Wednesday, February 21, 2018

Interesting Readings 21 Feb 2018

Here are some interesting readings/listen today:

Adventures in Finance by Real Vision Episode 53 - Unfixed Income: The Bond Market Meltdown: Grant Williams and team talks to Jeffrey Snider of Alhambra Partners & Greg Weldon of “Weldon Live” about the Bond Market. The episode was recorded on Feb 8 but nevertheless it is a must listen. 
  • Jeff believes current correction is similar to Oct 2014.
  • Jeff believes we are trending lower on the neutral interest rate and analyst believe the cap around 3%. There is merit in the argument. Look at the chart of 10-yr rates (annotations are mine). He states this looks like "Japanification".
  • Greg takes a different view - he implies that this trend is unhealthy and may reverse for a long time. 
  • Greg compares this time frame to 1987.

Cash, Cat and Mouse by JP Koning discusses the cat and mouse game between tax authorities and taxpayers in the domain of retail payments.
There are two weak points in the sales process that allow cash-accepting retailers to avoid paying sales taxes or VAT. The first weak point is at the very outset of a payment. When a customer pays with cash, the person behind the till can avoid ringing up the payment. Without a record of the payment having been made, the retailer needn't pay tax. 
But even if a retailer rings up all cash payments and provides receipts, they can still avoid paying taxes. At the end of the business day, they need only doctor the cash register's data using a zapper—add on hardware or software designed for this purpose—in effect purging all or a portion of the cash payments registered during the course of business. With the only record of that day's cash payments now being the paper receipts held in customers' wallets—most of which will have been thrown away—the retailer needn't worry about the tax authority discovering the doctoring. (Erasing card based payments is much riskier for the retailer because a paper trail still exists with the card-issuer.)...
One neat trick to get retailers to provide receipts—and therefore run all transactions through the tamper-proof cash register—is to recruit the customer into the cat and mouse game as helper. Public information campaigns exhorting people to ask for receipts are one technique. But the more interesting trick is implementing a tax-receipt lottery. All invoices issued from the tamper-proof cash register come with a unique lottery number. Anyone who keeps their invoices will be able to participate in a periodic lottery. Customers thus have an incentive to ask the retailer for a receipt, obliging the retailer to run the transaction through the fiscal till. 
This is another aspect of going cashless. Can payments app help in this? I think so.

India Bank Fraud 
Banks vulnerable to hackers without online interface between CBS, SWIFT says Leslie D'Monte in Mint. While the premise is not wrong, it is not the complete picture. There are multiple control systems in any organisation. IT system is one, management control is other. Management control includes operational control and audit systems. All these systems work together. The article airs another misgiving about cybersecurity. Cybersecurity does not imply one technology -but it is a set of processes. Each part by itself does not always grant complete security but the process, taken together, should make it secure. PNB, I suspect, did not fail at that. I suspect there is involvement of few more people at PNB and also few from regulatory agencies. So I was happy when I saw this:

CBI widens PNB fraud probe to include bank’s top brass. I hope they also look into the RBI and Finance Ministry. Alternatively, Subramanium Swamy may already be on that one.

World war Watch
Turkey will attack Syria's Afrin 'in the coming days', Erdogan says. The situation in the middle east is turning bad quite quickly. Just a few months ago ISIS was cramped and it seemed that the situation may stabilise soon. Yet, this new intervention will fuel further problems. The problems of middle east arise from the random drawing of borders by the British and the Americans after the Second World War. But they have been aggravated by what I believe is Kissinger policy. Thus, the rulers and their armies (who want control), the population (who want peace and prosperity) and challengers (who are being oppressed by the rulers) have completely divergent interest resulting in continuous festering. 

The Maldives, since its independence in 1965, has had an “India first” policy and leaders of both countries have held high-level exchanges on regional issues. But since Yameen took office, he has aligned with China, which has defended his authoritarian rule. The Maldives now owes about 80% of its foreign debt to China, which has been spreading its wings rapidly in South Asia and has been eyeing the atoll nation for its strategic location. China has already cosied up to Nepal by helping the latter reduce its significant trade deficit; it has invested heavily in Sri Lanka and Pakistan. China is strategically encircling India under the fancy name of the “Silk Road Project”. A part of the road will also pass through Pakistan-occupied Kashmir and may eventually help further Pakistani ambitions in Kashmir. 
Dhruva Jaishanker counters this with an article titled Reports of India’s demise as a regional power are greatly exaggerated 

Tuesday, February 20, 2018

Interesting Readings 20-Feb-2018

It has become increasingly difficult to keep tabs on interesting articles I read. Almost always when I need to reference them, I am unable to find those. I started using Zotero to keep references but I also want to write some short comments on the articles so I remember what thoughts were triggered by the article. Hence I am starting this series as a personal bookmarking feature. 

Interesting readings for today

PNB/Nirav Modi/Chokshi scam coverage claims highlights.

Mint did a basic profile of Nirav Modi - Who is Nirav Modi, the man linked to $1.77 billion PNB fraud? It is short but interesting.

Tamal Bandyopadhyay answers basic questions about The anatomy of the PNB fraud. This follows a short but smart note by Deepak Shenoy titled How The 11,400 cr. Import Ponzi Scam at PNB Unfolded. Both are must read.

Once investigations start then skeletons will tumble out. Shasswati Das from Mint writes Shell firms, benami assets on the radar amid fresh raids on Nirav Modi, Choksi.  
investigating agency and the income-tax department have zeroed in on 200 shell companies—both in India and overseas—that were being used to receive funds as part of the alleged fraud, in order to create benami assets in the form of land, gold and precious stones.

I cannot believe there is only one culpable officer and one errant company (or one bunch). There must be more officers involved and surely more companies using similar modus operandi.

Bank Stability
Fourth and finally, I would like to quote this important paragraph from the Financial System Stability Assessment Programme for India done by the International Monetary Fund (IMF) and published in December 2017: “India’s key banks appear resilient, but the system is subject to considerable vulnerabilities. Stress tests show that while the largest banks are sufficiently capitalized and profitable to withstand a deterioration in economic conditions, a group of public sector banks (PSBs) are highly vulnerable to further declines in asset quality and higher provisioning needs. Capital needs range from 0.75% of GDP in the baseline to 1.5% of GDP in the severe adverse scenario.”

The IMF added: “The authorities recently announced a recapitalization plan for the PSBs amounting to approximately 1.3% of GDP, as well as the establishment of a mechanism to seek consolidation across these banks.... This recapitalization package will effectively address the capital gap assessed in the FSAP (Financial Sector Assessment Programme) exercise even under the severe stress scenario.”

Mihir Sharma takes the attack on Government ownership in his Bloomberg Quint article State Control Has Opened India's Banks to Fraud. He is not wrong. But the next logical step in this process is not fully correct. Debashis Basu highlights it. He believes if we change ownership - i.e. sell off the banks then the problem will go away. [Behind paywall] I am all for private banking. The government needs to own just one bank - State Bank of India - rest can be privatized. The reasons for this one exception is a topic for another post. However, I am not in favour of selling banks or any PSUs at this stage. The best way is to turn it around and then sell it. The assets of people should fetch full value.

Ila Patnaik discusses some other solutions in addition to bank privatisation in her article titled Lessons from a fraud. They include improving bond market, small savings scheme, increase deposit insurance cap and narrow banking. Read the quote about narrow banking:
Fourth, if the government decides that PSBs should offer risk-free deposits above the cap on deposit insurance they should be allowed to invest only in government bonds, or, do “narrow banking”. Then the implicit sovereign guarantee could effectively turn into explicit sovereign guarantee. The business of giving loans, making decisions, figuring out risk management systems, hiring competent staff, provisioning for bad loans, creating mechanisms for accountability and punishing management when systems fail can be left to private banks. Today the taxpayer pays when PSBs fail to perform these functions properly. Narrow banking by PSBs can take this burden away from the taxpayer.

Ajay Shah, as is his wont, targets the RBI in this Business Standard artcile - First, build a capable RBI. V Ananthnageswaran counters this in his post Problem disguised as solution!

World-War watch
Building maritime capacity in South-East Asia
Article by Swee Lean Collin Koh says many important things.
What New Delhi has in South-East Asia is what Beijing has only in the past decade started doing and so far not yet accomplished in the Indian Ocean

Other things
Municipal corporations are increasingly offering through app services such as online ticketing booking and local services that has have so far been the reserve of start-ups such as UrbanClap, Quikr and Housejoy
The services that should be provided by public bodies cannot be abdicated to private players. However, public bodies may find it difficult to design the most optimum solutions to public service delivery. I prefer the PPP model here - DBOOT -or design build Operate own and transfer. 

In this article Vrinda Bhandari, Amba Kak, Smriti Parsheera, Faiza Rahman and Renuka Sane from NIPFP submit their suggestions for The Justice Srikrishna Committee developing comprehensive cross-sectoral data protection law for India.

Wednesday, February 07, 2018

Revenue Deficit vs Fiscal deficit and Fiscal responsibility

"Ballooning Revenue Deficit is far more worrisome than nominal slippage in fiscal deficit" said Mythili Bhusnurmath in ET. Her views are correct. But how to curb Revenue deficit. Let us understand the terms a bit more in detail.

Revenue deficit is amount by which Revenue expenditures exceed Revenues. 

What are revenues or Revenue receipts?
Revenues can be tax or non-tax. Tax component includes share of tax of Union Government in general taxes and "cess" or specialized taxes accruing to Union Government alone. [Refer Note 1]. Non-tax revenues includes interest on loans to various entities (state governments, etc.),  profits and dividends from enterprises, duties and fines received, grants from multilateral agencies or other governments etc.

What are revenue expenditures?
Revenue expenditures includes:
  1. Salaries and pension paid to government employees
  2. Subsidies
  3. defense expenditure (relates to national security)
  4. Government procurement from stationery to vehicles to arms and ammunition for police (internal security)
  5.  Expense required for running government schemes and programs
  6. Interest paid on borrowings - domestic and external.

Fiscal Deficit is more like capital account deficit.
Capital Account Receipts side includes recovery of loans to States etc., receipts from disinvestment or privatization and borrowing (external and domestic). Capital expenditures includes investments in Public sector companies, investments in public projects, etc.

Further, accounting 101 will tell you that revenue deficit accumulates in the Fiscal side and it has to be financed through borrowing which sits on the capital account. The servicing of this borrowing is done through revenue expenditures. These twin deficits thus, are quite interlinked. Mathematically, it is true that we can reduce Fiscal deficit (FD) while Revenue Deficit (RD) remains high. But it is true only for small values of RD. But a more ideal situation is when FD is higher (though less than the 3%) and RD is zero or lower. Then, one presumes, your excess FD would be mostly because of high quality capital expenditure. This capital expenditure will yield more Revenues and thus lower RD in the future. [Refer Note 2].

The Problem
For past decade or more, reverse is true. Most of borrowing is used for revenue expenditures - i.e. payment of salaries to bureaucrats. In return, bureaucrats and government employees have stifled any possible revenue growth for citizen or companies thereby reducing the revenues. This widens the revenue deficit and pushes the system into a negative spiral.

It is clear that the present malaise is largely self-inflicted. Imposing FRBM target without first having a RD at zero or lower is a recipe for disaster. At present, government appears to throw disinvestment money after revenue expenses and that is very bad idea. It erodes the structure of the economy.

How to kickstart the positive spiral?
The government is now required to first ensure that RD is reduced to zero but using revenue receipts. That requires expansion of tax base which is impossible without taxing agriculture. Thereafter, using asset sales i.e. disinvestment or privatization route, reduce the lower quality borrowing. Most of the borrowing by the government should be directed towards investments that yield revenues in the future and thus create structural zero- revenue deficits or revenue surpluses. This is the improvement in quality of budget is what prudent observers seek.

  1. Indian federal structure implies that both center and states have power to tax and they have share in the tax. Most of the taxes are shared and go into "consolidated fund of India" for central share and "consolidated fund of the state" for state taxes.
  2. Ideally, the any borrowing or loan or debt should create more revenue than expenses required to service it. To do that, borrowing must be invested in revenue boosting ventures. Companies borrow to buy new machine that can increase production. Similarly nations should invest in those assets that will increase profits for citizens and companies and thus improve tax receipts.

Monday, February 05, 2018

Taxes and the contract of Government

Taxes got me thinking about the kind of contract we have with the government. 
[Note: The following post is a thought process - neither complete nor complete in arguments]

Are we born into a government or do we grow up and contract with the government?

If we grow up to contract with a government, the contract begins when we enter into this contract - usually when we turn 18 years old. The contract is transitory and government is what I agree in the contract to be. People, who are present, come together to surrender some of their freedoms and money in return for the collective services that government shall enable these people to have. Now by implication, these collective services are best procured for the entire group and thus more or less obligatory. Like for example, security. It is easy for a group to protect itself from predators hence animals form into groups - giving up freedom to wander anywhere. In this transaction is the kernel of democracy. The freedom to roam / wander away is not denied. It is just that when you exercise your freedom to wander, you lose your security. This give and take is missing in modern democratic contracts.

A counter-view implies that we should not let an individual cancel her contract with the government. There are humane reasons behind this. If a person wants to opt out of this contract and he becomes ill and without access to some public benefit he may die. The question before the government is whether they should let him die or use the public services to prevent his death. If you think we should use public services to prevent his death then it starts sounding like "socialize the losses and privatize the gains". Then, he should not be allowed to renege on the contract in the first place. It leads us to a situation as if we are born into a government - where the government predates us. That is a bit queer. Governments i.e. countries are supposed to be perpetual entities. They can never die. So this every present, always alive and thus omnipotent (or rather more potent that any living person) government bestows upon us some benefits for which we are to return some favors. The benefits includes everything - air we breathe, water, public services, schools etc. and favors imply taxes. Now don't you want the government to give you more benefits, more sops and more things? Then you must pay more taxes! Next 50% inheritance tax.


Thursday, January 11, 2018

2018: Images from the crystal ball

As 2017 draws to a close, it is time to peep into the crystal ball for 2018. But before that let me just quickly give a brief prelude.

What a year!
2017 was supposed to be a dramatic year. Back in 2011, from the extent and nature of QE, I expected around 2017 to be the year when the shit hits the fan. How wrong was I! In the intervening period I was caught off guard by a smallish slowdown, a central bank response that far outweighed anything we have seen and an unprecedented surge in valuations.

Asset prices have increased over this period since 2013. In 2017, they have reached their all times highs. The valuations of all the asset classes increased almost linearly. Many are more expensive than 2007. The art market has gone up substantially. Bitcoins are the new game in town creating large price changes on an almost daily basis.

Inflation, on the other hand, has been relatively benign. Not much is happening in food prices. Oil and Gold, the two special 

The dichotomy between these two is quite important. In Subverting Capitalism and thereafter on this blog I have maintained that when you pump money while watching the inflation basket, it leads to non-inflation basket asset price inflation. This relative price discrepancy gets corrected as prices can flow through two central asset classes - oil and homes. Oil is on its way to becoming irrelevant. But not homes.

In 2018
Some of the important events that are likely in 2018 seem as follows:

Home prices, however, continue to rise till they break inflation.
Home prices across the world rallied between 2003-04 till the peak in 2007-08. The rise of the home prices was at an unprecedented rate. There was a lull in 2008-2010 period. While prices crashed, the house price to median income ratio was high. Since 2010, the housing prices have started rising. The rise has been documented by IMF here and by Economist here.

So how higher can these go? Well, they will go till they break inflation on the upside. There is a condition. The prices may not go up if artificially cooled. Singapore has done it, Canada is considering it and others are monitoring the house prices. In effect, house prices are almost included in the inflation basket. When that is the case, the excess money has to move somewhere before Fed and other central banks can suck it out. Commodities - gold and oil offer such bets.

Oil touching $100 then retracing back to $40-$45
Not many are pricing oil beyond $70 at present. Apart from one call from Goldman, there seems to calls for high Oil prices. Oil is also becoming irrelevant. It has now been established that "peak oil" is more peak oil demand rather than peak oil supply. The decision of Saudi Aramco to go for IPO is an acknowledgement of this reality. These days, IPOs are an exit for promoters not call for investment with promoters.

Oil is surprisingly inflexible in the short term and almost surely irrelevant in the very long term. It is possible for short-term geopolitics to drive a supply squeeze to push prices up. At present geopolitics is in a stalemate. As much as Saudi Arabia likes higher oil prices, those will help Qatar and Iran too. Further, the real target of low oil prices - US Shale producers have turned out to be more resilient than anticipated. Thus quagmire will solve itself gradually. With Russia entering the picture in the Middle East, you can be sure Oil price will rise in short term. The higher oil price beneficiary group is bigger than the low Oil price beneficiary group. Higher oil price will also ease pressure on Venezuela.

At the same time, I do not foresee Oil sustain at $100/bbl. After the $100 rendezvous, oil may recede back to $40-$45 range. So at present, I would like to be long oil right all the way till $100 and then short oil right till $55.

The story of 2017 is the breakout of bitcoin. Where will bitcoin go in 2018? More important than that question, what effect will bitcoin have on the main economy?

Return of Japan
2018 should be the year when Japan makes a comeback. There are a bunch of quality companies that have been stuck because of Japan's economic stalemate. I think Japanese companies will see some traction this year. Japans social re-engineering is going to be the thing to watch for. If Japanese women truly join the workforce and are allowed to operate at their potential then we could see something remarkable. It is possible that whole new segments of the economy may be created to support the working women. It will be stimulus twice over.

Europe - See-Saw?
Eurozone is basking in a bit of sunshine this winter - good news flowing all around. The French are putting their house in order with labour reforms. There is a decent amount of growth and banks are more healthy than ever before. There are some weird signs though. The Greek and Portuguese bonds seem to be too cheap. With these indicators what can go wrong?

Not much this year it appears. Europe should perform well in first half and the worries may appear only in late 2018. The ECB and SNB have bought substantial amounts of corporate bonds. This is not a great sign if you ask me. In a recent podcast, Felix Zulauf highlighted this. I was struck by his assessment impact on future of bond markets such moves are making. 

Impact on Politics
The response to the financial crisis of 2008 has left many befuddled. Mark Yusko, in his letter points to the very same issue - the actual behaviour of markets is at odds with the fundamentals. It is indeed. But aside from those issues, we must assess the other slow-moving forces this has unleashed - particularly in politics. Politics has become increasingly expensive because of this central bank policy.

That means we do not get the reform that is necessary. Thus, we have an enormous tax compliance process that is weighing the growth down. Yet, Democrats won't acknowledge that. Conversely, the Republican tax proposal does not simplify or ease that burden but complicates it even more.

What we also get are politicians who are increasingly out of touch with the citizens.

Coming War?
The combination of out-of-touch politicians, economic interests at loggerheads, economic and policy stagnation, distrust and fake news is a potent powder keg searching for a spark. My scenario for war now looks likely.

China's policy with One Belt One Road and lending-driven quasi-colonisation is also bound to create dissidence. The US and developed world will put pressure back on China by reducing demand for its factories which can service almost entire world's demand (maybe twice over) using robotics and automation. Automation, it is my belief, is the result of the prolonged low cost of capital. In that sense, China's communists will get a taste of Marx - Capital V Labour.

Add the uncoordinated US strategies in the Middle East, the fundamentalist strain of Islam and we have making of a world war. This Middle East angle de-escalated a bit after Iraqi victories against IS in Iraq and Syria. Yet, the threats continue. Iran may not be the problem area it appears now. The wildcard could come from Af-Pak area.

In Sum
We may be looking at an interesting year in 2018.