Monday, February 20, 2012

(P)Rice of the farmer - AP news item!

Today news featured an MLA being arrested for smuggling across state borders. Big surprise and small stuff compared to the blokes watching adult films in the assembly in Karnataka,  accepting bribes on video and depositing cash bribes in their bank accounts (the last category surely weren’t trying to hide anything, were they?).

The MLA in question is called Jayaprakash Narayan…this is sounding awful. But wait. There’s some more spice to this. The item he was smuggling was foodgrains. He was smuggling it across the border from Andhra Pradesh to Karnataka. Joining him was a few hundred bullock carts driven by local farmers who were trying to do the same.  Whew! The young Jayaprakash Narayan was protesting a 65 year old law that prohibited sale of foodgrains across state borders. He was arrested and technically, as per the law, is a criminal.  On the other side othe border was his party colleagues waiting to purchase the food grains. Bloody criminal politicans,  hang 'em high!  See 

It turns out that this is just one of a series of such events to sell food grains across the border into Karnataka, Maharashtra and Odisha. So selling rice (addictive commodity I'm sure once it crosses the border) in another state (the buyers must be anti-national) is a crime (yippee for our strong rule of law). 

The foodgrains law in AP is one of many such laws across many states that are pro-poor. Govt procures all these foodgrains at lower prices. Restricting the entry of buyers into a market results in lower prices.  The low earning farmer now pays low wages to the blokes who may be helping him cultivate. The low earnings from the land reflect in the lower value of the land. Just in case the farmer wants to sell out and do something else, most states have restrictions on sale of agricultural land to persons from outside the state or for non-agricultural use.  Low value of land therefore means that he can borrow even lower sums of money by offering the land as security. These sums of money can be used for better agricultural practices and inputs or for the badly needed education he needs to be able to do other things that help him earn. But you're missing the point,  this old law is a pro-poor law, its helping the farmer, you see! 

The other asset that the farmer has, and people like him/her, are themselves as workers.  Since there are too many of them around relative to jobs, wage levels are low. The first reasonable chance that a better skilled and educated person gets, he migrates to another sector – often to a big city.  Myriad laws prevent the conversion of agricultural land for other use. As a result, there is often little industry present around agricultural communities that are doing badly. Net result- lousy wages in the rural side - every incentive to migrate to an urban area.

The farmers’ bodies also include assets such as blood and body organs.  Commercial blood donation is a legally accepted practice. Donating kidneys is not. Donating kidneys is as safe as safe can get – a dear friend of mine who lives in the US donated her kidney to someone who needed it – no problems at all since then. She, in fact, brought it to my notice that its now very, very safe . I’m not sure what the law is on bone-marrow donations. A recently Supreme Court ruling in the US took the govt to task for impeding this, on the grounds that bone-marrow donation is as safe as blood donation for the donor. The simple truth is that the affluent do not need to donate organs for money, only the not-affluent need to. If the culture of a society is voluntary donation (as is the case with the US, as reported in The Economist), then the prices will reflect this. Both ways there is a transfer of a surplus to a person with a life-threatening deficit.

It’s bad enough that we have rules that work overtime to keeping people poorer, by killing the prices for their assets or even killing markets. All in the name of protecting the poor.  In practice, this drives them to high –cost finance (moneylending or even micro-finance) or, in the eyes of the law, outright criminality. Land deals use fake routes, black markets exist for food grains and organs.  The net inflow of income and cash into the system is either prevented or illegal. We also end up categorizing them as criminals. Someone is going to jail for selling surplus food at a good price.  Can this get worse? WIth their arms and legs tied, these constituents have no other option but to look to government to hand out "dole" for support. 

Many political leaders thus realize that channeling dole to their constituents is what is their only protection and they fight for it. And then there are others   like Mr JP, who grasp the underlying dynamics. 

Mr JP, MLA. This is what political leadership for your constituents is about. I wish more such things would happen and receive front-page coverage as good political representation. This article was buried in the middle pages.

Saturday, February 11, 2012

The Safe Investment Climate in India

(I wrote this in July 2003. A few things have changed, but some fundamentals haven't about the purpose of a liberal economic regime, i.e., citizens must benefit. I posted my thoughts on the telecom licence cancellation a few days ago, but many things I've dwelt on here, hold nearly a decade later. Aren't we a fast moving nation?!)

 Doing Business in India (July 2003)

A survey presented at the World Bank summit on Development Economics, ranked countries on investment climate. Apparently, despite its tropical location India is not a hot place on this count and has a lot of work to do to catch up with the leading pack. At least, that’s what the survey suggested. India’s obviously doing better on  the developmental funding grid (which wasn’t presented at the summit) because this is the first time the bank has held this summit away from home.

Developments in recent years in the Indian business climate may give us cause to reflect on the findings of such surveys.

Pay an entry fee

“Liberalization” of several Indian sectors has assumed a dimension of relicensing with a high one time fee – payable directly or indirectly. The direct fee is often collected by the government as licence fees (licence fees payable for liberalized investment environment). After all, the government is sacrificing monopoly revenue to private sector players.  The government has auctioned licences in the telecom sector and radio broadcasting.

If you are more nationalistic, then government is allowing foreign players to make money in sectors that only Indian industrialists were allowed. The indirect fee  is paid by placing equity caps on non-Indian investment. In many cases, it is always quite clear that many Indian partners don’t have the resources to stay the distance in the particular industry. For example, the initial ventures in the automobile sector were joint ventures. There is now only one truly Indian company making passenger cars, i.e., Telco. Maruti Suzuki is the other half breed. Telecom equity caps have been raised from 49% to 49/76% (through the indirect route). We won’t dwell on the technicalities of “indirect”, suffice to say more foreign owned capital can now come in.

Renege on your initial commitments on entry

Many telecom companies defaulted on the initial licence fee payments. Some went to the extent of seeking court assistance to stay the guarantees that government could encash for such default. Apparently, the telecom companies overestimated the market size when bidding. Never mind if leading investment banks and management consultancy firms and banks went along with the initial estimates as well. Telecom companies have since struck a deal on a new “revenue sharing” regime.

Automobile companies defaulted in their export commitments made in return for concessional capital goods import duty.


Seek government regulations to protect your business interests

It turns out that some markets aren’t as big as industry players thought. But companies have already  invested substantially in the India related businesses. The 700,000 cars per year automobile market is not large enough to sustain a single global scale production facility. Most cars are priced at a range that is 25-50% the cost of a home in larger cities, and closer to 75 % in others. The only way to enlarge this market is through lower prices. Such low prices would be possible through free import of second hand passenger cars. However, the automobile sector (comprising largely of international companies now) has managed to convince government to effectively block out second hand passenger car imports through excessively high tariffs.

FM radio licencees, who’ve known for three years that they’d bid ridiculous amounts, now want government to do something to help them out! If the government does make an effort to help these licencees, the honest and intelligent companies who bid realistic amounts and didn’t win licences will be reassessing themselves as “honest and dumb”!

Get regulations to assist you in keeping prices high to keep investment viable

In some parts of the telecom arena, the government has managed to push up the cost of services through charging high entry fees to new entrants. This inherently placed government owned incumbents at a huge advantage. Notwithstanding this, competition has pushed prices down. Most recently, led by a large telecom company prices were pushed down even further for some services. (If you are looking for a DSL connection at home, go with the government provider whose monthly costs of usage will equal the license fee you have to pay to its competitors).

This has led to a huge dispute on “predatory” pricing ( pricing services below costs). The regulator is in the fray to examine why prices are so low!! Many of the telecom companies, the international equipment suppliers and consortia of banks who have financed their networks will not complain. Their risk capital will be de-risked through mandatory higher pricing.

In terms of investment climate, why would any enterprise find fault with:

  • Gaining rights to operate in a market without unlimited entry
  • Fearlessly pay whatever is the cost of entry including notionally accepting terms that place the enterprise in a competitively unequal playing arena with the incumbents
  • Once you are in,  convince government of the need to protect the industry from imports
  • Ensure that other domestic entrants pay high entry costs
  • Keep prices high to potentially justify investments of producers of goods and service and compete with the incumbents
  • Rely on the government to not use the clause that states that policies could be changed in future, even if such policies would ultimately benefit consumers and not producers.

This is virtually the path taken in sectors that were hitherto government monopolies and or with just a few large domestic players.

Telecommunications and automobile sectors have been cited.
The power sector would have worked for producers. A lot of the initial private power projects were lining up “sweetheart” deals with virtually zero risks with state electricity boards. In fact, were it not for a thinking state regulator questioning the need to buy power from the most expensive source, viz., the Enron power plant in Maharashtra, many of these plants would also be up and running.
The petroleum sector is in the midst of this. Apparently, new entrants have to create their network for retail products (motor spirits). It seems unlikely that players who do this would like a free entry of additional players.
Development of containerised movement of domestic freight traffic is similarly faced with a large incumbent (CONCOR) placed unequally vis-a-vis potential new entrants. Road traffic is the dominant mode of domestic freight traffic at present and efficiencies will drive down costs for consumers.
There is a perception that such restrictions (imports or investments) are not true for sectors like consumer electronics. Perhaps investment restrictions no longer exist, but try importing a music system and check out what you pay as duty at the Customs counter.

Of course, at the end of all this politicians heading government talk about how “liberalization” has not reached and affected the common man. Apparently, “liberalization” that pushes up prices and protects a new set of high cost domestic producers should have worked for common people!

The practised liberalization in India is in many instances “relicensing” with a few more players of non-Indian origin. If the size and scale of the investment is large enough, government, the banks and regulation will ensure that your investment is protected.

To go back to the World Bank study. How many countries propagate an investment climate that ensures that your investment is secure and profitable? 

Wednesday, February 08, 2012

Its Taxing Explaining this....

Its taxing explaining this sometimes!

An Op-ed featured in The New York Times today, written by a tax lawyer called David Miller titled “The Zuckerberg Tax”.  (

Briefly, his argument is:

The US tax system is based on the concept of “realization.” Individuals are not taxed until they actually sell property and realize their gains. But this system makes less sense for the publicly traded stocks of the superwealthy. The fix is called mark-to-market taxation.  

To illustrate:

If I own 100 shares in which I invested Rs 20 each (Rs 2000 in total) and the current market price at the end of the tax year is Rs 50 each, then I pay tax on the increased value (Rs 50-20) or on the Rs 3000 of additional wealth I now own. I pay this even if I don’t actually sell the share, my bank account is still zero. Alternatively, if the share price falls from Rs 20 to Rs 5, then I get a tax refund on lost wealth of Rs 15 x 100 or Rs 1500.

This tax is to apply to the super-rich (some income cut-off over which it applies) and is therefore, equitable in his view.  To support the view he presents the argument that as a holder of stocks that are valued at say US $ 1 billion, I don’t have to pay taxes, but I can borrow against this and buy a luxury yatch (this is what Larry Ellison of Oracle apparently did). It isn’t fair that the rich guys don’t pay taxes on their wealth.

Prima facie, this is a strong argument that sounds quite fair. Why should rich guys avoid taxes and buy a yatch, while I’m struggling on mortgage payments? 

Except, let’s chase this down a bit:

     1.  The Rs 2000 that I invested in the shares above represents money I’ve earned and paid taxes on to start with. This portion is not taxable again according to Mr Miller’s plan.

    2. The Rs 2000 I invested contributes to an enterprise that’s, let’s say, earning Rs 3500 as net profit (after tax) every year. This contributes to the increased value of Rs 5000 of the stock I now hold.  So in effect, the value reflected in my share price, is because of the net profit of the enterprise is already taxed.

       3.   So the accounts of the firm I’ve invested in could look like this:

Sales Turnover
Rs 25,000
Various Expenses /costs
Rs 15,000
Salaries to employees
Rs 5,000
Taxes on Profits
Rs 1,500
Net profit after taxes
Rs 3,500
Total investment in equity of the firm
Rs 20,000
Taxes paid on salaries c. above @30%
Rs 1,500
Taxes paid by suppliers of various costs b. above @ 10%
Rs 1,500

The total tax generated by equity investment (and others’) is now Rs 4500 on an investment of Rs 20,000, (which is tax paid money) or 22.5 %. This tax money would not be there if the investment and enterprise wasn’t running. As a Rs 2,000 investor, I’ve created taxes for govt of Rs 450 per year plus have created earnings for several people and, therefore, families.

As the stocks I hold are not sold yet, the value of Rs 5000 cited earlier, is not cash in the bank. Let’s assume like Mr Ellison, I borrow Rs 3000 from a bank to buy an LED home theatre system.  I have to repay the Rs 3000 from money that has to be realized in cash to the bank. All money that I realize in cash is taxable in the system of “realized” income referred to by Mr. Miller. So I have to earn Rs 3000 after taxes or about Rs 4200 approximately in total to pay the Rs 3000 plus some more earnings to pay the interest. This is not, as Mr Miller suggests, a tax free ride.

Let’s contrast the Investment of Rs 2000 I’ve made, with an investment of Rs 2000 I’ve made in say, gold or a house. Both assets are essentially non-earning assets – they do not for the most part create jobs (you can say a house still does, but gold does not),  houseowners borrow against appreciated value (roughly what happened in 2007) just like Mr Ellison did and could end up buying their own yatch. (Now try telling me that a person in a US $ 0.5 million house is poor.) More importantly, would I as a member of society, rather have rich guys putting their money in things that create jobs or buying gold. This is the fulcrum on which taxation policy tries to be progressive or knee-jerk political. 

Realized income in your hand is what you can spend. Notional values can’t be spent – you can only borrow and you have to repay the borrowing with realized income that is taxed. The distinction between productive capital (ie investments that create more jobs and earnings), unproductive capital (gold, cash that sits in your locker) and earning (what cash you put in the bank and is yours to spend) has a sound economic reason and therefore, accounting reason.  If you can put your saved income, that is tax paid, into assets that benefit society through more jobs etc, that create more taxes as a by-product for govt. there seems no reason to tax you on just ownership. This provides an incentive for people to save and invest in assets of the kind society wants, ie, job creating.

Perhaps the view in these times of greater economic hardship in some countries is that the rich must do more for society. Why not incentivize them to invest their wealth in the country’s long term good? This they can do by investing in government bonds that the govt used to borrow funds to run its various programmes including health and education.  Rather than ask the holders of notional value to pay taxes in cash, that they may not have, incentivize them to invest in funds that have a longer-term socio-economic purpose. This last thing, in fact, is what many governments do, including the Indian government. Tax free bonds say in infrastructure is a means of channelling savings into more long term needs of the economy. So Bill and Melinda Gates have to sell their stock, and pay taxes, to provide funds for the development activity their Foundation supports around the world.  The government may in their wisdom, exempt them from some taxes, as all that tax saved is going towards things that the government would have done anyway. This is not a case of the rich guys avoiding tax, as its made out to be.

Taxation is not an extortion racket run by the government. This is the case with dictatorships and the monarchies of old, where sovereign right means that the King allowed you to earn, collected taxes from you that he blew on anything he felt like – including building the Taj Mahal for his dead wife.

Taxation is a means to channel funds to where a society needs it because otherwise there’d be no money for it. Taxation is a not a weapon to ensure that everyone has equal income. In a competitive environment, the latter approach will just result in people taking their wealth to another country – Bjorn Borg lived in Monte Carlo right through his high-earning years between 1976 and 1981. Then you’re worse off because of this. Borg's shelling out taxes for poor Monaco (per capita income reported in excess of US $ 100,000), watching F1 and sipping champagne with Princess Grace. 

Marked-to-market taxation, in my view, is a throw-back to the socialist way of ensuring that no-one gets rich and discouraging investments in things that create value. Taxation policy that takes a reasonable share of what people earn, ie, profit / income – is progressive in that you’re taking from what’s there. Taxes that are collected before earnings are realized in cash, are regressive – they not only create higher costs for usage but might render a job-creation activity unviable.  High telecom licence fees, that I wrote about in an earlier post, is a good example of the latter.

The reasonable share must be used for public benefit – not paying fat salaries for uproductive things! That’s what the debate on fiscal responsibility, budget deficits, austerity etc is about. But more on that another time.

Tuesday, February 07, 2012

Why isn’t nature the way the rules want it to be

(This is just plain experimental doodling on a random topic, so don't look for anything in particular....that's the subject topic anyway!)

A recent development in the field of science has been at the CERN experiment on particles traveling faster than the speed of light.  “…this can’t be happening” was the initial reaction and they did the experiment again two months later. With the same result.  If true, this has broken the back of several thousand Ph.D., called into question several related developments in science and the text books in schools will have to be re-written. Only the last will have a strong support base…new books, more sales,  more royalties…wow! Business Opportunity!

The speed of light experiment features prominently a sub-atomic particle called the “neutrino”. It does not have an electrical charge, resembles more closely an electron and  not affected by strong physical forces (gravity etc).  This is the guy that’s taken an approach that says  “to hell with the speed of light limit, I’m just going faster because I want to”.  The Mr India particle, you can’t see it..!  In case you think Mr India is small stuff, there’s about 65 billion of these shooting through matter on earth per second per square centimeter from the Sun’s rays!

More than a decade ago, a sheep called Dolly was cloned. To cut to the chase, a very important item as a result of this fell through the cracks on the public debate. Ie. You didn’t need a male cell to contribute to the reproduction of life! Dolly’s mom had the relevant cells extracted from her arm (..there’s some technical name, but lets stay with this for now)

Plenty of philosophy from around the globe takes a beating because of this.  

The part that’s caught the public eye and political spectrum is human cloning and the resultant reactions are around two themes:

     The conspiracy theory mob that says “what if that means more versions around of…
     A.      Ted Bundy;
     B: Adolf Hitler;
     C: Osama Bin Laaden  (tick suitable box)
     D. Kevin Costner in “The Bodyguard” or Salman Rushdie’s “Guide to simple English” (couldn’t resist that, but you can make up your own option on this!)

-         The other group is the touchy-feely mob “how will a child react to know that (s)he is an exact replica of another human being “.   Ask any group of teenagers if they’d like to be a clone of their parent(s), the jury will be in pretty quickly with a unanimous decision.

The part that’s getting to the public eye now is organ growing. The cloning experiment established that cells can be reprogrammed to grow new organs – simply put you didn’t need cells from your arm to regrow an arm, it could be from anywhere else. Like it or not, we’re well on our way to a society where we can conceivably have department stores selling organ transplants like mobile phones…”hey, you got a problem with your lungs?  Let’s just replace it…SpairBags – Your second wind! Original Japanese technology with lifetime warranty plus with ActiveZ inside for fresh breath, always!”

There are some parallels in life, that I wanted to toss around:

1.      The people who pushed out on these scientific endeavors didn’t care about the rule books. By the existing logic of the time, they’re crazy. Crazy people shouldn’t be believed, but look what’s happened? It’s the crazy people who create the quantum breakthroughs in the way life functions – imagine a guy with a walking stick taking on the might of an Empire that ruled one-quarter of the planet with “Mere paas sachaee hai” as his weapon. I’m pretty sure he’d get an “F” in Business Strategy at the world’s leading business schools.
2.      Defining limits through abstractions may be simplifying how nature and life works. Once you’ve measured it through such abstractions, you may be limiting the possibilities. If the speed of light isn’t an absolute limit, then Douglas Adams’ hitchhiker is now a real possibility.
3.      The Yogic Mr India particle – remains unaffected by physical forces prevalent and doesn’t have a charge + or -, ie., doesn’t take a position! This aids speed and ease of passage. A lot of philosophy I’ve grown up around, which is to suspend judgment as one of the building blocks of inner calm. It eases the passage of life.  

 Its easy to understand why nature doesn’t follow the rules. But just does its own thing. Its our desire to arbitrate knowledge and understanding, that creates the rule book on many things. Rule books are "guidelines" to an end, not an incontrovertible truth. 

Saturday, February 04, 2012

“Forward to the Past” – Imminent Tele “Con” Policy

What if I gave you a cricket bat and say, Rohit Sharma, a cricket bat? Who's likely to do more with it?...let's assume you're not a hoodlum enforcer who uses the bat for other things..and its about scoring runs for your team.
The value of spectrum (or any operating asset) ownership is pretty similar...a different owner will do different things.
  •      Value of spectrum in govt's hands = zero.
  •  ·         Value in the hands of Someone who knows how to run a business? = x;
  • ·         Value In the hands of Someone Else who knows more than someone? =  Something Else times x

Someone and Someone Else pays taxes on profits, purchases of equipment, creates salaried jobs that are taxed etc. Letting the value develop implies taxes on earned revenue (sales has happened) and lower costs of doing business as you don't pay these taxes before the sales. This translates into lower prices in a competitive market, what has happened in India. Compare this to excise duty, a tax levied on manufacture…this forms part of a minimum price that the product must sell at or its not worth producing it. The higher the price, the lower is likely volume of sales.  Telecom Policy is about enabling higher volumes of sales, i.e, more users of telecom services at lower prices.

Licence fees upfront through a mechanism such as an auction, attempts to collect all those taxes right now through forecasts of sales. (In underworld lingo this is called "hafta". Hafta, though is dynamically set, and good dons link it to revenues being realized as breaking property is not the objective of the exercise, collecting regular extortion money is). Auctioning spectrum is just like license fees, even if called something else. The higher the auction price, the higher the minimum prices on offer by the service providers.  We experienced this through the initial round of telecom "auction" licences in the 90s. The prices of telephone calls were astronomical and the user base remained quite limited to the affluent, contrary to what the policy intended.

Lets take the following scenarios:

Scenario I – govt auctions licences, awards highest bidders, restricts number of operators and collects huge licence fees.
Market Outcome : Higher prices of services, fewer subscribers, companies default on fees (so govt doesn’t actually realize the fees) and the services don’t expand.

Scenario II – govt. awards non-exclusive rights to offer services for an entry fee commensurate with the potential market size plus a share of the sales of operators
Market Outcome:  More competition, lower prices and a wider user base. 
These above scenarios represent what actually happened in 1996 (Scenario I) and over the last decade (Scenario II).

The Telecom Policy has come under fire for alleged wrong-doing of the Minister in violation of his own guidelines of approval. The slant being given to it all now, courtesy the Supreme Court verdict, is that the policy is wrong as its cost the govt licence fees. 

Government restrictions on economic activities on individuals cost the economy about 3-4% of GDP growth. These restrictions are on account of plain needless and suffocating policies and laws – ie – the strangulation of economic activity within the existing laws and rules. Nobody is being a crook by enforcing these laws. Vested interests want these laws and rules to continue. This translates into Rs 750,000 crores or more per annum of “income loss” to the citizens of India.  Should we charge the political parties this much for the right to contest elections and form the government? It’s the law and rules that they make that have resulted in the loss to the nation.
The purpose of good policy is to ensure maximum access to citizens – physical access and costs (lower prices) – of a service or a right or a product. The Telecom Policy has worked towards that end to the extent the operators are being killed on profits. But listen to the politicos instead – lets collect a promise of higher license fees and kill the industry altogether – up front (Scenario I above). A clear case of moving “Forward to the Past”  - I vote we go “Back to the Future”.