Yahoo

The Drachma Drama

2 comments Written on May 21st, 2012 by
Categories: Greece, Yahoo

I write at Yahoo: The Drachma Drama

Two years ago, there was a crisis in Greece, when it couldn't pay back debt that it had taken. The government's debt was 120% of GDP then. The country simply couldn't afford to pay back its loans, and the impact would have been felt all over Europe, where banks and funds had lent to Greek institutions and to the Greek government. Greece wasn't the only one in trouble — Portugal, Ireland, Italy and Spain were also in the now-infamous acronym for countries in trouble, PIIGS.

The initial reaction to the problems in Greece was to give them more money to help them pay back what they owed. A 120 billion Euro package first materialized on the promise, by the Greeks, that they'd try to earn more money from taxes and spend less. The problem? More than 50% of the Greek economy was from government spending, and reducing that meant that lots of Greek people would earn lesser and thus pay lesser taxes. The "black" or unaccounted economy in Greece remains very large, with people preferring to not declare income so they won't have to pay taxes.

Given these dynamics, the new "austerity" measures had two major consequences: They ticked off the Greek people, who wondered why they couldn't default on the debt instead. More importantly, the measures didn't help reduce the deficit at all. Austerity meant lower spending, even where it was required, and then, lower investment. A falling deficit as a percentage of an GDP that falls faster does no good. With GDP continuing to fall, and social unrest almost constant over the years, Greek unemployment soared, rising to as much as 54% in Feb 2012.

In the interim, understanding that regardless of a rescue package, Greek would be unable to pay, the European powers decided to ask the lenders to Greece - essentially, owners of Greek bonds — to see if they could take a "haircut". They would only be paid a fraction of the value of the bonds they owned, on the condition that they use the money to buy longer term Greek debt. The haircut would involve losses to the lenders, but at least they would get something instead of the near-nothing they would if Greece actually defaulted and refused to pay anything.

Lenders agreed, under stress. Yet, the crisis didn't go away. The conditions for the haircut were that Greece take on even more austerity measures, which to the Greek people was like hitting a man when he's down. The insistence by Germany that money should not be printed by the European Central Bank (ECB) to save Greece stemmed from their fear of hyperinflation which they saw in the 1920s. But only money printing would rescue the troubled Euro governments — print more Euros, use it to buy government debt, and hope that the governments will fix themselves by imposing austerity rules that don't allow them to do much. In fact Germany even attempted to send tax collectors to ensure proper tax reporting in Greece, only to find that the Greeks that weren't willing to pay tax to Greeks were definitely not inclined to oblige a German.

The loss of sovereignty, the lack of jobs and the tense political situation has resulted in a majority of Greeks supporting parties that were more radical in thought. The left-wing Syriza won over 17% of the vote while pro-austerity parties saw their vote-share reduce from 85% to 34%. With Syriza not willing to make a deal with any party that supported austerity, no majority could be found and Greece will go to elections again. With the economy still in shambles (Greek GDP fell 6% in the first quarter of 2012) voters are very likely to vote socialist again, and give the anti-austerity parties a majority. What happens then?

With no austerity, Greece will not get the European payments that it needs in order to pay back the debt it owes. It will then have to default on that debt, or some of it. The popular impression is that this will result in it's expulsion from the Eurozone, which means the Greek Central Bank will be back in action printing the drachma as a national currency. Greeks who own Euros in Greek banks will be forced to take back the new drachmas in a pre-fixed conversion ratio (I believe it could be 1:1).

As the drachma comes into play the Greek central bank will need to keep printing the drachma to pay for government spending, which will be a result of "no-more-austerity". The excess printing will, in time, cause inflation and the exchange rate to drop dramatically. And if they default on international debt, chances are that Greece will be shunned by the international community for a while, which means supply shortages of food, oil and other commodities (that Greece imports).

The greater concern for those on the outside is that lenders to Greece will suddenly become insolvent, with their meagre capital wiped out due to the extremely high leverage of nearly 20:1 they seem to have. To recapitalize the banks, the individual governments will need more cash, and when Greek debt goes to zero, the other Eurozone countries start seeing a shakedown as well. Even now, Spanish and Italian debt yields have gone up (that means they have to pay higher rates) and Portugal's yields are soaring.

Austerity at one end, inflation and shortages at the other. Greece has to make its choice but it seems that the people have decided. Austerity, in the current form, can't work. Even if they have to deal with the eventual turmoil, they might stand a better chance by going out of the Euro and defaulting, even partially, on the debt they owe. Other countries balk at having to hurt because Greece does, but short of a war they have little choice. Democracy is, at the extreme, Demo-crazy, the rule of madmen.

Yet the fault cannot lie with Greece alone. It had to leave the Euro anyhow; austerity of that extreme could never have worked, just like crippling a man doesn't make him earn any more than he did. But in a world where everyone is crippled, chances increase.

Posted in Greece, Yahoo

Of Losses and Low Prices

4 comments Written on May 7th, 2012 by
Categories: Yahoo

From my column at Yahoo:

Is "cheap" good, when you're making losses? In general, people like cheap. As in "inexpensive", not "shoddy". Prices can get lower for many reasons. Competition can force price cuts — either you compete or customers leave you. You can get greater productivity — producing more at the same price means you can charge lesser. You can lock in the price of your raw materials and retain customer prices at the same level.

Let's look at a few industries where, over a long period, prices haven't changed or have actually come down.

The most obvious is electronics. About 15 years ago, I paid Rs. 65,000 for a mid-level computer, and I'd probably pay about Rs. 25,000 today. Prices of chips fall, even as they add more computing power. Even as prices have dropped, profits of semiconductor companies have stayed high; volumes and efficiencies more than made up for increase in raw material costs or labour.

The car market has also managed to maintain prices, for the most part. A Hyundai Accent (one of the cheapest sedans in India) cost about Rs. 520,000 in 2005, and continues to cost around that much today. (Delhi prices) Again, carmakers aren't entirely miserable; Maruti has dramatically increased profits through greater volume.

While food costs have increased, the cost of staying in a hotel in a holiday location has largely remained the same. City room prices have gone up but that's largely due to business travel. Still, hotels have managed to retain margins for the most part. Some of the impact here is competition, but it's also that volumes have gone up and costs are spread across more customers and room-nights.

But this hasn't applied to a few industries which seem to be in the limelight today. Airlines have been losing money, even though their prices continue to be ridiculously low. Not that I'm complaining, having recently paid the same amount for a family of four (one infant) as I did for just one ticket 10 years ago. Airlines have almost no productivity benefits to provide — the aircraft manufacturers have so much demand they won't cut prices, labour costs more where good staff is in demand, and fuel costs are market determined and taxed to the moon and back. Regulators, too, step into every piece of the pricing process — recently, the airline regulator barred airlines for charging for pre-assigned seating, for instance. Even if there are more flyers than ever, airlines are simply not turning a profit. The massive capital required to buy planes, or the high operational costs (parking costs, landing fees, rent etc.) are either impossible to reduce or too difficult to influence. In addition, you have the taxpayer bailed-out Air India that seems to be able to make endless losses and still continue to get aided by the taxes collected of our sweat and hard work. If they charge less, everyone must follow.

Telecom companies must pay government mandated (or auctioned) fees for spectrum and for licenses, and yet, their average revenues per user have been going down. Some carriers show user revenues as low as Rs. 100 per user per month. These customers simply don't exist at higher price points — raise prices, and you'll find people start migrating away or using landlines instead. The high costs of supporting voice is expected to be made up through the more high-end data charges, but the 3G auctions have driven up the price of data packages so much that they're unaffordable except for the urban rich. With infrastructure costs mounting, from tower rents to equipment, and employee salaries rising, there's very little room for cost cutting, other than large layoffs and silent retrenchment that the industry has been seeing in the last year.

Oil-marketing companies that have been giving us substantially cheaper fuel than the market should otherwise allow. Oil companies are losing Rs. 512 cr. per day on the under-recovery of costs in diesel, LPG and Kerosene. Fuel is not cheap — in Bangalore, we pay over Rs. 73 per litre of petrol (which is equivalent to $5.3 a gallon), a large portion of which are state and central taxes. But oil companies still make losses because the real cost to us, the consumers, needs to be higher; and in 2011-12, they have lost over 138,000 cr. (Rs. 1.38 trillion).

In other industries such as online retailing or "deals", players attempt to gain market share by selling at a loss. A restaurant might attempt to give away meal coupons at a loss in the hope that patrons will continue to visit it even when there's no coupon. But if it turns out that most "new" customers wouldn't have paid the higher non-coupon rate anyway, the strategy fails. Other companies lose money on one product to make profits in another; shaving razors are sold at a loss that overpriced blades will more than make up for, printers are made cheap so you'll buy the expensive ink replacements, and newspapers are sold cheap so that you can see all those advertisements instead.

During the dot-com boom, losses were considered par for the course, and companies were valued using other metrics like eyeballs, page views or meters of cable laid. It got so bad that if you actually made profits people wondered if you weren't trying hard enough. That situation had an unhappy ending, but it was because of those investments (and losses) that the world got cheap fiber, as the current companies bought it for fire-sale prices when the loss makers went bankrupt.

The losses in airlines, telecom and oil will see different endings, not all of them happy for the survivors. My take: Oil prices will have to go up in order to curb demand, since you have nothing great in terms of alternatives or technological progress in the field. The existing telecom setup will change as some of the current companies die and sell their infrastructure cheap to new players, who will then be profitable at the same price points. Airlines will make losses till kingdom come, because it's that glamorous industry where no one ever seems to make money on a sustained basis anywhere in the world. The old joke goes:

"How do you become a millionaire?"

"Begin as a billionaire and buy an airline".

Posted in Yahoo

Why We Shouldn’t Ban Algorithmic Trading

No Comments » Written on May 5th, 2012 by
Categories: Yahoo

I write on Yahoo: Why We Shouldn't Ban Algorithmic Trading

On Friday, 20th April 2012, two mysterious events occurred on the National Stock Exchange (NSE). In the morning, Infosys futures crashed over 20% and quickly recovered back to the original level. In the afternoon, just before 2:30pm, Nifty futures crashed 6.7% from the 5,350 level back down to 5,000, and then nearly instantly recovered back to 5200. Both crashes were blamed on algorithmic trading.

Program trading has been blamed for "flash crashes" for nearly 25 years. In October 1987, US markets took a nose dive on a single day and for years, the blame game went on with the primary suspect being program trades. This is understandable. Since a computer can trade with much faster speed than a human, it can set off a spiralling price change by continuously buying or selling with no real control. Why then, should we even allow algorithmic trading?

Program trading can provide for great trading opportunities with less human error. Much of the arbitrage that used to happen in Indian markets was manual. To bridge any potential difference in prices between the NSE and BSE (the two largest stock exchanges in India), arbitrageurs would use two computers, manually entering a buy order on one and a sell order on another. The speed of the operator was his biggest skill, so the dealing room would resound with a cacophony of keyboards when an opportunity arose. The problem? A human can only look at so many opportunities, so many price differences remain. A slight error on that keyboard (F2 instead of F1) can result in a large loss. The operators cost money in terms of computers, real estate and benefits. You could eliminate much of these by using a computer to do exactly the same thing.

Program trading can curtail broker front-running and impact costs. Often, when a fund would have to take large positions, their brokers would put their own buy orders earlier, so that the large purchase from the fund would give them a great profit. In India, much of the volume is made up of the top 100 stocks. After that, stocks trade less than 20 cr. a day. For a mutual fund to buy about 25 cr. ($5 million) in a lesser known stock, its size will immediately drive up the price and a broker is quite likely to front-run their purchase. Using an algorithm instead will allow the purchaser to spread their purchase over several days and several brokers, hunting for volume slowly over time.

Algorithms can also provide liquidity where there isn't otherwise any. For you to purchase a stock, there needs to be a seller in place. Many stocks don't have the kind of interest from either investors or traders. Of the near-1,500 stocks traded on the NSE, more than 1,000 trade less than 50 lakh (Rs. 5 million) a day. The spread between the buy and sell prices on the exchange may be too wide; a typical market maker provides the liquidity that allows you to buy or sell at a reasonable cost. Market making operations used to be manual earlier; they are now run through algorithms.

Finally, large orders (greater than a few crores in value) are usually blocked by stock exchanges, assuming there has been a fat finger trade or a mistaken entry. Yet, large deals must take place when they must — if an investor decides to exit a large holding in a stock, they might use an algorithm to send in orders in allowable chunks.

Algorithmic trading, however, comes with its own set of problems. A rogue program can place orders continuously and take the entire system down. During Mahurat Trading in October 2011, such a program created a ruckus in the BSE, so much that the exchange canceled all trades made on that day to avoid a payment crisis. (Which in my opinion was also wrong — we should make the algorithm owner suffer the loss)

Even if an algorithm splits large orders into parts that stock exchanges let through, the input itself may be faulty (an extra zero for instance) which means the algorithm does exactly what the order limit was designed to restrict: the fat finger trade. This, they say, is what happened with the Infosys order last Friday.

With such large orders, stop-losses can get triggered, creating another spiral. Some traders place a protective stop (in simple terms: "Sell-If-The-Price-Falls-To-X") way below market prices; such stops get taken out when such large orders come by and those investors that sell feel disappointed when the market rebounds immediately. But that will happen even with large "manual" orders; algo trading is only a convenient scapegoat.

That steep falls are only engineered by automated trading is also suspect. The market has "circuit" limits which shut down trading when the index moves over 10%. After the 2009 elections, when markets moved up 10% in a short while, algorithmic trading wasn't blamed; neither was it when markets crashed 10% in October 2009. The feeling was that the moves were "justified" since there was news behind it (The election results and a Lehman bankruptcy impact respectively). Since there was no "reason" on Friday, computers must have been to blame.

This is just witch-hunting. Computers do exactly as they have been programmed to do, and there will be large errors if they aren't monitored properly (as manual traders must be). The regulators and the exchange must investigate each such case, and indeed, it has turned out it was more the human input that caused the error. Every rogue trader or trading program must be found and punished. Surveillance needs to get much more sophisticated to detect misbehaving automated trades. Algorithms already use a different code when entering trades; a series of checks can be run whenever required to see if any rules were violated. Some of this cost needs to be borne by the algo-trading community, by fees like a per-transaction or per-order fee payable to SEBI.

But we can't go around demanding bans on algorithmic trading just because of a flash crash. Knee jerk reactions like that will hurt legitimate players or put them at the mercy of their brokers, and that is plain wrong.

Posted in Yahoo

Defining India’s Poor

1 Comment » Written on March 31st, 2012 by
Categories: Budget2012, Yahoo

I write at Yahoo on the recent poverty report:

India may be a poor country but we all differ on what "poor" is. There was a furore last year when a per-capita income of Rs. 32 a day was considered "poor" — because Rs. 32 buys you nearly nothing these days. But that is hardly true if you consider the average size of a household is four, and that this means the per-household line for poverty is Rs. 128 per day. There is a more substantial Rs. 3,800 per month, a figure that most of the people, who were outraged at the Rs. 32 per day, will find their household help earns per month. (And in fact, around what the much-maligned rural employment guarantee scheme provides for one household member for 100 days a year)

"Poor" is what you make of it. At a broad level, being poor means the inability to afford what one would consider a basic necessity or standard of living. What I might consider a basic necessity will be different from someone else's; if I think access to clean toilets are a basic human need, someone else might argue that there are indeed enough people without clean toilets that have cable TV and refrigerators and electricity in their homes, which makes them not poor. But the divergent nature of opinion doesn't impact the creation and measurement of a statistic; after all, we follow a Consumer Price Index to calculate Consumer Inflation, regardless of whether we or anyone we know has the 50% expenditure on food that the CPI basket assumes we incur.

So what then is the line between the not-so-poor and the poor? The Suresh Tendulkar committee argues that we must satisfy the needs:

- to be adequately nourished (Eat)

- to be decently clothed (Dress)

- to be reasonably sheltered (Shelter)

- to escape avoidable diseases (Healthcare)

- to be mobile (Transport)

Even while these remain core, we will argue on what constitutes decent clothing or adequate nourishment. I think access to power, water and communication is essential to human survival today.

Earlier, this was defined entirely in terms of food and calorie intake. The Poverty Line Basket (PLB) — a set of goods that was needed to ensure that basic needs were being satisfied — had a price tag. Initially, the idea was to cover 2,400 calories a month for rural households (2,100 for urban). The Planning Commission defined the basket based on consumption patterns in 1973-74, and since then prices were taken every year, adjusted to reflect inflation since 73-74 for the exact same basket, and cast as a poverty line number.

This approach was flawed; economic development had vastly changed consumption baskets since 1973-74, for one. Secondly, as you move away from a base year, the inflation statistics get weaker and weaker, and given our data for inflation are very suspect, we understated rural poverty. Finally, some assumptions didn't pan out — the good people at the Planning Commission assumed that healthcare and education would be paid for by the state, and a household only needed to take care of the rest. So that portion of the consumption basket was never inflated in price. In reality, today, both cost serious money.

The Tendulkar committee decided to take a different approach. They started with the assumption that the only data of the old calculation that was "socially broadly acceptable" was that 25.7% of the urban population was poor. Using this, they constructed a price index, using per-household consumption data that was in the NSS Surveys and used the 25.7% number to create state-specific Urban and Rural consumption baskets for the poor. Additionally, they used annual data for items that weren't changed often (like footwear or clothes) but monthly data for items like food.

There was a lot of other work involved to adjust prices between states, and adjust relative prices to an all-India index.

The result was a set of poverty line numbers for each state, and an aggregate number for the country. This has been corroborated through other sources, such as cross verifying the calorie intake in the new method (around 1800) and matching it with the new suggestions for minimum calorie intake, according to the Food and Agriculture Organization, Rome.

ConsumptionBasket

(Total: Rs. 578.8)

This method, when used with the NSS data for 2009-10 shows us more, as per the latest report. The all India poverty ratio (also called the Head Count Ratio or HCR) has moved up from 37.2% to 29.8%, with urban poverty falling to 20.9%.

The poverty line number, for a India, was a higher Rs. 672.8 for rural and Rs. 859.6 for urban people (per-capita), which translates to Rs. 22.43 per day for rural people and Rs. 28.65 for an urban resident. This is even lesser than the outrageously cheap number of Rs. 32 per day!

image

States such as Andhra Pradesh, Tamil Nadu, Maharashtra and Gujarat have done well (for their size); they have all come from the 30% poverty rates or higher to the 21%-24% levels, lesser than the India average. But Bihar at 53.5% and Chattisgarh at 48.7% are way above national level numbers and haven't improved much since the 2004-05 survey. Other ways to slice and dice the data — by religion, case, education level or occupation, click here.

Overall, while this method seems to be far more consistent, it is unlikely to fit the definition of poor in the minds of any reader. While that is the nature of such data, there seems to be no real alternative that works better.

Yet, at a grand level, the Rs. 28 per capita that we would call the poor today translates to around Rs. 4,000 per month. That is a number that suits many urban households that are necessarily poor. Yet, if the definition of poverty were to include access to power, clean water, formal credit from banks or communication networks, then we will find that a lot more of India is very poor indeed.

Posted in Budget2012, Yahoo

The Vodafone Overreach and the Failure of Trust

1 Comment » Written on March 29th, 2012 by
Categories: Budget2012, Yahoo

From my Yahoo Piece:

Vodafone's Dutch Subsidiary bought a company in the Cayman Islands, in a transaction paid for in foreign currency. Vodafone is a buyer, and not subject to their worry for the last year or so? That the Indian Government wants to tax them.

India has a case. The company being bought controls Vodafone India, one of the largest Telecom operators here. The deal was done abroad purely to avoid Indian capital gains tax that Hutchison would otherwise need to pay, if they sold the Indian company instead. Nearly all of what the Cayman Islands based entity owned was the Indian company's assets in India. Yes, the tax would apply to Hutchison, but Vodafone should have cut taxes on the purchase and paid that to the Indian government.

Vodafone went to court and after a long battle, won the case. The Court specifically said that the law wasn't clear on whether such transactions, done abroad, are subject to Indian capital gains tax. The Direct Tax Code (DTC) does clarify, but the bill approving the DTC hasn't been passed, and in any case, the transaction happened before the DTC applies.

The Finance Ministry, seeing a potential loss of Rs. 10,000 cr. in revenue, has decided to grab money using a retrograde step. In the 2012 budget, Mr. Pranab Mukherjee mentioned what he calls "clarifying the tax position of the government since 1962" — a change in the tax law that includes transactions such as Vodafone's, retrospectively all the way back fifty years. Such a change would be understandable going forward, but to make a change today that applies back in time is distasteful.

Who will want to trust anything the government says anymore? It said that profits from Special Economic Zones would not be taxed, and then went ahead and introduced a Minimum Alternate Tax that would apply to everyone. It sold shares in ONGC in early March to investors in an open auction, and then introduced an 80% hike in domestic crude oil cess that hurts, most of all, ONGC. It supposedly deregulated petrol prices but seems to have informally told oil companies not to hike prices in a wink-wink-nudge-nudge sort of way, even if they made losses that we, the taxpayers, will eventually pay for.

But these changes might still be acceptable. Overriding of the authority of the Supreme Court should not be. When the Supreme Court has specifically chastised the government for not being clear about something, the correct approach would be to clarify for all cases ahead. But to make that "clarity" retrospective is a sign that they want their way at any cost; they want to win the very decision that they had lost, and effectively telling the court to decide again, under a new law that suddenly applies.

This will create unnecessary tension for foreign investors. Specifically, companies like Genpact, AT&T and SABMiller have cases pending in India, on the same basis. More importantly, the structure of the law says that share sales of any company whose assets are substantially in India will be subject, retrospectively, to Indian taxes.

Does it include, for instance, a Dubai based employee of a Cognizant Technologies (an Indian company listed in the US) who sold some stock options in the US market five years ago? Will it include two Cayman Island based investors who transacted shares of Rediff (another Indian company listed in the US) between each other in 2005? What about the retired pensioner selling shares in his 401K account in the US, of an India-based company? These sound like good questions but the nature of the question is terrible; it has introduced doubt where there should be none, and introduced it going back all the way to 1962.

It is not only for foreign investors to be troubled by the question of retrospective law. It is for all of us; after all, the tax concessions that we assume are given to us today — a tax cut for "infrastructure bonds" for instance — could easily be removed by a retrospective law a few years later, telling us that "Oh, when we said infrastructure, we meant bridges higher than 17 meters, and your company did only 16 meter bridges". Can you imagine having to deal with that?

On one note, the law creates an element of clarity for a few players, who would have otherwise liked to create entities abroad to skirt Indian taxes. They will be disappointed but they won't have my sympathies.

The matter will go to court, but it has a chance to be changed before that. In parliament, if our dear opposition isn't sitting there criticizing marginal increases in rail fares after seven years. They are the third arm of our democracy that can effectively end this needless battle between the other two: the executive and the judiciary. Sadly, our elected representatives seem a fragmented lot, and we'll have to see this play out in court once again. Until there is a decision on the ability of the government to make retrospective law of this nature, we'll always leave that element of fear in an investor's mind.

Posted in Budget2012, Yahoo

The Negative List: Service Tax Exemptions in a Nutshell

2 comments Written on March 29th, 2012 by
Categories: Budget2012, Yahoo

Archiving my Yahoo Piece:

The Service Tax provisions in the budget detail out 17 areas on which you will not be charged a tax, and for absolutely everything else that involves a service, you will need to pay 12 % (plus cess). The seventeen areas are:

1. Services by the Government or local authorities: These will include such services like getting a passport, a driving license, paying municipal taxes, car registration fees, police fines and so on. What you pay for such services will not include any service tax.

But of course, there are exceptions. Service tax will still be applicable on:
- Speed or Express Post, and life insurance bought from a post office
- airport services
- government services provided to businesses. (Companies will pay it on the annual filing charges payable to the Registrar of Companies, for instance).

2. Services by the Reserve Bank of India. They won't tax the ones that print the money!

3. Foreign consulates and embassies in India. Hopefully this will mean to visa fees as well.

4. Agricultural services. This includes harvesting, planting, or warehousing services, renting of either vacant agricultural land or machinery,

5. Trading, and (see point 6)

6. Manufacturing of goods. For this and trading, service tax will not apply but there is already the excise duty, customs duty and VAT structure that will ensure they are still taxed.

7. Advertisements on hoardings or newspapers: The clause says that service tax will still apply on advertisements in TV or Radio, but for every other form of advertising.

8. Toll charges: No extra charges; imagine trying to pay Rs. 23.60 at a toll booth with twenty impatient cars behind you.

9. Gambling: Yes, you don't have service tax if you visit a casino, buy a lottery ticket or bet on a horse race. But if you win, the income tax is quite hefty, so all this clause does is that they don't tax you when you lose.

10. Entertainment events: What you pay to enter a concert or an amusement park will not be subject to service tax.

11. Electricity: If you're paying a local utility, no service tax will be applicable. But if you pay for power coming off a generator, you'll shell out 12% extra.

12. Education: No service tax for pre-school to high-school education. And not for any education to purse a qualification recognized by law. (I imagine this applies to courses such as a CA, MBBS, or any recognized degree) That also means you'll pay it for a course that gives you an unrecognized diploma, and for private tuitions.

13. Residential rent: For those of us that stay in rented premises, we don't have to pay service tax. Offices, factories and other users must, but that was true last year as well.

14. Certain financial transactions like giving money as a loan, buying a deposit, where interest is involved will not be chargeable to service tax. However, the interest actually received (or paid) will be subject to service tax. Also, given the way this clause is worded, if you give anyone money without any interest, service tax will apply. (At the very least, give or take some interest)

15. Public Transport: Exemption applies to all kinds of transportation, on water or land, included metered cabs. You will still pay service tax on First Class or any air-conditioned coach seats in a train. And you will pay it on packaged tours.

16. Goods transport: Except if you use a road transport agency or a courier service.

17. For the absolute end: This includes funeral, burial, crematorium, hearse or mortuary services. Taxes may kill you, but they won't touch your final rites.

In general, you need to have a "service" in order to be taxed.  For the most part, if a transaction already has a different tax on it — excise or customs duty, or VAT — you may not need to pay service tax on it. (The exception being restaurant bills, where you might pay both!)

There are other "exemptions" to service tax , such as the maintenance charges you pay to your housing society (if the total amount is less than Rs. 5,000 per month). There is another list of “exemptions” that have 34 different sub items.

While you may fret that now everything else comes under service tax, note that the small service provider will not pay any service tax unless he makes more than Rs. 10 lakhs (Rs. 1 million) in a year. This spares you from the tax at the micro level.

We've got to get used to service tax, but it might not be quite as bad as initially thought. One of the biggest expenses — residential rent — is exempt, as is education and transport. And for the rest, it's only logical for us to pay, since taxes are applicable in every other kind of transaction: from soaps to cars to salaries.

Posted in Budget2012, Yahoo

What the Finance Minister Didn’t Say

No Comments » Written on March 29th, 2012 by
Categories: Budget2012, Yahoo

Archiving my Yahoo Piece:

Pranab Mukherjee has presented a budget that has left everyone wondering what really happened and whether we should give it more attention than Sachin's hundredth hundred. But after you have replayed the highlights over and over again, you might find it less heartening to see that customs and excise duty are higher, and you're going to have to pay more to watch your cricket matches in future.

But it could have been worse. Budgets come with expectations, and in this budget, the Finance Minister has ignored way too many of them.

Expected, in this budget, were direct tax cuts — income taxes have been cut in some way or the other in the last few years. What we got was a tax hike of some sort. The government is struggling for revenue and facing high expenditure, and it has raised both excise duty and service tax to 12% (from 10%)  Also, now every service comes under the service tax regime, barring 17 areas (such as school education, government service and so on). In addition, the imposition of AMT (Alternate Minimum Tax) on proprietary businesses will increase their burden and they'll pass it on to you. If you thought inflation was only about a rise in food prices, think again.

With Vodafone winning its tax case, the government was expected to wait till the Direct Tax Code to tax such transactions. But it has changed the clauses with retrospective effect all the way back to 1962 — not just will Vodafone be taxed, but so will any change in ownership in a foreign company whose assets are substantially located in India.

The government has just lost the UP elections and it was likely that some populist scheme was introduced in the budget. The FM has refrained, and instead, kept subsidies at less than 2% of GDP. Unfortunately, 2% of GDP means 200,000 cr., a sum so vast that it could build 19,000 km. of roads (the plan in this budget is to get to 8,800).

On a personal finance note, the FM was expected to increase the tax-deduction for home loan interest from 150,000 per year to 300,000 per year. The deduction for investing in infrastructure bonds was supposed to be increased from the Rs. 20,000 currently. The overall limit for section 80C, currently Rs. 1 lakh, would be increased, we had thought. None of these happened.

If oil prices are high, it's hardly useful to increase taxes on oil products — especially crude oil that India produces. But there is now an increase in tax from Rs. 2,500 to Rs. 4,500 a tonne , impacting even ONGC, whose shares were sold a few days back by the government in a public auction. This is like selling you a cycle and then demanding one wheel back as tax.

The market expected import duties on Chinese power equipment, since the local producers (BHEL etc.) were finding it difficult to compete. No such levy, and BHEL's stock ended down 4% after opening up 2%.

The markets thought Securities Transaction Tax (STT) would go away. Only delivery transactions — charged at 0.125% currently — will be charged a lower STT of 0.1%. Since the STT only really hurts those that trade a lot — intraday players and those that dabble in derivatives — the markets mourned the lack of a better announcement. However, commodities traders that expected a similar tax on their trades smiled as no such tax came about.

New investors, we were told, must be encouraged to buy mutual funds. However, the FM has provided a Rs. 50,000 deduction to the newest of the lot, if they earn less than 10 lakhs and invest directly in equity shares.

The capital gains you might make when you sell a house can now be used, without having to pay tax, to invest in a small manufacturing company which buys new machinery. Compulsory audit will now only be required if turnover exceeds Rs. 1 crore (from 60 lakhs). Small and Medium Enterprises will be pleasantly surprised.

You'll find that LCD and LED TVs get cheaper as the panels are exempted from customs duty, as are iodised salt, soya products and probiotics. So if you choose to be a couch potato, you might as well eat healthier. And if you choose to go abroad to buy your TVs, you can bring back, duty-free, articles worth Rs. 35,000 instead of the earlier Rs. 25,000 limit. Overall, surprising in a budget speech, but how much can you go on about agricultural research institutions getting grants of Rs. 25 crore each?

Since 2011-12 was really bad, the next year should have been better for government finances. The fiscal deficit is expected to be better, coming down from a revised 5.9% to 5.1% next year. However, the internal picture shows that the actual rupee amount of the deficit is expected to be Rs. 521,980 in 2011-12; but the figure for next year is only Rs. 513, 590. Magically, we will grow our GDP 15%, grow tax and other government revenues by a magnificent 22%, while expenditure only goes up 13%. This is possible, and might involve inhaling of certain substances, but indeed unexpected.

Perhaps we missed a lot more, but this budget left a lot unsaid.

Posted in Budget2012, Yahoo

Building affordable housing by curbing bubbles in real estate

12 comments Written on March 23rd, 2012 by
Categories: Budget2012, HomeLoans, Yahoo

As part of my pre-budget articles: I wrote at Yahoo about our overenthusiasm for real estate and how we can curb bubbles in there.

More than 2.6 crore houses are required in India, with more than 99% required for the economically weaker sections of society. To achieve this, the government has provided substantial impetus for housing, and some of it is in the wrong place. However, housing is an important part of the budget and GDP activity. If we need to provide lower cost housing, we actually need to lower the cost of housing.

That means we have to reduce the "bubbly" nature of the real estate game and reduce the concept of property to a functional object rather than a store of wealth. This can be achieved by switching tax rules to disincentivize speculation in the property market, and instead, incentivize homeowners that actually live in the houses they buy. The other objective of the budget is to increase revenue — a need never seen quite as important as in the forthcoming budget, when our deficits will be gargantuan and the government will want to increase tax revenue.

Today, a tax cut for interest paid exists upto Rs. 150,000 per year, for the house you live in. At the rate of 11% a year for a housing loan today, that translates to a loan of just Rs. 13.6 lakhs, and if you consider the 20% down payment that you must put, for a house valued at about 17 lakhs. . That would buy you only the tiniest house in Delhi or Bangalore, and a matchbox in Mumbai. If people pay more for a house, they will pay more interest than they can deduct from their taxable income. Since the RBI gives preferential treatment (discussed later) to housing loans less than 25 lakhs, and the finance minister might find it justifiable that the interest exemption be extended to Rs. 250,000 per year.

But if you buy a second house, what is the maximum amount of interest you are allowed to deduct? Answer: there is no maximum. The Rs. 150,000 only applies to the house you live in; if you buy a second one and expect to rent it out, you can claim ALL the paid interest as a deduction. This, you might argue, makes complete sense — after all, renting out a house is a business, and interest is a legitimate cost of running that business.

Not quite so. In the current tax rules, you already get a 30% deduction from rent earned — no matter what magnificent amount you receive — as a deduction for sundry expenses. Hardly any house that rents for Rs. 20,000 per month has expenses of Rs. 72,000 per year (landlords might be lucky to spend that amount in five years!).

Secondly, the devil is in the often missed details. In India, rental yields are very low — of the order of 2-3% of the property value. So if you buy a house for 1 cr (Rs. 10 million) you might only be able to rent it out for, say, Rs. 20,000 per month, or Rs. 2.4 lakh per year. Net of the above 30% deduction, the real "income" is only Rs. 168,000.

But the interest cost on a loan for the same house, at 11% a year, may be as much as Rs. 900,000. (Assume the loan is for Rs. 80 lakh, at 11%).

The difference — of more than 700,000 - is a loss from house property — a loss that you can offset with anything, including salary income. This sounds fair — after all, I lose money somewhere, and I make it elsewhere, these balance out, right?

Wrong.

Our tax laws do not allow "balancing out" of losses under any other kind of income with each other. That means, if you make losses in short-term trading of shares, you can't offset that loss with your salary; you have to wait till a subsequent year gives you profits in share-trading. So you'll lose money on the trading, and also pay tax on the salary. What losses you make in one "head" of income cannot be offset by income in another head. The concept also applies for losses made in proprietary or partnership businesses (such as for doctors, lawyers or professionals) or speculative losses.

This rule miraculously does not apply for housing. Losses in property can be offset against income in any other head. This is a grossly perverse incentive in favour of buying a second property, which only causes speculation in real estate and increases costs for primary homeowners.

The Finance Minister must remove the 30% arbitrary expense deduction clause, and make any deductions based on actual expenditure only. Secondly, losses from housing property should not be able to offset gains in any other "head"; so salary income cannot be offset by losses made by investing in a second property. This would bring speculation in housing in par with starting a personal business, which is a more fair proposition with the advantage of curbing bubbles in real estate.

The third kind of incentive we provide is "priority sector lending". The RBI allows banks to allocate lesser capital to loans that are provided against houses that cost less than 25 lakhs. This is misused by builders, who convince customers to take a loan three years before the property is constructed and promise to pay the interest; the catch here is that if the builder asked the bank for a loan, he wouldn't be a "priority sector" borrower and therefore, would get a much higher interest rate for the money. This loophole gives builders access to money at lower rates, and instead of using it to deliver faster they create more "under construction" properties to gather more money. Additionally, such a scheme, where the builder pays a borrower's EMI, is likely to be judged as taxable income for the borrower; since it is his expense that is borne by the builder. It may be in the government's interest to clarify that builder-subsidized-EMIs will be treated as income for the borrower, and thus curb another unnecessary perk for home prices.

We are among the only countries in the world that subsidizes the principal repayment of a housing loan, under section 80(C). The Direct Tax Code, applicable only from 2013 if the Parliament functions long enough to pass it, will remove this deduction. But I expect the Finance Minister to consider removing it this year.

Finally, there is the capital gains tax-saving incentive. If you make taxable long term capital gains of any sort — by selling shares or government bonds, selling gold or selling your property, you can buy a residential property with the proceeds and not pay that capital gains tax. Since the only other comparable avenues (of saving capital gains tax) are buying NHAI and REC bonds at 6% interest, we are equating buying a house with investing in the country's infrastructure. This is an overreach that requires correction.

With all the skewed incentives, the price of residential real estate has gone up substantially over the years. The cost of cement, sand and concrete have not changed so much, so the price rise has little to do with the cost of building the house. It has everything to do with the "feeling" that real estate prices must go up; but it is in the nations interest that we don't let it get overboard. If there was anything to learn from the crisis the west has just gone through, it is that housing creates enormous bubbles. It is better to think of a house as a place to live in rather than its current market value; but the lobby of builders, brokers and real estate speculators has a strong representation in government and they will fight policy reform every step of the way. Over to you, Finance Minister.

Posted in Budget2012, HomeLoans, Yahoo

« Older Entries