Paranormal Activity - How Para 102 is a hidden gem in Jaitley's budget

Majority of people missed a very important piece of announcement on the budget day. Even I did not think about it till I decided to read the full budget transcript this Friday evening – yeah, that’s how I spend my Friday nights.

I found a hidden gem in the orgy of information and announcement in the para 102 – just where the discussion about MSME sector starts. Here is the snapshot:

And now why this para is important. Before I start torturing my keyboard, here is a snapshot from India Market Strategy Report from Credit Suisse published in July 2013 – exactly a year ago.

The report cites and analyses National Statistics Commission data and reckon that Half of India’s GDP and a whopping 90% of its employment is generated in informal sector. The report also mentions that “Unlike in the developed economies where informality is purely a deliberate choice to avoid taxation or regulations, in India it is more structural: a reflection of the lack of development and limited government reach.”

This does not mean that GDP of India is underestimated by 50%. Nah. GDP of any country is anyway an estimated number – but this estimate is particularly doubtful and is bound to get revised, hopefully upwards, if 50% is outside the reach of government surveyors. Government conducts surveys, updates its methodologies and its GDP calculation series every few years. Last time it was done GDP calculation jumped by 0.6% annualized for all years in the series. See the chart below.

This data has implications for taxpayers also. It is a well-known fact that India is one of the most taxed countries in the world. And it is by definition, informal sector is outside the purview of tax authorities. So the formal part of the economy gets taxed heavily.

What Arun Jaitley has tried to do in his maiden budget is sort of recognize the contribution made by the informal sector – Own account enterprises and decided to set up a committee to study ways to reach, cover, finance and then maybe tax them.

When countries around the globe are busy finding ways to generate income from erstwhile illegal activities – for example, sale of marijuana in some US states (read here, here and here), India already has all the money on the table but not in the record books.

If India is able to make some significant progress in this area, not only India will have higher reported GDP, better employment records but also better insurance and banking penetrations, more people under social security net and in the meanwhile tax net will increase and will bring more equity to the taxpayers around the country.

Wonder, where is the debate over this?

How to Change a Habit

Hat tip: The Big Picture
Click on the image to enlarge

Weekly Market Commentary - July 07, 2014 - July 11, 2014

The most anticipated week since the general elections have concluded this Friday with Sensex experiencing a wild swing of more than 1200 points. Markets easily reached the all-time high status on Monday rising on hopes of “game-changing” budget, and ended the week in red after sky high hopes met the ground. To be fair, investors were expecting too much too soon. I will argue that FM did a good job of trying to prepare a solid fiscal ground for future growth. I bet that lot of subsidies would have got the axe if not for the fear of high inflation and weak monsoons. I will still give FM a modest 7/10. You can read my budget analysis here.

Sensex ended this week down by 3.6% while Nifty was down by 3.8% and Midcap down by 8.1%

Monday - Sensex up by 0.5%, Nifty up by 0.5%, Midcap up by 0.2%
Markets continued to roll on the expectations of better earnings expectations from Infosys and hopes of a fiscally prudent budget from Narendra Modi govt. FIIs have bought more than $10.5bn worth of equities so far this year.

Tuesday - Sensex down by 2.0%, Nifty down by 2.1%, Midcap down by 4.3%
Investors’ hopes were dashed as railway budget presented by govt. was devoid of any radical plan to turnaround railways. The budget also lacked specifics about much touted PPP route to raise funding for projects and was short of fresh ideas.

Wednesday - Sensex down by 0.5%, Nifty down by 0.5%, Midcap down by 1.6%
Markets continue to fall after railway budget turned out to be a bummer. Economy survey also highlighted the need for tough measures to shore up public finances and reduce inflation, raising expectations of a prudent and a non-populist budget.

Thursday - Sensex down by 0.3%, Nifty down by 0.2%, Midcap up by 0.6%
Budget day saw wild swings in the Sensex and Nifty levels. Investors were struggling to get a handle over the slew of measures announced by newly appointed FM. While the budget speech nailed the fiscal consolidation part, it lacked any growth stimulating measures, which spooked the markets, which ended the eventful day in red.

Friday - Sensex down by 1.4%, Nifty down by 1.4%, Midcap down by 3.2%
Markets continued to fall as investors booked profits amidst the disappointment over what few analysts call a “mile wide and inch deep” budget. With budget now out of the way, investors have trained their guns on global markets, earnings season and monsoon.

Budget 2014 - Economy before Markets

Arun Jaitley presented his maiden budget on Thursday. The expectations from the budget were running high since the Modi govt got elected to power with clear majority. Narendra Modi's election campaign was rife with promises of reforms, employment and better days ahead. This budget, along with the railway budget presented on Tuesday were closely watched as they signaled the real intentions of new govt in power. It was not just investor's but the general public's way of finding out whether Modi govt can walk the talk.

Arun Jaitley, in a limited time and little maneuvering room available to him did a good job. He presented a budget which clearly indicated that India meant business. He, through his policy announcements tried to build a strong foundation for pro-growth path ahead. He did not fell in the trap of announcing reform measures to make stock market investors happy. Rather, he kept the focus on the audacious task of bringing economy house in order now, so that the benefits of growth can be reaped by all later.

But this budget was also not without few misses and disappointments. Many investors expected some announcement of doing away with controversial tax laws which FM has deliberately chose not to address. He explained his reasoning here in this interview. He also did not mention any policy to strengthen the recovery mechanism for banks.

Most investors were keen to find out how FM will create a balance between fiscal consolidation and kickstart the growth cycle. FM bravely accepted the challenge of capping the fiscal deficit target at ambitious 4.1% set by his predecessor. The fact that markets would not have blamed him or his govt on seeing a higher target number clearly sets out the intentions of the new govt. How much success will he meet only time will tell. For now, we can see and check the math behind the numbers and see for ourselves how much of these targets are achievable.

To meet the fiscal deficits target, FM seems to rely heavily on aggressive tax collections targets and divestment proceeds. The tax revenue is assumed to grow by 19.8% over actual FY14 figures with nominal GDP growth estimate of 13.4%. This tax revenue target is difficult to achieve, if not entirely impossible. The implicit assumption of tax elasticity of 1.5 in the tax revenue target is more reasonable during boom times, not when economy is trying to get out of pits.

Also, a third of tax revenues is corporate taxes which depend on their profitability, something which is beyond govt control. It will be unfortunate if govt resort to tax terrorism like its predecessor. In the event of not meeting their targets, they may have to hike their divestment targets.

Speaking of divestment targets, govt is hoping to net Rs. 63,425 crores in proceeds. Private companies have raised Rs. 12,000 crores via QIPs (which were heavily oversubscribed) in last few months. With India receiving $20bn annual FII inflows, the divestment target does not look unreasonable. Most analysts/economists expects govt to put its stake in Coal India and ONGC on block for retail investors soon. This will not only help achieve divestment targets, they will also help govt to adhere to SEBI prescribed promotor stake limit.

All in all, I think govt is on right track prioritizing fiscal consolidation over pro-growth measures. It would have been easy for govt to get carried away as country struggles with low growth rates, high inflation and threats of weak monsoons and drought situations. Instead, FM focused on getting the house in order, tightening the belts while trying not to hurt the wallet of general public and preparing the ground for better days ahead.