measurement of delivery of efficient service a goal. As part of smaller government, the government needs to move out of providing services itself and instead set up monitoring agencies that set out goals and monitor results while using private enterprise to deliver.

3. Privatization – not disinvestment – This debate seems to have been set-back by the present government. While it continues to desire selling off bits of public owned companies, the approach is essentially episodic in nature. Efficiency of operations can only increase if there is a change of ownership that leads to a change of management style. Arguing that 51% stake would allow better performance is not demonstrable. On the contrary, the use of oil marketing company balance sheets to offer fuel subsidy, that of banks to write off loans and the “donation” by Gujarat state owned companies (where the government is in a minority) suggest that government ownership in any amount detracts from the commercial nature of business.

4. Economic friction in the form of ill conceived taxes (FBT, dividend tax, cash withdrawal) and the discretionary nature of multiple tax rates have crept in the taxation system over the past few years. While the nineties had established a clear road map of tax reforms, the previous UPA tenure marked the reversal of the trend towards simplification and instead returned ad hocism in tax matters. This needs immediate rectification. Another key area remains the implementation of GST – where the time frame of implementation does not seem feasible given the lack of preparedness of the government. Another key area of friction is the restriction on capital flows. The present FII registration requirements serve little purpose. In fact, with limited control over foreign institutions, government has less knowledge of who is the final investor than if it were to allow the normal “know your client” requirements of brokers to work in the case of foreign clients. We need to now drop “I” from “FII”

5. Land and labour reform remain glaring unfinished agenda for faster economic growth. While labour reforms are contentious, land reforms need not be so. Clarity in land titles, and land use planning are two areas that, if sorted out, can reduce corruption significantly.

The Judicial sector needs serious attention. The pile up of unresolved legal cases renders the system incapable of being used. While this is not an agenda for the budget, this has to be one of the key areas of focus for the government if they are serious about increasing the economic growth of India on a sustainable basis.