[ashokrajagopal]

Continuing in new post because of length

Our Perspectives

We all are participants of the economy and have own interests, lives and all kinds of plans.
But, there is a deep perspective problem which overcomes all of us once in a while, which is about what our own interests are VS what is generally good for everybody. We must all practice doing a neutral thinking. No, you are not being judged, certainly not by me; just think about how your children or your grandchildren will question you about this time.

With the deep stuff out, let me dissect further. Many many times in our life we conflate a good investment for "us" as a good investment for everybody.
An investment for you is something in which you can put money in and years/months later you can take out with some more value.
Think of everything from gold to stock market.

If we put this in a spectrum, we can easily see that they range from "only store+return of value and no other use"( think gold) to "store+return+multiplier effect in economy" (think investing in a people intensive industry like garments).

For the investor, all they need to care is what returns you get from this.
For the economy, its much more complicated, even though the economy is essentially a collection of investors.

It may make perfect sense for a rational you to finish your work at five and start for home at 5:10 PM.
If all of us take that perfectly rational decision, none of us reach home at stipulated time.

When we think of the economy, think of it like that.

Now, one might ask, if I buy more gold, doesnt that also move the economy ? Yes, it does, but in a very miniscule, non productive way. Sure, there are gold salesmen being paid, gold miners being paid etc, but the amount of money you are pumping into gold does not justify the miniscule multiplier effect.

So, with this concept, we can certainly redefine the spectrum with some easy maths.
Lets say A is the amount you invest.
R is the return you have.
And M is the multiplier effect.

For you as an investor, as long as R > A in real terms, you are good.
For a society, just R > A is not enough, M has to be a justifiable fraction of A, otherwise it is not good.

So, for gold, R > A, but M is very less.
For a garment factory, if R > A, its good and certainly M is a substantially good fraction; so for the society as a whole, this is good.

Now, think of M, which is the multiplier effect. If you do some straight thinking, it is clear that M can increase with new jobs, increase in salary, increase in demand.
There may be some other minor factors.

If M does not increase over time, no matter how much R or A increases, its not going to make much difference to what we call as real world.
Sure, you can increase A a lot if you have a lot of extra money.
Sure, the govt can backstop a whole lot of this stuff, and increase or maintain R.
But what happens at that point is M stagnates there, or decreases, but A and R can increase ?

So, technically, this can happen to any kind of investment. As this happens, the investment will slide to the side of Gold in the investment spectrum.

Where your investment is in this spectrum is anybody's guess.
What was Long term in equity was once 3 years, then it became 5 years, then 7, and now most advisors will tell you to wait 10 years for your Equity investments to bear fruit.
A's have increased, but R's remaining there and M stagnating ?

An interesting corollary comes up here -- if a substantial population has so much of A, that they just need to park that A somewhere and not really targetting an R ?
Isnt that, the Real estate world in India ?
No, its not an investment -- its a place to put your intergenerational handouts. Post 90s liberation, its been time for a generation to have earned and retired, so we can safely assume, its not the politicians, its not the brokers, its not the dark real estate tycoons. The Market stays there because there is too much money to invest anywhere productively in a section of the economy.

[ashokrajagopal]

To the state of the world, let me present this pre Covid graph.



This has been discussed to death in Econ circles -- real world demand has been dying for a long time now.
Yes, before Brexit and Trump.

So, what happens when demand slows down world over ? Roughly, the exporters need to adjust and make changes.
There are two ways in which this can be done
a) Increase demand locally by promoting local growth -- read heavy infra investment, increased wages
b) Keep chasing the lost demand by exchange rate adjustments, controlling wages, maintaining their Dollar reserves lest a market crisis happens, and all around atmosphere of deflation.

Guess which path did the exporting superpowers ( China, South Korea, Germany, Japan etc), and the exporting bottom feeders(Commodity exporters of South America and Africa) choose in the last 10 years ?

Welcome to a world of "Synchronized slowdown" ( IMF Chief, 2019)

Its been about 30-40 years since Govts around the world slowly gave away the concept of Fiscal policy and controlled only the Monetary policy side.
Now, the reckoning has come, and nobody has a clue to do anything with Fiscal side, when a once in century crisis hit.

With that picture, two things will happen
a) The surplus producers will have nothing to invest locally in, and they will almost always go into a savings glut.
Banks fill up, Money markets overflow, and high quality( ie. percieved high quality) equities grow the hell out.
b) When even these are not enough, the money flows into the traditional assets like high priced real estate, gold etc.

This pretty much explains the 2010s.
Theoretically, every rate cut, every single QE, every other Monetary policy adjustment is simply supposed to maintain the show, not "develop" like the popular literature says.
So, nobody is really spurring anything with monetary policy for a long time now, its required to maintain status quo.

We have had a macroeconomic regime with Deflation built in for about 10 years now.
Covid just accelerated it.


So, long story short, let me put the controversial term in. In my opinion, we are living in a class war, right in the thick of it.

Accelerated simulation and maintenance of the top 10%'s assets, and pittance thrown at the large precarious populace.
And where such pittance is thrown about ( US with the minimum wage adjacent checks and UK/EU with the furloughs), there are hours of morality discussions about it, while the central banks are producing millions from thin air every hour to maintain the top 10%'s assets.

Of course, we did not have any of these crumbs in India, so we made up our own stories.

In mid 2019, amidst our slowdown, I had written that there is a serious structural problem in the slowdown.
In Mar 20, I had written that the working population of India will get new lessons about hard days labor, nowhere in my mind I could have predicted that my civilized country will go after the 100 year old 8 hours labor law to squeeze the weakest amongst us in search of that stability.
Sure, never waste a crisis, right ? Strike them when they are down so we can keep the simulation running.

[Cessna182]

Great post.

Even the exchange rate adjustments for export promotion that you talked about seem so uncertain today. Japan, Korea etc could fill gaps in the market because no one else was producing that stuff earlier. Today, almost every country can make commodity products using off the shelf machinery. The competition is thus much higher.

[Samurai]

Originally Posted by ashokrajagopal

So, long story short, let me put the controversial term in. In my opinion, we are living in a class war, right in the thick of it.

Accelerated simulation and maintenance of the top 10%'s assets, and pittance thrown at the large precarious populace.

Wow, you have just committed a cardinal sin. You will now be called a bleeding heart socialist.

Welcome to the club. Excellent points in your 3-part series. In your first post, you have described all the financial smokescreens very well. That is why I always go back to the first principles to see if something makes sense. If 10 layers are slapped together and we only see the top layer, we could as well be reading the stars to predict the future.

One of the craziest thing that happened this year was Trump downplayed COVID19 until March because he feared that may affect the stock market. Talk about priorities...

[vrprabhu]

Thanks, Ashok. After a long time, I enjoyed reading economics! And, to be frank, I couldn't agree with your earlier views on working conditions (labour), but I am being proved wrong.... and this is an eye opener for me -

Originally Posted by ashokrajagopal

It may make perfect sense for a rational you to finish your work at five and start for home at 5:10 PM.

If all of us take that perfectly rational decision, none of us reach home at stipulated time.


..... The Market stays there because there is too much money to invest anywhere productively in a section of the economy.

Makes perfect sense to me.

Originally Posted by ashokrajagopal

Its been about 30-40 years since Govts around the world slowly gave away the concept of Fiscal policy and controlled only the Monetary policy side.

Now, the reckoning has come, and nobody has a clue to do anything with Fiscal side, when a once in century crisis hit.

Theoretically, every rate cut, every single QE, every other Monetary policy adjustment is simply supposed to maintain the show, not "develop" like the popular literature says.

So, nobody is really spurring anything with monetary policy for a long time now, its required to maintain status quo.

Let us hope RBI top brass see the light - there is no point in crying that banks have become risk averse, when no entrepreneur is going to risk investing in a new venture. Even existing ones are finding it tough to run business as earlier - even if they have cash - because future (which can never be predicted accurately) is even more uncertain now.

Ashok, assuming you have been given divine powers to set right the situation, what would you do (purely academic interest on my part)?

[V.Narayan]

Question for the experts.

The Centre is failing to pay the States their fair share of GST, Income Tax etc. Is the Central Government going broke? or are they playing mischief? Has there ever been a situation like this in the last 50 years where the Central Govt fails (I am restraining myself from using the word refuses) to pay the States their share of what has been collected.

This could damage the trust between Centre and State and compel States to claw back revenue collection into their own hands and undo any benefits that GST was to bring.

[Samurai]

Originally Posted by V.Narayan

Has there ever been a situation like this in the last 50 years where the Central Govt fails (I am restraining myself from using the word refuses) to pay the States their share of what has been collected.

Even I am curious about this matter. I started India sales on the very month GST regime started.

Before that how did the sales tax collection work? I think the state was collecting VAT and center was collecting CST. Not sure how they shared the revenues.

[V.Narayan]

Originally Posted by Samurai

Even I am curious about this matter. I started India sales on the very month GST regime started.

Before that how did the sales tax collection work? I think the state was collecting VAT and center was collecting CST. Not sure how they shared the revenues.

The States collected Sales Tax & kept it. I don't know how CST used to be shared if at all. Customs, Excise and Income Tax had some formula for sharing.

I personally don't recall a situation under any regime where the Centre told the States go out and borrow we cant pay you; though something close to this did happen in 1991 but not in 1979 which was the last time the economy shrunk. This may be the tip of the iceberg of a breakdown more fundamental than just the economy shrinking by X or Y percentage points. It could have some political ramifications. At the Centre there seems to be a fundamental lack of understanding of the levers that make an economy tick.

[vrprabhu]

Originally Posted by Samurai

... how did the sales tax collection work? I think the state was collecting VAT and center was collecting CST. Not sure how they shared the revenues.

Originally Posted by V.Narayan

The States collected Sales Tax & kept it. I don't know how CST used to be shared if at all. Customs, Excise and Income Tax had some formula for sharing

If I remember what I studied (), it was like this -

Indirect taxes (Sales Tax, Registration Fee, Motor Vehicle - Road Tax etc.) were within the ambit of State Governments and they could decide the rate and collect the tax and spend it.

Direct taxes (Income Tax, excise duty) was solely under the purview of Central Govt. The tax collected used to be shared as per the recommendations of the Finance Commission. Not sure if CST formed a part of this pool.

Finance Commission was the apex body which, among other things, arrived the revenue sharing between the Central & State Govts. i.e. how much of direct tax collected by the Central Govt. that will be shared with the States. Even the grants by the Centre to State was based on their recommendation. I don't remember how the sharing % used to determined - but recollect that all States used to raise a hue and cry about the unfair treatment meted out to them! They also used to get 'grants' from Centre, but that is another story....

Originally Posted by V.Narayan

The Centre is failing to pay the States their fair share of GST, Income Tax etc. Is the Central Government going broke?

Good question. Where does all the money go? May be salaries, pensions etc. themselves gobble up a good amount of the revenue generated?

This is similar to our paying 'toll' for a road which has not been maintained because the toll operator saying that the toll concession that he bid (and paid) for is not remunerative and that he is incurring a loss!.

[Sree]

Is the central govt refusing to pay the states the money that has already been collected. My understanding was that when gst came, states were promised guaranteed amounts to get them on board.
Now with the economy going south, GOI is in no position to pay these amounts unless they borrow. There is something like 3 lac crore deficit between collection and guaranteed payment due.
Naturally, they are not willing to borrow in order to pay the states, but wants states to borrow directly to cover their individual deficit.

I may be wrong and am willing to be corrected.

Is it ethical not to pay guaranteed amounts saying it is an act of God- is a different matter

[Sutripta]

Originally Posted by V.Narayan

Question for the experts.

The Centre is failing to pay the States their fair share of GST, Income Tax etc. Is the Central Government going broke? or are they playing mischief?

I would say going for broke, establishing one more 'new normal' in the new India!

Has there ever been a situation like this in the last 50 years where the Central Govt fails (I am restraining myself from using the word refuses) to pay the States their share of what has been collected.

Admirable restraint. Why?

What if it had been foreign debts. Have we faced it before?

Sutripta

[vrprabhu]

Originally Posted by Sutripta

... What if it had been foreign debts. Have we faced it before?

If Government doesn't repay interest / principal of the monies borrowers, it will be a default (government issued bonds will treated akin to junk).

This is not such a situation. Here, the Central Govt. guaranteed to pay the States to meet their shortfall in tax collection, arising out GST implementation (so as to transfer the power of collecting local taxes to Centre and also to apply uniform tax rates across the country). Now, they are stating there is a shortfall (exacerbated by COVID) and States may borrow to meet the gap.

Do you know how the States are supposed so such repayments? Through cess! Paid by whom? Ultimately, my friend, it is the tax payer who foots the bill

FM had indicated that GST @ 28% on two wheelers needs to be re-looked - as it is high for an item which isn't a luxury. If it is reduced to, say, 18%, there will be more shortfall in tax collection - where will the gap be bridged from?

As Mr. Ashok has observed, either way, we are in for tough times ahead.


BTW, talking of foreign debts reminds of the time (couple of decades ago?) when we had supposed pledged our gold reserves for forex, because our reserves were dwindling and the coffers would not have been sufficient to loan repayments. There was a hue and cry about pledging our gold to borrow from a foreign country....

[Sutripta]

^^^
How about the centre borrowing and paying the states the promised amounts? (I am seeing this as a breach of contract. With the principal party being the GOI.)

Sutripta

[vrprabhu]

Apparently Centre doesn't want to do this. Because the cause isn't related to Centre but the economy and Act of God?!

I am not too sure about this - but FRBM (Fiscal Responsibility and Budget Management) could be in the way, as also burgeoning interest burden.

Even assuming that they borrow - who will lend the money? RBI / Banks? (All Govt. debt i.e. bonds issued for raising money, is managed by RBI. They are 'auctioned' in the money market and subscribed by 'Primary Dealers' - essentially Banks and other investment entities). This may hamper liquidity, if the quantum is huge - not that liquidity is an issue now, but still neither RBI nor GoI want to take any chances by announcing fresh borrowing plans.

As it is, there was a news item that the recapitalisation bonds issued by Govt. of India has cast a heavy burden on the interest outgo on these bonds.... any borrowing will come at a cost. So further borrowing could put a strain on future budgets.

PS - Individual investors are now permitted to invest in the bonds (they are called G-Secs). No clue as to how much amount individuals have actually subscribed for such bonds. A few bonds - floating rate and tax free - were usually made available for individual investors, but generally government borrowing has a calendar based on which the G-Sec is put up for sale.

PPS - Expenditure Secretary has expressed some views, which appear to be pertinent and logical, given the current situation.

[Sutripta]

Originally Posted by vrprabhu

Apparently Centre doesn't want to do this. Because the cause isn't related to Centre but the economy and Act of God?!

I am not too sure about this - but FRBM (Fiscal Responsibility and Budget Management) could be in the way, as also burgeoning interest burden.

Force Majeure is a feel good clause which does not stand up in court. Countries don't use it.
Article of faith that India (implementing authority GOI) will not renege on its commitments, say sovereign debt. But till the other day one thought that it applied to ALL its commitments and promises.

It is a fact that it overpromised on states compensation. But that was necessary to clinch the deal, to get the consent of the states. Happens in business all the time. No matter the level of buyers remorse, the deal is done.

Massive borrowings by the GOI will cause Indias ratings will go down the tube.
But a contract is a contract, a promise is a promise. And no matter how ironclad the contracts, business and society runs on trust. Even amongst adversaries there is 'trust but verify'.
This has all the hallmarks of 'I will because I can' dadagiri.
VN mentioned something about what makes an economy tick. What makes a society tick?

Will leave the ensuing fight for the economists. But ultimately Central govt can print money, States can't. Expect tons of people to point out that I know nothing of economics. Which is true. And so my last words on the subject.

Sutripta