US Economic Stimulus

US Economic Stimulus

The economic  underperformance of the Developed countries continues.  Among the developed countries, US continues to do well. The Q3 adopted by the US government brought some semblance to the global markets and provided stimulus not only for the US economy but also to other economies around the world. The global investors /corporations were able to source low cost funds from US. The low interest loans were available to US corporates, Households and there was a good momentum created in the construction front in the US.

The overall  competitiveness  of US is improving supported by availability of cheap gas. The government has drawn up a strategy to revive the manufacturing sector and there are many new initiatives on the way to regain the competitiveness. The exports of consumer goods and consumer durables from US has started going up.

The announcement that US was about to withdraw the stimulus had a global impact and funds invested in emerging markets were withdrawn by the investors and there was a volatility in the emerging financial markets after the announcement. This has affected the global financial markets.

While announcing Q3 , the government mentioned that the withdrawal would depend on two factors that is unemployment level reaching 6.5% and inflation at 2%. The government also expected that the economic growth would be at a much higher level by adopting Q3. There is a significant movement in all these parameters towards achieving the  goals but it will take at least a year from now to reach the targets set by the Government .

There was an improvement in Trade data reported recently which is again a good movement towards achievement of set economic targets.

The adoption of indicator based approach during the economic crisis is a good method and it provides an objective basis for decision making to the authorities. Looking at these indicators, July 31^st Statement of Fed did not give any indication of any tapering by September as many of the Analysts were predicting.

Economic growth in First two quarters was  lower than expectations and the first quarter growth number was revised down to 1.8% from 2.4%. But the growth in the second of fed fiscal year is likely to pick up momentum.

Inflation in 2012 was at 2.1% and it is likely to come down to 1.6% in 2013  and it is expected to be in the range of  2.2% in the next few years.

Consumer spending rose by  3.4% in the first quarter, fixed investments by 4.1% and Residential investment by 12.1%.

All the corporates in US have a cash ( global resources )of more than $ 5 trn and non financial companies have a cash of more than $ 2 trn. They have started investing in Capex and many companies having high cash reserves will declare high dividends. This will increase the dividend yield for many companies.

The corporate sector performance in Q2 is likely to be better but as per analyst estimates , US has one of the high P/e ratios in the history. The banks had reported very good performance in Q2.

The government is able to move toward its target of sequestration and the budget deficit is likely to be down to 2% by 2017.

2.2 mn new jobs were created in 2012 and 6.3 mn since the employment level bottomed out. Wages are still growing.

Household debt to disposable income fell from 126% before recession to 104% by the first quarter.  There is a favourable trend showing a movement towards 90 – 95% under normal circumstances. Housing starts in first quarter was 968,000 annualised in Q1, 35% higher than the previous year.

Net wealth of US household sector has increased by nearly $ 15trn over the past three years.

US is not facing a short term fiscal deficit problem.

Recovery today does not look secure to withdraw the monetary stimulus immediately and it is likely to happen by July 2014 as per the above point.

In the past six months, congress made adjustments to both spending side and taxes and the deficit is likely to come down to reasonable levels.

At the end of 2012, Bush era income tax cuts were made permanent for low and middle income wage earners. Taxes rose for wealthier Americans. Wealthy will pay higher dividend, capital gains and estate taxes.

On the spending side $ 2.1 trn was identified. $ 900 bn of back loaded costs have already been settled and underway. Other $ 1.2 trn “sequester” focuses heavily on cuts to defence and other discretionary items. Despite there are concerns that this may not happen, there is a high likelihood that this would be implemented.

The government is taking special management steps to stretch its resources for several more months, putting off the real debt ceiling deadline until October.

Immigration reform would enable 12 million undocumented immigrants , to fill the job openings . This will create income opportunities for these immigrants thereby creating additional national income and consumer demand.

This reform would help the new manufacturing strategy of US which is based on low price for shale gas in US. Using the availability of this gas, the government has decided to revive the manufacturing sector and many of the imported items from countries like china will be produced in US going forward. The imports will go down and the trade deficit will be down.

S& P price gains seven months in a row up 15.4% between Nov 12 – May 13. Earnings are likely to beat forecasts.

YTD returns from S&P was at 12.6% by the end of June. MSCI emer markets had shown a negative return of 10.9% and 10 year treasury yield was up by 41.5%. The UBS commodity index was down by 10.5%.

Looking at the globe, Europe continues to be under economic pressure and the solutions are still not in immediate site and in Middle east, the political tensions are a great threat. Among BRIC , China is doing better but its performance levels were down compared to the peak and there is a pressure on exports. Considering all the above and the US increasing self dependence and better management of the economy supported by improving corporate performance and increasing household wealth, US is becoming attractive for investments.

The uncertainty prevails on when the Economic Stimulus would be withdrawn and the feeling is that the process would start soon from the month of September. From the present indications it would take a few more months to achieve the stability expected by the US government. The government’s approach to adoption of indicator based approach for action plans  should be intact.  There could be a clear  communication from the authorities that the stimulus withdrawal will be based on achievement of defined targets on Unemployment and inflation.

Whatever is said and done, one day the stimulus withdrawal has to start and the withdrawal could be made smooth by gradual withdrawal over a period of time. From the present indications, the whole process should take at least 2 to 3 years and the withdrawal could start with gradual reduction of purchase of bonds. To start with, reduce the purchase size by $ 2 bn a month and a maximum increment withdrawal in a month could be $ 5bn.  When the bond purchase programme achieves the level of $ 40 bn a month, then the Fed could look at increase in the interest rates in phases. The incremental increase in every instance could be 10 bps. The interest rates could be gradually increased. The programme for withdrawal could be drawn up looking at various scenarios and how it will affect the bond portfolio of banks and how it will affect the international financial system. The plan drawn up could be made less painful for those segments which are going to be affected due to withdrawal. From the present indicators, it appears that the first phase of withdrawal could be started in the month of March 2014 and the phased programme could be implemented.

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India - Public Finances - October 2012

Public Finance- Apr-Oct.12

Total Receipts: Revenue during Apr-Oct.12 was at 779467 cr , 52.3% of budget  and it grew by 14.6% YoY. It includes revenue and capital receipts. In eight months, the total receipts were 62.8% of the estimate for the whole year.

Revenue Receipts: Revenue received during Apr-Oct.12 was at Rs.404297 cr, 57% lower than the budget estimate of FY12-13. It grew 12.4% YoY compared to the same period last year. This contained tax and non tax receipts. Gross tax revenue was at Rs.486825 cr, 14.5% higher than the last year and it was before devolution to the states.

Capital receipts: It was at Rs.375170 cr during Apr-Oct.12, 32.4% lower than the whole year’s budget but it grew by 17% YoY.

In terms of composition of receipts, the share of all the sources did not show a big variation from the last year.  Non tax revenues were 100 bps lower than the last year at 9.09%. Borrowings composition increased by 208 bps of the total receipts and it was at Rs.367920 cr.

Total Expenditure: Overall plan and non plan expenses were at Rs.779467 cr, 52.3% of FY13 budget but it grew by 14.6% YoY.  Non plan expenses was at Rs.554518 cr, 15.7% higher than the same period last year where as plan expenses were at Rs.224949 cr, 11.8% higher than the last year.

Non plan composition of expenditure rose from 70.4% of revenue to 71.1% this year. This was much higher than the budgeted ratio of 65% of the total receipts. The variance on this count was very high.

The major variation was mainly accounted by subsidies which rose from 12.2% in the previous year to 20% this year. Since there was a sharp rise in this ratio , even saving on Interest payment of 2.25% of revenues were not enough to fill the gap.

Subsidies rose by more than Rs.66000 cr over the previous year and they were at Rs.148022 cr. Interest payments rose by only Rs.11000 cr. Pensions rose by Rs.600 cr over the previous year.

Revenue Deficit: During Apr-Oct.12, deficit was at Rs.285252 cr, 81.4% of the budget for FY13. It was higher by 17.4% compared to the previous year. The deficit was at 36.6% of the total receipts rising from 35.7% in the previous year. The budgeted ratio on receipts was only at 23.5% for the whole year, indicating the variance was very high.

 
Fiscal Deficit: Reported deficit was 71.6% of the budget for FY`13 at Rs.367920 cr. Deficit was higher than the last year by 19.8%. As a ratio of total receipts it rose from 45.1% to 47.2%  this year. This was much higher than the budgeted ratio of 34.5% of the total receipts.

Primary Deficit: Primary deficit during Apr-Oct.12 was at Rs.212069 cr, 30.5% higher than that of previous year. It was 109% of the whole year budget. The ratio had risen from 23.9% to 27.2% this year. The budget was only 13% of the total receipts.

The recent initiatives taken by the government in boosting the economic revival and the  growth numbers for Industry/ services reported during this week, indicate the movement towards revival of the economy. Already the stock market indicators had turned positive and this is likely to be followed by improvement in performance of the various sectors of the economy. The prospects for growth had improved substantially and now the investors and industries have turned bullish on the immediate prospects. There was a statement from the government that the borrowings would be managed well within the desired levels.

As I had presented on the Economic Prospects for India ,on 13^th September this year in the  Annual conference conducted by CFO Strategies forum , the pace  of the economy had picked up momentum. The government had moved ahead with fast response to the evolving economic crisis in India. The last three months was good for Capital markets and the investor sentiments revived. FII’s poured money into the markets and the IPO’s have started happening. The coal India has been asked to increase the output and sign FSA’s with the power producers. The gas allocation procedures were simplified. The government is inducting additional capital into the PSU banks , which will increase the lending capacity of these banks. The cash transfer was introduced which should put more money in the hands of poor which will result in higher consumption levels. The savings to be effected by various ministries was identified and non essential expenditure would be deferred.

The setting up of the cabinet Committee on Investments and merger of  Cabinet Committee on Infrastructure with  Cabinet Committee on Economic Affairs is likely to speed the faster implementation of projects which were stuck due to various reasons. We can expect traction in projects and capital expenditure by companies going forward, which will stimulate growth through investments..

 

 

Performance of Corporates in Q2 F 13

Performance of Corporate sector in Q2F13

 

The Analysis is based on the results of companies which have reported their results and the date of data taken here was as on 2^nd Jan for more than 4000 companies.

 

Sales: During quarter ended Sep.12 , Sales was at Rs.1290011 cr, 13% higher than the last year. YTD ( for 12 months trailing period ), it was at Rs.4875612 cr, a growth of 21.6% YoY. Other income during Q2F13 was at Rs.32435 cr, 24.6%  increase YoY. While till date other income was at Rs.113400 cr, 13.6% higher than the last year.

 

PBIDT : Operating profit margin was at Rs. 346728 cr (26.87% of sales), 28% higher than the last year in Q2. YTD it was at Rs.1179697 cr (24.19% of sales ), 17% rise YoY.

 

Interest cost ratio was at 12.95% of sales in Q2 while till date it was at 11.76% of sales. It used to be less than 10% a few years earlier and it has gone up in the recent past. The higher ratio is due to higher interest rates for borrowings.

 

PBT: Profit in Q2F13 was at Rs. 145842 cr, 46.9% growth YoY where as YTD basis it was at Rs.478323 cr, 3.3% drop over the last year.

 

The tax incidence was at 23.5% of Profit before tax which was lower compared to the trailing 12  months level of 26.9% indicating better tax planning and using tax set off by corporates to increase their after tax profits.

 

PAT: It witnessed 64% higher profit compared to the last year at Rs.111456 cr in Q2F13. YTD, profit was at Rs. 349196 cr, 4.1% lower than the last year.( previous 12 months ).

 

Profit margin was at 8.64% of sales in Q2 where as for 12 trailing months , it was at 7.16% of sales.

 

Cash profit during Q2F13 was at Rs.145293 cr, 11.26% of sales where as YTD it was at Rs.476900 cr, 9.78% of sales. The generation has improved by 150 bps on Sales. Many corporates are sitting on large cash surplus not investing in new projects and expansion due to general economic conditions. The lowered capacity utilization levels also had slowed down the pace of investment in new projects. Many of the sectors which were profitable two years back became unprofitable within a period of two years. Only when the prospects for the affected sectors improve , corporates will start investing in expansion and new projects.

 

Many of the corporates in India were able to pass on the inflation to the customers successfully which has resulted in good performance. Those who were not able to Pass on the entire cost increases to the customers witnessed the decline in profits.

 

The corporates which have borrowed funds from abroad through ECB’s expecting that Indian rupee would continue to be very strong , still have to recover from the depreciation of the rupee. Despite reporting good operational performance, some of the leading corporates reported losses on account of provision for rupee depreciation .

Deleveraging Government Balance Sheets

In many countries in the world today , the government borrowing has reached a level whereby more borrowings would put a strain on the economy and growth. In some countries, the borrowings had exceeded the acceptable limits and threatening the viability of the Economic systems. The accumulation of debt in many countries was accompanied by good growth. But when the growth slowed down and witnessed a flattening trend, the servicing of Government loans alone had consumed lot of resources generated by the government.

Reduction in interest rates as a part of the stimulus in the recent years, enabled governments to borrow funds at cheaper rates thereby reducing the pressure on account of high interest rates. But this trend cannot continue for a very long time and interest rates have to move up.

The countries which have high foreign debt have very high economic risks and the ones having high domestic debt are protected from high forex volatility. The ones having high domestic debt have high adaptability and flexibility and hence there is a need for countries to be careful when the foreign debt is being accumulated in the form of sovereign bonds and corporate debt.

Going forward, Governments across the world have to develop focussed debt management strategies and maintain the debt within the manageable levels and ensure orderly economic growth. There is a need to deleverage the balance sheets of the governments.

1. Achieve higher GDP growth through improved productivity of funds / resources. Since economic systems across the world had grown large and complex , there are many inefficiencies in the system. By focussing on productivity of resources, the need for capex by governments could be reduced, the surplus from deployment of assets would increase thereby reducing the need for large incremental debt funds for growth and service. The countries which have good economic growth rates will have an advantage in achieving this objective and reduce the need for borrowed funds and also the ratio of borrowed funds to the GDP could be held at healthy levels.

2. Maintain an inflation level of 3 – 4% p.a. Though inflation is a market determined variable in many countries , this is being controlled in many countries through government intervention and policies. The countries which are growing would be in a position to reduce the debt burden through inflation but there are many countries in the world which are having very low economic growth and low inflation and they would find it difficult to manage the debt and debt servicing.

3. Reduce the interest rates. This is the strategy being followed in the recent past whereby the governments  resort to very high borrowings, which did not result in high burden on interest servicing. Low interest rates make the loans affordable and repayment capacity is being enhanced.

4. Privatise the Government owned organisations. The role of government in initial phases of industrialisation was to establish the essential industries for Economic growth and in the present context , the government has to play a major role in orderly and stable economic growth. Since in many countries the level of industrialisation is very high, the need for government to invest in major industries is limited. The private sector in many countries are well developed and they will be in a better position to take over the so called essential industries. The governments can even look at disinvestment to the extent of 100% in the sectors where they are present and to reduce the forex loans, they could even invite foreign companies to take over the assets. This will generate funds .

5. Fund mobilisation. While raising funds, the governments could look at raising funds through the equity structure or equity type instruments, wherever the vehicles for raising resources are available. Only in case, the options for raising equity based funds are exhausted, the government could borrow through debt instruments.

6. Sources of funds. The emergence of capital markets offers many options for governments to raise funds through various sources. The options for raising funds could be based on the tenor of the funds available and the interest rates. The preference could be for sources from which concessional funding is available for long periods of time. The prioritisation of the sources based on similar criteria would enable orderly raising of debt.

7. Dividend. In many countries, still the government companies are one of the largest in their sectors and they continue to make good profits. The companies which make a very high surplus can pay generous dividends to the shareholders thereby, the governments also benefit through receipt of higher dividends.

8. Negotiate with Creditors for reduction of debt. In many instances, the countries had accumulated very high level of debt, which is not justified considering the size of the economy and repayment capacity. If the lenders and investors had made careful decisions , then the countries could have not accumulated large level of debt beyond their capacity to repay. The lenders , investors should have taken precautions and done the due diligence in investing in such instruments. Partly lenders are responsible for big debt accumulation. Hence, when it comes to debt restructuring, the lenders have to take a cut in valuation of their investments. Based on the future ability to repay, the country in distress would be able to extract a discount on the outstanding loans from the lenders.

9. Government Expenditure. In well developed and advanced countries where the growth potential is very low, the need for higher government expenditure is limited. In fact, the countries which have low potential need to look at improving the productivity of the resources and in line with the technological developments increase the productivity of the manpower and other resources. The non essential items and the ones with high cost implications in relation to the productivity could be considered for cost reduction. Manpower is one area which offers a very big scope for improvement in productivity. Subsidies is another area which offers lot of scope for reduction. Instead of providing subsidies, loans through directed lending by banks could support the targeted beneficiaries which will also help in creating enduring employment and sustainable businesses. The expenses on aid to other countries, defence and supporting new industries like renewable energy , offers scope for reduction of government expenditure.

10. Taxation. In many countries , when the tax rates were slashed, the revenue collection witnessed a multifold increase. The countries where the tax rates are very high, the tax compliance levels are very low. Some countries are in a very bad shape and there is a scope to  raise resources from those who are earning very high income . The countries where the residents had parked their income abroad without declaration, tax amnesties could be given and voluntary disclosure schemes could be introduced. Depending on the circumstance, the increase / reduction of tax could be looked at and voluntary disclosure schemes could be introduced.

11. In an initiative to create competitiveness, the countries allow currencies to depreciate. In the short term, it creates competitiveness but when the country relies on borrowed funds for growth especially through external borrowings, the depreciation of the currency leads to undesirable efforts in the long run . The value of external debt in relation to the borrowing country’s currency goes up. The strategy of achieving competitiveness should be approached with big caution to ensure that it is not going to  be a burden in terms of higher debt going forward.

12. Land. In high growth countries, the land in growing regions are in great demand and since Governments in many parts of the world were the early ones to set up industries, they own prime land in cities and growing regions. Governments also develop new centres of manufacturing and services. Sale of land can be a big source of funding for government which can reduce the need for debt. Many of the government companies which are in old industries, not doing well, own prime land and these companies can capitalise on the land to generate funds which could be given to the government in the form of dividends.

13. Looking at many countries balance sheets today, it appears that they would not be in a position to service even the existing debts. Adding more debts would worsen the situation making the economic viability of the country in jeopardy. In such cases, the scope for printing money without creating debt could be looked at. In the earlier post, I had discussed the criteria which could be looked at for creation of money without debt.

14. In many instances, governments have huge outstandings to be collected from other countries, corporates and individuals. The delay occurs due to many reasons including legal proceedings. The governments can identify action plans to collect the outstandings. Especially, the legal proceedings with Government departments and Government enterprises could be concluded through a separate mechanism to be created by governments. On the debt to be collected from corporates and individuals , action plans could be identified to collect the same.

15. There is a lot of cross border , mutual debt existing between countries. At the country level, an institution could be created for consolidating all the debt from within the country and from outside the country ( this could include even individual and corporate debt ) on country wide basis. The pooled debt through a process or through an international institution could be extinguished through a mutual process of consent. The foreign debt extinguished in the case of Individuals and Corporates could be substituted through local /domestic debt. This would help the Country to maintain good credit rating at the country level and help the borrowers from the country to obtain low rate of interests for foreign loans.

R.Kannan

Eurozone Exit – Cost Effective Solutions

The Eurozone was created with a view to achieve higher growth, leverage synergies , reduce the cost of trade and transactions. During the course of existence of Eurozone , many of the benefits accrued to member countries. But it also enabled countries with less financial resources to raise funds from the markets at very attractive rates. This has resulted in huge borrowing by member states without looking into the feasibility of  accumulating a large debt relative to the size of the economies.

After the global crisis and reduced Economic growth rates in these countries, the huge debt started threatening the viability of well established Economic systems. Creation of Euro zone did not result in consensus of political views or harmonisation of the Fiscal systems  across the countries in the Union. The flexibility of countries to adapt the monetary policy was lost. The interdependence on other countries and banks from other countries in the zone had increased. There is an immediate need for the member countries to stick to a common code for managing the finances and follow the austerity measures as required. Despite an urgent need for such measures, there is no support for following these measures in toto by Political parties and members from the society in the member countries.

The immediate economic growth prospects for many of the member countries are very bleak and measures were taken by IMF and ECB to provide stimulus to the economies. Whatever the measures being taken, the scope for achieving a positive growth for next two / three years for some of these countries looks very bleak. The countries have to accept the fact that there will be a negative growth for the next  two/ three  years and take measures to kick start the growth in the following years. The austerity measures are required. If they do not want to follow the common code, then it is going to affect the performance and prospects for the entire European Union and make the task of revival more difficult.

To provide flexibility and higher level of adaptability, it would be a  better option to allow the members to exit the zone. There are fears that the local currency would be devalued and it will create a systemic crisis which would be even worse than we had seen so far. The process could be made smooth and painless by  implementing the following action points.

1. Peg the currency to the Euro. ( Initially)  Allow a Exchange  variation of 0.5% against Euro from the previous day for every day. Cap the maximum variation of the currency for the whole year to 5% . At the max, the currency can depreciate or appreciate by 15.7% in three years. This will bring predictability and certainty to the investors.

2. Government / Central bank of the exiting country have to play a major role in controlling the inflation / deflation by closely monitoring the Demand / Supply of products and services.

3. On the day of exiting the Eurozone, convert all the external loans outstanding with lenders from outside to the local currency loans on par with the Euro. For one Euro – one Local currency could be given. The lenders benefit / lose as and when the Currency appreciation / depreciation takes place.

4. Continue the Aid programmes as planned by IMF and  ECB.

5. Reduce the Foreign Debt. Through Restructuring of the debt and debt reduction by negotiations . Extinguishing the cross balances of debt with other countries, banks from other countries and others. This strategy could be adopted for all the countries in the Eurozone by creating a mechanism whereby overall debt reduction could take place.

6. Bank Lending. Provide incentives for banks to lend . Set higher targets for  credit / deposit ratios . Focus on lending should be to create manufacturing industries and Entrepreneurs.

7. Since most of the banks are weak and require additional capital, the government has to induct more capital in to these banks.

8. Considering the poor immediate growth prospects, it would be difficult to achieve a viable economic model with the outstanding loans and the servicing costs of these loans. Hence, the country exiting the zone could be allowed to print money without creating Debt. This limit could be set at 25% of the total currency in circulation.

9. Prepare a comprehensive turn around plan for the country with a defined objective of increasing the competitiveness rank in three years. Identify the items imported which will not help to improve the productivity in the immediate future and reduce the import of these items to improve the trade balance.

10. Continue the free flow of resources with the  other Euro Zone countries.  The free flow of people, resources should be continued without any restrictions.

11. Focus on Manufacturing growth. Revive the old  industries and give incentives for setting up Small scale and Medium Scale industries. Develop county wide vocational training plans and give a big focus on vocational education on the similar lines of the practices adopted in Germany.

12. Develop the Tourism, Education and Services Sector. Create Specialised growth zones for these sectors. This will create lot of  employment.

13. Apart from focussing on creation of additional employment, formulate strategies for developing large number of entrepreneurs. This could be facilitated by National vocational training programmes. For example India has the largest number of entrepreneurs in retailing.

14. Government could guarantee all the deposits made in the banks. Since the currency is pegged to Euro, the flight of deposits to other countries could be reduced to a great extent.

15. Since the growth prospects in the immediate future is very bleak, there is an immediate need to put austerity measures in place. The government can identify all the non essential expenditure and postpone them by three years. The pension to the employees for three years can have a cap. There will be a reduction for those who are getting very high pension. Freeze the recruitment in the government. Freeze the salaries at the present level for two years.

16. Create new manufacturing zones. Announce fiscal incentives for large investments. Liberalise FDI rules. Open Most of the sectors for FDI.

17. Create a National Revival fund. Request the Wealthiest and those who are in high income bracket to liberally contribute to this fund.

18. The member exiting for all practical purposes to be treated as a part of the Euro zone even after exit and Status quo could continue in terms of Political, Economic and Trade relations. The only difference would be the flexibility of the exiting country to decide its monetary policy and the effects of the performance of the exiting country would not have any immediate bearing on the Eurozone as a whole.

R.Kannan

World Economy – Spillover from the financial crisis

The slowdown of economic growth in the US and Europeafter the financial crisis 2008-09 is an inevitable consequence of over-leveraged growth in the years before the crisis. The downward adjustment of asset prices, particularly in housing, and necessary fiscal adjustments create conditions which are not conducive for growth in the US and Europe in the medium term. This should come as no surprise as history has shown that after deep financial crises it took economies several years to recover to historic growth rates.

The expansive monetary policy of the US Fed as well as the European Central Bank (ECB) can only provide temporary relief, particularly for the ailing banking systems. In the medium term, the central banks will have to retreat from this extraordinary provision of liquidity to the markets and will have to mop up excess liquidity to avoid inflation. There is a discussion among economists as to the benefits and costs of those large liquidity operations. Notwithstanding the benefits in the short- to medium term with regard to the reassurance of financial markets and the low interest rates, there are considerable costs which have to be taken into account.

On a global scale, the revised risk perceptions of investors as to country risks has led to large inflows of liquidity into emerging markets with upward impacts on asset prices in real estate and equity markets as well as on emerging market currencies. What the Brazilian president Dilmah Rousseff has called a monetary tsunamiis putting severe pressure on the management capacity of central banks in emerging economies, walking on a tightrope between shoring up growth and containing inflation.

Furthermore, the international liquidity is clearly supporting the increase of commodity and food prices, with negative consequences for commodity importers and the poor in developing countries. An additional feature of global capital flows after the crisis has been their volatility, particularly affecting countries where economic fundamentals had not changed, but risk aversion of international, particularly European banks, has led to short-term disinvestment of capital from emerging markets for internal reasons of banks.

In Europe, the liquidity provision to European Banks and Southern European sovereigns through the Long-term refinancing operations (LTRO) of the ECB, as well as the financial firewalls in the Euro-Zone (EFSF, ESM), do help to calm the markets in the short term, but they provide only breathing space which has to be used by banks and governments to restructure. Without bold structural reforms particularly inSouthern Europe the liquidity provision will fail to reach its aims in the long run. There are indications, however, that weak governments as well as weak banks will not use the breathing space as required. Thus, the medium-term perspective for the Euro-Zone is not very positive, since there will be no return to normal market refinancing for some banks as well as for some sovereigns within the next 2-3 years.

For Asia all this is a clear case for gaining more resilience with regard to global capital flows by further developing domestic and regional financial markets. It is also a case for strengthening the intermediation of Asian savings into domestic and global investments by an ever stronger financial sector in Asia.

Dr. Peter Wolff
Head of Department "World Economy and Development Financing"
Leiter der Abteilung "Weltwirtschaft und Entwicklungsfinanzierung"

DEUTSCHES INSTITUT FÜR ENTWICKLUNGSPOLITIK (DIE)
German Development Institute - Institute Allemand de Développement

Union Budget FY 2013

Union Budget – F 13

The budget was prepared under Political and Economic Constraints. The options available to address the various issues were limited. The oil price was much higher than the budgeted levels. In FY 12, the revenue generation was not up to expected levels. There was a good balancing act done by the government. The government could have continued the stimulus for one more year by keeping the Excise duty and Service tax at 10% levels. But there was no visibility of immediate availability of funding from other sources. The government has prepared notes on strategy, Medium term fiscal plan ,etc. In the long run, many options to increase the revenue are  possible through widening the tax net. But the efforts could start this year and there was an effort towards brining more into the tax net.

Since there is a pressure from higher levels of deficit and this is likely to persist going forward, there is an immediate need to look at non conventional sources of finance. The government could consider, capitalising the land available with government departments, Central PSU’s. The sick PSU’s can be turned around within a short period if they have assets which are of very high present and market value.

The increase in Excise and Service tax is likely to increase the cost of inputs and final products. This is likely to have a cascading effect on price levels and likely to keep the inflation rates at very high levels. The oil price risk is a game changer and this could increase the inflation as well as put more strain on the government financees.

Financials

As against the budgeted gross tax revenue of Rs 9,32,440 crore for 2011-12, the revised estimate has been pegged at Rs 9,01,664 crore. Shortfall in corporate taxes is expected to be Rs 30,000 crore, there will only be marginal shortfall in personal income tax.

For F13, the Centre is targeting a 15.5 per cent increase in gross tax revenues. Indirect tax proposals to result in a net revenue gain of Rs 45,940 crore during next financial year. Direct tax proposals are likely to result in loss of Rs 4,500 crore. In all these years, the share of direct tax was going up .

Service tax. For the first time this will cross Rs.1,00,000 cr and projected at Rs 1,24,000 crore. But the actual collection might be higher than the budget .

Total revenue receipts is budgeted at Rs.935685 cr,21.99% growth over Rev. F12 budget. Rev. F12 revised estimate is 2.72% lower than the F11 at Rs.766989 cr.

Net tax Revenue: Estimate for F13 is kept 20.06% higher than the revised estimate of F12. It is at Rs.771071.00 cr. Forecast for  F12  is 12.7% higher than the F11 figure.

Non Tax revenue: It is at Rs. 164614 cr, 31.97% higher than the revised F12 forecast. Where as  F12 estimate is at Rs.124737 cr, 43% lower than the actual F11 actual performance.

Capital Receipts is estimated at Rs.555241 cr, 3.67% lower than the  F12 forecast. While F12 is estimated at Rs. 576395 cr, 43% higher than the F11. Out of which 92.5% would come from debt receipts and rest from Non debt receipts.

Total Receipts is targeted at Rs.1490925 cr, 13% higher than the revised forecast for F12.where as estimate for F 12 is  at Rs.1318720 cr,10% higher than the F11.

Total Non Plan Expenses: Non Plan expenditure for F13 is estimated at Rs. 969900 cr, 8.72% higher than the revised F12 forecast. Out of which capital expenses is kept at Rs.104304 cr , 36.5% higher than the Rev.F12.

Revised F12 non plan expenses was at Rs.892116 cr , 9% increase over F11 figure.

Plan Expenses: Total plan expenses are budgeted at Rs.521025 cr, 22% higher than the rev. F12. where as Rev. F12 was higher than F11 by 12.5% YoY.

Out of total plan expenses capital plan expenses is targeted at Rs.100512 cr , 25% higher than rev.F12.Rest are from revenue Expenses.

Overall Expenditure is estimated at Rs.1490925 cr, 13% rise over Rev. F12 forecast where as Rev. F12 estimate is at Rs.1318720 cr, 10% rise over F11.

Thus Total Expenditure is budgeted at 159% of the total revenue receipt for F13.And For Rev. F12 it is estimated at 172%.

Overall  Capital expenditure is budgeted to grow at 30.7 per cent as against 10.6 per cent growth in revenue expenditure.

The fiscal deficit target at 5.1 per cent for 2012-13 is lower than 5.9 per cent achieved in the current year.

GDP is projected at 7.6% +  0.25%

Direct tax receipts as percentage of GDP remains stagnant at 5.8 %. This could be increased substantially by improving the tax administration to bring those who are paying no tax and those who are liable to pay higher tax. The direct tax could be increased at least 20% a year and this would go a long way in reducing the fiscal deficit.

Interest costs. Expected to increase from Rs.275168 cr to Rs.319759 cr, 16% increase over the previous year. The net market borrowing through dated securities to finance this deficit is Rs 4.79 lakh crore. This is going to keep the interest rates at very high levels.

The fiscal deficit is pegged at Rs 5,13,590 crore, which is 5.1 per cent of GDP. This time budget is higher than for the last year but still there is risk that as we go along , this might be higher than the budget.

Disinvestment. The target is Rs 30,000 cr. If a few issues are planned from May, then a target of Rs.50,000 cr could be looked at. In F12 the government could mobilise only Rs.14,000 cr.

Subsidies . Capping  subsidies within 2 per cent of GDP requires fine balancing. By improving the implementation of the schemes, the subsides could be targeted towards those who require these subsidies. The government has planned Rs 60,974 crore fertilizer subsidies. This is  lower than expected subsidy requirement  of Rs 90,000 crore in F12. Since the Farm produce prices at retail level has gone up significantly, there is a scope by which within three years, the fertilizer  subsidies could be brought down to Zero within three years. This could be ensured through higher realisation for produce for farmers at the farm level.

The petroleum subsidies have to be better targeted and here again, government could look at a reduction of these subsidies of 20% year on year. Even if decontrol will take time, by better administration the subsidies could be brought down substantially.

Agriculture. Continued interest subvention on crop loans, an additional subvention up to 3 per cent for prompt loan payments and a 21 per cent increase in agricultural credit will give a boost to farm sector. The access to viability gap funding for irrigation projects will attract private investors. There was a plan to provide Rs.10000 cr to NABARD for supporting the RRB’s. This will increase the lending capacity of RRB’s.

The thrust on Agriculture and providing funds to leading Agri Universities is likely to provide a momentum to increase the productivity in agriculture and the we could achieve a higher growth projected than in the budget, provided, the funds are utilised for productivity improvement . We could target a higher growth in Agriculture than what was projected in the Eco Survey since our productivity levels are still low compared to many other countries in the world.

Automobiles. The Budget has proposed an increase in excise duty on large cars to 24 per cent. But, large cars with engine capacity above 1,500 litres will attract an additional three per cent ad valorem rate — expected to work out significantly higher than the previously fixed Rs 15,000 extra excise on such vehicles.The customs rate on completely-built unit imports will see a 15 per cent increase, apart from an around two per cent increase in countervailing duty (in lieu of excise).

Banks. Public sector banks (PSBs) are likely to receive a major portion of the Rs 15,900 cr  allocated for recapitalisation of government financial institutions. This will improve the capital adequacy ratio of the banks and help to raise additional resources of  Rs.150,000 cr which will increase the liquidity position and funds disbursement.

Capital Markets. Qualified foreign investors (QFIs) have been permitted to access the Indian corporate bond market. Additional Tax benefits in Infra bonds and widening the limit would help to attract funds from abroad. This could be the starting point for deepening the market. Reduction of STT will reduce the cost for Institutional players in the market. Reducing the withholding tax on ECB’s would reduce the cost of borrowing from abroad for the issuers of ECBs.

FDI. The proposed amendment in the Income Tax Act retrospectively from April 1, 1962. Under the proposed amendment, all persons, whether resident or non-residents, having business connection in India will be required to deduct tax at source and pay it to the government even if the transaction is executed on a foreign soil. This has created lot of confusion and those who brought FDI in earlier years are worried and there were about more than 500 such transactions. The amendment will apply to all past transactions concerning assets in India. The immediate one to be impacted will be a company like  Vodafone.

GST.  The intention is to start t his process in the middle of the year  but it might take more time since still many of the issues are to be sorted out.

Housing. There was a thrust on affordable housing and ECB tax guidelines and interest subvention up to Rs.15 L of loan for an individual will help to boost the demand of houses in this segment. It will also help to reduce the cost for the borrower.

Infrastructure sector. Steps to improve access to funding and tax  concessions will help to increase  investments in the infrastructure . The limit for tax free bonds in the infrastructure sector has been doubled to Rs 60,000 cr. The relaxation in withholding tax for ECB’s will reduce the foreign borrowing cost.

Oil . The proposed increase in cess on production of crude oil, to Rs 4,500 per tonne from Rs 2,500 per tonne, will increase the cost of domestic oil production by Rs.250  to Rs.300 per barrel. Oil prices can play spoilsport in determining the fiscal deficit for the year. The government may have to provide higher subsidies. But the scope for very high subsidies is limited. There may be a need to increase the fuel prices which would have a cascading effect on the entire costs in the economy.

The budget also has a provision to exempt payment to certain foreign companies in India in Indian currency for import of crude oil. While the intended beneficiaries have not been explicitly mentioned, this provision would enable ease of crude oil imports from Iran. This would aid refiners such as MRPL, which depend on Iran for the bulk of their requirement.

Power . Exemption of 5 per cent customs duty on thermal coal,natural gas and liquified natural gas (LNG) will make the cost of power cheaper. The extension of 10-year tax holiday and additional depreciation of 20 per cent in the first year will marginally improve the performance of this sector.The dividend distribution tax (DDT) rationalisation will help improve return on equity for the multi-tiered structure of most power companies.

The  duty cut on imported coal will result in a saving of  Rs. 480 a tonne to the power producers in case of Indonesian coal and higher for for African coal. India imported nearly 84 million tonne of coal in 2011. This will result in lowering the power generation cost by 25 paisa per unit.

Telecom. The government has estimated  a revenue of Rs.40000 cr from the auction of Spectrum. The government should initiate the process immediately after the start of financial year and try and mobilise these funds by the first half. Despite the scope exists for looking at a higher revenue through this mode, the government should make sure that there is no exhorbitant cost for spectrum, so that the cost of communication remains at competitive levels in India.

Road ways.The allocation to the highways sector has been increased by 14 per cent to Rs 25,360 crore in F13 and the government has set a target of covering a length of 8,800 km roads under NHDP next fiscal.

SME’s. The financing available under the proposed ‘India Opportunities Venture Fund' will be routed through the Small Industries Development Bank of India  and Rs.5000 cr fund would be created to support SMEs. They are the major suppliers to the large corporates and facilitating the growth of SMEs would result in higher level of industrial growth. Exemption from capital gains tax on sale of a residential property has also been proposed, if the funds raised are used for subscription in equity of a manufacturing company for purchase of new plant and machinery.

UID. Budget  gave a big-boost to the Unique Identification Number (UID) initiative, with an allocation of  Rs 14,000 crore for the Aadhaar scheme. The budget has a target to cover 40 cr Indians. This is the starting point for moving towards better management of Subsidies and tax administration. The Unique Identification Authority of India (UIDAI) has completed coverage of 20 crore Indians.

Venture Capital. Liberalising the operation of Venture capital Funds will increase one more window of financing for sectors which are not able to attract funds from Venture capital companies.

R.Kannan

Global Economic Crisis – Immediate Solution

Global Economic Crisis –  Immediate Solution

The turbulence we are going through is unprecedented in the world History. What started as A financial  institution failure, affected not only the leading financial institutions in the world but also the major developed economic systems in the world leading to a systemic failure.

Unlike in the past , when it had an impact on only a few  countries and few asset classes, this time, the crisis had its effect on almost all countries in the world and all asset classes. The crisis had a contagion effect and spread far and wide without an end in sight creating more and more uncertainties day by day.

When Government creates  stimulus it goes to increase the government debt making the government vulnerable to financial weakness. In a few cases , where there was a government failure,  investors have taken an hair cut in their investments. But in General, Sovereign debt is supposed to be more trustworthy since Central Banks can print money to lend it to the government when in need.

Governments in an effort to stop economic slide, tried many measures including Monetary and Fiscal Stimulus but black swan events had overtaken the efforts of governments. Many of the developed countries printed more money  and tried to stimulate the Economic Growth and reduce the unemployment. But it has gone into a spiral. The only effect is the outstanding debts of governments are going up, their credit rating is being downgraded and there was a lot of trust deficit between governments.,Banks and investors.

Everybody is in a dilemma searching for solutions and  immediate remedy. The effective  solutions are eluding the policy makers.

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According to Classical Economics, Printing money is likely to increase the demand, inflation and reduce the value of money. This is true in cases of countries  where the potential for high growth, high employment levels and low debt repayment needs exist.

Economic History has proven that only a few countries at any point in time  have high economic growth rates and those who were growing at high rates for long periods of time will see a decline in growth and potential for growth is almost negligible.

The developed countries which are affected by crisis today has less potential for growth , less opportunities for providing additional employment and supply exceeding demand levels for many of the product categories. The scope for stimulating the domestic demand and increasing  inflationary tendencies are limited.

The need for new money creation has to continue in these economies till they achieve an economic balance but with a difference. The classical economic theories were created when the world was very simple, the financial architecture in the economies  were very simple, the products available in the financial market were very simple and transparent. The world was not integrated like today. The theories proved right, whenever there was an economic crisis.

But we are living in a modern world with many factors influencing the economic performance and it is very difficult to exactly quantify the impact of each factor on the economy. The present crisis gives an impression that there is no solution in sight. There is a fear, gloom and high level of uncertainty.

The crisis in Europe today is due to high level of government debt which was created because of the  high acceptance of debt denominated in Euro issued by member countries. Only the Monetary union happened and to some extent economic integration.  There was a total absence of Fiscal Union and Political Union and lack of full economic integration. There is a need to move towards a fiscal integration and member countries should give the mandate to Germany and France to evolve a fiscal system within Euro Zone as if it is a Federal Structure. The Fiscal union is the immediate need.

The crisis today is due to Debt at Country Level , Province/State Level, Municipal Level, Corporate level and individual level. All the players in the system are affected but the degree of impact varies on each stake holder. Unlike in the past, it looks like the issue could not be resolved within a short period.

One solution seems to be in sight, that is the way in which the debt levels could be reduced for all stake holders. This could be achieved through creating money by Government without adding debt to its balance sheet. That is to just print money and allocate to all the Stakeholders based on criteria to be evolved which will ensure the  viability of the macro economic system, banking system, corporate sector and individuals who are indebted. The amount of money to be created depends on the need of all the stakeholders. It could be capped at 25% of the money in circulation today. This strategy might require, control of inflation within specified levels and managing the currency exchange rate within a specified levels. Since the actions taken in one country will have impact on all other countries in the world there has to be a coordinated action which is facilitated through a body like IMF. This strategy will change how Economic systems function, Capital markets work and transmission of money takes place. How this system will work can be tested through applying  this concept to the  most affected country in the world today and see the results in six months and if after effects are manageable then  this concept could be implemented in other countries.

Introducing this system will make the economic systems viable. Improve the liquidity, bring back the trust levels. , removing the gloom and doom and make the financial systems functional. Today, financial systems are in a limbo and their traditional roles in financial sector have been totally hampered . The employment levels will go up.

Adopting the above strategy might require a close coordination of Fiscal and Monetary functions in a country and both Fiscal and Monetary policies have to be developed in an integrated manner. There has to be an increased integration between all the regulators in a country and continuous exchange of information on the developments in each domain.

The Analysis to be done and the parameters to be tracked.

Analysis of Debt  with the average maturity period of the debt with Aging profile.

At the Country Level

State/Province  Level

City/Municipal Level 

Corporate Debt

Individual debt.

Criteria for determining the Printing of Money without Creating Debt for the Government

Total Debt in the system / GDP

Government Debt / GDP

External Debt / GDP

Repayments/ GDP

External Repayments / Reserves.

Forex Reserves / Negative Balance

Budget Deficit

Current Account Deficit

GDP Growth Rate /Potential Growth rate for next 5 years.

Interest Rates

Inflation and the likely trend in 5 years.

Unemployment level. and the likely trend in 5 years.

Distribution of Money Created.  

The end use of money created should go to reduce the debt levels of stake holders including investment in Equity capital . The government can invest in Equity capital of Banks and Companies. Whenever governments had given stimulus in the form of investments in shares of companies, when there was a boom , governments were able to exit the investments at good profits.

There has to be a careful deployment of the money created and as per the criteria to be developed in consultation with a body like IMF, World Bank.

These are my initial thoughts and this concept could be further refined and modified after discussions and debates. Hope adopting this approach would help to address the issues before the world leaders in the Short term.

R.Kannan