Vijay Kumar Gaba: crisis of confidence

Showing posts with label crisis of confidence. Show all posts

Tuesday, August 20, 2019

Suggestions for stimulating the economy

Suggestions for stimulating the economy

The number of people cautioning about a deeper and longer economic slowdown in India is rising by the hour. Tata Motor's management has guided for double digit fall in automobile sales in FY20 (see here). Most auto companies have announced shut downs; some have also announced significant reduction in the employed workforce. SBI chairman is insisting on urgent need for some stimulus in almost each of his public presentations (see here). Most other senior banks and industrialists have also sounded the caution begul (see here)

The stock markets have corrected sharply in past one year; though the benchmark indices may not be reflecting the correction as yet. The wealth erosion for investors has been material. The market participants are clamoring hard for a stimulus package to bring the economy and market back on path of high growth.

Whereas, most businessmen and market participants have echoed the demand for stimulus, I have not seen many actionable solutions being suggested. Generally the solutions suggested are limited to lending rate cut, GST rate cut, and roll back of tax provision relating to surcharge and long term capital gains.

In my view, roll back of the tax provisions relating to long term capital gains and surcharge on high income non corporate entities may not add to the economic growth in any significant measure, though it might be a short term sentiment booster.

As per the available data, SBI has already cut MCLR by about 30bps post recent repo rate cut of 35bps. Current SBI MCLR (8.25%) is now ~100bps lower than the highest rate seen in early 2016. However, the current interest rate is still 300bps higher than the lowest rates we saw in 2003. Given the persistent low inflation, low money multiplier and global strong deflationary trends, there is scope for meaningful rate cut. To be effective immediately this rate cut must have some shock value. Small doses of 10-20bps cut in lending rate may take much longer to reflect in higher demand and therefore may not qualify as "stimulus".

A material cut in GST rates for automobile etc may stimulate demand. However, the impact may be somewhat neutralized as lower GST revenue shall constrict government's spending ability. In case the government chooses the path of fiscal expansion through additional market borrowing, the private investment may get crowded out. GST rate cut therefore may not be an easy option for the government to exercise.

I believe the government needs to take these conventional stimulating measures steps in adequate quantity. However, to enhance the impact of these measures, a number of additional measure aimed at boosting sentiments and stimulating higher trade volumes and activity level would be needed simultaneously.

The following are some of the illustrative measures that could be considered by the government for immediate implementation:

(a) In most parts of the country, the Ready Reckoner or Circle Rates (minimum property rates considered for levying stamp duty) are much higher than the prevailing rates of property. The government must consider bringing this minimum threshold to 10% below the prevailing market rate to stimulate transactions in property market.

(b) Capital gains of upto Rs25lacs on all constructed properties may be exempted from income tax for two years, i.e., AY21 and AY22.

(c) Capital gains on sale of gold may be exempted, provided the entire sales proceed is invested in buying one or more constructed property (residential or commercial).

(d) Concessional Housing advance by companies to their employees in next 2years may not be treated as perquisites during the term of the advance.

(e) Trading in agri commodities may be exempted from cash transaction limits completely for 2yrs, i.e, till March 2021. Post that restrictions may be applied in graded manners over next 5yrs.

(f) GST input credit for automobile purchase may be allowed for six months, i.e., October 2019 to March 2020.

(g) Upto 50% discount may be offered on power tariffs to all green field industrial units that are approved before March 2020 and begin commercial operation before March 2022.

(h) The payment time for all government contracts and supplies may be cut to 15days from the present 60-180days. All outstanding payments to contractors and suppliers may be released immediately. The arbitration and legal awards in favor of the contractors and suppliers may be honored immediately.

(i) PSU banks may be adequately recapitalized immediately.

(j) Long term corporate bonds (10yrs or more original maturity) may be treated at par with equity for capital gains taxation purposes. Periodic Interest on such bonds may be taxed @10% without any limit.

(k) CSR spend in setting up rural schools and health centers may be made tax deductible at 125% of the amount spend. The operating and maintenance expenses on such schools and health centers may also be made tax deductible.

(l) 25% capital subsidy may be provided to agri produce processing units set up in the rural areas, provided the farmers who would supply agri produce for processing to such industrial unit form a cooperative society; and such cooperative society is allotted 25% equity in such unit free of cost. Gram Sabha land may be leased to such industrial units at nominal rent.

(m) The government may make a solemn promise that the effective rate of direct taxation for any assessee shall not rise for next 3yrs

Tuesday, July 30, 2019

Enforce rule of law and ensure certainty of policy

Some food for thought

"Thank goodness I was never sent to school; it would have rubbed off some of the originality."

—Beatrix Potter (English Author, 1866-1943)

Word for the day

Fulgurant (adj)

Flashing like lightning.

First thought this morning

Reportedly, Prime Minister Narendra Modi will feature in an episode of Man vs. Wild, to be aired on Discovery Channel on 12th August 2019. Enticing stills from the episode, with PM enjoying the wilderness of Uttrakhand with UK television presenter and adventurer Edward Michael Grylls, popularly known as Bear Grylls, are splashed all over the internet.

Distressed participants in financial markets, stressed businessmen and disenchanted commoners have naturally reacted negatively on the social media. The general feeling is that the prime minister himself should be focusing more on the economic slowdown and depressed markets rather than indulging in this almost contemptuous show of love for nature.

On the other hand there are many who believe that this rendezvous of prime minister is important from two viewpoints: (a) It encourages countrymen to see that PM is in full control; and (b) the real socio-economic conditions may not be as bad as the popular narrative on social media, pink papers and blue TV channels is indicating.

I would avoid taking a view this morning, but honestly I am not comfortable with the present socio-economic environment.

Chart of the day

Enforce rule of law and ensure certainty of policy

The first thing after assuming charge of office, the incumbent Chief Minister of Andhra Pradesh had ordered cancellation of many projects awarded by the preceding government (see here).

Andhra Pradesh Government has also decided to reopen power purchase agreements (PPAs) inked under the previous TDP government, that could potentially bring 5.2GW solar and wind energy projects with an estimated debt exposure of over INR21,000cr under stress (see here). The state seems to be moving ahead with this proposal despite strong request from central government (see here) and order of the High Court (see here).

Subsequently, the World Bank decided to "drop" funding of “Amaravati Sustainable Infrastructure and Institutional Development Project”, seriously affecting the future of the project which has already swallowed Rs 45,000 crore worth of public money with less than twenty per cent of the work completed. (See here) Following the World Bank, the Asian Infrastructure Investment Bank (AIIB) has also decided to withdraw from funding the project. The decision to withdraw funding has been reportedly taken after the Central Government withdrew its request for funding of this project.

I understand from various sources that the Chief Minister Office has also ordered a hold on payments due to contractors for various projects under execution, pending investigation of any irregularity in awarding of contracts by the preceding government.

Reportedly, the newly sworn in Chief Minister of Karnataka has also expressed his intention to review the decisions taken by the preceding government.

These decisions to "review" or "cancel" contracts awarded by outgoing administrations are ostensibly "anti corruption" measures, giving the incumbent governments a high moral ground. We have therefore not seen much outcry against such appalling decisions. Media, central government, corporate, civil society, youth, and judiciary all seem to have accepted this as fait accompli.

The immediate impact of these decisions is -

(a) Firms which have invested in capacity building to execute the contracts "under review" and/or part execution of the contracts face losses and uncertain future;

(b) The lenders who have funded the firms for execution of these contracts face uncertainty about the realization of loans already disbursed and future demand of funds;

(c) Political risk exacerbate to a new level. This "review" process sets dangerous precedence for all future government contracts. This might deter all firms to bid for government contracts, especially during the last couple years of the term of the government.

(d) Investors will take a negative view of the government business leading to material erosion in the valuation of contractors executing government projects. We have already seen almost 40% erosion in the share price of NCC Limited, who got Rs61bn worth of order cancelled by the Andhra Government in past two months.

The worst impact of such actions is however immeasurable. The trust deficit between private enterprise and government has been a major impediment to the growth and development of the country. These actions would only further widen the deficit.

I understand that besides these latest instances of government reneging on its contractual obligations, there are numerous cases where the governments (central as well as state) are refusing to honor arbitration awards given in favor of contractors like HCC Limited and others.

This also reminds me about the concerns and promises made in the recently released Economic Survey 2019. For example, consider the following:

Chapter 05, Part 1 of Economic Survey 2019

"Arguably the single biggest constraint to ease of doing business in India is now the ability to enforce contracts and resolve disputes."

"The relationship between economic governance and the Rule of Law (Dandaniti) has been emphasized by Indian thinkers since ancient times. It is seen as the key to prosperity, and a bulwark against Matsyanyaya (i.e. law of the fish/jungle). It should be no surprise, therefore, that the Preamble to the Constitution of India defines that the first role of the State is ‘to secure for all its citizens: Justice, social, economic, and political’. In other words, it is well accepted that economic success and prosperity are closely linked to the ability to enforce contracts and resolve disputes."

"India continues to lag on the indicator for enforcing contracts, climbing only one rank from 164 to 163 in the latest report of EODB, 2018."

Chapter 06, Part 1 of Economic Survey 2019

"What is the effect of uncertainty/ambiguity in policy making on the investment climate in the economy?" "...such uncertainty can spook investors and spoil the investment climate in the economy. Such uncertainty in economic policy can be avoided. In contrast, a nation state that ensures predictability of policy action, provides forward guidance on policy action, maintains broad consistency in actual policy with the forward guidance, reduces ambiguity and arbitrariness in policy implementation creates economic policy certainty. Investors may enjoy the certainty provided by such an environment and flock to invest in this environment."

The government recognizes that the biggest impediment to the ease of doing business in India is State's inability to "enforce contracts and resolve disputes". And policy uncertainly and ambiguity could "spook investors and spoil investment climate".

Despite this realization we see absolutely no effort to guarantee at least the contracts where the government is a party. In fact as per several reports, the government itself is the largest litigant in the country.

Wednesday, July 24, 2019

Crisis of Confidence

Some food for thought

"I may neither choose who I would, nor refuse who I dislike; so is the will of a living daughter curbed by the will of a dead father. "

—William Shakespeare (English writer 1564-1616)

Word for the day

Qua (adv)

As; as being; in the character or capacity of. For example, The work of art qua art can be judged by aesthetic criteria only.

First thought this morning

Tumbling stock prices, sagging business sentiments, outcry on social media against anti business policies of the government have all failed to motivate a review of tax proposals in the Union Budget for FY20. The government and IT department are showing strong determination to retain the proposal to impose higher tax on super rich, including the foreign investors not registered in India as a corporate entity.

After three weeks of persuasion and threats, it seems the tax payers are beginning to reconcile with the new reality. The demands are now narrowing down to "at least exempt foreign sovereign funds from this surcharge" and "Please do not charge interest/penalty on June advance tax installment, which was paid before budget and did not consider this surcharge in calculations".

I am not sure how to react. Congratulate the government for holding its ground firmly, or regret choosing a government that is not bothered about the serious repercussions of a questionable decision.

Chart of the day

Crisis of Confidence

I received a number of comments on yesterday's post regarding sagging business sentiment in India (see here).

Except for their email addresses, I do not have any other information about the respondents. Therefore, it is not possible to make a qualitative analysis of their views. Nonetheless, a rudimentary view could certainly be formed based on these comments.

The commentators broadly appear divided in three camps, insofar as the factors affecting business confidence in India is concerned.

(a) The largest camp believes that lower business confidence is function of excessive controls and compliance pressure imposed on businesses in past 5years. This group believes that despite great promises, the NDA government has not been able to obliterate the growth impediments that caused "policy paralysis" during late years of UPA2 government. For example-

The sustainability conflict has actually exacerbated in past five years with businessmen, policymakers, regulators, and judiciary taking divergent views, leading to avoidable, repetitive, protracted litigation. Decision of Bombay High Court to stay construction of Mumbai Coastal Road Project, is the latest example of this conflict.

Overreach of tax authorities to tax payers has crossed the line of harassments. Taxmen are supposedly under tremendous pressure to extract maximum revenue to fill the fiscal gap. This pursuit of tax maximization is bordering the line of extortion, making even honest taxpayers fearsome and frustrated. One respondent highlighted how the IT department did not acknowledged the self assessment tax paid by him and issued a huge demand notice. The reply to e-proceeding did not elicit any response for months. He was called to the IT office personally and bluntly told to pay the demand and claim refund later.

Similarly, there are several glitches in GST system, which are not in the priority of the department for correction. For example, the status of GST refunds for the bills which remain unpaid due to inability of the customer to pay or litigation/dispute is still not clear. Moreover, IT authorities are usually matching the GST return and revenue reported in the IT returns and making it a case of misreporting of income and tax evasion, liable for penal action.

(b) People in second camp appear to be of the view that the sagging business confidence is function of two factors: (i) over-expectation from the government which have naturally been belied; and (ii) cyclical economic slowdown that has resulted from tight liquidity conditions, high real rates, stagnant real wages in private sector, NPA cycle, global demand slowdown, and rise in household leverage causing poor consumption demand growth. This group feels, that the cycle could be reversed by usual measure like rate cuts, more cash in consumers' hand (fiscal and monetary stimulus), tax incentives for private investment, easier liquidity and lenient credit terms.

(c) People in third camp are in minority, but most vociferous. They feel that the businesses that have traditionally prospered on the back of state patronage, unfair exploitation of resources (labor, capital, natural resources etc) and tax evasion deserve to be handled with iron hand. These businessmen need to learn to play by the rule book, pay due taxes, comply fully with sustainability, corporate governance & other regulations, desist from excessive profiteering, pay market price for land, capital, wages, and other natural resources and obey the law of land in letter and spirit. If this means few quarters or even years of slower growth, the pain would be worth every pang of it.

My final take on the issue could be summarized as follows:

It would be a mistake to view the present state of poor economic sentiments as a simple economic problem catalyzed by mistrust between the government and businesses, higher taxation, tighter liquidity or down sloping demand cycle. The roots of the problem are much deeper. I feel, besides the usual economic problems listed above, the following factors could also responsible for the sagging sentiments, both for consumers as well businesses.

(a) The fast changing technology landscape is making many businesses redundant. Largest ever number of medium and small sized businesses who do not have wherewithal to adopt new technologies are facing existential risk. Many large legacy businesses which have been lethargic in timely adoption of new technologies are finding it tough to compete with the smart businesses which adapted to the change early and raced ahead.

(b) Globalization of Indian economy is happening at accelerated pace now. Every quarter some new area of business is being thrown open to global competition. The businesses that have been used to operate in protected environment with full state patronage are naturally finding it hard to compete with global businesses with access to larger capital, better technology and wider markets.

(c) The fast changing technologies are also leading to higher rate of workers redundancies. Besides, the compulsion of businesses to become more flexible and lean is also causing the insecurity amongst the employees to rise. Rising job insecurities, erosion of wealth effect due to depressed real estate prices, and poor visibility of professional growth, and elevated household leverage could be some of the reasons for poor consumer sentiments.

Breakdown of dialogue between the government and businesses post Demonetization has deepened the mutual mistrust. The first step to resolve the crisis of confidence must be to bridge this gap and reestablish the dialogue. Making the economic development and growth a one way street, where only the government dictates the terms, may not work under the present circumstances.