Monthly Archives: August 2016

Thursday Trivia – Dr. Raghuram Rajan : An Economist that India deserves!

On September 4, 2016 the Reserve Bank of India (RBI) Governor Dr. Raghuram Rajan will end his term as the 23rd Governor of RBI and will return to academia.  Dr. Rajan is often introduced as ‘Rockstar Central Banker’, ‘Inflation Warrior’ and the like.  Apart from his academic records that include a bachelors degree in Electrical Engineering from Indian Institute of Technology, Delhi, a Post Graduate Diploma in Business Administration from Indian Institute of Management, Ahmedabad and received a PhD from Massachusetts Institute of Technology for his thesis titled ‘Essays on Banking’.  One of his claim to fame was that he had predicted a global meltdown which happened in 2008 and had warned the United States Government in 2005 through his paper “Has Financial Development Made the World Riskier?”.  Apart from this he has authored two books namely, Fault Lines and Saving Capitalism from Capitalists.

 On August 10, 2012 Dr. Rajan was appointed as Chief Economic Advisor to India’s Ministry of Finance and on September 5, 2013 he took charge as the RBI Governor for 3 years.  During his term, Dr. Rajan has been widely appreciated for stabilising the falling rupee and going after the banks to clean up their balance sheets through reducing influence on bad loans.  He also set Consumer Price Index (CPI) as benchmark to assess inflation and did not lower the bank lending rates as well despite following huge criticism for everywhere.

 Before we look into Dr. Rajan’s journey, let’s first look into the role of an RBI Governor :

1.    Controlling the money and credit supply in the system

a.  Repo Rate : when RBI lends its money to other central banks.

b.  Reverse Repo Rate : when RBI borrows money from commercial banks

c.  Cash Reserve Ratio : A percentage of total deposits that a scheduled bank has to be mandatorily deposited with RBI.

2.    Monitoring of key indicators such as Gross Domestic Product (GDP) and Inflation

3.    Issuing licenses to banks

4.    Risk Management, Audit and Inspection of Banks

5.    Controlling Foreign Exchange

Now let’s look at some of highlights of journey of Dr. Rajan during his tenure as RBI Governor :

1.    Easing Inflation

As we discussed above that benchmark to assess inflation was changed to CPI from Wholesale Price Index (WPI).  At the end of October, 2013 CPI was at 10.62% reaching a high of 10.9% in November 2013.  Through strategic reforms over the years and a hawkeye to ease inflation we saw it eased to 5.77% in June 2016.  RBI’s Inflation target is 4% with a band of plus / minus 2% which has been achieved to a great extent.

2.    Improvement in Current Account Deficit (CAD)

India’s CAD had touched a peak of $21.77 billion a quarter before Dr. Rajan assumed office while it has significantly eased to $320 Million as of March 2016.  Ofcourse apart from policies framed at the RBI even a steep decline in oil prices has had a major role in bringing India’s CAD down significantly.

3.    Stabilising rupee against dollar

For a while, it had seemed as if rupee would almost slip to the levels of 85-90 while some financial pundits had even predicted 100.  Then Dr. Rajan set up a scheme where banks were offered various incentives to offer dollar deposits to non-resident indians abroad which beefed up India’s foreign exchange reserves and restored confidence of investors in Indian markets.

Rupee hit a record low of 59.18 in May 2014 and till then has been on a gradual uptick but stabilised near 66-68 mark.

4.    Growth in India’s stock market

India was considered as one of the ‘Fragile Five’ nations back in 2012-13.  RBI then set up policies and effectively monitored them along with the help of Government, now India is one the strongest growing economies in the world.  Both Domestic and Foreign Investor confidence has been restored in stock market too.

Taking benchmark as Nifty 50 index, it was 5471.80 as on August 2013 and reached a high of 9119.20 on March 2015 and now it is around 8575.30 as of August 2016.

5.    Early detection and provisioning of stressed assets

When we bring something new to our house, we ensure that we make some space for it by cleaning out some of the old objects.  Similarly, it was seen that a lot of loans were being distributed but the productivity of the country was not going up. In order to curb that and bring it to the notice of everyone, banks were directed to clean up their previous loans which had gone bad by detecting them and making a provision for them under stressed assets.

While the numbers for stressed assets with the banks has risen from approximately Rs. 2 lakh crores to Rs. 4.5 lakh crores which has added to worries of financial health of Indian banks especially Public Sector Banks.

6.    Easy Banking

During his tenure, RBI came up with a number of reforms which included easier Know-Your-Customer (KYC) norms to check dubious accounts.  Additionally, many payment banks were given licences which will increase the adoption of e-payments and keep a strong check on fake currency in circulation.  Even Non-Banking Financial Companies (NBFC) were given licences to operate in semi-urban and rural parts of India where it was not feasible for bigger banks to operate, this added to easier availability of credit and a boost in productivity of those regions.

Apart from this, an incident happened at the RBI which gave a new name to Dr. Raghuram Rajan as ‘Rockstar Central Banker.’

A Class 5th student, wrote to Dr. Rajan that she would like to help the RBI with $ 20 as she overheard her parents discussing how weak the Indian economy was.  Dr. Rajan was quick to return the letter with an invitation at RBI Headquarters.  You may read the complete story here.

With the reforms in place and a positive demographic situation in India, one would have expected for Dr. Rajan to continue in his current role and add immense value.  Certainly, at this juncture of the economy where ground work is being done effectively for higher growth in coming years to come, Dr. Rajan is certainly an economist that India deserves!

 

Thursday Trivia – Goods and Services Tax (GST) – Pass ya Fail ??

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On August 3, 2016 Rajya Sabha passed the much awaited 122nd Constitutional Amendment to turn Goods and Services Tax (GST) Bill into law and replace different state and local taxes with unified value added tax system.  In 2000, the Vajpayee government started discussion on GST by setting up and empowered committee under then West Bengal Finance Minister Asim Dasgupta.  In a nutshell, it has taken 16 long years for the GST bill being approved by both the houses of parliament. But as they say better late than never.

 

 

Analysts say the implementation of the goods and services tax (GST) could provide the kind of productivity boost helping the economy massively in long term. Here are the various ways in which GST will help.

 

1) Unified market: The GST will cut down the large number of taxes imposed by the central government (e.g. central VAT or excise duty, services tax, central sales tax on inter-state sales, etc.) and states (VAT on sales, entertainment tax, luxury tax and octroi and entry taxes levied by municipalities). This will lead to the creation of a unified market, which would facilitate seamless movement of goods across states and reduce the transaction cost of businesses.

 

2) Lower incentive to evade tax: Currently, companies have to pay taxes on entire underlying value of the product/service, but under GST, companies in a chain will have to pay tax only on the value-addition. So, the actual tax paid will likely be small and reduce the incentive for evasion.

 

3) Widen tax base: GST will give credits for all taxes paid earlier in the goods/services chain incentivising tax-paying firms to source inputs from other registered dealers. This will bring in additional revenues to the government as the unorganised sector, which is not part of the value chain, would be drawn into the tax net. Besides, states will be allowed to tax services (as opposed to only the central government) under the GST.

 

Let’s us look at an example as to how GST will start benefitting the businesses and economy as a whole.

 

Indian truck drivers clock an average of 280 km per day, much below the world average of 400 km per day and far below the 700 km the average truck driver in the US does every day. The underperformance of Indian truckers has less to do with bad roads and less fancy trucks and more about prevailing archaic laws.

Truck drivers in India spend 60 per cent of their time off roads negotiating check posts and toll plazas, says UBS Securities, which has also found that there are 650-odd check posts in the country and 11 categories of taxes on the road transport sector.

 

Since road traffic accounts for 60 per cent of freight traffic in India, the slow movement of trucks across states leads to productivity loss. According to UBS, if the distance covered goes up by 20 per cent per day, Indian truck productivity would improve by 12 per cent.

 

Higher productivity would cut the need for buffer stocks; reduce the loss of perishable goods, cut down the need for many warehouses, etc.

 

According to the National Council of Applied Economic Research, government’s tax revenue will increase by about 0.2 per cent because of GST implementation, while GDP growth could go up by 0.9-1.7 per cent. Exports will also get a boost as they are zero-rated for taxes and also because the fall in cost of manufactured goods and services under GST will increase the competitiveness of Indian goods and services in the international market, UBS says.

 

 

Now let’s understand this proposed impact of GST bill on supply chain and end consumer through an example. (GST assumed at 18%)

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As we can see from the above, distributor will prefer to purchase with an invoice because it will give them a better profit margin.  In the present scenario, the distributor will bear the burden of excise duty makes him more vulnerable to avoid taxes.  This might make a few goods a little expensive but since tax evasion will be checked it will provide huge benefits to the country in years.  Also, with more collection of taxes through an indirect route, it will provide much relief for direct taxes through income tax in years to come.

The party is not yet started

Yet, GST is far from reality as such.  Rajya Sabha has approved 122nd Constitutional Amendment to turn the GST bill into law as there is no such law as GST Act till date.  The bill will now be passed onto Lok Sabha, once an okay is received it will go for President who will ask the states to participate.

 

If 50% of states approve to the amendment, it will go to the President for the final ‘okay’.  This will mean that constitution has been amended paving way for GST law.

 

Now the GST Bill will go through a parliamentary committee which will have to be introduced in the winter session.  If there is an agreement, then the bill will be further discussed and put to vote in Lok Sabha and Rajya Sabha.  After that it will be again sent to various states for approval, after that president will assent to it.

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Hence, with a such a long process being on its way the Central Government is targeting to introduce it as early as April 1, 2017 or as late as April 1, 2018.

 

(Infographic courtesy Times of India and visual.ly).