Thursday, March 28, 2024

End the pretense – choose between Democracy and Monarchy

A new study by the World Inequality Lab highlighted one of the most obvious facts, i.e., the income and wealth inequalities in India have been rising and are now worse than the colonial period. The study highlights that “Inequality declined post-independence till the early 1980s, after which it began rising and has skyrocketed since the early 2000s. Trends of top income and wealth shares track each other over the entire period of the study. Between 2014-15 and 2022-23, the rise of top-end inequality has been particularly pronounced in terms of wealth concentration. By 2022-23, the top 1% income and wealth shares (22.6% and 40.1%) are at their highest historical levels and India’s top 1% income share is among the very highest in the world, higher than even South Africa, Brazil and the US.”


The study suggests that “A restructuring of the tax code to account for both income and wealth, and broad-based public investments in health, education and nutrition are needed to enable the average Indian, and not just the elites, to meaningfully benefit from the ongoing wave of globalization. Besides serving as a tool to fight inequality, a “super tax” of 2% on the net wealth of the 167 wealthiest families in 2022-23 would yield 0.5% of national income in revenues and create valuable fiscal space to facilitate such investments.”


 

This is probably not a good time to publish such reports which highlight any deficiencies in India's governance model. The opposition parties use these reports as a tool to attack the government. The ruling party rejects the finding as malicious propaganda to malign the image of the country and its government - everyone misses the point, i.e., there may be some serious flaws in the socio-economic development model used in the past five decades by various governments. These flaws, on the one hand, may have resulted in a widening of socioeconomic disparities, and on the other hand, might have constricted the growth and development of the country.

 

Bloomberg columnist Andy Mukherjee opined “‘Billionaire Raj’ Is Pushing India Toward Autocracy”. A known critic of the establishment, Mukherjee extorted the voters to ask questions. He wrote, “The super-rich have opened their wallets to Modi, and income inequality has soared over the past decade. With an election coming, ordinary voters need to ask, ‘What’s in it for us?’”

My view is that India never had democracy. We have always been a feudal society. In the post-independence era, democracy has mostly been a tool to capture feudal power. Since the late 1970s most parties have used the façade of socialism to become feudal (e.g., BSP, SP, RJD, and DMK, TDP, TMC, BRS, AAP, etc.) BJP also adopted Gandhian Socialism as its guiding philosophy briefly. The longest-ruling Congress party had turned feudal in the late 1960s. Parties like SAD, PDP, NC, NCP, YSRCP, etc., have been blatantly feudal ab initio.

We, the people of India, have always celebrated the feudal powers of our leaders. The poor and oppressed admired and vehemently defended, for example, the diamond jewelry of Mayawati, the Luxury cars of Mulayam and Lalu, the riches of the Badal, Jayalalitha & Karunanidhi clan, and the variety of designer attires of our prime minister.

The unemployed, ill, starving, and oppressed take pride in some Indians making a place in the Forbes list of global rich, spending billions on their children's weddings, and visiting temples to ask for more wealth from God.

They also feel empowered in queueing up for hours to shower rose petals on their leaders’ retinue of luxury cars in meaningless pretentious roadshows.

They celebrate when patriarchs of the parties they support, “nominate” their favorites to public offices. No one wonders that they have been given no right to elect their representatives or leaders. Feudal parties impose people of their choice as the parliament, assembly, and local body candidates on them. The set of people who would be PM, CM, Mayor, minister, governor, etc., is pre-determined by patriarchs irrespective of who is elected or defeated in the elections. Nobody is interested in discussing or following any ideologies.

The people who suffer the most do not seek accountability from their leaders. On the contrary, the random guys daring to ask questions are termed seditious by the same people. No one dares to challenge the feudal lords.

The debate should therefore be on the core issue – “Whether we should end the pretense and choose between a true representative democracy or a proper Monarchy?”

My vote is for a true democracy, where people choose their representatives (not merely vote for the candidates imposed on them by some random guys sitting in Delhi party office).


Wednesday, March 27, 2024

Add a pinch of salt to free advice

In the past few days, three noteworthy events took place in the global financial markets. These events highlight the policymakers’ dilemma and the uncertainty faced by the financial markets.

First, the Bank of Japan changed its policy stance of “negative interest rates” ending its massive decade-long monetary stimulus exercise to a virtual close. Addressing the press after the policy decision, Governor Kazua Ueda emphasized that BoJ has “reverted to a normal monetary policy targeting short-term interest rates as with other central banks” He also added that “if trend inflation heightens a bit more, that may lead to an increase in short-term rates”.

An overwhelming market consensus now believes that BoJ will hike the policy rates from the present 0-0.1% to 1% in the next year. However, given the massive debt accumulated over the past two decades, Japan may not afford any rate hike beyond 1%.

USDJPY (151.38) is now at its lowest level since 1990.

Second, the Swiss National Bank (SNB) cut its policy rates by 25bps, its first rate cut in nine years. The other European central banks, viz., Norwegian Central Bank (Norges Bank) and Bank of England however decided to maintain the status quo. The decision of SNB was unexpected as the market consensus favored a status quo. SNB did not commit to any further cuts.

This ‘surprise’ move by SNB led the Swiss Franc (USDCHF) and Swiss treasuries to tumble down to their lowest level in eight months.

Third, the US Federal Reserve maintained the status quo on its policy rates, holding the policy rates in a range of 5.25%-5.5%, as expected by the market consensus. The market expectations are now veering around 0-3 cuts this year, against the expectations of 6-8 cuts four months ago. The ‘no-cut’ this year is gaining more support every day.

In the post-meeting press interaction, Fed Chairman Jerome Powell was as non-committal as one could be, leaving the markets confused and speculating. Powell said, “despite high interest rates, economic growth has remained relatively strong and inflation has materially lowered over the past year. Consequently, the FOMC raised its growth and inflation expectations for 2024”. Powell added that “there is still plenty of progress to be made on meeting its 2% inflation target” and hence “the path forward is uncertain.”

After reading the three policy statements carefully, my understanding of the situation is as follows:

·         The central banks are increasingly confident of avoiding any deeper recession in the short term at least (1-2 years). Even the “soft-landing” (shallow recession) appears to be slowly becoming a bear case. The base case is low growth for a longer period.

·         The central bankers are inclined to accept 2-4% inflation as normal. This suits everyone. The governments that have accumulated massive debt over the past decade would be happy if the real rates just stayed negative for long. Savers are happy to earn higher nominal rates on their savings. Corporations are happy to borrow more at negative real rates, buy back their equity, and enhance the market value of their businesses with low earnings growth. We may also see a relative currency depreciation of countries with high external debt (e.g., the US) as a tool for debt management.

·         The popular narrative revolves around “resilient growth”, “sticky inflation” and “calibrated easing”. None seems to be positioned for a Fed rate hike presently. Though the probability may be negligible presently, further strengthening of growth momentum, a strong El Nino, and/or worsening of geopolitical conditions in the Middle East Asia and Central Europe fueling inflation could enhance this probability.

In the Indian context, the RBI has been on pause for over a year now. This is despite inflation consistently remaining close to above the upper bound of its tolerance range of 4-6%; growth surpassing its mostly optimistic estimates; distinct signs of heating in certain pockets of the credit market (especially credit card outstandings and unsecured NBFC lending); and the regulators frequently expressing concerns over excesses in financial markets. RBI has chosen to use tools like withdrawing liquidity through open market operations and nudging NBFCs and banks through advisories to regulate the credit markets.

The popular market narrative in India also revolves around the timing of the cut rather than “cut or hike”. For the financial sector, it means “Margin pressure”, “slower growth”, and “pressure on asset quality”.

RBI’s pause hinders the lenders’ ability to hike the lending rates when the cost of funds is rising due to tighter liquidity and stricter norms. The government has hiked the rates on small savings and EPF. This pressures banks’ cost of deposits. Stricter lending norms might adversely impact the product mix of lenders as the weightage of high-margin personal and unsecured loans reduces. Pressure on low-cost CASA rises as the savers move to high-yield options like corporate bonds, credit funds, and even equities.

In my view, investors should be wary of the free advice of deep value in the banking sector. The large banks are underperforming for a valid reason and smaller banks may have completed their re-rating journey.

Wednesday, March 13, 2024

Do not fight markets

The financial market regulators (RBI and SEBI) have repeatedly cautioned investors and intermediaries in the past few months. However, regulators’ cautions mostly went unheeded as both intermediaries and investors continued to ignore fundamentals, moved with the momentum, and exceeded their limits – regulatory and financial. Consequently, the regulators have begun affirmative action. Following some preventive and corrective actions the regulators took, there is palpable panic amongst the market participants.

There are a lot of queries, especially from small investors, who are usually gullible and easily get misled by the manipulative tactics used by the devious operators and end up buying junk stocks at high prices. The queries usually include – “should I buy more to average my cost?”; “it’s already down 40% from high, how much more could it fall?”; “The stock is falling daily, should I sell it now and buy lower?”

I do not have any specific answers to these queries. However, from my experience of over three decades, and having seen multiple instances of such manipulative euphoria and subsequent meltdown, I would say as follows:

Cost Averaging

Cost averaging in an individual stock is not a prudent idea, especially for small investors with limited resources. Investors need to aim to earn a return on their total investment. To maximize their return, they need to decide at the time of investing, which investment has the best return potential. If it is one of the stocks they are already holding, they should add to that holding. If it is some other investment option, they should invest in such a better option. Buying more of an underperforming stock if there are better options available would be a bad strategy. It might result in the dissipation of scarce resources (money), compounding of losses, and missing good opportunities.

Catching a falling knife

Not long ago, Future Retail Limited (FRL) was a famous company. The promoter of the company was considered a genius. He pioneered the organized retail business in India. Learning from global retail majors like Walmart (USA) and Asda (UK), he built a strong business in India. However, failure to manage growth and excessive debt created problems for FRL and several other group companies, eventually leading to insolvency. The problems for the group had started after the global financial crisis, but it survived for a few years through selling of assets and business restructuring. Covid-19 hit the company hard and it could never recover from that shock.

Post restructuring of the group in 2016, FRL hit a high of ~Rs634 in November 2017 and has been on a steady decline since then. At the time of Covid-19 breakout (February 2020) the stock of FRL was trading close to Rs350.

Tracking the stock movement from the high of 2017, we get this.

·         The Stock price fell 22% (635-493) in one year from November 2017 to November 2018.

·         If one got tempted to buy it in November 2018, it was down another 33% in the next year (November 2018-November 2019) from 493 to 330.

·         If one averaged it in 2019, it was down another 79% in the next year, from Rs 330 to Rs68.

·         In November 2020, if you thought that the stock is down 90 from its 2017 highs, and how much more it could fall, it was down another 29% in the next year to Rs48.

·         If one believed that it is now available at a dirt-cheap price and bought it, he would have lost 92% of his investment in the next year as the stock touched Rs4 on November 22.

·         If in November 2022, you thought there is not much to lose in this, the investments made in November 2022 are down by 50% as the current stock price is ~Rs2.

·         The investment made at this “lottery” price can still potentially lose 50% to 100%.


FRL is only one example. There are hundreds of stocks that were very popular at one point in time, fell 90-99.9% from their euphoric highs, and never recovered.

 


Therefore, before cost averaging, investors must understand that a stock down 90% from its high, is a stock that has fallen 25% from its immediate previous price eight consecutive times (100-75-56-42-32-24-18-13-10). If at any point of this journey, you thought that it has already fallen so much, how much more this can fall – the answer is it can still fall another 90-100%.

Selling to buy lower

An investor needs to understand his/her limitations. Most investors do not possess the skills required to be a successful trader in the market. So, it is better to avoid trying these kinds of adventures. If you are comfortable with the fundamentals of the company, ignore day-to-day price movements and stay put. If you are not comfortable with the fundamentals of the company, ignore day to day price movements and exit at once.

Tuesday, March 12, 2024

Trends in household consumption

 The National Sample Survey Office (NSSO) released the results of the latest Household Consumption Expenditure Survey a few days ago. The report highlights some interesting trends in household consumption patterns over the last two decades. The changes in the rural consumption patterns are particularly noteworthy.

Some of the key highlights of the survey could be listed as follows:

Consumption levels

·         The average monthly per capita consumption expenditure (MPCE) in rural areas is Rs3773 while in urban areas it is about 71% higher at Rs6459.

·         Rural population spends 46% on food and 54% on non-food items. While in urban India this ratio is 39% and 61%.

Consumption disparities

·         There is a significant regional skew in both rural and urban expenditure levels. Sikkim has the largest MPCE (Rs7731 for rural and Rs12105 for urban consumers) while Chhattisgarh has the lowest MPCE (Rs2466 for rural and Rs4483 for urban consumers). Delhi, Goa, Kerala, Punjab, Tamil Nadu are some notable states with above average MPCE.  Assam, Bihar, Gujarat, Jharkhand, Odisha, Uttar Pradesh, West Bengal are some notable states with below average MPCE.

·         SC/ST have below average MPCE, while OBC’s consumption levels are close to national average.

·         Rural-Consumption gap has reduced over the past two decades, but it is still quite high. In FY05 Rural MPCE (Rs579) was 91% lower than the urban MPCE (Rs1105). In 2022-2023, the gap has reduced to 71% (Rs3773 vs Rs6459)

·         Overall, the top 5% of rural population (MPCE Rs10501) is consuming 7.6x more than the bottom 5% (MPCE Rs1373). The skew is much higher in urban India where the top 5% population (MPCE Rs20824) spends 10.4x more than the bottom 5% (MPCE Rs 2001). MPCE of the top 5% in urban areas (Rs20824) is almost 2x as compared to the MPCE of top 5% in rural area (MPCE Rs10501).

·         Not only between the top 5% and bottom 5%; the gap is significant between the top 5% and the next 5%. In urban area, this gap is 68% (Rs20824 vs Rs12399) while in rural areas this gap is 58% (Rs10501 vs Rs6638)

Consumption patterns

·         Beverages, Refreshments, and Processed Food is the largest item in urban and rural consumption baskets. Urban consumers spend 10.64% of MPCE on this while rural consumers spend 9.64% of MPCE on this. Dairy products are the second largest consumption item in both rural (8.33%) and urban (7.22%) baskets. Conveyance and medical expenses come at a close third and fourth.

·         Since FY05, rural India has seen a significant rise in expenditure on Fruits, beverages & processed foods, hospital expenses, conveyance, entertainment, and durable goods. The share of cereals, sugar & salts, fuel & light, clothing and footwear have seen a significant fall. Education and toiletries are two notable items that have not seen much change in share in MPCE.

·        In the case of the urban consumption basket, the trends are similar, except that spend on education has fallen and expenditure on rent has seen notable increase.




Thursday, March 7, 2024

Is your glass half empty too?

We are currently in a market phase where most asset prices are rising. Equity indices (Nifty over 22200) are close to an all-time high. Gold prices (over US$2125/oz) are at an all-time high. Bond prices (benchmark 10-year yields 7.05% from 7.50% a year ago) have recovered from their recent lows. Bitcoins (US$66000) are trading at an all-time high. Real Estate prices in India are also close to their highest levels in most metros.

Wednesday, March 6, 2024

Myth of tax-free agriculture income

The tax-free status of agricultural income has been a contentious issue amongst the urban middle class of India for a long time. The issue is raked up every year close to the budget presentation. It is also commonly used as an argument against farm subsidies, MSP, and other farm sector reforms.

In my view, the whole debate and discussions around the taxation of agriculture income in India amongst the urban middle class is driven by misunderstanding and ignorance about agriculture economics in India.

Constitutional status of the Agriculture Income

It is important to understand the constitutional and legal status of the agriculture income in India, before discussing the taxation aspect.

·         Agriculture is a state subject as per the Constitution of India (Entry 46 in the State List of Schedule VII). The power to tax agriculture income vests in the respective state government. The central government cannot tax agricultural income. A few state governments, like, Assam, Odisha, Tamil Nadu, and West Bengal, have enacted legislation to tax the agriculture income in their respective states. Most of these legislations tax only orchards and plantations and exempt staple food crops like wheat, rice, and vegetables, etc.

·         Agriculture income is exempt from Income-tax under section 10(1) of the Income Tax Act, 1961. As per section 2(1A) of the Act, agriculture income that is exempt from tax is defined as:

           i.            Rent (cash or in kind) earned from any land in India which is used for agricultural purposes, or

      ii.        Any income from the production of agricultural goods; from activities necessary to make agriculture produce fit for selling (e.g., removal of husk from paddy), and from sale of such agriculture goods by the cultivator or receiver of rent in kind.

     iii.        Income from building owned and occupied by the cultivator or receiver of rent, provided the building is on or near the land and is required as a dwelling house, or as a store-house, or other out-building.

·         Income from livestock, fisheries, forestry, etc. (commonly referred to as allied activities) is not considered part of the agricultural income.

·         Income from Coffee and Tea plantations is subject to presumptive taxation. 40% of such income is considered taxable income.

·         Agriculture income is considered for determining the marginal rate of tax for assessees, and all non-agriculture income is taxed at such marginal rate of taxation.

Quantum of agriculture income

As per the second advance estimate of national income for FY24, total GVA from Agriculture and Allied activities is estimated to be Rs46.92 trillion (About 18% of total GVA). The share of crops (agriculture activity as per the Income Tax Act) in this GVA is approximately 55% (Economic Survey FY23). Hence, the GVA from Agriculture is roughly Rs25.81 trillion.

As per the last agriculture census (2015-2016), the total number of operation holdings in the country was 146 million. It is most likely that the number of holdings now is higher than this. However, if we take this number only, the average income per farm is approximately Rs1,76,700.



It is pertinent to note here that during AY2022-23, a total of 74 million income tax returns were filed. Out of this, 51.6 million (appx 70%) income tax returns declared zero or negative (refund) tax liability. In the case of farmers, over 99% of farmers would have total income less than the threshold of Rs7 lacs.

Agriculture economics


The last agriculture census divided the operational holdings as per their sizes in the following categories.


 

·         The average size of an operational holding was 1.08 hectares (approximately 2.67 acres).

·         Small and Marginal holdings (0 to 2 hectares or less than 5.3 acres) accounted for 86.2% of total operational holdings. This accounted for appx 47.3% of the total operational area.

·         Semi Medium and Medium holdings (2 to 10 hectares) were 13.2% of total holdings accounting for 43.6% of the total operational area.

·         The large holdings (10 hectares or above) were only 0.57% accounting for 9% of the total operational area.

Now consider farming economics.

The largest part of the operational holdings is used for growing staples like wheat, rice maize etc. The maximum a large farmer can earn from these crops is Rs200000 to Rs2,50,000/hectare per year, assuming he takes two full crops. For small and marginal farmers these earnings are limited to Rs125000 to Rs175000/hectare per year. (Assuming average productivity of 3.5 tons per hectare)

For Sugarcane average earnings is Rs140000 to Rs165000/hectare per year. (Assuming average productivity of 85 tons per hectare).

For Pulses, and oilseeds the average earnings per year could range between Rs2,50,000 to Rs3,00,000. (assuming average productivity of one ton for pulses and 1.2 tons for oil seeds)

For vegetables and fruits, average earnings could range between Rs4,00,000 to Rs5,00,000 in good years.

Tax revenue potential

As per the above optimistic earnings estimates and assuming only one bad crop in three years, the total tax collection potential from farmers could be projected as follows:

·         Small and marginal farmers (46% of operational holdings) assuming an average holding of one hectare per family of two adults – NIL

·         Medium farmers (43.6% operational holdings), assuming an average holding of 5 hectares per family of 2 adults growing one staple crop and one cash crop- NIL

·         Large farmers (9% of operational holdings), assuming an average holding of 15 hectares divided equally between staples & cash crops and 50% given on rent or crop share, accounting for 15% of crop GVA, four adults per family, and effective tax rate 20% - Rs40000cr.

Of course, these are back-of-the-envelope calculations with very optimistic estimates of crop productivity and prices. If we consider one bad crop in three years (which is the normal case) the potential tax collection will diminish materially. Also, if we adjust it for the taxes already been collected by the states, the potential will be even less.

For context, during FY23, the government collected Rs19,72,248 crore in gross direct taxes. The top potential for tax on agriculture is just 2% of this amount.

Trivia

Many people might be using agriculture income for laundering money. They may be showing exaggerated income from their farmlands just to convert their black money (cash) into white money. If we start taxing agricultural income, they will just stop this practice. Nothing will get added to the revenue kitty. Rather, the cash will stay in the parallel economy, and the interest income (which would have been otherwise fully taxable if the principal amount was declared as legal money), will also escape the taxation.

In conclusion, this whole discussion about taxing agriculture income is much ado about nothing.

Tuesday, March 5, 2024

Cognitive dissonance- 4

Continuing from last week

Thursday, February 29, 2024

Cognitive dissonance- 3

 Continuing from yesterday.

Wednesday, February 28, 2024

Cognitive dissonance- 2

Continuing from yesterday’s post, let me share my thoughts on the issues raised therein. 

If the condition of the economy is so bad, why are the equity markets booming?

In my view, there is nothing unusual or unprecedented in the current equity market behavior. We have witnessed markets scaling new highs during 1989-1994 (Sensex up 482%) when the global economy was struggling in the aftermath of the severe global economic slowdown; NATO forces attacking Iraq and a sharp rise in energy prices; India facing a severe balance of payment crisis, needing an IMF bailout; fall of National Front government in two and a half years and subsequently Chandrashekhar government within six months, and a minority government led by P. V Narasimha Rao at the helm in Delhi; first major financial market (Harshad Mehta) scam in India; belligerent BJP taking out Rath Yatra from Somnath to Ayodhya, Mosque demolition in Ayodhya and subsequent acts of terrorism that killed thousands; a slew of economic reforms causing the decimation of numerous MSME businesses. Commodities producers led the charge in this rally.

During 1999-2000, markets scaled new highs (Nifty up 42%) despite massive political uncertainties (3 general elections in 3 years); severe global economic sanctions post-1998 nuclear tests leading to sharp growth deceleration and capital outflows; LTCM default; sharp currency devaluation by Brazil, an Asian economic crisis; etc. The market rally was however very narrow, mostly led by IT services and the Internet.

The 2003-2007 market move was perhaps the most phenomenal (Nifty up 461%). Markets scaled new highs without any earnings growth. Corporate and lenders’ balance sheets worsened at an unprecedented pace – both in India and globally. The up move was much broader with consumers, financials, and capex all contributing in some measure.

The 2017-2024 market rally is remarkable in more than one sense (Nifty up 170% so far). First, it is perhaps the longest bull market in India. It survived the worst pandemic in over 100 years, rather easily. It has also survived, perhaps what could be termed the worst geopolitical crisis since the end of the Cold War. The leadership of the rally has rotated remarkably between a variety of sectors like consumers, financials, small and midcaps, capital goods, infra builders, realty, commodities, energy, healthcare, IT services, telecom & digital, etc.

My take on the current equity up move is:

1.    Equity markets have always looked for opportunities in the crisis. The markets are looking much beyond whatever is happening today. Of course, there will be intermittent corrections and crashes, but Indian equities are geared for much longer bull markets this time, regardless of the global conditions. We have seen similar secular bull markets in the US, Europe, Japan, etc. in the post-WWII era.

2.    The Indian equity market may be inching towards reality, i.e., rising income inequalities, stressed household finances, geopolitical uncertainties, and near-shoring and friend-shoring. The market is rewarding premium consumption, workforce rationalization (cost cutting), geopolitics (defense), local capex, manufacturing, and logistic infra, etc., and punishing staple consumption, savings, etc.

3.    The market is not expecting any significant disruption due to civil unrest or political changes.

…to continue tomorrow

Tuesday, February 27, 2024

Cognitive dissonance

Last week an appeal purportedly issued by Birla Institute of Technology & Science (BITS), Pilani, to its alumni, seeking their help in the placement of its current students went viral on social media. The appeal mentioned that the global economy may be experiencing its worst slump in decades, with around 4 lac employees being laid off since January 2022. The cost-cutting measures taken by the small and large businesses have resulted in hiring restrictions (including at the campus level) and a funding winter. It added, that the hiring slowdown has deepened in recent months. Some other top-level higher education institutions have also reported challenges in campus placements.

Wednesday, February 21, 2024

Keep the option open

 My recent interactions with many market participants indicated that selling deep Out of Money (OTM) options (mostly Call Options) on the last day of the weekly option expiry days (e.g., Wednesday for Nifty Bank and Thursday for Nifty50) has become a very popular trading strategy for many high networth individuals (HNIs). By pledging stocks, mutual funds, and bank deposits as margin money, HNIs claim to be enhancing their overall returns by 6% to 8% p.a. using this trading strategy.