Economic Survey 2017-18:Underscoring the pink

The Economic Survey 2017-18

The Economic Survey provides us with analytical overview of how the economy has fared in the previous year, which in turn acts as a guiding light for the government to chart its path for the next fiscal year. The survey is also used by laypersons to understand the general direction of the economy.

The Economic Survey for the 2017-18 was tabled in the parliament on 29 January 30, 2018. This year’s survey was presented in Pink colored booklets to highlight its support for movements to end violence against women.  It was also the second time in history when Big Data Analytics was effectively used to provide insights for the survey.

Following are the major highlights on the state of the economy as described in the survey:

1)  The Economic Survey predicts the GDP growth for FY2017-18 to be at 6.75% YOY, the average GDP growth rate after 2014 has been 7.3% YOY which is highest among the major economies.

2)  For the coming FY GDP growth is predicted to be at 7-7.5% YOY, the survey argued that this growth will be supported by:

1. Revival of global demand
2. Impact of shocks like demonetization and GST to the economy will smooth over time

3)   Introduction of GST has led to a direct increase (50%) in number of indirect            taxpayers.

4)    India has jumped 30 spots to reach top 100 in the ease of doing business ranking, which is a sign that more foreign and domestic investments can be expected over time.

5)    Survey highlights the steps taken by the government to resolve the “twin balance sheet problem” by:

1.  The increase in recognition of stressed assets
2. A bank recapitalization package amounting to approximately 1.2% of GDP 
3.  By implementation of the asset resolution process as mandated by the Insolvency and Bankruptcy Code (IBC).

6)    The survey acknowledges the twin balance sheet problem as the “festering, binding constraint” on growth.

7)    The story of revival in the Survey is not without warnings of risk factors within the economy. A key risk in the upcoming fiscal arises from the rise in oil prices.

8)  The second major risk as highlighted in the Survey, which can impact India's growth, is a possible correction in the stock markets. As the Survey points out, a sharp correction cannot be ruled out in case future growth of the economy and corporate earnings do not remain in line with current expectations.

Concluding Remarks:

In conclusion, the outlook for 2018-19 will be determined by economic policy in the run-up to the next national election. If macro-economic stability is maintained and the ongoing reforms are stabilized, and the world economy remains on a revival path, growth could start recovering towards around 8 percent in the medium term.

Putting all these factors together, a pick-up in growth to a range between 7% and 7.5% in 2018-19 can be forecasted, re-instating India as the world’s fastest growing major economy.

The biggest source of upside potential will be exports. If the relationship between India’s exports and world growth returns to that in the boom phase, and global growth for 2018 is in line with IMF projections, then that could add another 0.5% point to the national GDP.

Against this overall economic and political background, with general elections coming up next year; policy formulation will be challenging in the coming year. The obvious threats (such as fiscal expansion) still have to be avoided and the risks well mitigated by fiscal prudence and planning, for India to achieve its full potential. All this has to be done while ensuring that the rural demand picks up and corporate earnings increase, so the government has to tread a fine line and come up with a balanced budget.

Note To Readers: Due to some academic constraints I, Anurag Dubey, was unable to publish new blogs since August last year. I will try to publish more this year. This blogpost has been co-authored with Prasad Pansare.
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Ripples: Demonetisation, Trump and OPEC Part-3

This is the third part of ripples series. For the previous parts click on :-
PART 1
PART 2

The oil prices have been under pressure for quite some time due to the supply glut. This has diminished the profit margins of many oil exporting countries. 

The organization finally attempted its first production cut since 2008. Despite many political difficulties, a September 2016 decision to trim approximately 1 million barrels per day was codified by a new quota agreement at the November OPEC conference. The agreement (which exempted disruption-ridden members Libya and Nigeria) will be in effect for the first half of 2017 – alongside promised reductions from Russia and ten other non-members, offset by expected recoveries in the US shale sector, Libya, Nigeria, and spare capacity.

International oil prices rose to an 18-month high of more than $58 a barrel after the Organization of Petroleum Exporting Countries and several non-members agreed on Dec. 10, 2016  to end two years of unfettered production and instead cut output to increase price in the market. 

Despite this agreement to cut oil production and thereby reducing supply Crude still slipped about 5% from that peak as traders await proof that OPEC will follow through on the deal. Producers have already removed 1.5 million barrels a day of supply from the market, Saudi Minister of Energy and Industry said in Vienna. 

Representatives of OPEC and several other major oil producers met in Vienna for their first meeting to monitor compliance with an agreement to cut output. It remains to be seen as to how effective this agreement is in bringing down the supply and increasing prices of crude oil. 

With the prices slipping again it will become imperative for the OPEC to prove  that the group is serious about finally eliminating a three-year crude oversupply and dispel skepticism stemming from previous unfulfilled promises. The outcome will depend on the degree of compliance.

Whatever be the out come on the compliance front, this decision by OPEC is bound to create Ripples in the global markets.

Ripples: Demonetisation, Trump and OPEC Part-2

 This blog post is part of the series on "Ripples: Demonetisation, Trump and OPEC". To read the previous part click here. This post was written in collaboration with  Akansh Gangil and Shikhar Bansal.

 Trump election and failure of Analytics

The election of Trump as the next President of the United States came as a shocker for many. The various pre poll surveys and analytics failed to predict his victory. Trump has campaigned on a slogan of "Make America Great Again" by announcing to do away with past economic policies of the US. His policies of first 100 days will have huge implications on global economy and polity.

The good news can start with US growth, which might accelerate above the 2.2% average annual rate. Trump may implement the Keynesian fiscal stimulus that Obama often proposed but was unable to deliver.

Trickle Down Economics

Mr Trump proposed to cut taxes dramatically. His tax cuts would mostly benefit the rich, which would limit the boost to demand somewhat, but a large increase in the government deficit could not help but give a jolt to the economy. At the same time, Mr Trump seems likely to increase spending on defense and on infrastructure (and, possibly, on a wall, which would seemingly count as both).

Decrease in corporate taxes will help mainly the service sector and not the manufacturing sector. As the taxes are lowered, more disposable income will be available with individuals which will raise the inflation levels, which even though desired, leading to raising the already high wages. Thus labor cost will remain as the major hurdle for manufacturing growth.

 Shift in Trade Policies

 During the presidential campaign Trump has repeatedly called for repealing or renegotiating the trade deals.

 This adamant attitude towards US participation in blocs like NAFTA, TPP  and TTIP will adversely impact automotive industry all over the world as import duty on automobiles and auto-parts, coming from Japan, China and other countries, will increase by a large margin. Consequently the big OEMs (Nissan, VK, BMWs, Ford) and their suppliers manufacturing outside the US might shift their manufacturing plants to US. But, as already discussed, labor cost will make manufacturing costly, thereby leading to price rise for SUVs, Trucks and as well as cars.

 Geopolitical Issues

Mr. Trump being the next commander in chief has to tread very carefully as geopolitical tensions can rise by any impulsive move from his side. And tensions among nations is always bad for business( other than defense suppliers). US position on critical international issues like climate change can change. The US stand in various international forums on climate change will need to be carefully analyzed. 

 It is hard to know or anticipate how he will use the army, or the diplomatic machinery of the American government. Any move toward greater conflict in the Middle East or Asia could have serious economic consequences: from soaring oil prices to market panic to interruptions in global trade. The economic and human costs of war are impossible to anticipate but frightening to consider.

Indian Perspective

Perhaps the most negatively impacted industry will be IT as more stringent laws and higher cost for H1B visas seems to be  in the offing. This will considerably increase the cost for IT companies. Apart from trade, the diplomatic position of US towards Pakistan and China will also have huge implications on Indian trade and international policy making.

Whether we like it or not, Donald Trump is set to be the US President and his policies are bound to create Ripples.  

 

Ripples: Demonetisation, Trump and OPEC Part-1

Since my last blogpost, a lot has changed around the world sending shockwaves through the economy. Some of the ripples form these shocks have been felt globally, some felt nationally, and others are looming to be felt.

The three major events from an Indian economy point of view were the demonetisation of Rupees 500 and 1000 notes, election of Donald Trump as the US President, and the decision by OPEC to cut oil production.

I will be writing about the three major shocks in this "Ripples" series in 3 different parts in collaboration with Shikhar Bansal.

Demonetization

On November 8, 2016 Prime Minister Narendra Modi in his address to the nation announced the demonetisation of Indian Currency notes of 500 and 1000 denominations from midnight, thereby, turning almost 85 percent of the Indian cash in circulation to "worthless pieces of paper" as these notes will no longer be legal tender. There’s a complex system of exemptions and exceptions to this demonetisation. The public was asked to submit the old currency in the banks and post offices, and was urged to embrace cashless transactions using mobile banking and internet banking.

The move was touted as a masterstroke against corruption and black money. The opponents of the move, on the other hand, are citing it as a major hubris. They point to the lack of preparedness and proper planning in implementation. The lack of proper internet and financial/general literacy in the rural India is also being considered as a major hurdle to India transcending to a cashless society.

The businesses and markets reacted to this shocker in the manner as described below:

1.  Sensex performance after demonetisation.

Due to initial panic among the investors, specifically those who were invested in adversely affected sectors, the markets tumbled by about 1800 points in just five sessions of trade. Demonetisation cannot be hailed as the only cause for tumbling of the markets, as US Presidential elections also had a major impact on IT bigwigs. But the largest impact of the government's move will be in the unorganised sector, which isn't represented in the markets.

     2.  Sectors which are affected negatively are: Real Estate, Auto, FMCG, Luxury, and Bullion Markets.

The sudden drop in money supply and increased incidence of deposits have had an adverse effect on consumption in the economy. This sudden demand curtailment further leads to a cascading effect due to decline in consumer confidence. With consumers preferring to hold cash in hand, consumers will stick to purchase of necessities and will cancel/ postpone buying premium FMCG products and luxury items. Due to real estate and construction sector getting affected, related industries like cement and construction material will experience a slowdown.

    

   3. Sectors with an upswing: The number one beneficiary are banks, with an improved CASA. RBI might cut rates by 50 bps. This will help banks lower funding cost, therefore, lending fillip to credit demand (in near to medium term). SME may face near term payment issue due to sudden scrapping of high currency notes. This would increase demand for working capital loan. Cheaper credit coupled with Make In India will provide imputes to SME, which may lead to a boost in manufacturing growth. With the cap on gold holdings being announced, pressure on gold finance players will increase.

  4.  Digital wallet and UPI : The demonetisation has been a boon in disguise to the mobile banking and digital wallet providers like Paytm and Mobikwik which have been successful in increasing their reach to local vendors. Digital Paytm on 29th november said that it has seen 35 million transactions for mobile and DTH recharges on its platform since demonetisation which is over 70 percent of the total recharges done in the country. Also, the banks have come up with Unified Payment Interface which can act as game changer in making mobile transactions safer and easier.

Does India has what it takes to become a cashless economy? Only time will tell, but one thing is for sure that such an endeavor will need the private sector to create the cheap and easy mechanisms for cash transfers using smartphones that would make cash redundant. And though this process is ongoing, and swift, it’s far from complete.

Is it time for RBI to cut interest rates ?

The inflation data for the month of August is out. The consumer price index (CPI) fell sharply to 5.05% year-on-year from 6.07% in July, thanks largely to a sharp fall in food prices, which enjoy about 50%  weight in the inflation basket used for CPI calculations. Food inflation has slowed to 5.91% from 8.35% .

  

Also, Industrial output data showed that July index of industrial production (IIP) came in at -2.4 percent, compared to 1.95 percent (revised) in June. 

The Reserve Bank of India( RBI) is going ahead with the inflation targeting of  to bring down CPI to below 5% by January 2017. This target seems achievable, due to the falling food prices and the base effect.  The weakness in the Industrial output however is being largely associated with weak demand for Capital goods globally. 

These two data coupled with Urjit Patel taking over the reins of RBI has increased the hope of a Rate Cut by RBI. The interest rates were last revised in April. Since then many people have been vying for the rates to be cut down. Raghuram Rajan, former RBI Governor,  specifically stated that there was no room for rate cuts as inflation has to be reined in.

Now that inflation seems to be under control and there is a need to revive the industrial output, chances seem high that RBI may cut Rates in its next monetary policy meet.

August consumer price index (CPI) fell sharply to 5.05 percent year-on-year from 6.07 percent in July, thanks a sharp fall in food prices, which enjoy about 50 percent weight in the inflation basket, government data released today showed.

Read more at: http://www.moneycontrol.com/news/economy/august-cpi-falls-to-505-july-iip-contracts-by-24_7444961.html?utm_source=ref_article

consumer price index (CPI) fell sharply to 5.05 percent year-on-year from 6.07 percent in July, thanks a sharp fall in food prices, which enjoy about 50 percent weight in the inflation basket, government data released today showed.

Read more at: http://www.moneycontrol.com/news/economy/august-cpi-falls-to-505-july-iip-contracts-by-24_7444961.html?utm_source=ref_article

consumer price index (CPI) fell sharply to 5.05 percent year-on-year from 6.07 percent in July, thanks a sharp fall in food prices, which enjoy about 50 percent weight in the inflation basket, government data released today showed.

Read more at: http://www.moneycontrol.com/news/economy/august-cpi-falls-to-505-july-iip-contracts-by-24_7444961.html?utm_source=ref_article

Post Brexit musings - Bullish vs Bearish.

As markets struggle to adjust to the post Brexit bloodbath,  many analysts and experts are looking backward, juxtaposing the event to past crises and modeling their responses accordingly. There are many who see it as the seeds of doom, and believe that it is time to cash out of the market. There are others who vehemently argue that not only will markets bounce back but that it is a buying opportunity. The sentiments in India on Brexit also fall in the same binaries, along with some out of the box witty tweets.

Here are some of the major global economic effects of Brexit:

1. Government bond rates in developed market currencies (the US, Germany, Japan and even the UK) have dropped, gold prices have risen, the price of risk has increased and equity markets have declined.
2. If this is a battle, the British Pound is on the front lines and taking heavy fire, plummeting to 10% over the last week against the US dollar and approaching three-decade lows, with the Euro seeing collateral damage against the US dollar and the Japanese Yen.
3. The Pound is expected to go down further as predicted by various rating agencies.                                 
   
                                                  Source: Bloomberg
4. The damage is greatest in the EU, but even within the EU, it is the old EU countries (primarily West European, that joined the EU prior to 2000) that have borne the biggest pain, with sovereign CDS spreads rising and stock prices falling the most. The new EU countries (mostly East European) have been hurt less than Britain's other trading partners (US, Australia and Canada) and the damage has been damped in emerging markets. At least for the moment, this is more a European crisis first than a global one.
5.  Many people have opined that financial sector companies are being hurt more than the rest of the market by Brexit and that smaller companies are feeling the pain even more than larger ones,what I have observedis that the evidence is not there for either proposition at the global level. At more localized levels, it is entirely possible that it does exist, especially in the UK, where the big banks (RBS, Barclays) have dropped by 30% or more and mid-cap stocks have done far worse than their  large-cap counterparts.
   

   Contradictory advices from 'experts'

    At one end of the spectrum, some experts are suggesting that Brexit could trigger a financial crisis similar to 2008, pulling the global economy into a recession, and that investors should therefore reduce or eliminate their equity exposures while they have the time. At the other end of the spectrum are those who feel that this is much ado about nothing, that the UK will renegotiate new terms to live with the EU and that investors should view the market drops as buying opportunities.
   
   Going the way experts have failed miserably in the past, I am skeptical to trust either side and decided to study the basics to understand how the value of stocks could be affected by the event and perhaps pass judgment on whether the pricing effect is understated or overstated. The value of stocks collectively can be written as a function of three key inputs:
   a) the cash flows from existing investment,
   b) the expected growth in earnings and cash flows, and
   c) the required return on stocks (composed of a risk free rate and a price for risk).
   

   Ending Note

   I see the effects as falling midway to the two extreme 'expert advice'. I think that doomsayers who see this as another Lehman moment have to provide more tangible evidence of systemic risks that come from Brexit. At least at the moment, while UK banks are being hard hit, there is little evidence of the capital crises and market breakdowns that characterized 2008.Like in India the markets have stablilized and the Brexit shock absorbed. It is true that Brexit may open the door to the unraveling of the EU, a bad sign given the size of that market but buffered by the fact that growth has been non-existent in the EU for much of the last six years.
   If the European experiment hits a wall, it will accelerate the shift towards Asia (look East) that is already occurring in the global economy.
   I also believe that those who believe that is just another tempest in a teapot are being too naive. The UK may be only the fifth largest economy in the world but it has a punch that exceeds its weight because London is one of the world's financial centers. I think that this crisis has potential to slow the 'new mediocre' global economy further. If that slowdown happens, the central banks of the world, which already have pushed interest rates to zero and below in many countries will run out of ammunition. Consequently, I see an extended period of political and economic confusion that will affect global growth and some banks, primarily in the UK and the US, will find their capital stretched by the crisis and their stock prices will react accordingly.

Handling the long period of weak economic growth in the world economy: limitations and solutions.

In my last blog post , I discussed the arrival of the "new mediocre" in the world economy. In this blogpost I am going to venture into some solutions and challenges, which stand in the way of managing the new mediocre.

Pre-empting the new mediocre is going to require a variety of measures: loose monetary policies, fiscal support, and structural reforms. Lets discuss them one by one.

 Monetary policies

Following the global economic crisis of 2007, the interest rates were cut in the U.S. and elsewhere. After interest rates came close to zero and their effect on aggregate demand declined, U.S resorted to quantitative easing(QE)  in 2008 and ECB in 2009. This meant the central banks buying long-term securities and it was intended to lower the long term interest rate.

Now, we have entered a brand new era, with central banks in EU and Japan moving towards negative interest rates. This means charging depositors to keep cash in banks and paying borrowers for taking loans.

But, since depositors have little incentive to deposit money so negative rates end up passed on to borrowers and not to depositors. This diminishes the profitability of banks. Moreover, negative interest rates may lead to a surge in productive investment but to asset bubbles and another financial crisis.

Fiscal support

Many of the economists now believe that monetary policy has run it's course and for couse correction we need fiscal support. This fiscal support has to be in the form of increased government spending on infrastructure or tax incentives to promote a higher minimum wage.Governments are, however, unwilling or unable to boost spending. Main causes for this may be the high cost of social security and debt obligations of U.S. Countries like Germany which might have some leeway for spending believe that there is only so much that it can do to help others in the Euro zone. Fears that minimum wages if raised will lead to inflation which can go out of control and the wages cannot be lowered once lowered. 

Structural reforms

It includes things like cutting unemployment benefits, making it easier to hire and fire, reducing barriers to entry, etc. But many of these measures are unpopular due to the electoral ramifications . Also, such measures yield benefits only over a long period.

Two viewpoints have emerged. One, that the growth potential of the world is limited. And, that we lack the instruments to step up the growth rate without creating serious risks. Therefore, in dealing with the new mediocre we don't have to aim for the sky. Just focus on minimising the vulnerabilities  in the economy, such as those in the financial sector or on the external account.

Arrival of the 'new mediocre' : Why global growth rates continue to be low.

Let me begin with some facts and figures-

1. The latest growth projections for the world economy as provided by IMF predict a 3.6 per cent growth rate.
2. The falling oil prices have failed to provide an impetus to the world economic growth.
3. As revenues have fallen, the oil companies have cut their expenditure and this has plummeted the global demand.
4. In many developing countries, like India, where oil is imported in huge amounts, the fall in prices has not been passed on to the customers.
5. The growth rate numbers from China and Japan are indicating a slowdown in the global economy.
6. Several central banks in the EU and Japan have moved to  negative interest rate policy  in order to boost demand.

This low rate of growth in the economies is being called the "new mediocre", a term  used by IMF Managing Director Christian Lagarde, is a cause of worry because of mainly two factors.

First, when the growth rates are low then the financial markets are bound to be unstable. Since most of the world markets are interlinked, so when one country's markets fail others feel the tremors. Also, the nervous investors have the proclivity to dump assets at even the mildest hint of trouble. This kind of money movement can wreck havoc for small and emerging economies.

Second, geopolitical risks have risen sharply in the recent years. The heightened tensions between Russia and U.S.; the humanitarian disaster and the influx of refugees into Europe; the possibility of BREXIT; the rise of protectionist tendencies in the U.S.; and the internal strife in several countries which can be a huge market, are some of the major geopolitical factors that are affecting business. And as someone rightly said,"when geopolitical risks rise, investors tend to retreat."

But, is there no way to recovery? How do we tackle this "new mediocre"? In my next blogpost I am going to explore the solutions to and roadblocks ahead of the global economy.

Union Budget 2016-17 : Left Of Centre

The union budget, this year, clearly brings to fore the left-of-centre turn for the government. The budgets main focus points were the rural economy, social sector, agricultural infrastructure. There was not much for corporate India in it.

Fiscal aspects

The fiscal deficit this year is pegged at 3.5% of the GDP. This is in line with the previous year's estimates. Such fiscal prudence has been achieved despite the increased burden of implementing the 7th pay commission recommendations along with the one rank one pension norm.

Social sector spending and agricultural sops

The major announcements were-

1. A new health insurance scheme with cover of 1 lakh rupees for families below the poverty line.
2. Total outlay for the infrastructure sector ha been pegged at Rs. 221246 crore.
3. Rs. 8500 crore have been provided for integrated power development schemes,with the target of 100% electrification for villages by May 1, 2018.
4. In a boost to rural development, the allocation has been increased to 87765 crore.
5. The allocation for MGNREGA has been increased.

 These steps are expected to provide a fillip to the rural demand and help grow the rural economy.

Defence

 The government on Monday allocated Rs. 249099 crore for the defence sector for the year 2016-17, which is 11 per cent more than the revised estimates of last year. The allocation does not include defence pensions as well as certain civil expenses of the defence ministry. 

Business and Taxation

1. The corporate tax has been reduced from 30 pe cent to 29 per cent.
2. A new amnesty scheme for tax defaulters aimed at domestic black money is in the offing.
3. Even though the direct tax slab for the salaried class has remained unchanged there is disappointment as the indirect taxes have been raised.
4. Service has been raised by 0.5% to 15%, which will translate to all the services getting costlier.
5. The government will come out with a comprehensive Bankruptcy code.
6. The 60% of EPF saving will be taxable.
7. Reforms in taxation, foreign direct investment, dispute resolution in PPP projects, and methods of dealing with the retrospective tax demands were promised
8. The airfares are likely to go up as the excise duty on airline fuel has been increased from 8% to 14%.
9. The government has shown faith in the PSU banks which are currently facing a huge NPA problem.
10. The banks will be recapitalised with a capital of Rs. 25000 crore this fiscal year and additional funds, if needed will be provided to overecome the stress of NPA.
11. Car prices will go up with the levy of infra cess and luxury taxes based on thecar model.

Final word 

One of the bizarre proposal of the budget was increase in the duty on tobacco but not on beedis. This is an attempt at sin tax on the rich even though both of these products are almost equally harmful. The direct revenue collection will incur a loss of Rs.1060 crore, while the indirect taxes will yield nearly Rs.20670 crore. It is axiomatic that indirect taxes are regressive and can be passed on to the common man as the ultimate consumer.

The small corporate houses have to pay only 29% as corporate tax. This benefit should also have been extended to non-corporate entities and individuals who have to give more than 30% plus surcharge on thair incomes exceeding Rs.10 lakh.

 I have always held that this annual extravaganza should be more focused on the fiscal aspects and the macroeconomic aspects of the economy. There should be enough room for the government to make necessary changes to these allocations as and when required.

Part 2- Special Economic Zones: Making Them More Effective

Government has launched the Make In India campaign to boost the domestic production. The success of this initiative depends largely on the basic infrastructure available to industries. The SEZs can play a pivotal role in the success of this program.

The Indian Export Problem

India’s exports have been declining for 13 months. To reverse the trend, the commerce ministry wants to exempt exporters in special economic zones (SEZs) from all corporate taxes, including the minimum alternative tax (MAT). This is a bad idea. It goes counter to finance minister Arun Jaitley’s welcome proposal to abolish most tax exemptions, and have a uniform low rate that does not arbitrarily favour this unit or that region.

Favouring SEZs leads to not just a big loss of tax revenue but to cronyism (several SEZ land allocations became scams), and waste (units will shift to SEZs despite big expense and loss of productivity, just to get the tax break). Many companies that would be exporting from traditional bases anyway will shift to SEZs for the tax break. SEZ exports may look big, but may not represent additional exports or policy success. They may simply represent policy failure through export diversion and revenue loss.

India has an export problem right now but not a balance of payments problem. So there’s no need for panic or emergency measures. The current account deficit is well under control at barely 1% of GDP, since imports have fallen along with exports. China’s slowdown has led to a global export slowdown. Almost all Asian countries are suffering from falling exports, and many have suffered steeper declines than India.

What is urgently needed

To be competitive, India needs both competitive facilities (in and outside SEZs) plus competitive tax rates with very few exemptions. India has a corporate tax rate of 30%, and with cess and surcharge this comes to 34.5%, one of the highest in Asia. Finance minister Jaitley rightly seeks to cut this to a competitive 25 %, while removing today’s myriad exemptions so that he does not lose tax revenue. This is a laudable, far-sighted reform. It should not have holes punched in it by demands for tax breaks from SEZs or other interest groups.

In dismal global conditions, tax breaks are irrelevant for export buoyancy. We must instead raise our competitiveness through better logistics, skills and procedures. Only then will exports boom sustainably. We cannot have lousy facilities and yet become world-class exporters through tax breaks. Ideally, the whole of India should have world-class facilities. Since resources are limited, a start can be made in SEZs.

Part 1- Special Economic Zones: Making Them More Effective

Special Economic Zones or SEZs are some geographical regions in which the economic laws are more lax when compared to a nation's domestic economic laws. These liberal laws are put in place to boost the business, increase FDI, increase domestic production and to have more job creation.

Historical perspective and the Chinese success story

Between 1965 and 2005, India built eight tiny export processing zones( a type of SEZ), with very limited success. By contrast, China succeeded in creating massive SEZs. These behemoths have world class power, water, ports and airports, and have become world-class manufacturing clusters. These SEZ were instrumental in making China a global manufacturing hub.

Indian Story

In 2006 we adopted a new SEZ policy. The main provisions of this policy were-

1. Tax exemption for units in SEZs for five years( not even MAT was to be collected),
2. The units were to get a 50% tax break for next five years,
3.  A further five year tax break for reinvested profits, and
4. SEZ developers would also get a tax holiday for 10 years.

Results of this policy change

Instead of creating massive SEZs, this policy encouraged hundreds of small SEZs in every state. These amounted to tax shelters and a grab for land rather than world-class enclaves. No less than 564 proposals for SEZs were approved, but of these only 204 are actually functioning. Most operating SEZs are small IT establishments that are little more than tax havens.

The 2006 Act provided that the minimum size for information technology, jewellery and biotech parks should be just 10 hectares, smaller than even some schools. Size limits were kept especially low for hilly areas, where flat land is scarce. This was a classic case of making SEZs an end in themselves rather than a means to improve competitiveness. China does not create tiny SEZs in the Gobi desert or Tibetan mountains: it creates large ones in areas with the best logistics, infrastructure, financial and transport facilities.

Exports from Indian SEZs rose from $5 billion in 2005-06 to $81 billion in 2013-14. This looks very impressive. But a lot of it is simply trade diversion. Many top IT and jewellery companies shifted their operations to SEZs for the tax break. Since units outside the SEZs continued exporting at a good rate, it is unclear whether the SEZs achieved additional exports or just diverted exports.

Because of such factors, MAT and the dividend distribution tax was imposed on SEZs in 2011-12. Industries protested that this discouraged additional investment. True, but would this fresh investment have been for export diversion or export addition? The operating profit margins of software companies often exceed 20%, so they hardly need tax breaks. Old export units in areas from textiles to engineering, many having very slim operating margins, get no tax breaks. Why should they be discriminated against?

How India lost rapport with Nepal...

On 28th October, we got two major news stories from Nepal. First, Bidhya Bhandari was elected as the first woman President of the country; second, Nepal inked its first fuel agreement with China thus ending decades long monopoly by India.

While the news of a woman leader being elected as the President of a country was news that brought cheers to many of us in India as we saw it as a sign of decreasing gender inequality in the Subcontinent, but the other one about the fuel deal with China surely upset many on both sides of the border.

India and Nepal had a historic bonhomie because of the similar cultural and social structures. India was in fact one of the first nations which helped Nepal with relief measures when the earthquake struck it.The relief work of Indian army and other volunteer groups was lauded by one and all, until of course the Indian media started harassing the victims with insensitive and completely apathetic questioning. Even after the media fiasco the work of other India agencies
was widely acclaimed.

The problem between the two nations started shortly after the Nepalese constitution was adopted by the elected constituent assembly of a sovereign country. Some groups in the southern part of Nepal along the Indo-Nepal border started protesting against the constitution on the pretext that the Madhesi people and their interests have not been properly dealt with. The Indian government in an unprecedented move decided to formally pressurise Nepal to not accept the constitution. This was perhaps the first time that Indian government formally tried to interfere in the internal matters of Nepal which is a sovereign country.

This formal acknowledgement of the grievances of the Madhesi people gave a fillip to their movement and within days the protests became violent. The major roads that were used for transportation of fuel from India to various destinations in Nepal passed through the region marred by protest and violence. Many transporters refused to enter landlocked Nepal due to security concerns. The Nepal government tried to allay their fears by stating that it will guarantee the safety of the trucks entering from India. But even after such Guarantee of safety the trade did not resume.

All this led to acute fuel shortage in Nepal which was further worsened by the festive season and the chilling cold season which was just beginning. With scores of trucks lining  up on the border and refusing to enter Nepal the situation kept on deteriorating with fuel rationing across the Himalayan nation. The Nepalese people felt that India was using its fuel monopoly to force Nepal's hand.They are accusing India of perfidy.

China, at this point, tried to quell the fuel dearth by agreeing to donate 1.3 million litres of petrol to Nepal. Nepal which was irked by the hegemonic attitude of India thus decided to sign its first fuel agreement with China. China National Oil Corporation signed the MoU with Nepal government, ending a decades-long monopoly by India.

The relations between New Delhi and Kathmandu have reached an all time low following the recent events. The facade that is left of the good relations is also eroding quickly. It is the need of the hour for both the countries to iron out their differences as sour Indo-Nepal relations are in the interests of none. The business on the Indian side and the common people across the border are both on the losing side if this ebb in relations is not addressed with utter urgency and sincerity.

  

The Chinese Slump.

The People's Republic of China, the world's second biggest economy is facing a major crisis today. With over 30% of the value being knocked off the Chinese market since the slump began in mid-June.

The crisis comes after the rallying of the Chinese markets as the:

1)county's central bank cut interest rates 3 times since November last year,

2)the rules regarding Margin trading were eased.

Margin trading has always been considered risky, but with the loosening of the reins, trading in stocks on borrowed money by mostly the retail investors of china increased.

 Unlike most other stock markets, where investors are mostly institutional investors, in China, 80% of investors are small retail investors.All the above factors led to volatility in the markets.with Greece in the backdrop,the volatility in China is of great concern owing to the huge size of the china's economy.

The concerns are justified as in the last three weeks about $3 trillion ,which is more than 10 times the GDP of Greece($237 billion in 2014) or 1.5 times the GDP of India($2 trillion) has been wiped out from the chinese markets.

With the shanghai composite losing about 34% in 3 weeks and the number of chinese firms who want to halt their trading in the Shanghai and the Shenzhen Exchange reaching to above 1200 out of the total 2800 enlisted firms, some are describing it as the busting of the chinese bubble.
 
Effect of the Chinese slump on the world economy:

1. Metal prices plunged with the crash in the Chinese markets and the strengthening of the US dollar.
2. Asian markets as well as the US markets have also shown a slowdown.
3. Commodities like gold, silver and platinum fell as a stronger US currency makes dollar dominate        commodities more expensive for holders of other currencies.
4. Crude oil prices along with coal, natural gas and iron ore price are trending lower.
5. Aviation sector shares benefited with the fall in crude oil prices as it accounts for 50% of their operating cost.

With the Eurozone members giving Athens until the end of this week to propose reform measures in order to secure the funding it needs to stay in the euro zone, and the market crash in China threatening a new blow to the country's already slowing economy, all we can do right now is observe and take notes.