Vijay Kumar Gaba

Tuesday, September 24, 2019

Change in corporate tax structure - What does it mean for me

The sudden changes announced in corporate tax structure last week galvanized the Indian stock markets. It has turned the sentiments by 180 degrees from extreme pessimism to extreme optimism within a matter of few hours.

Not only the stock market participants, but all the corporates have also been positively surprised by this sudden announcement. The move has been welcomed by businessmen almost unanimously.

The decision to change the structure of corporate tax is not totally unexpected as this structure has been part of almost all versions of "New Direct Tax Code" that has been a work in progress for past one decade at least. However, the timing and method (through Ordinance) just 2months after announcement of full budget caught the markets by surprise.

Many readers have asked for my views on this decision to suddenly change the corporate tax structure, which I am happy to share as follows:

(a) I believe this decision is very good.

It shall serve to enhance the competitiveness of Indian businesses (i) as exporter of goods and services and (ii) manufacturing location for global corporations which are either looking to diversify their manufacturing facilities away from traditional bases like China and Malaysia etc., or want their manufacturing closer to their target customers in South Asia.

The new structure being a simple one shall also lead to significantly less litigation and disputes.

Since the new structure does away with exemptions and incentives related to SEZ, Backward Area investment etc. it could lead to significantly more efficient industries. This combined with GST and improved logistic infrastructure, may enhance the efficiency of Indian industry materially.

(b) In my view, this change in corporate structure is primarily aimed at attracting FDI in manufacturing and must be based on the expression of interest and/or feedback of global corporations.

It is basically a supply side measure and may not immediately result in higher consumer demand. If the stock market reaction and analysts forecast revisions are to be believed not many companies shall be passing on the benefit of lower tax to the consumers.

In my view, however the assumption of 1 to 1 gain in profit after tax (PAT) is totally unjustified. The gains, if any, will be shared between the consumers and shareholders. A 2-3% cut in tax liability therefore may not result in 2-3% higher PAT.

Therefore, the government may need to supplement these changes in the corporate tax structure with changes in personal income tax and GST to aid the consumer demand.

Insofar as investment demand from the domestic companies is concerned, the current capacity utilization level do not augur well for further capex. We may see some revival in investment demand only towards second half of next fiscal in my view.

(c) To make the new corporate tax structure sustainable and credible, the government must almost immediately announce an aggressive disinvestment plan that involves privatization of a large number of public sector enterprises (PSEs). The practice of disinvestment through book entries (one PSE buying the other or buy back of shares) may not be sufficient to fill the fiscal gap that may be created by the new proposals.

(d) The other countries vying for the business fleeing China, e.g., Indonesia, Vietnam and Thailand etc al. have also cut corporate tax rates to stay competitive. Therefore, only tax rate cut may not be sufficient motivation for the foreign businesses.

The government must follow this up with adequate non fiscal measures like easier land acquisition norms, necessary labor law changes and perhaps higher degree of INR convertibility.

These changes need to be considered and implemented promptly before the investment decisions are taken by the target global businesses.

I am sure the "surprise" has not been a pleasant one for many of the market participants. I know a lot of traders are caught on the short side.

The option writers in particular may have suffered "once in a decade" 6 or 8 sigma event that snatches away a large of profits made by the whole decade. If my memory serves me right, last time an event of this magnitude occurred in 2008. A lesser degree event occurred in 2016.

Besides, many investors who had decided to sit and wait on the sidelines have also been caught totally off guard. Most of them could be heard regretting the missed the "opportunity".

Friday, September 20, 2019

Overcome the inertia first, rest will follow

Since 2014, Prime Minister Narendra Modi has been consistently exhorting the foreign investors to invest in India to take advantage of 3Ds - Democracy, Demography and Demand; a unique strength not possessed by any other major economy of the world.

After 5years of NDA rule under his leadership, many are now challenging this claim.

A large section of domestic and foreign media, and many senior political observers & commentators have raised questions over the present health of the democracy in India. We may heavily discount their stance as deeply prejudicial and driven by ulterior motives, but rejecting it outright may not be totally logical.

The Union Labor Minister himself recently raised question over the quality of human resources in the country, especially the northern states where about two third of the youth population lives. Most business leaders, both from manufacturing and service industries, have frequently expressed grave concerns about the employability of the engineering and management graduates. A host of government and private studies have shown that the level of average students at middle school level in most populous states like UP and Bihar is unacceptable. In many cases class 6 students failed to answer 2nd standard questions. The government has failed miserably in formulating a nation youth policy or even an integrated education policy. If this trend continues, the demography could soon become a liability rather than strength of India. (Also see)

The third dimension, i.e., demand has always been an inarguable strength of Indian economy since early 1990s. The common refrain was that India is so short on the supply side that you could sell virtually everything here. I remember attending an investors' conference in late 1990s, where The CEO of a large automobile company presented that demand is something business manager in India do seldom care about. That was the time when a large FMCG company had launched a 25gm pack of Multani Mitti (Fuller's earth) for Rs40. A Google search would show that even today there are numerous listings on various ecommerce sites for this product at crazy prices.

Earlier this week, the principal economic adviser in the union ministry of finance Sanjeev Sanyal admitted that "The current economic situation is unique in India. All these years, we saw a slowdown in India because of supply-side constraints. This time, we are witnessing a genuine demand-driven slowdown." (see here)

The question is whether Indian Economy has lost its key strength (3Ds) in past five years.

I would not like to make it a political debate and reduce it to BJP vs Congress slugfest. In my view, the weakening of 3Ds is a reality and a deeper independent research study is required to assess since when, how and why the Indian economy lost its key strength. My gut feel is that this trend started more than a decade back and still continues.

On a structural note, I believe that the 3Ds of economic growth are intricately intertwined. The weakness in demand could be arrested and reversed only if some deep rooted reforms are implemented to strengthen the democracy and demography.

Nonetheless, the government may take some short term measures to begin the process from somewhere.

In this context, it may be pertinent to note that the businesses, consumers and markets, all are getting more frustrated with each set of "support measures" being announced by the government to lift the sagging sentiments. The measures announced by the government are misdirected, half hearted, inadequate and in most cases just repackaging of the already prevalent schemes and incentives. This gives a feeling that either the government is not able to comprehend the magnitude of the problem, or it is totally helpless.

In my view, the first thing government must earnestly focus on is to stimulate the economic activity at the lowest level in economy.

To break the negative feedback loop, the traders, investors and businessmen must be encouraged, nudged and coaxed into increasing their level of activity materially. We need to increase the velocity of money. Some small concessions having only notional fiscal impact can do the trick, in my view.

For example, consider the following examples, as suggested earlier also:

(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) 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.

(i) 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.

(j) An aggressive scrappage policy for old automobile (10-15yrs) may be implemented forthwith.

Thursday, September 19, 2019

Is India facing a financial emergency

Yesterday, while wandering through my social media walls and timelines, a thought suddenly stuck my usually slow and lazy brain. I felt that our country might be passing through an economic emergency.

The top most lawyer of the country was found blaming the top court for the economic slowdown in the country.
The RBI governor was widely quoted for admitting that the extent of economic slowdown has surprised the central banker.
The principal economic advisor was seen admitting that the current economic slowdown is unusual as it is for the first time that India is facing a demand led slowdown. Till now the "demand growth" was a constant in India's economic policies and business planning.

The managements and analysts of automobile manufacturers were seen expressing serious concerns over short to medium term prospects of the industry.
A former prime minister was seen criticizing the government for inept handling of economy and making some suggestions.
A former minister and government nominated Rajya Sabha MP was seen criticizing the finance minister and implying that she may not be qualified for the job in a crisis like situation.
The body language of the finance minister, while announcing a set of measures to lift the sagging economy in various tranches appeared unconvincing; as if she her is convinced that these measures are token and may not help the economy in any significant measure.
The core inflation continues to be low indicating total lack of pricing power with the producers.
The prospects of a sharp spike in global crude prices post attacks on Saudi Arab's oil facilities appears to have sent a shiver deep down the spine of many policy makers and market participants. Hopefully it appears that the damage may not be as much as anticipated earlier and Netanyahu's less than expected electoral performance may also have diminished the chance of a full escalation in the Persian Gulf.
Media reports suggested that the residents Indian are sending money abroad under liberalized remittance scheme (LRS) at the fastest rate.
A private equity fund till recently headed by a star banker has defaulted on its debt obligations in a bizarre case, raising the specter of a fresh round of NPAs for banks and mutual funds. Another entity of the beleaguered ADAG has filed for bankruptcy protection.
The politicians belonging to the opposition parties were seen drawing government attention towards the plight of common people due to economic slowdown and contraction in employment growth; while the BJP leaders were mostly dismissive. The NDA allies were conspicuous by their absence from the entire debate.
A pulp fiction writer who is a very vocal and ardent supporter of the prime minister wrote a detailed article in newspapers giving advising the government on how to stimulate an economic recovery. The article was aggressively highlighted on social media also.

The question that bothered me for sometime was whether the government can (or should) use this opportunity to use Article 360 of the Constitution to impose a financial emergency and carry out material administrative reforms. There was a news item that suggested that the government may be considering a salary cut for employees for some PSUs. I wonder if that is possible without using Article 360.

Wednesday, September 18, 2019

Winter of discontent

Yesterday, I made my periodic visit to the Delhi's wholesale and popular retail markets to assess the current trends and mood of the markets. A visit to markets at this point in time is important because this is the time when most of the retailers build inventory for the coming festival & marriage season which usually accounts for almost half of their annual sale.

Unlike, previous years, this time I was not expecting any surprises; and I did get none. The mood of traders as well as buyers was despondent. The following is the feedback from my rendezvous with traders in Delhi.

(a) This year the trade is marginally slower than the last year. However, many traders are expecting the declining trend of past 3years to bottom out this season. Inventories have reduced materially. Costs rationalization has been mostly achieved. GST has been imbibed completely. Integration with

(b) The wholesale trade in grocery items, especially spices &, pulses, is facing structural problems. The volume of trade is rising, but the margins are compressing. The price manipulation by hoarders and large importers has almost ended, so has the volatility in prices. The wholesalers are now keeping much lower inventory and learning to live with nominal trading margins.

The import of confectionary and dry fruits has been lower this year, a second consecutive year of decline. The import of fresh fruits and vegetables is higher as compared to the last year. The volumes are higher but margins much lower.

The working capital finance by banks and NBFCs is much tighter and expensive this year.

(c) The textile trade is slow. The rural demand from J&K, Himachal, UP, MP, Chhattisgarh and Haryana (the markets mostly served from Delhi wholesale trade) is down for second consecutive year. Besides volumes, the prices are also lower this year.

(d) Packaging material trade is also witnessing second consecutive year of contraction. The pricing is stable.

(e) The festival related demand of decorations, lighting, toys, gifts etc. is 15-20% lower as compared to past two years. The pricing is however higher as compared to last year.

(f) Electrical hardware and sanitaryware demand from retail segment is lower than last year (that was not good in itself). However, wholesale demand from realty sector seems to have picked up from last year.

(g) Bullion and Jewelry traders are expecting the demand this season to be lower than last year and appear to have liquidated some of their inventory to take advantage of high bullion prices.

(h) Retail traders were more despondent than the wholesalers. Although the buying season has not even started and this is the leanest fortnight (Pitru Paksha or Shradh) of the year, most retailers are expecting lower foot falls on their shops this year. The wholesalers believe that this pessimism is without basis and retailers may be positively surprised on demand side in next three months.

(i) The traditional markets, where many more people visit and much more business is done as compared to swanky malls in the southern parts of city, had scanty security apparatus; whereas the mall areas had overwhelming presence of security personnel. It is difficult to gauge what is primary objective of the security management by government agencies.

My overall assessment is that with little support from the government trade cycle can accelerate much faster. The steps taken so far by the government are however inadequate and mostly misdirected.

Tuesday, September 17, 2019

Missing pieces in the Jigsaw Puzzle

Last week the media (both social and mainstream) was buzzing with the "source based news" that the government may be considering yielding a controlling stake in public sector oil company Bharat Petroleum Corporation Limited (BPCL) to some large foreign petroleum company. There was however no hint of confirmation from the "official sources".

On Friday, The stock price of BPCL jumped sharply on the basis of this news. However, most of the gains were given up within 5 minutes of the market opening on Monday. The fall was apparently outcome of the rise in global crude prices due to attack on a large oil facility in Saudi Arab.

The enquiry with some large brokerages and traders indicated that the traders, who bought on Friday, were mostly in panic throughout the weekend and capitulated into selling their positions as soon as the opening bell sounded on Monday morning. This stock price movement, though it confirmed the "herd mentality" theory of stock market price discovery, is still befuddling. When I tried to put all the pieces together in the Jigsaw Puzzle, I could not find place for the following pieces:

(a) In 2003, the then Atal Bihari Vajpayee led NDA had attempted to privatize HPCL and BPCL and split Indian Oil Corporation (IOCL) into two separate companies to separate the marketing and refining & petrochemical businesses. The attempt was thwarted by the Supreme Court which ordered that privatization of HPCL and BPCL requires approval of the Parliament.

It is true that the present regime enjoys a brute majority in the Lok Sabha and as such getting approval of the Parliament for selling controlling stake in BPCL may not be a tough task, unlike 2003 when NDA enjoyed thin majority and many within the government (including the Petroleum Minister Ram Naik) were averse to such a move.

Nonetheless, any such move would still require a parliamentary approval. In my view, this proposal cannot be pushed as a money bill, not requiring Rajya Sabha approval.

(b) Any reasonably prudent buyer for BPCL would insist that the policy regarding subsidy on transportation fuel must be cast in stone before any bid is made for the oil marketing and refining company. If I have to take a majority stake in BPCL today, I would insist on a law that either totally and irrevocably prohibits subsidy on transport fuel by the government through public sector retailers, or makes sure that all such subsidies in future are through DBT method only and "at pump prices" are not impacted due to the subsidy on transportation fuel.

(c) The collective wisdom of the market as of today at least does not believe in the government's ability and/or intention to stay firm on its decision to deregulate the prices of transportation fuel. The common belief seems to be that if the crude prices jump sharply higher, the government may still force public sector oil & gas companies to bear some part of higher fuel cost.

Otherwise, how would one explain that a company which deals with an essential commodity having low price elasticity, and earns its margins ad valorem to its raw material, could be a loser on a sudden and temporary rise in raw material price.

Moreover, since the company usually owns significant inventory of the raw material (crude oil), and is also allowed to take forward position in the raw material also, the quarter end results, just two weeks away, shall reflect decent inventory gains and MTM gains on forward positions.

(d) The government may also have to confirm whether it still plans to move completely to EVs by 2030 as announced earlier.

Friday, September 13, 2019

We need to bring down the Prices, not just inflation

Last month a trending news on media highlighted that Mukesh Ambani, chairman of Reliance Group, has not got any salary hike in past one decade. He is drawing the same salary since the global financial crisis.

Incidentally, he is not alone in her suffering. The rickshaw pullers who transport me to and from metro station have also not hiked their per trip charge for past one decade. Porters in Sadar Bazaar, the wholesale market of Delhi, who carry heavy stuff on their head or back, have also hardly got any raise in past one decade. My banker friends are also complaining that they never got the pre global financial crisis level bonus again. The recruiters are happy to claim that they are able to recruit an average fresh management graduate, engineer, CA or lawyer almost at almost the same initial salary as 2008.

Last year The 'State of Working India' report published by Azim Premji University highlighted that despite economic growth and gradual formalization of the workforce, low wages and wage growth remain key challenges with 57% of regular employees earning ₹10,000 or less a month. Even among regular wage workers, more than half (57%) have monthly average earnings of ₹10,000 or less, well under the Seventh Central Pay Commission (CPC) minimum stipulated salary of ₹18,000 per month. As for casual workers, 59% have monthly earnings of up to ₹5,000.

The data seen in isolation may suggest that we are almost a developed economy, where inflation and wages have been absolutely stable for past decade. Ram Rajya is all around, where the richest Asian and a poorest man (rickshaw puller) are contended with no wage hike.

It may be relevant to note that since 2008 we have two pay commission reports and the salaries of government and public sector employees have grown multifold, despite rising deficit, inefficiencies and redundancies. But these employees constitute a very small percentage of the total workforce.

In my view, the price situation in the country needs to be critically examined from this viewpoint. Merely the rate of price inflation may not be an adequate criterion to be considered in policy making.

I believe that the present absolute price levels of most consumer staples, and even durables like passenger automobile, may be high and unaffordable. Therefore, even a low consumer inflation rate of 2.5-3% might not be a thing to celebrate. The government needs to work hard to bring the absolute price levels lower even to sustain the present consumption, saving and growth levels. Juxtaposing the following data points to the low wage growth, shall give a glimpse of the problem I am worried about.

(a) The prices of milk and milk products rose 75% between 2011 and 2018 and are ruling at the higher prices.

(b) The prices of vegetables doubled between 2011 and 2014. Post 2014 they have been cyclical but mostly sustaining at higher level.

(d) The household expenses on energy have seen a70% jump since 2011, and not showing any signs of correcting.

(e) The housing expenses (rental, maintenance, renovation, furnishing etc.) have risen over 75% since 2011, and continue to remain in strong uptrend.