Vijay Kumar Gaba

 In a paper published in 1988 researchers William Samuelson and Richard Zeckhauser highlighted that a large majority of people have a cognitive bias against change in their present conditions. In their research, they found that “people show a disproportionate preference for choices that maintain the status quo.” They referred to this trait of human behavior as “status quo bias”. Several other researchers have added subsequently to the findings of Samuelson and Zeckhauser.

In my personal life, I have noticed several instances of status quo bias whether it is ordering in a restaurant, making investment decisions, buying vehicles, choosing healthcare professionals, or even voting in the elections.

I find that status quo bias is particularly strong during periods of stress or crisis. I have observed that during periods of stress or crisis (actual or perceived) people generally avoid trying new things, people, or places, etc. They prefer to trust their existing captain when the waters become rough, rather than preferring a change of guards.

The politicians world over perhaps recognized this cognitive bias of people a long time ago and internalized this in their election strategy books. In this age of social media, where information (especially falsehood) spreads faster than sunlight, they often manufacture crises to distract people from real issues and nudge them to maintain status quo, i.e., keep the extant establishments in power.

The reaction of many heads of government, e.g., the US, the UK, France, India etc., to the latest attacks of the Palestinian Hamas Militia on Israeli territories and people indicates their eagerness to shift the popular narrative away from the domestic problems to a distant localized geopolitical event, which may or may not have material implications for their domestic constituencies. To the naked eye, it appears that they are manufacturing a crisis that does not exist just to distract the attention of their domestic constituency and invoke their cognitive status quo bias.

The US economy is struggling to manage the mountains of debt it has accumulated in the past three years; elevated inflation that is hurting the household budgets badly; rising homelessness; rising crimes and drug abuse; crashing ratings of the incumbent President; an apparently clueless central bank; rising discontentment over its policy to fund Ukraine’s war efforts; and diminishing clout over global policy-making (especially in light of the total failure of economic sanctions on Russia and dismal impact of its tariff war with China), pensioners and savers staring at huge losses on their bond portfolios; and financial system placed precariously as MTM losses on their treasury holding climb (eroding their reserves), household delinquencies rising and corporate bankruptcies also rising ominously.

The situation in the UK and France is no different. It may actually be worse than the US, as any visitor to the cities of London and Paris would tell you about the collapse of civic infrastructure, and the rise in homelessness, petty crime, and racial slurs.

Back home, I find that “Hamas” and “Israel” are trending in all social media ahead of the Cricket ODI World Cup. This explains the kind of frenzy created to distract people from core issues that affect their day-to-day lives. Our government seems to have changed our long held Middle East policy of equidistance from both Israel and Palestine, without any discussion or offering any explanation, totally disregarding the fact that it could have serious implications for our energy security and internal security.

 In my view, we have entered a phase in world history where the politico-economic ideologies, e.g., free market, socialism, communism etc., have lost their theoretical context. In a significantly large number of countries the ruling parties and their leaders are not particular about adhering to their core ideologies. The voter base of the parties also appears to be divided on the basis of current issues rather than the core ideologies.

 Yesterday I had a long discussion with a renowned social media influencer. The core topic of the discussion was what could be a good method to test the character and strength of a phenomenon, e.g., popular leader, progressive society, ideology, innovation, system, organization, etc.

The point of debate was whether the evaluation should be based on how the underlying has performed under the normal stable circumstances or should include the handling of exceptions as well. The conventional wisdom says that the true test of character and strength of a phenomenon is tested during a crisis. When the sailing is smooth, even an ordinary captain will command the ship safely to the destination.

My view is very clear in this context. I believe a phenomenon could be termed so only when it has helped in normalizing an exception(s). For example, to me a captain would be phenomenal if he designs or helps in designing a guidance system that enables all sailors to navigate through turbulent waters comfortably. Similarly, a political leadership would be phenomenal in my view, if it implements a policy framework that is efficient enough to handle most exceptions in the normal course.

In the investment context, enterprises that are always geared to handle economic cycles in the normal course of their business should be the most preferred investment candidates. The enterprises that have shown extreme volatility in their profitability and sustainability during crises like global financial crisis and Covid-19, regardless of eventual recovery and growth should be less preferred than the enterprises that weathered the crises smoothly and maintained a steady progress.

To put it simply, the managements which were showing extreme exuberance in 2018-2019 and have been regularly complaining about raw material price hikes; worker shortages; supply chain issues; consumer demand etc. to justify their poor performance every quarter since mid-2020 may not be the ideal companies to invest, regardless of their popularity or average performance track record over a longer period.

Investors need to remember that it is highly probable that they may need to sell their investment during a crisis when there would be few buyers in the market and the stock they own would be trading at the lowest price in the market cycle. Because this would be the time when their finances would be constrained and their inclination to borrow money, while staying invested in equities, would be at the lowest. Hence, the statistics about 10yr XIRR (usually from the low point of previous market cycles to the highest point in the current market cycle) of a stock is not only redundant but also ridiculous. If at all, they should consider the XIRR from the median point in the previous market cycle to the lowest point in the latest market cycle to assess the performance of a stock.

Elsewhere, some of the most powerful political leaders (technically) in the world, e.g., Joe Biden and Boris Johnson, et. al., have shown extreme vulnerabilities in handling crises. The unconventional monetary policy followed since 2009 has also failed its first examination. Many experiments with laissez faire in India have failed repeatedly. Accordingly, long US equities (on Trump loss); Long London real estate; long developed bonds and long PSUs in India have been some of the notable disappointing trades in recent years.

 It was a sunny afternoon in winters of 1991. I was enjoying coffee at a famous public café in Connaught Place (New Delhi) with couple of my friends. All of us were waiting for our CA Final result, which was to be announced in couple of weeks. My friends were senior to me and were already working, having completed their articleship two years ago. We were discussing the economic changes that were getting unleashed in the country by the new regime that had assumed office a few months ago.

The economic changes had not impacted me in any positive manner by then. INR devaluation had led to inflation spike disturbing our household budget. Some of my close relatives who were running micro and small industries (then called SSI) were deeply worried about sustainability of their business as they were now exposed to competition from larger businesses and imports. My cousins had their own set of worries. The implementation of Mandal Commission recommendation was reaffirmed. The competition to get government jobs and admission into public educational institutions had intensified for general category candidates. The aftershocks of former Prime Minister Rajiv Gandhi’s brutal killing, gulf war, Punjab terrorism, were still being felt in Delhi. Overall things were not looking great from where I was standing that afternoon.

My friends who had started investing in stocks were however in high spirits. They had earned very good profits by trading. Their employers had promised them promotions if they pass their final exams. They already had a new Idol in (now infamous) Harshad Mehta to look up to. That afternoon, they could not see anything wrong. Arguably, this was their best time in life.

Our discussion was obviously not harmonious.

About an hour later, a middle aged man with very ordinary personality entered the scene. Tarun, my friend, excitedly jumped out of his seat to greet him. “Meet Mr. Hemant Pandey, my stock broker. Hemant ji advices me and also helps in executing my trades at Delhi Stock Exchange. He also knows brokers who can execute trade at BSE”, he proudly introduced the man to us.

And here begins the story.

On enquiry, I found that Hemant, a college dropout, was an “authorized agent” of a “sub-broker” of DSE broker. A friend of his friend was a remisier (a person authorized to go on trading floor) of a broker at BSE. He was therefore able to place orders of his “clients” to brokers at DSE and BSE. Though it could usually take upto 4 days to execute a trade and get confirmation of trade. The brokerage charged ranged between 2% to 5%; and only “market price” orders were acceptable. Delivery of physical share certificates with a valid transfer deed was not guaranteed. It was mostly on “best effort” basis.

That was the situation of Indian financial markets when the liberalization started 30years ago. Having direct access to a stock brokers’ office was sufficient to make someone “important” in his/her social circle. Something similar to if you have direct access to a Minister’s office today.

The people in their 20’s and 30’s who are spammed daily by multiple brokerages to open a trading account at zero brokerage, would never be able to fathom what it was like to be a stock trader or a “retail investor” in pre 1994 days.

Democratization of financial market is one of the most understated reforms of past three decades. The impact of democratization of society in past three decades is visible in almost every sphere. People belonging to the bottom of the pyramid have done particularly well in politics, administration, sports, entertainment, business & professions and science.

However, the easy and free access to financial and banking services has been the most remarkable achievement. Financial inclusion, as we call it popularly, is one of the core pillars of the entire socio-economic development endeavor in past three decades. Technology (especially digitalization) and Telecom Infrastructure are two other strong pillars which have supported the financial inclusion as well.

The tendency to overregulate is one of the undesirable aspects of modern democracy, as it promotes chaos, rebellion and anarchy. Since, the global financial crisis we have witnessed this tendency to overregulate dominating the financial markets also. As a natural corollary, the chaos (heightened volatility), anarchy (unassimilated assets trading at unfathomable valuations) and rebellion (rejection of conventional wisdom in favor of untested experimental ideas) is also prominently visible in markets. May be time is approaching fast when the democratization of financial markets that started three decades ago would also need an affirmative agenda for renewal.

Like Robinhood Markets of US, which pioneered commission-free investing model which allowed many people to start investing, including those who otherwise would never have ventured into stock markets, many platforms have emerged in India also. Zerodha, for example, is now the largest stock trading platform in India in terms of number of clients.

There are multiple platforms for trading of unconventional financial products like cryptocurrencies (e.g., Bitcoin) and Non-fungible tokens (NFTs).

Advent of new technologies, new products, new set of investors, new methods of valuations and different risk profiles perhaps require a fresh approach to the financial markets regulatory framework.

So far the regulators and governments have adopted an incremental approach for regulating the emerging developments in financial markets. This is apparently resulting in overregulation, misregulation, rebellion and chaos.

Margining and disclosure norms which are not in synch with the current market realities; abundant trading in unregulated (grey) markets; mushrooming of unregulated crypto & NFT exchanges and platforms; participation of large number of individual investors with inadequate financial literacy and risk tolerance etc. are some of the problems that are plaguing the markets.

Some of the problems that may require a totally new approach to regulations could be illustrated as follows:

·         Under pressure from market forces, the market regulator SEBI has been forced to defer the implementation of proposed tighter margining norms.

·         The managements are disclosing so much irrelevant and redundant information to the market, on the pretext of regulatory requirement. The relevant information many a times is getting lost in this overwhelming deluge of redundant information.

·         There are numerous cases of offer for sales (in guise of initial public offers) where the existing investors have exited at apparently unjustifiable price. The managers of these issues owe no accountability to the gullible investors who may lose substantial money.

·         Trading in new assets (Cryptos, NFT etc.) so far is unrestricted. There are numerous traders who may not be adequately skilled to understand the risks. There is no visible effort from regulators so far to improve the literacy and awareness level of these traders. It is therefore desirable that for the time being the trading is restricted to the discerning traders only.

President Biden stated on the International Day of Democracy, “No democracy is perfect, and no democracy is ever final. Every gain made, every barrier broken, is the result of determined, unceasing work.” He has made it clear that renewing democracy in the United States and around the world is essential to meeting the unprecedented challenges of our time. He brought the global leaders from government, civil society, and the private sector together to a global democracy summit, to “set forth an affirmative agenda for democratic renewal and to tackle the greatest threats faced by democracies today through collective action.”

It is imperative that this principle is applied to the financial markets also. The promised new code for the regulation of financial markets must take a fresh approach to regulation rather than adhering to the usual incrementalism.

Recently, the President of US, Joe Biden, laid out a framework for nearly US$1.75trn in social sector funding. The plan, inter alia, proposes a spending of $400 billion to help provide subsidized childcare for more than 6 million children and tuition-free preschool for 3- and 4-year-olds, along with $555 billion for clean energy initiatives, including $320 billion in tax credits, to help Americans pay for environment friendly home improvements and corporation’s transition to clean-energy manufacturing, over the next 10 years.

The President has proposed to fund this spending through a 15% corporate minimum tax on large corporations, tax on stock buybacks and a surcharge on the top 0.02% of high earners.

However, the proposal to tax the superrich (700 odd billionaires) on their unrealized gains on assets could not be pushed for lack of necessary support. Nonetheless, the proposal has reignited an intense debate, as the opinions are vertically divided on the legality and morality of the proposal.

Those opposing it are arguing that taxing the unrealized gains on stocks etc. would not stand the legal scrutiny as such gains are mostly notional and do not meet the criteria of “taxable income”. Even Democrats like Senator Joe Manchin opposed the proposal on the ground of disparity. He reportedly said, “I don’t like it. I don’t like the connotation that we’re targeting different people.”

Elon Musk, one of the Billionaires who would be most affected by the proposed tax, argued that the proposal could open the door to future tax hikes that would cover a wider range of middle-class Americans with investments. “Exactly. Eventually, they run out of other people’s money and then they come for you”, he reportedly commented on the proposal.

The supporters of the proposal however appear convinced that it is morally and ethically appropriate, that the superrich pay taxes on their entire income and not just the meagre salaries and dividend they draw from their corporations.

Chuck Marr, Director of Federal Tax Policy at the Center for Budget and Policy Priorities thinktank, cited the example of Jeff Bezos, Founder of Amazon.com Inc. Jeff Bezos, reportedly draws a salary of about $80,000 a year from his company, though his Amazon stock holdings increase in value more than $10bn a year. “If Mr Bezos does not sell any of his Amazon shares in a given year, the income tax ignores the $10bn gain, and effectively he is taxed like a middle-class person making $80,000 a year”, Marr tweeted.

In view of the supporters of the proposal, it is not correct to argue that the rise in value of shares is totally notional. The superrich are able to leverage their shareholding to borrow substantial money to grow their wealth even more, giving rise to the already wide and deep inequalities. In that sense, the rise in value of the shareholding is tangible and could be taxed.

As per some estimates of the White House economics team (see here), the top 400 wealthiest families in the US paid federal taxes at an average rate of 8.2 percent; whereas an average American citizen pays federal taxes at an average rate of 14.6 percent. Therefore, apparently, the present tax code is regressive and needs to be reformed.

Though the plan did not find favour with a of majority law makers, there appears to be a strong popular support for such a measure. As per a Vox and Data for Progress poll, ‘71 percent of voters support raising taxes on the wealthiest 2 percent of Americans to pay for the bill. Eighty-six percent of Democrats and 50 percent of Republicans backed the idea. Other tax provisions focused on the wealthy that could be included in the bill — such as tax increases on corporations and capital gains — found 65 percent or more support overall.”

It may be relevant to note in this context that the concept of taxing the unrealized gains on investments is not new to the US tax code. US taxpayers are taxed on their unrealized gains on the investments in Passive Foreign Investment Company (PFIC), e.g., mutual funds, every year. The unrealized gains on employees stock options are also taxed.

Context for India

Like the US administration, the government in India has also embarked on a massive social sector and infrastructure building plan. In the latest Independence Day speech, prime minister Modi had outlined a Rs100trn Pradhan Mantri Gatishakti Bharat Master Plan for integrated infrastructure growth. As part of the comprehensive Covid-19 relief plan, a Rs20trn Self Reliance (AatmNirbhar India) program was also announced last year.

To muster financing for these plans and mitigate their fiscal impact a number of measures have been proposed - aggressive sale of public assets and hike in duty on fuel being the two prominent ones. A committee has also reportedly proposed hike in duty on cigarettes from the next fiscal year.

It was widely anticipated that the government will impose some kind of surcharge on rich in the union budget for the current fiscal FY22 to raise additional resources. However, the government refrained from doing that.

The current status is that the sale of public assets has started to gain some momentum with privatization of Air India and scheduling of LIC public offer. This shall help in keeping the fiscal math balanced. We may not see the interest rates rising materially from the current level. The interest on savings shall also remain low, which essentially means stress for pensioners and small savers.The persistent hike in duties on fuel and cooking gas (except one major cut on Diwali) has also significantly impacted over a billion common people directly, or through a second round inflation impact.

The question now is what would be a better course of action for the Government of India—

Should it consider taxing the superrich Indian billionaires on their wealth and/or unrealized gains? Or

Should it continue taxing over a billion commoners who are already struggling with Stagflationary conditions for the past few years now?

Prima facie, the tax structure in India appears to be progressive as the effective rate of tax on tax payers with taxable income of over Rs10million being substantially higher than the tax payers in lower income groups. Also a large majority of households have been kept out of tax net by keeping the threshold higher. Less than 15million people in India are liable to pay tax on their income. Even out of these 150million, about 100million report an annual income of less than Rs one million, and have an effective tax rate of less than 20%.

Obviously, this debate does not suit the stock markets and equity investors. Nonetheless, the issues are important and need to be discussed objectively and intensively.

 Historic performance of a banker

In the summer of 2007, at the peak of sub-prime bubble, a top executive at a global bank presented to the Board that the bank has expanded its footprints to 11 new frontier markets and materially augmented the operations in the 13 emerging markets by enhancing the workforce by 19% in the past one year, a record in the 90year history of the bank. The board applauded the presentation and approved the 100% hike in the annual bonus for the top executive.

In the spring of 2009, the same manager made another enthusiastic presentation to the management. He said, “the management has been able to cut the cost by a whopping 28% to meet the challenges of global financial crisis. We have optimized our operations by exiting the non-profitable operations in 17 frontier market and 2 merging markets, and materially curtailing the operations in 9 emerging markets, to achieve 20% cut in the total workforce in the past one year; a record in the 92years history of the bank. The board applauded the gigantic effort of the management and approved a modest 35% increase in the bonus of the top executive.

Super Heroes and the Super power

The President of the United States, Joseph Robinette Biden Jr., defended the decision to withdraw forces from Afghanistan after 20 years of conflict. He described the decision as “the best and the right decision for America which ended an era of major military deployments to rebuild other countries.” In his address to the nation on Tuesday, Biden said, “there was no reason to continue in a war that was no longer in the service of the vital national interest of the American people.” He further assured is people by saying, “I give you my word: With all of my heart, I believe this is the right decision, a wise decision, and the best decision for America, he said.”

When the US decided to send the troops on ground in Afghanistan in the wake of the attack on World trade Center in New York (9 September 2011), the then president George Bush has commented, "The attack took place on American soil, but it was an attack on the heart and soul of the civilized world. And the world has come together to fight a new and different war, the first, and we hope the only one, of the 21st century. A war against all those who seek to export terror, and a war against those governments that support or shelter them."

After 20years, the US government has ended the war by handing over the power to the same people who it was supposedly fighting for 20years.

However, both the decision to invade and quit have been described as historic and in the best interest of the people of United States.

Art of managing the denominators

“This is massive! India records a GDP growth of 21.1% in Q1 o FY21-22”, exclaimed a leader of the ruling party.

One of the key economic advisors of the government emphasized that “the GDP data for the first quarter reaffirms the government's prediction of an imminent V-shaped recovery made last year.”

“It's a big economic comeback. Q1 GDP of 2021-22 grows by a phenomenal 20.1% as per provisional estimates”, a senior union cabinet minister exuded ebullience.

Similar sentiments were expressed by most office bearers and prominent supporters of the ruling party, advisors to the government and members of the union cabinet.

On the other hand, the members of opposition parties, their supporters and some outside experts were not too impressed with the apparently high growth number.

A prominent left party leader rejected the claims of the government by highlighting that “Compared to 2 years ago, India’s GDP shrinks -9.2%.”

A Congress spokesman clarified that “India's GDP for April to June 2021-22 (Rs32.38trn) is lower than India's GDP for April to June 2019-20 (Rs35.85trn) and very close to India's GDP for April to June 2017-18.”

A former senior economic advisor to the government who is presently a senior official with IMF, rejected the GDP as a shocking bad news. He commented, “It needs just a little arithmetic to see that India's Apr-Jun 2021 growth of 20.1% is shocking bad news. The 20.1% is in comparison to Apr-Jun 2020 when India's GDP had fallen by 24.4%. This means compared to GDP in Apr-Jun 2019 (i.e. 2 years ago) India has had a negative growth of -9.2%.”

The politicians these days have mastered the art of managing the denominator. They set a weak denominator to exaggerate your status and performance. Most governments have, for example, moved the denominator to “pre Covid” levels to make exaggerated claims of their status and performances. Not many people are bothering to note that “pre Covid” conditions were pretty bad in itself and reaching there by making a V shaped recovery may not be a great feat in itself. Though it certainly provides comfort that we did not deteriorate much due to covid.

Insofar as the common people are concerned, they would be better off ignoring these manipulated narratives and focusing on the per capita real growth in GDP and change in the Gini coefficient that measures the scale of economic inequality in the country.

The real GDP growth in percentage terms will have little meaning if the base or the denominator is very low (which is the case at present) or it is not adjusted for the population growth or the real household inflation. A 5% real GDP growth with 2% population growth would mean just 2.9% growth in per capita income. This is not likely to cause any material improvement in their lifestyle; especially when it is deflated by the headline inflation which may be very different that their actual household inflation. Also if the income inequality rises more with rise in GDP, it would mean that their income may not rise in tandem with the rise in average per capita income of the country.

 My dilemma this morning is whether I should be concerned about the internal politics of the United States of America, as most of my colleagues and financial market participants appear to be! In past 20yrs, we have seen George Bush Jr. (Republican, 8yrs), Barak Obama (Democrat, 8yrs) and Donald Trump (Republican, 4yrs) as presidents of United States. In these 20years, India witnessed Atal Bihari Vajpayee (NDA, 3.5yrs), Manmohan Singh (UPA, 10yrs) and Narendra Modi (BJP, 6.5yrs) as India’s prime minister.

Evidently, a Socialist India (UPA) has lived well with Republican US (Bush); and a free economy supporter India (BJP) has lived well with Democrat (Obama) US. In past two decades, we have achieved progress in our civil nuclear program and we have been able to materially enhance our relationship with key US allies like Japan, Australia, UAE, Saudi Arab, and France; while maintain our strong relationship with Russia and Iran. The relationship with China has been volatile all through these years; though US has supported us in the rough patches of Sino-India relationship.

The issue of VISA, especially H1B VISA, has frequently made news in these past two decades. The volume and profitability from US business of our IT companies has grown manifold in these two decades, despite all this noise. The issue of FDA being particularly strict on Indian pharmaceutical exporters to US has also made to the headlines frequently. The US business of our pharmaceutical industry has also grown multifold in these two decades. The number of USFDA approved facilities in India has grown exponentially in past two decades.

Of course we can debate that the trade could have been much higher; or we did not do as well as we could have due to VISA restrictions, FDA actions etc. But, then we will have to answer some tough questions like lack of ethics and discipline at some of our pharmaceutical manufacturers, protectionist policies of Indian government, misuse of H1B and L1 VISA by some of Indian IT services companies, etc. It is therefore better to go with the empirical evidence rather than dwelling upon some hypothetical outcomes. And the empirical evidence is that Indo-US trade and strategic relations have been widening and deepening consistently. George Bush had famously expressed his “respect” for Atal Bihari Vajpayee, and “Love” for Dr. Manmohan Singh. “Barak” visited India twice (most by any US president) and expressed his reverence to Gandhi, admiration for Prime Minister Modi and commitment to relationship with India. Trump has gone much ahead in showing bromance with Prime Minister Modi and expressing love for “Hindu”. Biden has chosen Kamala Harris as his running mate and has promised favorable H1B regime for Indian IT companies. Regardless of who gets to live in White House for next four years, 2020 election may end up with highest number of Indian American elected as federal and state law makers.

I feel, worrying about the outcome of US elections may be out of habit of worrying too much. I believe, in broader context, the question “Trump” or “Biden” may not be any different from “Suicide” or “Murder” (of SSR).