Blowing hot air & fanning a controversy: The R.B.I.

The Bullish Bear is back to tell the tale of the Indian central bank a year into the arguably illegal sanctioned demonetization program of the Narendra Modi-led BJP government. Fiscal 2016-17 proved to be a watershed year for the R.B.I., which at a stroke shed its image as a holier-than-thou technocratic governance-based institution (Blocking The Economist and BBC from its pressers) and exposed its vulnerability to a sordid moneyed-political campaign of a bullying government (Reforms of an overzealous Modi) through, at the very least, its poor set of financial disclosures, which will be our focus here in this article.

Part 1: The checksum failure discovery

Back in December 2016, the Bullish Bear had discovered a loophole in the disclosures of R.B.I.’s currency management, which is akin to inventory management of a paper manufacturing (banknote printing) firm. Here’s the problem depicted in figures in the tables below:

tableSnap

In a nutshell, a basic checksum on outstanding currency fails – the number of banknotes supplied and disposed off by the central bank can’t account for the net change in the number of the banknotes. To illustrate: on March 31, 2016, instead of the published 90.266 billion banknotes in total, only 88.406 billion could be accounted for by checksum – a difference of 1860 million banknotes or Rs. 977 bn! (We exclude the latest fiscal FY 2016-17 due to the unusual event of demonetization). On March 31, 2015, instead of the published 83.579 billion banknotes in total, a larger figure, 85.845 billion, could be arrived upon by checksum calculation – a difference of 2.27 billion banknotes or Rs. 119 bn. And the internals would make one’s head spin.  On March 31, 2016, published volumes of the Rs. 100, Rs. 500 and Rs. 1,000 banknotes exceeded calculations by 1.011 billion, 1.088 billion and 362 million, respectively! On March 31, 2015, published volumes of the Rs. 100, Rs. 500 and Rs. 1,000 banknotes exceeded calculations by -30 million, -448 million and 142 million, respectively. Of course, the problem stretches back to prior years as well.

It has to be noted that the problem isn’t that there is merely a checksum failure. After all, there is such a thing as currency in transit – banknotes in limbo – as they make their way from the printing presses to the currency chests. It is the swing in this figure that really matters. And even that is not evidence, in and of itself, of incompetence at the highest levels in the R.B.I. (a) It is the non-disclosure of the significant swings which leads me to believe that something is amiss about these banknotes in transit, which need to be tracked & accounted for fully in real-time, and (b) The way the formula in the table above has been applied, a positive figure indicates oversupply (Akin to ATM unloading) and a negative figure indicates undersupply (Akin to ATMs withholding cash). While either action is entirely permissible in R.B.I.’s currency supply operations (More in the following section), it is the large swings from undersupply to oversupply & vice-versa that don’t square up & need explanation. For instance, in FY 2012-13, the checksum on Rs. 500 transitioned from+2.40 billion to +186 million, a swing in volume to an oversupply of 2.21 billion. But this constitutes as much as 21.6% of the volume of Rs. 500 banknotes at the beginning of FY2012-13. Simply inexplicable that the currency chests can hold & unload over 1/5th of all of the Rs. 500 banknotes in the country in just one year! Also equally discombobulating is the swing in value terms (Right most column). For instance, in FY 2015-16, ID+CC unloaded Rs. 1.10 trillion of cash in to the public circulation!

Part 2: The R.B.I. calls up the Bullish Bear

On the afternoon of Friday, 22nd Sep, 2017, the Bullish Bear received a call from an official from the R.B.I. (Name & designation withheld), who wished to clarify the discrepancy. He was fairly straightforward about it, saying that the discrepancy is merely the cash withheld in the ID (Issue Department) and the CC (Currency chests). To me, this was merely technical arrangement, and I said as much.

I proceeded to explain my calculations and also gave an additional insight: Around 2013-14, analysts and econometrists were complaining about a perceptible increase in money supply leading to an uptick in inflation. However, at the R.B.I.’s end, at the end of 2013-14, a situation akin to ATM withholding (i.e. ID and CC unable to supply to the public) of banknotes flourishing (2.92 billion deficit in volume from a surplus position of 3.90 billion) coincided with the introduction of the Lead Bank scheme of currency distribution by the R.B.I. (More on this in the following section), which could explain the situation partly.

Similarly, that the Lead Bank scheme was discontinued in FY 2015-16 may explain, at least directionally, the reason that the volume of total banknotes ran into an ATM unloading situation at the end of FY 2015-16 by 4.13 billion notes (4.94% of all banknotes outstanding at the beginning of FY 2015-16) in volume or Rs. 1.10 trillion in value! But there is no tangible data to back up this large swing in banknotes.

I politely conveyed to the official that the institution has to explain the figures and demonstrate with figures that the cash position within the issue department and currency chests account for discrepancy fully. In common parlance, dot one’s I’s and cross one’s T’s. Otherwise we have a square peg in a round hole! The official was courteous, and I thanked him for his call too.

Part 3: Is the non-disclosure of ID+CC data due to the fact that the R.B.I. is technologically challenged?

Looking into the past disclosures, the R.B.I. has not been shy of experimenting with its currency distribution system. This may help explain the wild swings, though only partly. Nonetheless, I do want to point this out as something that has been accounted for while making the headline claims & continuing on the stated big picture theme in this article. Per the R.B.I.’s FY2014-15 annual report, p. 108-109:

“The Lead Bank Scheme for currency management was introduced on a pilot basis in 2013 by identifying one district of each state and assigning the same to a lead bank, which, in turn, is responsible for ensuring that genuine needs of members of the public for clean notes and coins are met through coordination with currency chests and small coin depots situated in that area. The lead bank as a nodal bank for currency management (BCM) attends to issues, such as linkage of non currency chest branches to currency chests, facilitation of supply and issue of banknotes and coins to and from bank branches in the area, prompt routing of diversion requests and redress of public grievances. The nodal BCM undertakes functions relating to spreading awareness/ literacy campaigns on security features of genuine notes and exchange of mutilated notes. After a year of operation, the scheme was reviewed and it was decided to continue it in 2014-15; it is under review for 2015-16.”

The R.B.I.’s FY 2015-16 annual report (p. 90) confirmed that in order to strengthen the distribution of currency by “leveraging technology,” the banknote distribution system was changed to a hub-and-spoke model with mega currency chests (MCCs). Did you read that… “Leveraging technology” at the CCs?

At this point, may I draw the reader’s attention to just show two instance proving that the R.B.I. has been deficient in technology all throughout: (1) Government-owned Security Printing and Minting Corporation of India Ltd (SPMCIL), which supplies ~40% of R.B.I.’s banknotes, admitted in its FY 2014-15 annual report (p. 38) that it first deployed an ERP system (Enterprise Resource Planning) in as late as FY 2014-15! Also that it has “Old machinery & inefficient layouts at some units” on p. 49 of the same report, (2) And in the latest FY 2016-17 annual report itself, on p. 129, the R.B.I. used a “sample” of just 25% of Currency Chests to determine the total number of fake Indian currency notes.

Just to clarify the hypocrisy, at this moment the Indian government and its central bank have been pushing all kinds of demands on the public in the name of digitization and simplification such as the GST, Aadhar, and demonetization. Yet the country’s most respected public organization, the central bank itself, has been dragging its feet on technology & can’t even count properly the banknotes it prints up!

 

To sum up, it is not just that the swing in the discrepancy ID+CC bucket was large. That it remains undisclosed in the first place and was likely poorly tracked historically – is the nub of the issue

There is plausibly little reason for non-disclosure. Data related to financials of the issue department (ID) (R.B.I.’s accounts for FY 2016-17) is public information and so is the data related to the physical location of the currency chests (CC). And if there are any insecurities about mass looting if the public gets to know how much money there is in which currency chests & that is the reason for non disclosure, it begs the question: how come the banks are so secure with known large deposits of cash at call at all times??

Advertisements

Stinks to High Heaven: Air India Bailed Out by Life Insurance Corporation (LIC) of India

Against a backdrop of rising concerns over NPAs in the banking system, it was reported that Air India was looking at the possibility of availing a new scheme, the Scheme for Sustainable Structuring of Stressed Assets (S4A), to rejig debt to the tune of a minimum of Rs 100 Bn. Since 2012, the airline has been on a life support with a Rs 300 Bn bailout package from the government, spread over ten years. In fact, this may be one of the biggest sums that LIC has ever loaned out till date: this new loan to Air India of Rs 100 Bn (If that number is correct), will grow its loan book by an enormous 9.26%.

Who reported this? A Secret deal? Was it leaked?

Since, at the time of writing, Air India has made available annual reports only until FY 2013-14, all the financial figures and plans of rejig coming out in the newspapers, if true, are very likely being leaked from Air India/ Civil Aviation Ministry itself, and being dealings in material non-public information, this constitutes a situation of non-uniform dissemination of sensitive information, and possible violation of securities law.

short-pbnks-up

Indeed, the public sector bank index was up by a chunky 1.5% today, being the first day since the story broke, with two of the three stocks mentioned in the story (Bank of India, Bank of Baroda) up over a per cent and the third stock (Punjab National Bank) within 3% of its 52-week high.

Best of socialism at its worst?

There are many facets to this development that stink to high heaven. As Firstpost pointed out – Why the bailout when it was already turning around? It has also been queried before on multiple occasions when LIC was bailing out public sector Companies and investing aggressively in public sector disinvestments, who has the authority to approve this and why isn’t there a public outcry? And all this for a saving of Rs 3 Bn (A 3% saving on Rs 100 Bn), which Air India could save anyway by paying its fuel bills on time, as has been reported here by the Business Standard.

Hypocrisy unlimited

Arun Jaitley: “LIC is not a body which invests only to bailout the government in disinvestment. In issues by private companies, LIC also participates.”

That’s right. The (dis)honorable Finance Minister had agreed, last year, that LIC bails out & bails out repeatedly. And that LIC, with the public’s insurance money, routinely bails out private Companies too!

The government speaks highly of transparency and accountability, yet hijacks the public treasury to bail out desperate banks and monopolies, placing an incremental debt burden on the public.

Here’s another quote from ex- Finance Minister, Yashwant Sinha, a senior leader of the current ruling party, while he was in opposition in March 2012, around the time LIC bailed out ONGC’s disinvestment auction with an unnecessarily high-priced bid:

“LIC is a captive source of funds for the government. They have misused the status of LIC to misappropriate policyholders’ money and brought it to the government’s coffers through the ONGC disinvestment.”

Now that his party is engaged in the same treasonous act, in his own words, a “daylight robbery”, I’m sure he will stand up for the public and do everything in his power to stop this transaction.

Fat chance!

A case of honest kleptocracy

But the Bullish Bear wouldn’t write this if there wasn’t a silver lining to this all. There is an honest side to this, y’kno.

This bailout has proved that the government can openly rob the public of its money, via the LIC, to bail out bankrupt Companies.

Such instances of naked cronyism can at least serve to warn the public that their savings and insurance are at risk. The Life Insurance Corporation of India is not a safe house, nor are any of these banks offering 4-7% return on savings, making loans to extremely indebted Companies while maintaining tier-I ratios of just 10%.

Related reading: Debt-ridden Government makes more claims on LIC (NDTV Profit) >>

This amounts to a rather more transparent & direct socialistic involuntary bailout. Which is bad no doubt, but incrementally better than an indirect socialistic involuntary bailout! As Canadian billionaire and philanthropist Eric Sprott warned, “Whenever you think of the word bank, you should think risk.”

For a brief education on bailouts funded with public money, it can’t get any better than this short video segment, in which Peter Schiff, an Austrian economist and a guru & mentor to yours truly, lambasts a pitch for a government sponsored bailout of American car manufacturers by Lansing, Michigan Mayor Virg Bernero on live television! “If you think these Companies are such good investments, you put your own money into it!”

In conclusion

As mentioned previously, the Bullish Bear is an ardent fan of free markets and open competition. Yet, I have sympathy with Air India’s Chairman & Managing Director, Ashwani Lohani. Coming from the head of a public sector enterprise, these are astonishing words, admitting that a public sector entity does not really care about the delivery of its services. Although he does shy away from writing the public sector off completely, the Bullish Bear believes that he is headed in the right direction!

“Often my airline is questioned on its inability to match the private sector on various operating parameters, and this is unfortunately always done without due appreciation of the fundamental reality that there is no level-playing field… A course correction is the need of the hour, for contrary to what many may think, the public sector has still not lost its relevance in entirety… Unless and until we all, and that includes the mighty government machinery, start believing in the supremacy of deliverance over everything else, such dilemmas would always continue.”

Leeching Human Enterprise: Indian Government’s Booty Swells with Spectrum Auctions while Companies, Banks and Investors Muddle Along

“If it moves, privatize it. If it doesn’t move, privatize it.” – Dr Walter Block

Public ownership of any good or service is fraught with inefficiency and lack of accountability. The Keynesian explanation in the case of, say a manufactured toy, is that a monopoly (i.e. in the classical sense,  government ownership) always produces less of a good or service at a higher cost. But Keynesians rebuke strongly any idea of non-public ownership of “public goods”, such as radio spectrum. Coming from a libertarian point of view, the Bullish Bear professes private ownership even for a public good or service, say military defense, and strongly refutes the need for government ownership. And how come the government came to own radiowaves – this valuable resource – in the first place? It wrote itself a title. Or probably did not bother to do even that!

Globally, low spectrum utilization has been observed and documented. A study in 2003 found that only 19% of frequency space in Washington, DC was used in peak times. Clearly, radiowaves are more abundant and hence less valuable than apparent at first. But we can hardly rely on the public sector to resolve this issue – the Indian Spectrum Management Committee (GOT-IT, 1999) had found that the armed forces had “squatted” on the radio frequencies they occupied while using very little of them (in the words of Ashok Desai, whose critical insights we rely on very much, and whose work we highlight later on).

The 2016 spectrum auction, which lasted for a workweek, enabled the government to sell 965 MHz of spectrum for a total sum of Rs 657.9 Bn or $9.85 Bn. This is equivalent to over 2.5 months of revenue of the largest private sector Company in India, Reliance Industries! Yet, this was an underwhelming yield for the government, because spectrum supply was plentiful, there was less need for renewals and also because the government shot itself in the foot with sky-high reserve prices for the most lucrative segments of spectrum, despite financially stresses of participants.

However, in this blogpost, the Bullish Bear will dwell more on the historic development of the telecom industry’s auctions and take a look at the harsh impact of the government’s severe interventions into what should have been the free market operation of this industry.

 

Competitive nature of the industry shaped by part-liberalization in the 1990s, giving relief from public sector stranglehold

The first glimpses of liberalization in the mid-1990s led to private sector participation being allowed in basic services, and growth in wireline services picked up. The Indian Telecommunication industry tried to embrace a more modern image with the National Telecom Policy of 1999, allowing private sector players to break through the monopoly of DoT little-by-little.

The short history of India’s Telecommunication Industry is, as laid out in this brilliant publication by Mr Ashok Desai, a tale of how entrepreneurs climbed their way out of the government’s impossibly high license fees by getting foreign partners and public sector banks themselves involved in funding telecom operations!

In the period before the liberalization began that we can get a glimpse of how state monopoly was playing a balancing act between hiding its laziness on the one hand, thus keeping at bay any deregulations and new entrants and yet, on the other hand, showing a substantial-enough pipeline of pending orders & risking revealing its laziness, thus staking a claim on additional funds from the government. We can post this revealing table below, in which we can see that despite substantial backlog of orders worth 25% of installed lines in 1982, growth in installed lines barely broke out into the teens in 1992! All this while, the waiting list was kept hovering at around 4 years!

dot-waiting-line

 

Indeed, telephones were classified as a luxury item and given low priority in India’s socialistic five year plans. “The telephone system began to expand rapidly only in the late 1980s, when the ITI-Alcatel factory delivered switches in large enough volumes,” Mr Desai sighs.

 

How come the government owns the air above us?

Socialist India gave monopoly power to the Department of Post and Telegraphs, until 1985, when Mahanagar Telephone Nigam Limited (MTNL) and Videsh Sanchar Nigam Limited (VSNL) were created as public sector undertakings under the Department of Telecommunications (DoT). It is through this entity, the DoT, that the law still bestows an exclusive privilege on the Government to provide telecommunications services. The DoT issues various notifications imposing onerous obligations and restrictions on players in the industry.

 

Spectrum value is artificially high as the public ownership is creating artificial scarcity

“Is the radio spectrum a unique resource that belongs to the public, or can it be privately owned like any other good or service? Most people assume that public ownership is axiomatic—a starting point rather than the historical consequence of special interests pretending to misunderstand economics. This is wholly incorrect… Full-scale privatization of this resource is essential.” – B. K. Marcus, Mises Daily

It is worth our time to pause and evaluate this situation. At the moment, the government is holding back all the spectrum and renewing licenses to operate on it via the auction method. Some spectrum is in the low frequency ranges (Which have better ranging abilities), whereas some are in the high frequency ranges (Which can carry higher bit rates). But the government’s reclusive actions are creating artificial scarcity, particularly for the spectrum being used currently – as the government will obviously not auction spectrum that is Not in use currently in the telecom industry. Thus, not only is existing spectrum valued artificially highly, but there exists a systemic latency to discourage switching to higher spectra. Thus, players, particularly the incumbents, who have large amounts of capital and resources at their command, are less willing than they would otherwise be, to trial newer technologies at higher bit rates, thus retarding the speed of technological development.

Clearly, the government is meddling in the formation of lower prices at the consumer level both directly (through high taxes and license fees) and indirectly (through deceleration of technological innovation by encouraging extant spectrum usage).

 

Government’s Telecom booty: High spectrum fees accounts for all of the debt accumulated in recent years

gov-vs-industry2

An analysis of the government’s revenue from the telecom industry in the form of corporate taxes, licenses fees, spectrum usage charges and spectrum auction revenue suggests that the government is running its own parallel Company alongside: about the size of Idea Cellular, the #3 telecom company in India by market share. For every Rs 100 of honest revenue earned by the top-4 listed Companies, the government “earns” Rs 36, Rs 17.5 of which comes from License Fee (LF) and Spectrum Usage Charges (SUC), Rs 12.5 from spectrum auctions and Rs 5.5 from corporate taxes.

And it doesn’t stop there. The Bullish Bear estimates that the incremental indebtedness brought to bear upon the Companies brings the government an additional 0.5% through dividends from publicly owned banks (We have to assume a share of 50% to PSU banks, as break up of this data is not provided by the Companies nor by the banks). This equates to a cool Rs 4.4 Bn in FY16.

According to these estimates and adjusting for inflation, the Indian government has amassed nearly Rs 2,300 per man, woman & child in India since 2010, compared to the monthly income per capita for an average Indian of Rs 7,774. Were it not for spectrum auctions raking in Rs 85,000 crore since 2010 ($12.9 Bn at today’s exchange rate), the telecom industry, the top-4 listed players of which have accumulated total debt of Rs 1.26 Tn (57% of which have accumulated since 2010), would be almost certainly debt-free by now.

 

End result: Investors disinterested and Companies financially stressed

telecom-ros-gr

For investors, the golden period seems to have come to an end with the industry in a mature phase and the companies in serious financial stress.

Telecom companies, even including tower Companies, which are much more profitable (for now), have underperformed almost all prominent sectoral indices over the last three years. Despite exponential growth in data, overall growth seems to be slowing and it remains to be seen how the $20 Bn new entrant, Reliance Jio, impacts the structure of the industry.

telcos-underperform

From the perspective of corporations, by logical and empirical evidence, we have seen how onerous public sector ownership and regulations have hampered the development of the telecom industry. India’s Telecommunication regulatory bodies: DoT, TRAI and COAI have become mightily powerful and can potentially become broad-based regulators and censors as well, if we were to look at the example of the United States: Marcus educates us as to how the regulator there, the FCC, has become “the largest censorship body in the world.”

But if we were to ask “Cui bono?” Not only has the government benefited, but the regulated industry itself being cartelized, its members have benefited as well. They pull together when in need to erect artificial barriers to entry (say a minimum paid-in capital or unbundling free internet messengers) and push together when defending from higher tariffs.

In summary, the government, the banks, the regulators and bureaucrats, foreign & domestic entrepreneurs are all in the gravy train, and the investors and public treasury have to protect their invested capital (in telecom companies and in the banks) & bear the risks (of investments failing). Investors blame the Companies, the Companies blame regulations and high interest rates, the regulators want revenue to shore up government revenue and the government cannot do without revenue, can it? All this while, the elephant in the living room, namely the unethical public ownership of radio spectrum, lives happily ever after!

Government Continues its Regulatory Onslaught with Aadhaar Despite Supreme Court Orders: 6 Separate Instances of Flagrant Abuse in 25 Days

Deepening the erosion of civil liberties, subsidies of LPG now cannot be received unless you sign up into the club of Aadhaar. A firm warning was fired to the some 20% subscribers who have not yet given in to enrolling with UIDAI’s database by the Oil Ministry. Chief Executive of the UIDAI, Mr A. B. Pandey cited Section 7 of the Aadhaar Act to rifle home the point that Aadhaar numbers are mandatory for the receipt of subsidies that fall under the Consolidated fund of India.

The Bullish Bear has earlier neurotically documented the hidden abuses of the UIDAI system in this blog at Liberty Here and Now. Here, I document how, contrary to the claims by politicians, the UIDAI system is extremely costly, insecure, exclusionary and is basically meant to control our existence and identity. On 22nd April, 2013, a Parliamentary panel headed by former Finance Minister Yashwant Sinha, who himself was a prominent member of today’s ruling party, had stated that the UIDAI was “discharging its functions without any legal basis.”

Murky legalization

aadhar-money-bill-the-hindu

Since then, the same party has come into power, but instead of terminating the program, continued throwing money into the system, making a terribly awkward push for its legalization via the route of the money bill (which avoids formal scrutiny of the Upper House) as late as March of 2016! This only proved how dubious the whole system was – that it had to be dressed up as a financial matter of transfer payments – whatever happened to all the social motives! But let’s leave aside the question of whether LPG subsidies make economic sense, and focus solely on the technical aspects of the use of Aadhaar by the government.

Alert readers may recall that the Supreme Court, in a much publicized ruling in August 2015, had rebuked the RBI and the Election Commission, who tried to mandate the Aadhaar card for banking and voting purposes. It instructed the Government to make people aware through public advertisements that Aadhaar card was not mandatory. Moreover, in February 2014, Petroleum and Natural Gas Minister Veerappa Moily had admitted in public that the Aadhaar was not mandatory for receiving LPG subsidies. A year is all it has taken for the  public to lose focus and for the government to continue its unethical database building.

A report filed by the Mint newspaper also suggested that the Aadhaar number could be mandated for use in the PDS, MNREGA and pension schemes.

“There can’t be a situation where you say, ‘I don’t want to enroll for Aadhaar’”

mh-students-moneylife-in

 

This latest transgression by the government, Center or State is far from the first. Readily searchable, I document 6 such instances over the past month alone:

#1 Maharashtra’s state level education boards mandating Aadhaar card for registration in examinations and disbursal of scholarships (Times of India, Oct 6, 2016). This was the second time the Maharashtra government was caught openly flouting orders issued by the apex court. In April, 2015, the same government had issued a resolution for making Aadhaar mandatory for all students up to 14 years of age in the state and connect it with their school admission number (Moneylife, Oct 5, 2016)

#2 The Wrestling Federation of India requires that wrestlers have an Aadhaar card to participate in national level tournaments (The Indian Express, Sep 27, 2016)

#3 Central Board of Secondary Education (CBSE) schools not only forcing students to provide the UID number, but also arranging camps for enrolment of Aadhaar for those who do not have the UID number (Moneylife, Sep 27, 2016)

#4 A letter on July 14, 2016, addressed by the Center to States and Union Territories demanding that Aadhaar card be made mandatory for students for applying for pre-matric, post-matric and merit-cum-means scholarship schemes. (The Hindu, Sep 26, 2016)

#5 The UIDAI instructed all the Union and State Ministries that the Aadhar card will be mandatory for all services, benefits, and subsidies funded from the Consolidated Fund of India. He was quoted as saying, “There can’t be a situation where you say, ‘I don’t want to enroll for Aadhaar.’” (Inc42, Sep 20, 2016)

#6 Indian Railway Catering and Tourism Corporation (IRCTC) Chairman and Managing Director A.K. Manocha: Senior citizens will be unable to get ticket concessions without Aadhaar from December, 2016 (The Hindu, September 12, 2016)

 

Aadhaar [Hindi “आधार”] means “base” or a “foundation”. So far, the UIDAI’s Aadhaar system has been destroying the foundation of citizen’s privacy and the bureaucratic class has been desperately ramming home this database shamelessly and baselessly.

emma-stone-sarcastic-thumbs-up

3 Reasons Why Urjit Patel Is a Dove Trapped in Hawk’s Clothing

The Bullish Bear is back with a few delectable insights into yesterday’s rate cut by the Reserve Bank of India, a relatively unexpected one, albeit a sixth cut in just under 2 years. A basic survey of newspapers after yesterday’s events will reveal that many analysts seem convinced that Government has now sidelined its CPI target in coming years of 4%. Two quick deductions: (1) Interest rates are decidedly headed in one direction only: and that’s down. For now. And (2) Monetary Policy Committee (MPC) or not, Urjit Patel is there to command the ship as per the directions of the BJP-led government. I present my case here in support of such a growing belief that Urjit Patel is a dove trapped in hawk’s clothing under the previous governor’s regime.

#1 Recent data releases were mixed and technically, did not merit a reaction

Consumer sentiment was robust and ahead of forecasts (A: 113, F: 110, P: 112), likewise the August PMI manufacturing forecasts (A: 54.7, F: 52.3, P: 51.9). July’s industrial production index (IIP) missed wildly (A: -2.4%, F: 4.0%, P: 2.0%), though these are known to be volatile, but August’s inflation (A: 5.1%, F: 5.8%, P: 6.1%) and current account deficit in Q2 remained under control (A: -$0.3 B, F: $0.4 B, P: -$0.3 B). [All statistics sourced from tradingeconomics.com/india]

india-interest-rate

A cut in interest rates seems to be the obvious course of action from the statistic of Bank Credit growth FYTD of 0.8% significantly lagging Bank Deposits growth of 5.0%. However, sound economics will deduce, infact, a necessity to raise interest rates based on this data point! More money growth in the system is a warning sign of excess money creation, and a cut in interest rates will only add fuel to the fire. In any case, even if we were to analyze the conventional view of cutting interest rates, rate hike transmission was the key intermediate step to resolve: Over the last 150 bp of rate cuts, only 70bp have been passed on.

india-among-bricscd

Comparing India’s positioning to BRICS nations, for the large part, India has favorable growth statistic (9th highest in the world), but is at risk from rising prices. Upside risks to CPI include (1) rising crude prices, (2) upcoming strong quarter for Gold, which may strain deficits & the Rupee and (3) government largess in wages and compensation fueling consumption demand. And although RBI’s release cited moderating food prices as a relief, it should be noted that the food price inflation index is first of all, volatile, and second of all, at a level of 8.23% in July, still very high!

 

#2 Ex-ante polls were markedly more dovish under the new governor

Since Urjit Patel’s appointment as governor on August 20th, analyst polls on rate cut swung significantly to a more dovish stance (From under 12% expecting a rate cut in deposed governor Raghuram Rajan’s last meeting on August 9th to over 40% ahead of October 4th meeting chaired for the first time by Mr Patel). Reuters on 30th September stated that “Several analysts in the poll said they expect him and the newly-formed Reserve Bank of India Monetary Policy Committee to follow a more dovish path than his predecessor.” If analysts are to be considered “informed,” then this large movement in the informed consensus on what’s coming held valuable information for the market.

 

#3 Urjit Patel was installed by a government crying out for lower interest rates

Numerous instances have been reported documenting politicians criticizing Raghuram Rajan’s monetary policies. Dovish Government stalwarts such as Rajya Sabha MP Subramianian Swamy openly backed the instalment of Urjit Patel, who thought it was “idiotic” to believe that Patel will be as hawkish as deposed RBI Governor Raghuram Rajan. Mr Patel may have some wrongful history as well: it was reported that Patel was involved at the highest levels with scamster Jignesh Shah, according to a report by India Samvad.

And lest we forget the basics of how the central bank operates in India. Per the Reserve Bank of India Act, 1934 (Updated January, 2013): (1) Its governors are appointed or nominated by the central government, (2) the Government of India also dictates the appointment/ nomination of all directors to RBI’s board of directors, (3) the RBI was nationalized on 1 January, 1949, and is fully owned by the Government of India.

And best of all: the RBI does not even get audited!

Independence.. what independence?!

The Indian GST: What is needed

Image courtesy: indiamike.comThe bullish bear is back with a look at the Indian Goods and Services Tax (GST) legislation. With the observation that procedural simplification in the taxation system without taking a sledgehammer to taxation infrastructure is merely window dressing, concern is that, just like the enthusiasm surrounding the reduction in corporate tax rates (revenue neutral and phased in slowly) has fizzled out, the conundrum of the appease-all democratic mujra surrounding the Modi government’s trophy legislation, the GST Bill, may defeat its purpose entirely.

What’s the claim?

According to Finance Minister Arun Jaitley, the GST reform can boost economic growth by as much as 2 percentage points by way of introducing more efficiency in the movement of goods and services across state boundaries. It is also claimed that Automotive OEMs and logistics sector companies stand to gain as it may become easier to transport goods across India. However, the stock market drew mixed reactions, profit-taking, and amidst the disclosure of monthly volume numbers, the impact of the long-pending indirect tax reform on automotive stocks was unclear.

What is the process from here on?

The 122nd Constitutional amendment, having been passed by the Upper House (Rajya Sabha) with certain amendments, will have to be ratified once again by the Lower House (Lok Sabha), which should be a formality given the control of the House by the ruling party. The bill will then proceed to the state-level, where it will have to be approved by at least half of the states (simple majority). A detailed tax structure will then be appended and the legislation will once again go through the ratification process in the two Houses of the Parliament, followed by a presidential assent.

The earliest implementation of the GST will be by 1st of April, 2017 – and that’s assuming there are no technical hiccups on the technology side (The GST Network Company awarded a contract to develop & implement its system as late as November 2015 to Infosys.)

Issues

#1 Implementation issues encompass not only technology but also the lists of items to be included in the GST. The GST purportedly leaves out staples such as alcohol, petroleum, real estate, and there may be a separate higher levy on luxury items, which seems downright farcical! That’s right: let’s leave these utterly common items such as petrol and housing out, and then call it a unified tax structure.

Fresh concerns have been raised by the IT industry association, NASSCOM, which is claiming that the GST will replace the existing administration of single-point central service taxation with one consisting of as many as 111 different taxation agencies!

Moreover, if replacing 17 complicated state and federal levies with consolidated agencies at 3 levels (CGST, IGST, SGST) sounds complicated, it must be terribly more so to actually administer the system procedurally and technically. By April, 2017? And pigs can fly.

#2 The tax rate hasn’t been decided yet. If it is too low, the states will attempt to block the bill and legal ramifications could be very messy. If it is too high, the popular appeal of the GST will be lost entirely. Modiji’s BJP has to walk the tightrope with finesse – which cannot be taken for granted.

#3 Revenue-neutrality could scupper the longer-term benefits. If August 3rd was any indicator, political parties across the spectrum are willing to appease and to be appeased, except the AIADMK (the ruling party of Tamil Nadu, which stands to lose out as a primarily manufacturing state), but on the major condition that revenue neutrality be assured. Granted that satisfying a few tax authorities is easier than satisfying many, but without a meaningful reduction in the tax burden, this seems analogous to dealing with 3 kidnappers instead of 17, without any reduction in the ransom amount! And the 17 kidnappers are still there, enjoying the spoils with the first 3!

Take it to the limit

The issues discussed above aside, the whole objective of the GST is voided if the state-level infrastructure of taxation authorities is not dismantled. After all, what economic efficiency will we talk about if the overall federal level tax collection is unchanged and all these taxation authorities are preserved, still making a living off Indian businesses as earlier? Then, all the GST is, is calling for more bureaucracy at the center by concentrating taxation power, which until now, was dissipated among various states. To study the other extreme, if all the taxation power at the state level is demolished, the objective of revenue-neutrality will have been dealt with, implementation issues will be minimized, and there will be no tax rate to debate over! That is what a real tax reform should look like.