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

A Faustian Debate - Inflation vs Growth

This article appeared in Feb 2012 edition of Wealth Insight - Surprisingly still relevant :)

 The author tells us why the real reform in India would be reducing the size of government expenditure & not raising user prices

By Anand Tandon | Apr 14, 2012

Economic growth requires savings (investment) and savings need positive real interest rates. Industry and markets have been quick to lay the blame of a recent fall in economic growth at the door of the RBI. RBI had, since February 2010, increased the repo rate from 4.75 per cent to the current 8.5 per cent in the face of persistent high inflation levels. This has fuelled fears of an economic slowdown, something that the policy makers want to avoid in an election heavy year.

Has the RBI really been "hawkish"?
The graph below tells a different story.


Post the economic meltdown in 2008, RBI moved quickly to drop interest rates. The same alacrity was missing on the way up. Inflation started to rise by November 2009. RBI took corrective steps only in March 2010, that too in very small steps allowing inflationary expectations to build. Real interest rates (=interest rate - inflation) which measures the payment a saver receives for postponing consumption has been negative since November 2009 - and continued to be so till now.

How does negative real interest penalize the saver? Let's assume movie tickets last year cost Rs 100. With interest rates of 10 per cent, a bank fixed deposit (FD) of Rs 1000 yielded Rs 100 in interest - you could use it to watch a movie. This year, price of movie tickets increased to Rs 112. If interest rates remained unchanged, you would now have to dip into your FD to watch a movie. In other words, you would have been penalized for saving (postponing consumption).

The Indian economy witnessed a sharp recovery in 2009-10. The justification of negative real interest rate did not exist - but did either industry or market participants complain? Monetary policy is supposed to be counter-cyclical. It has to provide stimulus when the economy slows, and "take away the punch bowl" when the economy is over-heating. The latter is always difficult if the stimulus stays for too long. Borrowers get addicted!

But isn't it obvious that higher interest rates will slow the economy?
The relationship between growth and inflation has been the subject of much research. Evidence is mixed - but in general, it appears that low rates of inflation may help growth, while sustained high levels inflation harm long term growth rates.

In the Indian context, "threshold inflation" below which inflation is assumed benign has been variously estimated at between 4 per cent and 7 per cent. A RBI working paper published in September 2011 suggests the relationship as in the graph below. Inflation as measured by WPI becomes damaging as is rises beyond 7 per cent.

Other studies, e.g. Prasanna and Gopakumar, (IGIDR) conclude unequivocally "that any increase in inflation from the previous period negatively affects growth". In any case, not curbing inflationary expectations when the inflation rate is near double digits would mean that the RBI is not performing its key task - that of maintaining price stability.

In short, while the near-term growth prospects may seem subdued, failure to curb inflation would hamper longer term growth in the economy. Don't shoot the messenger!

Domestic saving and growth
Why is it necessary that savers receive positive "real returns"? Growth requires investment. In India, it requires Rs 4.5 of investment to generate Rs 1 of income per year going forward. This rate is referred to as ICOR (Incremental capital output ratio). ICOR is a measure of the efficacy of use of capital. ICOR has averaged between 4 and 4.5 for the past two decades.


Over the past few years, domestic savings have averaged around 33 per cent of GDP. Current account funds another 1-3 per cent. Overall, assuming that the ICOR remains at 4.5, India should be able to sustain a growth rate of 8 per cent (= {33%+3%}/4.5) on an average. To increase this to 9%-10% however, one of two factors must change - either savings rate has to move to 40 per cent, or ICOR has to drop to nearer 4. Offering negative real interest rates to savers (as has been the case for the past 3 years) is not likely to move savings rate to 40 per cent.

Efficient use of capital too requires that poor capital allocation decisions be avoided. When interest rates are low, borrowers are encouraged to take risks - often leading to mis-allocation of capital - and increasing ICOR. The real estate asset bubble of the US is a case in point. In capital deficient India, this would be unacceptable.

Reducing ICOR requires policy initiatives
Post liberalization (1991), the Indian economy used capital judiciously as witnessed by an ICOR of 4. India is now entering a period of infrastructure building. This is more capital intensive, with returns that are often back-ended. ICOR will rise.

Another factor is the increasing dependence on government decision making. While the early 90's marked the removal of the need for government approvals, many industries now are again dependent on licensing and allocation of public resources (e.g. telecom, mining, power). Once again, industry looks to government policy to grow. Lack of policy initiatives will drop growth not RBI.

All policies are not equal
Post the polls in UP, markets expect several policy changes - indicating government's willingness to address the concerns of investors. It's likely that there will be a slew of announcements.

When examining announcements, keep a "framework" in mind. Ask if a policy announced allows industry to make better capital allocation decisions over the long term. Ad hoc exemptions and tax rate changes may provide temporary relief, but not sustainable growth. Investment requires a stable policy environment. Fickle decision making does not work - not even favourable decisions.

Foreign investment may receive favours. Policy makers would do well to remember that foreign savings make up less than 10 per cent of the total saving in the country. Undue focus on international capital flows while neglecting domestic markets does not make sense. Money has the same color - irrespective of its origin.

Real reform for India would be reducing the size of government expenditure and not by raising user prices. The government has created a list of entitlements and threatens to create more without debating. How these will be paid for.? Last year, the finance minister promised not to have costs off the "balance sheet". He failed. Let's wish for a better year ahead. Else, the Indian growth story will remain the best potential play - only the potential will take another decade to realize.

From Debate to Spin

My article published in "Wealth Insight" in Jan 2012 . Reproduced below as well:

Will consumers benefit from 100 per cent FDI in multi-brand retail? The author finds the benefits are not easily visualized

By Anand Tandon | Mar 10, 2012

If you don’t share the government’s enthusiasm for allowing dominant foreign ownership in Indian multi-brand retail, you must be a luddite – that’s what the media would have you believe. The spin doctors of the policy have simplified the issues to the level of “with me or against me” – and opposition to foreign ownership is being defined in terms of resistance to “reform”. But are the issues really as clear?

Waste reduction through improved supply chain
India’s supply chain is regarded as inefficient. This is particularly true for perishables. Improving this is one of the key benefits of foreign investment, we are told. However, a broad-brush assertion of this nature is only partially accurate. The supply chain of milk and milk products does not seem to suffer from this infirmity. Cereals, pulses, sugar, edible oil, spices too – which make up more than 24 per cent of monthly expenditure per person (NSSO study 2004) — are well handled. Fruits and vegetables seem to suffer the most, but make up less than 10 per cent of the consumption basket.

This graphic shows that per capita food loss in Europe and North America is between 280-300 kg/year. In South and Southeast Asia, this figure is 120-170 kg/year – about half! While it is true that a larger part of the waste in South Asia is in the “production to retailing” chain, it’s important to note that it is lower in absolute terms compared to the “more efficient” supply chains of Europe and North America. The loss in the “retail to consumer” segment is not even worth comparing. The assumption that foreigners do better at preventing wastage is not supported by facts.

Back-end investment is already allowed
Importantly 100 per cent FDI is already allowed in supply chain infrastructure. Actual investment has been insignificant. The DIPP (Department of Industrial Policy and Promotion) attributes this to absence of FDI in retailing. In other words, it is not worthwhile to invest in back-end infrastructure, even to service the “organised retail” outlets owned by Indian entrepreneurs – unless one owns the final retail outlet. How is this to be explained?

If the need for cold chain infrastructure is so compelling, returns on these investments should be attractive. Additionally, government incentives are available. There should be investors lining up to set up these. Discussions with large supply-chain managers – the likes of NBHC (National Bulk Handling Corporation) and NCMSL (National Collateral Management Services Ltd.) reveal that investment returns on supply chain infrastructure does not exceed single digits – unless one also factors in the appreciation in land value. Business returns are lower than domestic cost of capital, and returns are derived from speculative asset price changes. Perhaps, the issue is less to do with the availability of capital as with high land prices, and uneconomic land sizes which increase the cost of procurement and handling.

Better farmer prices – price discovery is more important
Another “benefit” that is ascribed to foreign ownership is better price realisation for farmers – at the expense of the intermediary. However, this is more a case of price discovery and its transmission.
Lately, price of processed pepper (garbled) has been lower than that of unprocessed pepper. First, this is unusual. But it does demonstrate that for commodities where there is an organised “price discovery” mechanism – through a functional exchange — the farmer is not being fleeced. In fact, today the farmer is well informed about prices across markets, and sells at a price that just leaves the intermediary with margins that equal cost of capital and transportation costs, leaving the aggregation risk to be managed by the intermediary.

Procurement issue is also about size
More losses occur due to farm holdings that are fragmented, leading to multiple handling and storage issues, than due to any “inefficiency” in the supply chain. To think that managers from ITC, Reliance and Tata’s, or for that matter, those from Olam, Cargill, or LD would not have sorted out supply chain issues if there was a way to do so, is to assume that Indian companies are poorly managed!
Yes, procurement is already 100 per cent FDI compliant – so if large efficiencies were to be gained by foreign capital, they already would have been. If despite being free to buy from India, large global retailers buy 20 times more from China, that tells you what is going to happen once they are allowed to sell in India – we will build a supply chain for Chinese products to be sold in India.

Lower consumer prices – but how?
With no likely improvement in procurement methodology, and with higher costs associated with supply chain (assuming that it is actually set up), how will the prices at the retail level fall? Perhaps by diverting more supplies to towns (cold storages will allow perishables to last longer) at the expense of rural India. But will higher cold chain storage and transport costs allow final prices for urban consumers to fall? And, importantly, what happens to the food supply to semi-urban and rural areas – they are left with less food diversity and poorer health perhaps.

Who gains?
Industry, in particular owners of retail chains, will benefit with expectations of large investments from foreigners at a premium to current prices. Real-estate mall developers will be direct beneficiaries in a sticky market. For the rest, the benefits are less easy to visualise. For retail investors, in the event that FDI in multi-brand retail is allowed, the run-up to the decision is likely to be more profitable than the post-event entity that is formed. Transfer pricing issues will take a long time to sort out, and domestic minority shareholders will find it difficult to make money. As with all investments, hype often does not mirror reality.

A year later (well almost)

After my last post in Aug 2011, I fell silent. Besides the excuse of not finding time (only partially true), the more important one was a complete state of disgust with the affairs of the nation. I thought that rather than venting, I should take some time off and let things settle.

Well, things have settled. It is now settled that the momentum of the economy has run aground. Its settled that the incumbent policy makers suffer from serious nostalgia - they are trying their atmost to return us to the "mai baap" sarkar of the decades of the seventies - when most of them must have been in their "youth". The "inspector" raj is back in full force.The difference is that a activist judiciary has decided it needs to decide where you can dig up mud from (almost - there is a court imposed bar on mining sand in the state of AP!)

The only writing I have done in the past few months has been to contribute a monthly column to "Wealth Insight" - a magazine targetting the equity investor, and being published by Dhiraj Kumar of Value Research. I started writing in Jan 2012 and have contributed 5 columns to date. The next few posts will carry these columns. From now on, I hope to start writing again, and I look forward to seeing you readers back !

Anna - The end of a beginning

Democracy is defined as “rule of the people” – and the Indian democracy showed that it is just that. Last evening was a red-letter day in Indian democracy - as Parliament passed a resolution to take on board the three demands that Anna Hazare had raised before it.

Anti-protest commentators which included a pro-government channel, and members of the NAC (an extra-constitutional body that "advises" the government on law-making - a clear case of constitutional impropriety) kept up the charade that these protests in some way detracted from India's democracy. My take on three key issues that were raised :

1.       Supremacy of Parliament – huh? What’s that?

A key claim was that Parliament is supreme in law making and that the agitation somehow diminished the “prestige” of parliament. Absolute Balderdash!  Nowhere in the constitution is there either a direct or implied “supremacy” given to the Parliament. Quite the opposite - The constitution is clear that the PEOPLE are supreme, when it states “We the People of India..... do Hereby Adopt, Enact and give to Ourselves this constitution”. MP’s are but representatives of the wishes of the people. The "confused" are mistaking procedural matters for “fundamental” issues.

2.       This is “mobocracy” and somehow sets a bad precedent. First, we have to agree that self regulating bodies rarely work. Allegations of corruption and nepotism in higher judiciary, a medical council that refuses to book errant doctors, and failed self-regulation in the case of life insurance companies are cases in point. If we agree, then when it comes to making laws that effect the law-makers and the bureaucracy, self-regulation will not work, and we HAVE to take into account the wishes of the people directly.

Can this be repeated? We have only to look at the case of Swami Nigamananda, who died earlier this year fasting against the government's inability (or worse) to implement a supreme court decision against illegal mining in the Ganga river bed, or that of Irom Sharmila from Manipur who is protesting against Armed Forces Special powers Act for the past decade. In both cases, the public imagination could not be captured, and while both causes are legitimate, they have failed to attract anywhere near the kind of public participation to force the government to act. To see Anna's protest as something that can be easily replicated displays a misunderstanding on what led to the massive public support that the movement generated. If our politicians do not get this, they are really not in touch with their constituents and should anyways be voted out.

3.       The Lokpal bill will not stop corruption. This must rank as among the silliest complaints. Courts and police do not stop crime, they just create enough of a disincentive to stop most people from committing them. Likewise, Lokpal may not stop corruption – where ever there are people, there will be greed and some will succumb. However, it will hopefully create some disincentive. Additionally, as I have argued in the past – what prevents us from modifying and improving the law once it is enacted. Should we start with an imperfect law or wait another 50 years in the hope we will get a “perfect” one.

The debate in parliament showed up the real leaders. Sushma Swaraj sparkled, Sharad Yadav argued like a has-been, and Anand Sharma rambled. Our PM was ofcourse silent - but could you expect anything else?

Anna - The idea

Watching the "release" of Anna from jail - its an uplifting moment.

The spin doctors of the government - viz NDTV have this as a comment - "Anna's rally a traffic hazard?" This statement says it all - when the popular mood is fired like rarely before, when people have left their work to vent their frustrations against their elected representatives and are protesting against rising prices, looting politicians and corporate leaders and general corruption, our Nero's in government are hiding behind bluster and legalese.

The mark of political leadership is to sense the popular mood and to take a position that allows one to LEAD it. The bureaucrat will fight it, and sulk if not successful. I have always believed that in a democracy, when enough people feel that they need to do something, things change. It appears that we are at one such defining moment in our history. All power to Anna Hazare.

What scenario is likely to play out? The UPA will no doubt attempt to use delay as a tactic - submit the bill to a standing committee for discussion, and hope that the momentum behind Anna fades away.

What can the Anti-corruption camp do? As I see it, the best option is to co-opt the politicians - now that they have them on the mat. I hope Anna asks all his followers to call up their MP's and ask a simple "yes/no" question - are they willing to support the bill UNCHANGED in parliament. If enough answer yes - its game over. If not, we will have clearly identified who needs to be voted out. The finessed argument that PARTS of the bill are acceptable is silly - any law can be amended later. What is the harm in setting up a law and then allowing its functioning to determine how it is to be modified. After all, there is hardly any law that works well when first drafted!

Another scenario that can play out is that the UPA partners withdraw support, and let the government fall. An early election would be the best opportunity for this country to find new leaders. Who will come in is anyone's guess - but we would have restored the primacy of the people over the parliament - something that the current lot seem to have forgotten.

I hope for the first, will be happy for the next, and dread the status quo. 

Bungling government

India is an emerging economy. We are now emerging as one of the important players on the world stage. There are many forces that would not like to see India realize its true place in the Comity of Nations. We must not play into their hands. We must not create an environment in which our economic progress is hijacked by internal dissension.

Indira Gandhi reborn? Not really, this is the never-elected Manmohan Singh who is seeing signs of a "foreign hand" in the popular uprising against the corruption in his government. The hamhandedness of the government response - trying to put the blame of Anna Hazare's arrest on the police, portraying Anna as corrupt, and last but not least - attempting to present Rahul Gandhi as the person responsible for his "release" - reflects the lack of leadership that the party currently suffers from.

Perhaps, the bunch of lawyers advising the PM should seek solace in Chidambaram's earlier statement - the response cannot be termed "intelligence failure" - there was no intelligence after all !