Risk

Risk Perception/Risk Assessment/Risk Management.

“But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade? And how do we factor that assessment into monetary policy?”

Alan Greenspan, 1996

“If anything kills over 10 million people in the next few decades, it’s most likely to be a highly infectious virus rather than a war,” Gates said. “Not missiles, but microbes.”

Bill Gates, 2015

Risks usually don’t get picked or play-out just because somebody has the vision to see it.

A “Risk” is not a risk if it can be anticipated.

That’s true because then you have the opportunity to plan for it.

For example, if you go on a jungle safari, you anticipate wild animals and hence you have a guide/expert taking you through the safari with enough safeguards to protect you.

It is a “Risk” when either you cannot anticipate, or once anticipated, don’t plan for it, ignore it or even under-play the risk.

Let me give an example:

The rising complexities of the markets, which spawned more and more complicated instruments like credit-default swaps and mortgage-backed securities, had in fact made the global financial system a much riskier place, not less so as many believed.
Raghuram Rajan, 2005 Jackson Hole

“the basic, slightly lead-eyed premise of [Rajan’s] paper is misguided”.

Larry Summers, Former US Treasury Secretary on Raghuram Rajan Jackson Hole speech

Where is my TAIL?

The tail risks is usually a rare event.

Probability of a rare event is low but impact is very high.

Usually in good times, liquidity sloshing around, asset prices inflating, portfolios making you feel good can make even the most obvious risks appear irrelevant.

Often investors in a bull market wonder about risk and then themselves discount it citing exuberant environment.

However a tail risk is like steam pressure building up in the cooker, you know it is going to be enough at some point for the cooker to give you the whistle.

That whistle is your warning, however mental exuberance makes people continue to build on the risks.

What should an investor do?

  1. Have an “objective” with a timeline?
  2. Have a thesis on which asset class and within that asset class which particular asset will you choose and why;
  3. Choose quality of investment over returns, basically don’t get driven by speculative reasons or short-term outcomes to make investing decisions
  4. Quality businesses with healthy balance sheets survive crisis and emerge stronger as the pandemic has shown us and hence choose quality over businesses over any other proposition
  5. Patience-not only after but even before investing-Get your price right in a quality business and enjoy the journey
  6. Remember you are not responsible for an NAV but your goals.
  7. Investing finally is not entertainment nor is it show business.
  8. The biggest show-off can be when you achieve your goals and that day you will not have to show-off, everyone will see it for themselves

Finally “Stay the course”

Salt, Fat, Acid, Heat

Courtesy Samin Nusrat book titled “Salt Fat Acid Heat

In her eponymous book “Salt, Fat, Acid, Heat, Samin Nusrat lays down the 4 basic principles of good cooking.

She says and I quote “there are only four basic factors that determine how good your food will taste: salt, which enhances flavor; fat, which amplifies flavor and makes appealing textures possible; acid, which brightens and balances; and heat, which ultimately determines the texture of food.”

Looking at these elements the thought that will strike anyone who is passionate about cooking is how simple it seems, however most amateur cooks or equivalent of “bathroom singers” don’t appreciate enough how following principles makes a difference to how a dish will taste and how the recipe becomes irrelevant when the basics are done right.

Investing Parallel

I couldn’t help but draw a parallel to how investors need to think about investing principles that can make the recipe irrelevant.

Most advisors will state “behaviour management” to be their number 1 challenge when dealing with investors.

Often enough financial and behavioural theorist have put up mechanisms or principles to manage behaviours

Risk

Risk is often not appreciated by investors till they face it. For different investors it has different meaning and that’s why I feel “Risk” is to investing as “Salt” is to cooking;

Right from loss of capital to mark to market losses to loss of opportunities. Any of these or all of these could be equivalent of Risk to an investor.

Most experts would however put “permanent loss of Capital” as the only real risk. However for investors it is important to understand what risks means to them and not what some expert states risk is.

Perception of risk is more important for investors psyche than its textbook definition and so while some people prefer low salt content other prefer their food to be fully flavoured and just as food taste is individual so is risk.

Just the way salt defines flavour, understanding of risk defines how an investor will compound.

Objectives

From retirements, education, house, car, marriage, lifestyle maintenance to just the kick that investing gives, varied investors have varied objectives.

Professional chefs are not just particular about the flavour but even the texture of the food as it’s the texture that makes the food presentable. The texture of the food comes from its fat content.

When the buffet of an investor is laid out, the objectives and how well they are defined not just increases the probability of its achievements but also makes it attractive to embrace.

Advisors need to ensure that right amount of “FAT” ( read “objective”) is added to the recommendation to make the meal attractive to the investors.

Knowing their objective can potentially make an investor accept their risk profile and make it more palatable than the lack of it

Asset Allocation

Acid adds balance to a dish just like asset allocation does it to investing.

Maintaining asset allocation in good times as in bad helps manage behaviour and makes sure compounding happens.

Investors losing hope when markets crash or becoming exuberant when markets in upswing get the temptation to give up the asset allocation discipline that can completely ruin the discipline of investing.

Advisors recommending investors to change asset allocation basis short-term momentum do long term injustice to investor portfolios. Yes the investor will feel good in the short run to seem some profits in the bank instead of on paper, however the compromise on long term compounding that this imbalance will cause is like adding either too much or too less acid to that food that will imbalance the taste and ruin the dish.

Expectations

Some people like their food crispy while others like it flaky and some want softness. Different people different expectations.

Just as Heat creates the magic that can determine the final outcome of the food as per individual expectations, similarly “ return expectations” determine the final contour of how the investment strategy will be designed and played out.

High return Expectations while being a conservative risk profile can cause serious distress and damage to the investor portfolio and psyche.

Managing these expectations and understanding the risk at every level that such expectation create can ultimately shape what the final dish will look like.

Investing is challenging not because of lack of intelligence but because of how individuals react to their own objectives, risk profiles, asset allocations and expectations.

Understanding them and reflecting on the same regularly, just the way one will do when one is cooking or giving instructions to someone on how they prefer their food, and can help the investor manage their investing life cycle better.

And finally as the introduction of “Salt, Fat, Acid, Heat“ explains Receipe becomes irrelevant when principles are understood.

Similarly products, timing, volatility becomes irrelevant to an investors when the principle are followed.

Happy Reading

THE ICE AGE BEARS

The long-term trend for planet Earth is a cooling one.

Earth started out as a molten ball and over hundreds of millions of years began to cool, eventually forming a crust and creating an atmosphere and the oceans.

Currently we are in the middle of an Ice Age, in fact it has been so since last 2.6Million years.

The Earth has experienced five major ice ages and this one is called the Quaternary. 

These ice ages have witnessed alternating periods of glaciation averaging 70000-90000 years and interglacial warming periods of 10,000-30,000 years.

The current interglacial event began 12000 years ago.

At the peak of the last glaciation, about 18,000 years ago, there were ice caps and glaciers over two miles high covering Detroit and much of North America, Europe, and the southern parts of South America and Africa.

For the last million years or so these have been happening roughly every 100,000 years – around 90,000 years of ice age followed by a roughly 10,000 year interglacial warm period.

An ice age is triggered when summer temperatures in the northern hemisphere fail to rise above freezing for years. This means that winter snowfall doesn’t melt, but instead builds up, compresses and over time starts to compact, or glaciate, into ice sheets.

THE LONG-TERM BULL CYCLE

The 30 year chart of BSE-SENSEX has been like the long ice age interspersed with interglacial bear markets:

The four stages of the economic cycle are expansion, peak, contraction, and trough.

During the expansion phase, the economy experiences relatively rapid growth, interest rates tend to be low, production increases, and inflationary pressures build. The peak of a cycle is reached when growth hits its maximum rate.

Peak growth typically creates some imbalances in the economy that need to be corrected.

This correction occurs through a period of contraction when growth slows, employment falls, and prices stagnate. The trough of the cycle is reached when the economy hits a low point and growth begins to recover.

As visible above, while the long-term trend is positive, business cycle keeps playing out overtime due to variety of reasons.

Same plays out for the market-long term positive trend with short-term drops.

What Should the Investors Do?

Long-term investors need to understand these cycles and how they should react to the drops when the start the journey.

Investing for objectives and not market timing is crucial

Recognise the pains of the cycle while avoiding exaggeration of both growth and decline factors

Using the troughs to strengthen long-term savings is an opportunity-instead of being fearful be brave

Stick to the asset-allocation

Finally, STAY THE COURSE

Not All Curves Are Lines

In his brilliant book “How not to be Wrong”, Jordon Ellenberg explains something basic that most human beings don’t realise in day to day life.

He writes and I quote- A line is one kind of curve, but not the only kind, and lines enjoy all kinds of special properties that curves in general may not. The highest point on a line segment as to be on one end or the other”

Most of the middle to upper middle class that makes decent money has an angst about the taxes that they pay.
Now consider the Following picture

The above shows higher the tax rate, higher the collection and this is what a socialist state aims for and that’s why you see politician.

However then came the “Laffer Curve”

The Laffer curve presents a unique picture which tells us if the tax rate is 0, obviously there will be no collection and if the tax rate is 100-no one will have the incentive to work so again tax collection will be 0.

Ultimately suggesting that the story will be somewhere in the middle that will optimize the tax rate and collection.

In practice it has been observed how the rich change tax jurisdiction to escape high taxation rates.

Linearity & Investing

Understanding linearity is perhaps the most important favor that investors can do to themselves.

This is an interesting curve for one of the most followed businesses in India.

If you had invested in 2002 and stayed invested, the returns today are 3651% or a compounding rate of 25%.

However, look at the curve from 2009 onwards till 2017.

An investor would have got flat returns and anyone who invested at the peak of 2008 (INR741) would have needed 9 years to merely break-even.

That same investor would have again encountered the 2008 peak price in March-2020.

That’s 12 years of lost opportunity.

However, if the investor had the patience to hang-in there, the compounded returns would still be a 10% which an intelligent investor will grab with both hands and run.

Understanding the non-linearity of returns and keeping the faith are 2 important traits that an investor can develop to make peace with their investment decisions and their outcome.

Lastly, here are some nuggets to ponder about:

“If the path before you is clear, you’re probably on someone else’s.”

– Joseph Campbell

“Of all the paths you take in life, make sure a few of them are dirt.”

– John Muir

Paranoia is GOOD

Sept 11, 2001 is a date now etched in the history of world and minds of countless Americans.

As the world commemorates the death of thousands of innocent civilians who were simply minding their business and going to work when being hit in an unanticipated attack from terrorist, it opened the eyes of everyone from everyday people to politicians to the perils of terrorism and its ability to disrupt life as they knew it.

Trust-in systems; leaders; environment is what makes life a series of consistent events.

Even an alarm bell that has been set by a person him/herself has the ability to raise the blood pressure which just tells us how vulnerable human beings are to unanticipated events and what would they not do to avoid it given a choice.

However, history tells us that human actions are often disjointed and undertaken without the prescience of their cumulative impact.

When large systems move, they have a habit of visiting all parts of the space they exist in, in a random but uniform manner.

The 2008 Financial crisis was a prime example of several thousand individual trades coming together to create a crisis large enough to impact the entire world.

Human beings instinctively try to create safety nets around themselves, whether it’s by means of family, community, being part of corporation or in today’s world on social media.

These safety nets have a tendency to create an impression that “All is Well” and can be managed without the realization of how flimsy these can be.

An element of mis-trust in the system, its components, fellow human beings instead of blind reliance on the flimsy safety nets can go a long way in mentally preparing people for risks that they don’t’ see.

Risks-We Don’t’ See

Yes, these are the only real ones that we need to worry about.

Any risk that can be anticipated can be prepared for, its only what you don’t see that you cannot prepare for.

Take Covid-19 for example, no one was prepared.

From recklessness to ignorance to fear, helplessness to despair people went through all possible emotions as the crisis generated by Covid hit everyone either physically, financially, mentally or all of the above.

Andy Grove (Former CEO, Intel) used to tell his colleagues- “Only the paranoid survives”.

This is a highly positive statement-no one can possibly predict all risks.

Anyway, as soon as a risk is predicted, it is no longer a risk as you can figure out a way to deal with out.

What Happens?

The only way to hence prepare for unanticipated risk is to make sure that you have hedged your bets and diversified your resources, businesses, capital, investments enough for you to get to fight another day.

Take your investments, when the markets are up, mood is good, portfolio is going up every-day, all prospects are positive and there is nothing to worry about.

Suddenly life goes in a tailspin as markets fall 10% every-day for a few days.

Nothing is suddenly good, sky is about to fall, world is coming to an end.

You surely see the extremism.

Then the tide turns, and everyone vows to never repeat such irrational behavior.

Again, the markets are up, everything is hunky-dory, mood is good!!

You get the drift.

What to do?

As Andy Grove said-get Paranoid.

De-risk yourself.

Don’t give up on your asset-allocation even if it is frustrating to live with low returns in a major part of the portfolio.

Remember this is the part that will give you a chance to fight another day.

Also remember to follow the following discipline when everything is fine:

  1. Have an asset-allocation.
  2. Write down thesis for every decision.
  3. Re-visit the thesis periodically to check if things are in order.
  4. Be prepared to exit a decision if the thesis does’nt turn out the way you anticipated.
  5. When a crisis visits, re-visit your thesis and evaluate the basics of your decision, if the thesis stands tall, maybe it’s time to take the bull by the horn and add to your position.

Lastly when things go back to normal-you go back to being “Paranoid”

The long and Short of it

Even before the end of the  construction for the Eiffel Tower, it was already at the heart of much debate. Enveloped in criticism from the biggest names in the world of Art and Literature.

The “Protest against the Tower of Monsieur Eiffel”, published in the newspaper Le Temps, addressed to the World’s Fair’s director of works, Monsieur Alphand was signed by several big names from the world of literature and the arts 

Insults were hurled at it like : “this truly tragic street lamp” (Léon Bloy), “this belfry skeleton” (Paul Verlaine), “this mast of iron gymnasium apparatus, incomplete, confused and deformed” (François Coppée) etc.,  etc.

Build in preparation for the 1889 world’s fair, the tower once completed was not only appreciated for its granduer but also received over 2 Million visitors during the fair.

Every year 7 Mn visitors visit the tower and produces tickets sales in excess of 60 Mn Euros.

If the short-termish view of the tower’s construction and lopsided outlook on how it would fit into the architechtural beauty of Paris had prevailed, the world would have missed out on a monument of such scale and engineering excellence.

Long-term Expectations/Short-Term Thinking

Human tendency to let short-term events impact long term thinking gets amplified during big events and tests human behaviour and discipline. 

  • Events disrupt, they don’t end the life.
  • They create a crisis, impact individuals negatively, 
  • Small businesses can even get wiped out
  • Individuals lose out their livelihood
  • Govt.’s have to react and create easier monetary and fiscal policies to support.
  • However the “ONE THING” it doesn’t do is “END THE WORLD”.

One things we have been hearing regularly during the “covid-19” crisis is how several businesses, even if temporarily, have gone to “ZERO” earnings and would take very long to recover.

Those of us who saw 2008 will remember same discussions during that period when the market was in a free fall everyday.

However that didn’t exactly happen. The Earnings Per Share of Nifty 50 that peaked in July 2008 at 234 went back to the same levels within 2 years in June 2010 and then moved to 391 in June 2014 and over 450 recently in 2019.

Life and businesses didn’t come to an end.

Human spirit survived the crisis and came back strongly.

This is not the first “PANDEMIC” that the world has faced and would not be the last.

Each time there have been valulable lessons and hopefully next time we will be better prepared as a community to face this.

As an investors all you want to remember is to stick to your risk-profile and your asset allocation.

  • Such times don’t raise the questions of who is smart and who is not-but who has the guts to stick to their asset allocation.
  • Yes-your equity portfolio has gone down.
  • However valuations have now created the space where you can not only re-build the equity portion of the portfolio but do so at a far better risk-reward.

Here are a couple of Warren Buffet Quotes that could help you chart your path:

“Predicting rain doesn’t count, building the ark does.” 

When every one is depressed, businesses are not being able to open and no one is able to see when things will normalize, worrying over whether your stock will be impacted or not will not make things better. Instead, try to analyse the financial of the business to understand if the company can survive a short-term financial hit.

“Only when the tide goes out do you discover who’s been swimming naked.”

Weak businesses get exposed during times of financial stress. This is not the time to be fearful but actually the opportunity to find out and better understand the companies that are able to hold up better than others. 

Lastly follow what Peter Lynch the legendary fund Manager said:

  • Identify a good business-business doing well and managed by a good management;
  • Figure out a fair price for the business
  • Wait for the opportunity when you get that price, if its not already available in the market

This is that time

So stop fretting and get going

REDEEMING DURING THE CRISIS

“If you are not willing to react with equanimity to a market price decline of 50% two or three times a century, you’re not fit to be a common shareholder and you deserve the mediocre result you are going to get”

Charlie Munger

Crisis impact us on several levels irrespective of its nature.

Even when it’s not personal, it creates fear that has the potential for bringing out the worst in us in terms of behaviour.

The Great Depression of the 20’s or the great financial crisis of 2008, each created a unique experience, for the generation that lived through it.

Generally there are 3 distinct parts to this experience:

  1. I experience the crisis personally- losing a job; suffering a loss in business; health
  2. I experience the crisis voyeuristically-I see businesses closing down; someone known has suffered etc.,
  3. Personal Finance suffering damage

The fear that a crisis creates whether due to a personal experience or through someone else influences how we project the short-term to the long-term.

Most of the time the crisis is out of my control, what decisions others will take is not a known variable, however my fear is personal.

The only way to safeguard myself is risk-aversion of all kinds.

Today for example everyone is wearing a mask, gloves, sanitising constantly; maintaining social distancing, working from home etc., etc.,

The fear of losing money is also real.

We turn to experts, watch TV channels-no one knows a thing (because they really don’t) and so I start believing the worst case.

There are special interests that create doomsday scenario, look at this for instance, https://goldswitzerland.com/the-demise-of-the-financial-system-is-imminent/

Clearly this writer has a vested interest in gold prices going up, however all I need is a validation of my fear, to make changes to my personal portfolio, that might now serve my long-term interest.

I have only considered a small set here of some businesses that were considered great businesses then and are considered great businesses even now.

All of these businesses suffered tremendous losses in share prices from 30% to 60%, however they were considered good businesses and those who held unto them have come out ahead.

What’s a Good Business

  1. Revenue generating (even if not Profit making for now); with positive cash flow, industry beating RoE, Margins
  2. Stable Management that’s competent and ethical

What Should you do?

  1. Maintain Equanimity
  2. Review your holdings and determine whether it’s a good business/Good manager (if it’s a fund) that you would hold irrespective of the situation
  3. Check your asset allocation sand how that’s got impacted by the market
  4. Rebalance to get back to your ideal asset-allocation

Finally remember 

“The big money is not in buying the selling, but in the waiting.”

Charlie Munger

Stay the course

#coronavirus; #marketcrash; #personalfinance; #assetallocation

Manish Verma

Investing During a CRISIS

Financial Advisors, investors don’t tire quoting the adage “Buy Low, Sell High”.

Most however become indecisive when presented with the opportunity.

According to the “prospect theory” humans fear a loss more than the pleasure from a gain.

This perhaps explains the outflows from equity mutual funds between January-March, 2009 when the bottom had already got established.

March 09, 2009, Nifty 50 hit 2573, which was the bottom and a fall of over 60% from the market peak achieved in early January-2008.

Investor risk-aversion didn’t ebb till July-2009 even though the markets were already up 62% from the bottom at that point.

It wasn’t just the rationality of humans that took a hit. Efficient market theory, which says humans act in a rational way and make the right decisions because they have access to all available data, also took a hit.

Investors of-course realize that the economy will not go down to “0” still the paralysis created by the recent losses make them incapable of making sound decisions and for the time-being it seems-everything is over forever.

What does the data suggest though?

I looked at what would have happened to the value of INR 1000 invested every month beginning starting from January-2008 till March-2009 by the end of December-2010:

** This is where we are today-around 30% down from peak.

Even though the market fell another 31% from July 2008 levels, the investor who invested in 2008 still ended up making a CAGR return of 18.5% over the next 2.5 years.

The investor who was already invested from January-2008 ended up making almost 16% CAGR.

The investor who invested in March, 2009, made 12% CAGR over 12 years.

When fear grips, its difficult to “stay the course”.

The issue is not of who’s “smarter” but who is “braver”.

And the “BRAVE” are the one who win the world.

So here are some tips:

Review your portfolio:

  1. If you are holding something that you would not hold in good times too, get out of it;
  2. If you are holding a quality business (business with track-record of going through cycles successfully), a quality fund (A fund Manager who has outperformed the market through cycles)-hold it
  3. Be dispassionate, don’t look at losses, look at the possibilities;
  4. Strengthen your portfolios by increasing allocation to businesses you thought were expensive earlier;
  5. Buy good businesses, that you missed earlier, at favorable risk-reward
  6. Position yourself for success not for “REGRET”

HAPPY INVESTING

Manish Verma

Budget Trends

2 important factors to consider before any critique of this budget are:

  1. Govt. didn’t have resources for stimulus;
  2. Tax Cut stimulus doesn’t’ work as far as history is concerned

In the context the budget has been an exercise in balancing the priorities without over-stretching the books.

Here are some important numbers:

ItemFY-20FY-21Comment
Fiscal Deficit4.5%4.3%Including off-budget items @0.70% for FY-20 and 0.80% for FY-21
Net tax Receipts15,04,58716,35,909Modest 8.73% increase assumed
Non-tax Receipt427,117609,98443% increase in non-tax receipt primarily coming from disinvestment (going by 3-times) On back of LIC IPO (At a valuation of INR 8 Lakh crore), LIC IPO can yield 80K Crore to the govtAlso budgeted 1.3L Crore from sale of spectrum-seems ambitious; Cause of concern and potentially can leave a hold in govt finances 
Borrowing(Lakh Crore)498972535870Only a 7.9% increase in borrowing which might provide an upside risk given the heavy dependence on divestment and spectrum sale to fund the deficit
Rural Spend(Lakh Crore)1.882.41Increase of 28% in rural spend-ensures priorities in the right place

Trends

Focus on Bottom of the Pyramid-Increased spend here will potentially improve rural consumption RuralBig focus with a 28% increase across, except for MGNREGA, where spend has been cut by 13%;Increased spend for PM Kisan Samman Yojana shows that the Govt. is looking to broaden the scope of coverage;Other initiatives like solar power on barren land might take time, however are good steps towards increasing rural income;Education & Job CreationBig increase in primary education using Eklayva model; Focus on Entrepreneurship; budget down on skill development and job creation HealthcareAnother focus area with large increase in spending especially Ayushman Bharat where budget has gone up by 94% 
TaxationGovt. expects to add 40K crore to consumption through the changesBig Message-get ready for a world without exemptions;Makes the tax structure simpler, however targeted savings for retirement and long-term goals sacrificed;These savings contribute a large pool to the Govt as resources as well as helping the govt. avoid creation of social security schemes;It might set dangerous situation going forward and hence govt must look at encouraging long-term savings while taking away exemption/deductions like HRA; LTA etc.,
Sectoral Power SectorIn a Jam for long, needed urgent intervention; Govt. has finally taken cognizance, without admitting failure of UDAY; Lot will depend upon execution to reduce dues and indebtedness in the sector and strengthen players across thermal and renewable sector; AIF structure especially given the tax incentive for the sovereign funds could go a long way in solving the current mess InfrastructureGovt. looking for a helping hand, hence tax exemption for sovereign funds ConsumptionNo big-bang, incremental and in-direct;   Expect consumption trends to continue, no big changes Consumer durables especially AC that was doing well to be hurt by increased duties expectedMake-in-IndiaAnother shot at make in India in form of assemble in India;Increase in duties to encourage local manufacturing;aaHas not worked in the past 

Markets

The trend of market chasing growth basis liquidity to continue

Trend of private players whether banks; insurers or NBFC’s taking away market share from public sector will keep the prominent players in the market a focus

Rural being a focus, rural/semi-urban focused financial services players to continue to be in focus

Also improvement in rural income should provide impetus to the Auto/consumer durables and consumer sectors to be in play thanks to the aspirational and emerging class 

Markets will provide value with some more correction especially some of the larger names in financials; auto and FMCG correcting;

Investors should take advantage

Summary

The govt. did the right thing by not stretching itself too much;

Overall Another incremental budget that doesn’t cross the major T’s and dots the I’s, however stays prudent on fiscal, which was highly necessary given the low correlation between tax-cut based consumption expectations

However big bang reforms like land and labour reforms were not mentioned which could have given a cheer from an intent perspective;

No further intervention declared for liquidity and real-estate sector which is probably an important element to kick-start consumption will be missed

Manish Verma

Keynesian or Monetarist-What should the India FM be?

Stimulate the economy

Put more money in hands of consumer,

Unleash the animal spirits

Cut the personal income tax rates, Cut GST, cut capital gains tax, Cut dividend distribution tax

Increase infrastructure spending

We want the moon, the sun and the sky???

How will we pay for all this-divest, expand tax base, increase tax buoyancy????

The real question is does it really help.

Lets look at some numbers:

FYIncome Tax SlabTax Collection (INR Cr.)Increase in tax collection (%)GDP Growth Rate (%)Direct Tax to GDP Ratio (%)No. Of Individual+HuF  Income Tax AssessesNo. Of Assess growth Rate (%)
2000-0150-60K-10%;
60k-150K-20%;       
Above 150K-30%
 31,764 7.703.25
2001-02Same as above 32,004 0.76%8.503.03
2002-03Same as above 36,866 15.19%7.763.38
2003-04Same as above 41,386 12.26%12.063.81
2004-05Same as above 49,268 19.05%17.704.1
2005-06100-150K-10%;
150k-250K-20%;     
Above 250K-30%
 63,689 29.27%13.924.47
2006-07100-150K-10%;
150k-250K-20%;    
Above 250K-30%
 85,623 34.44%16.285.36
2007-08110-150K-10%;
150k-250K-20%;    
Above 250K-30%
 1,20,429 40.65%16.126.3
2008-09150-300K-10%;
300k-500K-20%;    
Above 500K-30%
 1,20,034 -0.33%12.895.93
2009-10160-300K-10%;
300k-500K-20%;    
Above 500K-30%
 1,32,833 10.66%14.695.85
2010-11160-500K-10%;
500k-800K-20%;    
Above 800K-30%
 1,46,258 10.11%18.845.81
2011-12180-500K-10%;
500k-800K-20%;    
Above 800K-30%
 1,70,181 16.36%17.405.48
2012-13200-500K-10%;
500k-1000K-20%;   
Above 1000K-30%
 2,01,840 18.60%12.255.53 2,96,06,986 
2013-14200-500K-10%;
500k-1000K-20%;  
Above 1000K-30%
 2,42,888 20.34%12.285.62 3,13,71,241 5.96%
2014-15250-500K-10%; 500k-1000K-20%;  
Above 1000K-30%
 2,65,772 9.42%10.455.55 3,32,75,233 6.07%
2015-16250-500K-10%; 500k-1000K-20%;  
Above 1000K-30%
 2,87,637 8.23%8.255.47 3,70,79,448 11.43%
2016-17250-500K-10%; 500k-1000K-20%;  
Above 1000K-30%
 3,49,503 21.51%13.235.6 4,26,01,569 14.89%
2017-18250-500K-5%; 500k-1000K-20%;  
Above 1000K-30%
 4,19,884 20.14%11.28 5,21,04,008 22.31%
2018-19250-500K-5%; 500k-1000K-20%;  
Above 1000K-30%
 4,73,121 12.68%11.20 6,07,11,199 16.52%

Here are some interesting highlights:

  1. Tax collection grew in sync with economic growth from 2004-05 onwards and continued till global financial crisis on 2008-09
  2. Tax rate cuts of 2008-09 or 2012-13 or 2013-14 didn’t move the needle on tax collection;
  3. Tax collection to GDP ratio has remained stable throughout with no appreciable charge this way or that

The most recent and big tax rate cut was in United States in 2017.

All it did was increase deficit while not having any incremental impact on the growth or job creation.

GDP growth was expected to cross 3% consistently, however it’s has averaged barely 2.4%

Job growth has been at the same rate as pre-tax rate cut;

It was contended that individual tax payers will gain USD 4000 PA, however that has not panned out. It was later claimed that hourly wages have increased, however hourly wages are stuck at 3.3% and will have to rise to 7.8% to get an increase of USD 4000.

US corporations spent only 20% of increased revenue gained thanks to tax cut on capital expenditure (as trade war weighted heavily on corporate sentiments); 80% of increased revenues went to share bust-backs and dividends.

Trade war ensured that manufacturing index has remained below 50 and hence under contraction, thereby ensuring that the positive impact of tax cuts didn’t help the sector.

Why then ask for tax cut?

Most of the demands put forward are self-Centered;

Corporates want consumers to spend at any cost that they don’t have to bear.

After having already get a big tax cut, they believe rate should be reduced further, to stimulate them to invest, even though there is no sign that any of them is planning any major capex in near-to-medium term.

Consumers want more money in their hands to boost their financial situation.

All everyone wants is a quick-fix that will push the stock-markets higher and improve sentiments.

Whether there will be a real impact or not-there is no patience to consider.

Economy is Complex

Any economy is a complex organism.

While the basic idea of any intervention is growth or avoidance of recession.

The tools are limited and need to be used judiciously.

While on one hand managing money supply can be a critical tool to stimulate/curb consumption;

Fiscal policy has to work hand-in-hand with monetary to ensure supply and demand is not disrupted in an opposite direction.

In India the government has been the only stakeholder committing and managing capital expenditure to stimulate the economy in the last 6 years.

RBI has also been cutting interest rates in trying to support govt. efforts.

As the above 2 have not helped growth, everyone is clamouring for personal income tax rate cut. Now if income tax rate are also cut, it will only stimulate inflation (in an already inflationary environment) thereby pushing wages and further putting pressure on job creation.

In the event the government wants to cut tax rate then it will also need to cut spending to ensure that inflation doesn’t go out of hand.

It’s not worked in the Past

The tax cuts of 2008-09 combined with duty cuts, export stimulus and higher govt. spending with increasing global commodity prices created unsustainable inflation India going into double digit.

In 2016, most Economist famously called India going through job-less growth.

Clearly anything that the govt. is planning now has to balance various scenarios.

Ronald Reagen’s famous tax cuts of 1982 had to be rolled back partially within 12-months owing to its onerous impact on inflation and job losses.

However the bigger impact came from the investment made in the 70’s and 80’s on education, research and infrastructure that created the right conditions for growth.

On the other hand the austerity of Bill Clinton administration is credited with growth in the 1990’s by keeping the interest rates low.

Big Picture

The govt.’s budget has to keep in mind the larger picture rather than short-term stock market gains.

Various estimates seem to suggest a loss of INR 100,000 crore to govt’s revenue if personal income tax rate cut creating a 20% hole in the already weak tax base.

How will this be made up?

Will increased consumption make up for loss of revenue?

The past doesn’t seem to hold up for this.

There are no easier options for the FM-however staying the course is the need of the hour.