The ‘real illusion’ in India

It is nearly two weeks since I wrote the piece titled, ‘Raghuram Rajan has the last laugh’. I cannot believe it is almost two weeks!

In that post, I had mentioned what the Government of India needed to do:

It has pursued a policy of targeting tax dodgers and other wrongdoers in the business community. Nothing wrong here. I am not even going into the question of whether the government had been selective or unbiased in these pursuits. It has done well to do this for it is never the case of this blogger that India’s private sector is an epitome of business ethics and virtues. Far from it.  India’s economy or capitalism always was in peril and is in peril from India’s capitalists with very few honourable exceptions. So, the pursuit was fine.

But, the government should have realised that it would have an impact on sentiment and on investment by businesses. It must have had a Plan B already. [Link]

But, this was not the Plan B I had in mind. The Government of India is setting up an anti-profiteering authority to ensure that the tax credits accruing to businesses under the new ‘Goods and Services Tax’ (GST) is passed on to consumers and that there is no profiteering. Perhaps, the government is paranoid about the inflation impact and hence, of the Reserve Bank of India’s tight money policy. It desperately wants low interest rates. Or, it is really worried about popular backlash that could arise if profiteering were rampant. More likely both. Alas, the road to hell is paved with good intentions.

This morning, I read my friend Niranjan’s piece in MINT on Money Illusion. I think, if I understood him well, his point is that the public are used to high inflation rates and expect their nominal earnings to rise at a certain rate based on their own estimates of what the inflation is. Since prices are rising far slower, probably, incomes and earnings of certain categories of the society – small businesses, wage-earners, may be? – are rising far too slowly. Naturally, they feel unhappy about it. Hence, they may be holding back their spending, etc.

Although the real growth rate is around 7%, the nominal growth rate is lower – around 10% to 11%. But, society is used to nominal growth rate of around 15% and the concomitant growth in many nominal quantities. That is not materialising and hence, they feel that growth is suffering. That is money illusion. This can also become a vicious circle. Or, it probably, has already.

As hypotheses go, this is not a bad one.

But, I have some reservations on Niranjan’s hypothesis:

(1) The 7% growth rate that is reported under the new methodology and new base year 2011-12 may not be the same as the 7% in the old methodology with the old base year, 2004-05. In other words, we do not have a benchmark. Under the new methodology, the potential growth rate of the economy may be 10% or 12%. Who knows? May be, that is a reason, the inflation rate is declining. NO, scratch that. I have a better hypothesis that follows.

(2) Some nominal quantities such as credit growth are really low, even after one adjusts for lower nominal GDP growth and also for the fact that electricity boards may not be borrowing as much as they used to from banks as before, after UDAY (debt restructuring for State Electricity Boards). Further, many FCNR (B) loans taken by Indian businesses are being unwound now.

Notwithstanding these special factors, it is difficult to argue that credit growth numbers are better than they really are. They do indicate both absence of demand for credit from potential borrowers and banks’ capacity to supply credit.

(3) The implicit assumption he is making is that the Indian economy is indeed growing at 7% real and it is the absence of inflation that makes us feel that there is no growth, because we are used to thinking in nominal terms.  Actually, I question the premise that we we are indeed growing at 7%. I very much doubt that.

If we drop the pretense that we are growing at 7% or thereabouts, then there is no money illusion to speak of. The angst is real.

I think one of the reasons – it, too is a hypothesis – that India’s inflation rate is declining – and it does not preclude economic explanations – is that economic uncertainty has increased relentlessly in the last one year +. It is still rising and that it has dampened economic activity and hence, weakened aggregate demand except for personal spending to a limited extent. Hence, there is no inflation impulse. Yes, yes, I am aware that, in India, food items has a weight of 45% in India’s consumer price index (CPI) and that the prices of agricultural produce have been declining. In fact, even Wholesale Price Index (WPI) inflation is low and the weight of food in that is not this high. It is more weighted towards manufacturing. So, my hypothesis is highly plausible.

Why do I say that uncertainty has been rising relentlessly? India’s tax terrorism has been relentless – many tax circulars and notifications have been issued and then withdrawn or clarified (The SARAL form was changed to include declaration on assets and then withdrawn and taxation of mutual fund transactions in third-country locations was announced and clarified and amended later). There has been badly designed tax amnesty schemes. There has been the pursuit of black money. Retrospective taxation remains in the statutes.

Now, there is an anti-profiteering authority. It is not possible to arrive at a mechanical or mechanistic interpretation of profiteering. But, that risk now exists. Going by past record, that risk is non-trivial.

Then, there was the pursuit of non-performing assets guided by the Reserve Bank of India, under the previous governor. In any case, loan growth had slowed under the weight of bad assets in the books of banks and under the weight of high liabilities in borrowers’ balance sheets.

There has been the note-ban exercise which created its own uncertainties, besides acting as barriers to transactions in rural commerce, in agriculture. The All India Manufacturers’ Organisation (AIMO) had done surveys that found extensive impact on rural employment. Now, AIMO has actually sought a postponement of GST. Unlikely to be conceded.

The real estate sector, awash with black money, has been hit by the note ban. Then, they have had the Real Estate Regulation Bill. Anecdotal evidence suggests that real estate sector activity has considerably slowed. It showed up in the national income statistics for the fourth quarter of 2016-17. I do not think it is over yet. Probably, it is just beginning. Then, there has been the benami transactions bill. There is a new bankruptcy code and, may be, the mother of all uncertainties, GST. Hope not.

The icing on the cake is the anti-profiteering authority. The more the government wants to curb and check and prevent profiteering, the more it is going to strike at the roots of economic activity. It is failing to follow the 80-20 principle or management by exception.

Some or many or most of these government measures, legislative proposals may be good for the long-term while some may offer mixed benefits. But, they are inevitably short-term negative for economic activity.  They are essential surgeries, may be. But, painkillers are needed during and after surgery. Further, the recovery is aided with nutritious diet and vitamin supplements. Where were they? Except for Foreign Direct Investment (FDI), nothing much.

No relief from tax terrorism, no reduction or simplification in tax rates, no reduction in operating costs for businesses through reduction in labour costs (payroll deductions), no privatisation, no banking sector reforms. There were lots of promises of reduction in inspector raj.  How much of it has materialised? How many laws have been repealed out of the earmarked laws for repeal in the Union government and in State governments?Indian companies were supposed to have one single corporate ID. I doubt if it has materialised too. Happy to be corrected.

I think the government is missing the problem completely. In general, the government has displayed extreme risk-aversion in the design of its schemes, making static assumptions on revenue foregone, etc. No allowance made for improved activity and compliance on account of lower rates, for example. This risk aversion could be the consequence of a controlling or untrusting mindset. Or, it could be the mindset of the senior bureaucrats in the Ministry of Finance who guided many of these policies. Or, they could be simply reflecting the mindset of the Minister concerned or the Prime Minister. Any or some or all of the above could be influential factors.

The truth is that economic uncertainty in India is not an illusion. It is not money illusion that is behind the absence of ‘feel good’. Given all that has happened with government’s policy decisions and legislative changes – good, bad, hasty, measured, sound, unsound – it is just that Achche Din is becoming an illusion.  This time, it is not a money illusion but a ‘real illusion’.

UK’s non-recovery and the Labour Party

I came across a link to Andrew Haldane’s speech at Port Talbot on 30th June 2016 in a WSJ article that was trying to dissect the UK election results. Andrew Haldane is the Chief Economist for the Bank of England.

I had analysed the UK election results briefly in my weekly column for MINT on Tuesday. The Conservative Party had managed to score two self goals in two years. My article also took a closer look at Eurozone economic health and outlook. First, about the UK.

Andrew Haldane asks the right questions in his speech. Significant that it was delivered in Port Talbot where the closure of the Tata-run steel plant dominated the news last year. He said that the recovery in the UK economy post-2008 has been felt largely by middle-to-old age Britons who own property or more generally, asset-rich and who live in London or more generally in the Southeast.

Clearly, this group would have voted against Brexit. But, will this group have voted for Labour’s James Corbyn? Unlikely. But, how much of their votes did the Conservatives capture? It will be interesting to know the breakdown. The Conservative Party also lurched towards the Left. The ‘Economist’ notes that here. Although, I must state that I did not find any of them necessarily wrong or incompatible with ‘Enlightened capitalism’. For example, minimum wages and caps on executive compensation are not necessarily incompatible with capitalism.

It is very likely that those who have not been touched by the UK economic recovery – that is a good, vast majority, especially the young and renting, compared to the very narrow that have benefited as mentioned earlier – chose to vote for James Corbyn. FT has an analysis here.

Tim Price has some good points to make of James Corbyn:

That 262 British parliamentary seats fell to a party led by a self-confessed Socialist is bad enough. That said leader lacks the support of 172 of his own MPs is troubling. But that someone who has publicly supported the IRA, Hizbollah and Hamas could attract 12.9 million votes while the United Kingdom is under attack by terrorists simply beggars belief. Sir Richard Dearlove, the former head of MI6, the British Secret Intelligence Service, points out that Jeremy Corbyn – who seeks the office of Prime Minister – would not be cleared to join either his former agency, or GCHQ, or MI5; and indeed would, in the past, have been actively investigated by the latter. [Link]

What is interesting and disappointing about Andrew Haldane’s speech is that he does not link his admission that the recovery has been narrowly based to the monetary policy of the Bank of England although he does cite one of the most important discussion paper of the Bank of England on the distributional consequences of asset purchases by the Bank of England (‘The distributional effects of asset purchases’, Bank of England Quarterly Bulletin, 2012). That paper is worth a read.

Haldane went on to reassure his audience that the Bank of England would further ease monetary policy in response to the Brexit referendum – the speech was after the Brexit referendum. But, really, to what extent would a further ease of monetary policy help broadbase a recovery? If anything, it would (and it did) boost asset prices, particularly home prices in London putting them further out of reach of the young who found homes increasingly unaffordable and were spending close to 30% of their income on rents.

It is astounding to me that, despite such a lucid analysis of the problem, he came up with a solution – further monetary easing – that would not only do nothing to solve the problem but would only aggravate it further.  No surprises that the Labour Party did far better than it should have or it deserved to.

As Tim Price put it,

The millennials and Generation Z are right to be angry. But last week this anger manifested itself in the form of some Corbyn supporters burning newspapers. To anyone with a sense of history, the UK today feels like a very strange, and disturbing, place. [Link]

The good thing about GST and other links

Good to know that cars would be more expensive after GST rates were announced. One should welcome it. A country like India cannot be encouraging personalised mode of transportation. It is a small step to making both producers and buyers pay for the externalities of hydrocarbon based travel in India.

India’s 5-star hotels are already quite expensive, given the overall level of purchasing power in the country. They have a plethora of taxes. But, now they will become even more expensive.  That is not a good thing. May be, I am wrong.

Revenue Secretary Hasmukh Adhia has said that GST would lower the inflation rate by 2%. I am not sure if there is any mileage to be had in saying that. The margin for error is huge and second, international experience is that there is an initial jump in the inflation rate as businesses round off prices to the next higher level. It will be quite likely to happen in India.

Aparna Iyer had a good story on SBI 4Q results. Has the problem of NPA peaked? She is not sure. Neither am I. Notice how the GST rates would raise mobile phone tariff and prices for devices too at a time when the sector is facing a huge wave of competition from Reliance Jio.

Her earlier articles on the credit culture (or, its lack thereof, to be more precise) of companies in India are worth following. This is a classic understatement:

Corporates need to vastly improve their credit culture. [Link]

In the second part of her series on credit culture, Aparna Iyer argues that companies have been biggest beneficiaries of the culture of loan forbearance in India than farmers. One should not be surprised. Most Indian professed policy goals are mostly symbolic in nature – pro-poor, pro-farmer. In reality, they are not helped but hurt, both short and medium term.

But, the problem with such stories is that they would be used to argue the case for loan waivers but not against forbearance in general. Further, providing cash support to farmers to repay loans and waiving loans are two different things. The optics matters a lot.

In the third and final part of her series on credit culture, she again makes the point that banks have been far more lenient towards companies. Obviously, a lot remains unsaid. It is about unholy nexus and second, it is about the ethical foundations of corporate promoters.

Tadit Kundu has a good article on the Investment Proposals turning into actual investments in India. This is based on DIPP data. Actually, I track it regularly. The pick-up in ‘Implemented Investments’ in 2016 could be deemed ‘green shoots’ for manufacturing. Or not.

It was good that the Prime Minister has called for better data on the labour market. Not a day too soon. But, this government by Pronob Sen bears repetition:

“NSSO has a capacity of 3,200 people and its Chinese counterpart has 29,000 people. How will you conduct comprehensive employment data collection with this?,” he asked .

“We had demanded an increase in the headcount to around 5000 and also that the jobs survey should be expanded and made comprehensive. But the then government (the previous UPA government) did not agree. We need comprehensive jobs data,” Sen added. [Link]

Good to see that NASA will be collaborating with ISRO – an organisation that was on America’s banned list. Times, they do change.

Bibek Debroy has a good interview with Business Line. He does make a good case for taxing agricultural income. I endorse it:

The Centre has no plans to tax agricultural income. Constitutionally, it is a State subject. About seven States tax certain kinds of agriculture. I do think agriculture income should be taxed, in a way similar to personal income taxation, based on a threshold. In his taskforce on direct taxes, Vijay Kelkar had computed that given the levels then, 95 per cent would be below the threshold. Agricultural income is subject to year-to-year variations but you can do an average of three-four years and tax on the basis of that. [Link]


The iron laws of public policy are…

… that the road to hell is paved with good intentions and that the law of unintended consequences always applies.

Read this:

April 20, 2005, President George W. Bush signed into law the Bankruptcy Abuse Prevention and Consumer Protection Act, which reformed the rules overseeing bankruptcy , especially personal bankruptcy.

At its inception , the nation had to borrow heavily from England , and thus the protection of debtors was in the national interest.

The debate over the 2005 reform was completely dominated by the credit lobby and organized by the National Consumer Bankruptcy Coalition . In the words of one legal scholar : “ Never before in our history has such a well – organized , well – orchestrated , and well – financed campaign been run to change the balance of power between creditors and debtors.”

In the pre-bankruptcy – reform world , distressed homeowners would have filed for personal bankruptcy , which would have allowed them to discharge their credit – card debt , making it easier to hold on to their houses. Under the new law , this option was no longer open . According to calculations based on a recent study, the 2005 reform increased the number of people defaulting on their mortgages by almost half a million; and when a mortgage holder defaults and the house is auctioned off , on average it loses 27 percent in value.  If we apply this loss to the average price of a house sold in 2005 ( $ 290,000 ), we can estimate that the financial industry lost $ 39 billion as a result of bankruptcy reform.

Source: Zingales, Luigi. A Capitalism for the People: Recapturing the Lost Genius of American Prosperity (p. 68). Basic Books. Kindle Edition.

AFPSA and the Indian corporates

These are my thoughts on reading the article by Somasekhar Sundaresan on the topic above and I had posted it on the Business Standard site under the article.

The article has multiple targets and it hits them all well. The Army, the Union government, the Indian corporate sector, a popular singer and even concepts like moral equivalence, etc. It does not even spare the public that sides with the Army or the Union government. Space constraints must have come in the way of commenting on the role of the militants, their external sponsors, anti-India outfits in Kashmir, the role of the political parties in the State, the legacy, etc.

I suppose moral clarity, moral certitude and moral outrage are possible only if one manages to see one side of things and does not complicate oneself with abstract notions like objectivity, history, context, multiple perspectives, etc.