Punting on Pranab

BUDGET MUSINGS

2012

The first question regarding the Budget is whether the FM has decided to deal with the reality of his fiscal situation, or will project revenues based on a much higher growth rate than is likely. Ajay Shah’s tracking site,  http://www.mayin.org/cycle.in/tracking.html, correctly predicted the last number of 6.1%; it is now showing a GDP growth number of below 5%. There is no question of the FM registering this.

The lowest GDP growth number he is likely to bake in to his budget predictions is 7.5%; this will lead him to grossly over-estimate tax revenues; nevertheless, it will call on additional resource mobilisation, now that higher expenditure has been legislated via food, fertiliser, and NREGA spends; not to mention the refusal to hike diesel and kerosene prices.

So how will he mobilise these resources?

Firstly, I think he will raise the MAT (Minimum Alternative Tax), for which there is no longer any justification.

Second, I would believe he will add back some excise, in a (partial) reversal of the 2008 stimulus measures.

The coverage of service tax will pretty much certainly go up.

In addition, I am thinking he will come up with one or more of the following, or their variants:

-         - Some form of Voluntary Disclosure Scheme, to bring back money from abroad

-          - Some removal of exemption on long-term capital gains on equity investments

-         -  Enhancement of wealth tax/a new ‘Upper-Upper’ slab for Income tax on those with income above some level like 25 or 30 lakhs per annum. 

Gold and central banks

Robert Zoellick, Jr., outgoing World Bank chief,
" I've noticed that the price of gold has started to reflect some lack of confidence n national policies and central bankers."

That's very perspicacious of Mr. Zoellick. In terms of the path ahead,
"I do not mean to suggest a gold standard - in reality, I'm talking about flexible exchange rates. Therefore, I believe that gold should be used as an indicator, and information tool. It shouldn't be considered a formal anchor, but as a way of being a check on the checkers."


In the current situation, the degree of looseness of central banks is very relative, so the movement in exchange rates not very helpful. In this context, the moment you concede that gold should be used as an indicator, you are underlining how low the signalling value of the other currencies is.

At the 29th Annual Monetary Conference, held in Washington D.C. on November 16, 2011, Zoellick went on to say, " scholars have long pointed to the problems with the gold standard during the Great Depression. But sometimes, they then overreact against the idea that gold could ever play a role...sometimes scholars become captive to their own past analysis. They get so wedded to the beauty of their ideas that they ignore markets. I believe that is a mistake."


Here Zoellick is absolutely right, and I wish to expand on the issue of the gold standard. If one accepts that no monetary system is perfect, then the fact that the gold standard created problems in the past is a statement with little information content. The relevant questions are:
- whether the current fiat currency system works well
- whether a gold standard, which puts a brake on monetary expansion, better protects the interests of the economy at large - investors, households, and businesses, rather than just borrowers.

Steve Jobs, honesty, and high political office

The FBI file on Steve Jobs echoes the now wide perception of the Steve Jobs "distortion field", his ability to manipulate people and facts. I found one interviewee's remarks quite piquant, not just for what they say about Mr. Jobs, but also about high political office (highlighted)

The interviewee, whose name has been withheld from public record, worked with Steve Jobs, and :

-         -  Characterised Mr. Jobs as a deceptive individual, who is not completely forthright and honest.  He stated that Mr. Jobs will twist the truth and distort reality in order to achieve his goals.

-        -  Concluded the interview by stating that, even though he does not consider Mr. Jobs to be a friend, he (Mr. Jobs) has the qualities to assume a high level political position.

-         - It was (his) opinion that honesty and integrity are not required qualities to hold such a position. (He) recommended him (Mr. Jobs) for a position of trust and confidence with the government.

Reading Frau Merkel's lips

Wolfgang Munchau writes in the FT on 20the Feb that Mrs. Merkel is doing everything possible to force Greece's exit from the EU. Assisted suicide, he calls it:
http://www.ft.com/intl/cms/s/0/16f04ffa-5963-11e1-9153-00144feabdc0.html#axzz1moAdPAft.

And this is what I wrote on Feb 3rd, 17 days ago:

17 summits in the last 3 years. No, that’s not the track record of a mountaineer, but the number of meetings EU leaders have held in the effort to save the Euro.

Through the serial summits, German Chancellor, Angela Merkel, has made it clear that German purse-strings are going to be opened very cautiously; this is dictated by fiscal prudence, by the strictures of the German constitutional court, and above all by domestic German politics. In a situation where three-quarters of German voters do not want their government to aid Southern Europe, Chancellor Merkel would be irresponsible to go against the will of her people.

Economic commentators have been saying that the costs of saving the Euro go up with every week of delay, echoing Shakespeare’s Macbeth, “If it were done, ‘tis best it were done quickly”. I am sure Merkel has enough advisers for her to put pretty precise estimates on the cost of this delay. My sense, then, is that she has no intention to save the Euro by expanding her government’s guarantees for the debts of other nations.

The surest signal, to my mind, of her intention came from her recent demand that the Greek government hand over its budgetary process to German supervision. As a politician herself, Merkel would have known that no government can be seen to accept such a submission of its sovereignty, and certainly not one like Greece, where the political temperature is already high. I believe this was her way of telling Greece, “I want you to leave the Eurozone, but you won’t hear me saying it.” To ensure this, she made Greece a proposal that was politically unacceptable.

Under this scenario, Merkel is making a Greek debt default a virtual certainty; my sense is she is using this time to shore up German banks against the impact of such a collapse.  Of course, there will be many unpredictable outcomes of such a development, and she cannot guard against all of them. However, given the depth of the European debt crisis, there does not seem to be a good solution. Merkel has to choose what she thinks is the least bad solution.

If she does allow a Greek default, risk will switch off like a 1970s Delhi black-out. 

The cost of law and order

Huge swathes of our country are ungoverned. Or, to be accurate, let's say that the definition of governance standards is set so low that criminal activities are not seen as being remarkable. The fact that such norms do not disturb us should be a reason to be disturbed!

Business friends of mine recently established a factory in Mayawati's newly colonised Greater Noida. As the plant neared completion, the local village 'leaders' offered factory management their services for transport of finished goods from the plant. A couple of weeks later, they returned to remind the plant manager; he said he would talk to Head Office. The would-be transporter left behind his rate-card. Turned out that the transport charges on offer were 40% higher than prevailing rates.

Discussing this with me, the CEO felt that plant management should find a way to work with local people, and believed the transporters would come around to rates which were on par with the market. This was clearly not the intention - within a couple of days, they had parked some 70 trucks around the factory, and sent word that this was a gentle reminder of the services on offer.

Plant management inter-acted with other manufacturing facilities in the area, and were told that prices were not negotiable, and that the attempt was to create a monopoly on out-bound trucking; the only exit route that would work was to say that the plant had decided to deploy its own trucks.

This is what was done; my friends bought a fleet of trucks, and used them to ship finished goods to a sister plant in Ghaziabad, about 50 km. away. A reliable network of transporters trans-ship the goods onto onward vehicles. The cost of this exercise? Rs. 15 lakhs per month.

One medium-sized factory that won't show up as a blip on any industrial statistics for India. One bunch of local operators, whom many Indians wouldn't even classify as thugs. Jack the numbers up by several orders of magnitude to get a sense of the scale of moral depravity in our country. And then try to get a sense of the waste generated because our leaders are not concerned with law, order, and justice, but with power, lobbies and re-election.

The Price of Uncertainty

“People with MBAs”, it used to be said, “know the price of everything, but the value of nothing.”

As an investor, price is the starting point of any decision. Value (though of a different kind from the moral content of the MBA put-down), too is critical: it is when you find a gap between current prices and the fair value of an asset that you make an investment decision. When you have a major disturbance in financial markets, huge price adjustments are required for a new equilibrium to be reached. Unfortunately, these price adjustments throw up many losers, and can lead to massive after-shocks. In order to contain the damage, governments around the world moved rapidly in 2008 to buffer asset prices. There was a certain pragmatic value to this buffering; at the same time, it is delaying recovery.

By their actions following 2008, governments have populated the financial world with fake prices. In our own economy, we don’t know where buyers and sellers would set bond-yields, as the RBI has bought a record volume of bonds from the market, artificially inflating bond prices, and depressing their yields. We don’t know how the market is pricing the rupee vs. the dollar, as the RBI has been selling dollars. We don’t know how demand and supply would price diesel, because the government sets the price. And we don’t have an accurate picture of bank balance sheets, because of the shifting guidelines with regard to Non- Performing Assets.

Last week, Ben Bernanke, Chair of the the US Federal Reserve trumped Indian financial managers, by fixing the world’s single most important price for the next 3 years, namely the interest rate at which his institution will make funds available to US banks. In effect, Ben Bernanke is banker to the world’s banks. He has now committed to a Zero Rate Interest Rate Policy (ZIRP), for the next 3 years, effectively saying that he will flood the world with cash through the end of 2014.

The immediate impact of the extended ZIRP was on gold prices, which soared almost 5% in the wake of his policy statement. That apart, it makes me wonder about the nature of what I would call a ‘Fake Certainty.’ Imagine a scenario in which inflation re-entered the US economy. Since the Fed is committed to holding the annual rate of US price increases to around 2%, higher price rises would force the bank’s hand into lowering interest rates. In that case, the Certainty of ZIRP would have to be abandoned, and I would be justified in calling it fake.

Could this happen? I think so. Consider the following scenario in Europe: the peripheral countries, like Greece and Portugal, realise that their austerity program is not working, and that a German-led Europe is not going to extend them unlimited financial aid; as a result, they take the time-honoured path of deeply indebted nations, which is to devalue their currency. In this case, this means exiting the Euro. If this were to happen (quite apart from the losses to banks, etc.), a Euro without the peripheral nations would suddenly be a very attractive currency, and would get bid up hugely. Commodity prices would rise, and the dollar would come under attack. This would make it very difficult for producers to hold prices in the US, and for the government to borrow funds at its current all-time lows. The certainty the Fed is trying to inject into the system would be out the window. Banks would be hurt, bond-holders would get hurt, and the US government's own deficit would swell.

The underlying point here is that the more artificial price fixes you have in a system, the more prone it is to a brittle collapse. Market players know this, which is why, for example, trading volumes on the New York Stock Exchange are lower than they have been in over a decade.

The present cheery recovery is built on this assembly of rigged prices, fake certainty and poor conviction. Reminds me of Bob Dylan – “something is happening, but you don’t know what it is…”

Didi and the Hausfrau

Mamata Banerjee, Chief Minister of West Bengal, seems to have put paid to our government's plans to allow foreign direct investment (FDI) in the retail business. The Finance Minister, Pranab Mukherjee, has been evasive in replying to media questions about his government's intentions, but it doesn't appear that the UPA  has the mojo to take on both its partners as well as the opposition.

I saw the FDI announcement as untimely, given the fact that a dysfunctional, unruly parliament was in session. Under the circumstances, it could only be seen as a last-ditch effort to inject some positivity into the rupee, especially given that the RBI had pronounced it would not attempt to shore up our currency. Now that the FDI prop has gone, the RBI has stepped out and said it will defend the rupee. This may not work, especially with crude oil prices seeming more and more firm every day.

In Europe, Angela Merkel has the Eurocrat-socialist consensus in her thrall. The overspending, overpaid mob want to pile all the failures of bloated European government debt onto her plate, and get her to sign blank cheques and bank guarantees to pay for their sins. In response, Merkel's saying, "I'll pay the piper, if I can call the tune". This is not what they want - they want her to pay the piper now, and then 'help' her write the tune later. It's not going to happen - she has a parliament to run, and an electorate to respond to, and they have made their sentiments well known - no supporting lazy Southerners.

Whatever comes out of the European summit this week, its not going to be a Big Bazooka rescue for Europe.  World markets, which were riding on this hope, are going to be sorely disappointed.

But well before that, in the next couple of hours, we are going to see a sell-off in the rupee. The RBI may try to jump into the fray, but that would be ill-advised.