Tuesday, April 17, 2018

India’s Regulatory Dodgeball with Bitcoin


Government warnings have hardly restrained one of the world’s most active cryptocurrency markets.

This article was first published in the Global Association of Risk Professionals on April 13, 2018. Co-author: Anisha Sircar


One in every 10 bitcoin transactions in the world takes place in India, according to cryptocurrency payment company Pundi X. https://pundix.com/  Indian trading in bitcoin grew substantially in 2017, with over 2,500 people trading daily. Demonetization of high-denomination Indian currency in November 2016 triggered an explosion of interest in alternative currencies. According to some estimates, the volume of rupee-denominated bitcoin trades is third in the world, behind only U.S. dollars and Japanese yen.
However, on February 1, Finance Minister Arun Jaitley announced – after similar warning statements by the central bank in 2013 and twice in 2017 – that the state does not consider cryptocurrencies legal tender. The already-slumping value of bitcoin plummeted further, by an estimated 6.5%.
Still, cryptocurrency operators remain positive about the future of virtual currency, and some economists are convinced that this evolving technology will determine the future of the global economy.

Not Explicitly Illegal
The Reserve Bank of India has taken a stance against licensing any entity to operate with bitcoin and other virtual currencies, and frequently communicates warnings to users, holders, and traders about the risks that they are exposing themselves to.
On December 29, 2017, the Ministry of Finance issued a statement http://pib.nic.in/newsite/PrintRelease.aspx?relid=174985 emphasizing that virtual currencies had no legal tender in India, equating them to Ponzi schemes, and saying that transactions, because they are encrypted, are “likely being used to carry out illegal/subversive activities, such as terror-funding, smuggling, drug trafficking and other money-laundering acts.”
By not declaring virtual currencies legal, and by choosing not to regulate them without actually declaring them illegal, the government placed bitcoin in a troublingly grey area. (This is in contrast to Japan, Canada, Australia, Estonia and Chile, which have legalized it; and Bolivia, Iceland, Vietnam, Venezuela and others that have either banned it or imposed punitive measures.)
Moreover, at the beginning of 2018, Indian cryptocurrency exchanges and payment gateways received notifications from banks to make immediate changes to the way money flowed into their platforms, and warning them of account closure if they didn’t comply.
Koinex, India’s largest cryptocurrency exchange, posted a statement https://medium.com/koinex-crunch/inr-withdrawals-update-january-7-2018-6279bbe42bd2  on January 7: “A tussle between our payment service partner and their bank has caused an indefinite delay in the settlement of a large portion of deposits to Koinex in the past 2 weeks . . . While we have taken firm action, we are also in constant touch with the payment service provider and are providing our complete cooperation to help resolve the matter at the earliest.”

Vague Authority
The rationale behind Indian banks’ moves to suspend virtual currencies in India remains unclear, but hint at a directive from the central bank, which, as noted earlier, has shared an uneasy relationship with the traction of bitcoin in India. This directive would fall in line with the general pattern of task forces, nationwide surveys, and notices to traders and financial intermediaries to rein in what governments and banks believe to be a dangerous emerging phenomenon.
However, despite statements and actions discouraging people from trading and investing in bitcoin, several Indian investors began doubling down on the cryptocurrency market, driving bitcoin prices in the country even higher than global market trends.
The number of registrations across exchanges in India surged; bitcoin prices jumped nearly 14-fold in 2017, hitting an all-time high of $19,500 by mid-December (before plummeting to $12,000 and then recovering to $17,000 early in 2018). Trading volumes began doubling in the first weeks of 2018 (see figure 1).
Figure 1
Source: Coin Dance

This general rise in Indian bitcoin trading volume occurred despite the backdrop of a tumultuous global cryptocurrency market. Its popularity in India, particularly among celebrities and entertainers, is due to its appeal primarily as a financial asset, according to Zebpay, India’s first bitcoin exchange, as well as a market for remittances.
The drop in bitcoin trading volumes, from INR 83,214,245 to INR 11,637,525 between January 27 and February 10, seems to owe itself to the budget announcement. on February 1, in which Finance Minister Jaitley stated, “The Government does not consider cryptocurrencies legal tender or coin, and will take all measures to eliminate use of these crypto assets in financing illegitimate activities or as part of the payment system.”
Citi India, the only multinational bank among primary card issuers in India, on February 14 banned its customers from using the bank’s cards in purchasing cryptocurrencies: “Given concerns, both globally and locally including from the Reserve Bank of India, cautioning members of the public regarding the potential economic, financial, operational, legal, customer protection and security related risks associated in dealing with bitcoins, cryptocurrencies and virtual currencies, Citi India has decided to not permit usage of its credit and debit cards towards purchase or trading of such bitcoins, cryptocurrencies and virtual currencies.”
At the same time, it was reported https://news.bitcoin.com/more-crypto-jobs-in-india-despite-delhis-stance-on-bitcoin/   that jobs and applicants for employment in the country’s cryptocurrency sector have increased.

Allure Despite Volatility
During one period in 2013, bitcoin’s price increased 85-fold; the following year, it crashed. By the end of 2017, the big U.S. bitcoin exchange Coinbase said that it had signed 12 million customers, surpassing the accounts of several established financial institutions and brokerages, and became the most downloaded iPhone app. https://www.recode.net/2017/12/7/16749536/coinbase-bitcoin-most-downloaded-app-iphone  In early February, talk of government and bank bans caused bitcoin market capitalization to fall 14% in a week. http://fortune.com/2018/02/05/bitcoin-price-crash/ as major international banks stated their plans or actions of banning customers from using their cards to purchase it.

A bitcoin user should invariably tread carefully given the wild price swings.
Source: CoinGecko

Nonetheless, strong interest stoked by geopolitical unease and distrust in traditional financial institutions will perhaps continue to add to the allure of a decentralized, volatile currency outside the control of banks and governments. This has been happening in India amidst flailing international prices, representing an increasing demand in India that supply, particularly with institutional forces working against it, may not be able to handle.
With platforms such as WhatsApp and Telegram making it even easier to connect sellers and buyers of virtual currencies (through the means of the platforms themselves, or through cryptocurrency wallets), the government could be at a loss for ways to stop the spread of cryptocurrency – because if they prohibit exchanges on platforms, the transactions will find a way to migrate elsewhere.
Perhaps the overarching lack of clarity from India’s leadership regarding the legality and mechanics of virtual currencies in India remains a determinant of their survival in the country. The larger question for the global economy, however, perhaps extends beyond the regulation of bitcoin – and seems to stem from that of decentralized technology itself, with its power to replace financial transactions, systems of power and meaning, and the very nature of our tomorrow.

Monday, April 16, 2018

ETFs and Liquidity Shocks


Professor Vikas Agarwal on the effects of commonality of stocks under varying market conditions

This interview was first published by the Global Association of Risk Professionals on April 13, 2018

Assets under management in exchange-traded funds have grown from $151 billion in 2003 to more than $3.4 trillion in 2017, according to the Investment Company Institute. Like stocks, ETFs trade on exchanges and, like mutual funds, represent portfolios rather than individual companies. But unlike mutual funds, they trade continuously and can track the performance of various indices.

Amid the trend toward passive investing, ETFs offer the advantages of low expense ratios and transaction costs, a high degree of diversification, simplicity and transparency, and tax efficiency. Due to the burgeoning size of the market, the impact of ETFs on the underlying stocks is significant. Academic research finds that ETFs increase volatility and reduce liquidity of the underlying securities. In addition, it finds that ETFs increase the co-movement in returns and liquidity of the component securities.

Vikas Agarwal, H. Talmage Dobbs Jr. Chair and Professor of Finance, J. Mack Robinson College of Business, Georgia State University, has been studying commonality in liquidity of underlying stocks owned by ETFs. A London Business School (University of London) PhD in finance who has served as a distinguished visiting scholar in the Securities and Exchange Commission’s Division of Economic and Risk Analysis (DERA), Agarwal has published extensively on hedge fund and mutual fund subjects. In this interview with Dr. Nupur Pavan Bang of the Indian School of Business, Hyderabad, Agarwal discusses the workings of the ETF market and the findings of his research with Paul Hanouna and Rabih Moussawi of Villanova University and Christof Stahel of the Securities and Exchange Commission (SEC). Agarwal says that the commonality in liquidity affects investors’ ability to diversify liquidity risk, and that it comes at a price.

If ETFs are basically derivatives on underlying securities, when and why does an investor prefer to invest in ETFs rather than index futures?
ETFs provide long and short exposure to many more asset classes, styles, and segments that are not all tracked by futures. Additionally, a typical U.S. large cap long exposure through ETFs can be more efficient than the same exposure by index futures. For example, ETFs, unlike futures, do not involve a rollover of the expiring contract, which can erode performance for investors with holding horizons spanning beyond the maturity of a futures contract.

According to BlackRock, the annualized rollover cost of a long futures position in large-cap stocks (S&P 500, Euro Stoxx 50, FTSE 100) ranges from 0.9% to 1.4%. The total expense ratio for an ETF on the same indexes can be as low as 0.05% (e.g., the Vanguard S&P 500 ETF). Hence, ETFs provide a more cost-efficient way to track an index, especially for investors with longer or uncertain trading horizons.

Additionally, ETFs provide various exposures to styles (e.g. value/growth, industries), asset classes, and geographies that are not tracked by futures or do not have existing liquid future contracts.

How are ETFs managed, and what are their structural features?
Most ETFs are structured as open-end investment companies and are governed by the same regulations as a mutual fund. Similar to index mutual funds, ETFs have fund managers. However, ETFs are fundamentally different from other passive or active funds registered under the Investment Company Act of 1940 since they are traded on a secondary exchange. Unlike closed-end funds, ETF shares can be created or redeemed by ETF primary market makers, called authorized participants (APs).

For U.S. equity ETFs, shares trade concurrently with the underlying basket of securities they hold, thereby providing intraday liquidity to their investors. Additionally, unlike open-end mutual funds, ETFs can be sold short.

The concurrent trading of ETFs and the securities they hold presents the challenge to uphold the law of one price. Therefore, continuously throughout the trading day, ETF prices are kept in line with the intrinsic value of the underlying securities through a process of arbitrage in which APs, market makers, as well as hedge funds and other institutional investors, participate.

How does the arbitrage mechanism work?
APs can engage in arbitrage activity by taking advantage of their ability to create and redeem ETF shares. If ETFs are trading at a premium relative to the net asset value (NAV) of their underlying securities, APs will buy the underlying securities while shorting the ETF in the secondary market until the two values equate. At the end of the trading day, the APs then deliver the underlying securities they accumulate during the day to the ETF sponsor in exchange for newly created ETF shares in the primary market. They then use these new shares to cover their ETF short positions.

However, ETF arbitrage is not limited to AP primary market activities, as it also takes place continuously throughout the day by hedge funds and high-frequency traders. Secondary market arbitrageurs hold long-short positions on the ETFs and the main underlying basket constituents until prices converge.

What is commonality, and why should an investor worry about commonality in liquidity?
Commonality represents the co-movement of a stock’s liquidity with the rest of the market. Higher co-movements with systematic liquidity factors imply lower ability for investors to diversify liquidity shocks, which can be crucial in market downturns.

Commonality is especially important in market downturns due to systematic liquidity dry-ups. The higher the commonality of a stock, the more likely it will exhibit liquidity withdrawals in times of market stress. If ETFs exacerbate the commonality of stocks in their basket, then this would translate in a reduction of the possibility to diversify liquidity shocks that these stocks are exposed to, especially in stressful market conditions, which would give rise to an “ETF-specific” liquidity risk factor.

What should be the benchmark against which we measure liquidity going up or down?
We benchmark the stock to itself by including stock and date fixed effects, and thus exploiting changes in the stock commonality that are related to correlated trading by ETFs due to arbitrage. We also benchmark to other stocks with similar characteristics. In particular, we use two experiments to properly identify the causal aspect of the relation between the ETF ownership and commonality in liquidity.

How does the commonality behave during various time periods (crisis versus normal)?
Our evidence illustrates that ETF-driven commonality is not a crisis-only phenomenon but is also significant in normal times.

What are the implications of commonality in liquidity for investors and policymakers?
Our paper contributes to the policy debate of widespread implications of ETFs in security markets. Specifically, we show that as ETFs continue to grow and gain bigger ownership of stocks, it can reduce the ability of investors to diversify liquidity shocks due to an increase in the commonality in liquidity of stocks included in ETF portfolios.

Friday, April 6, 2018

'The Inheritors' book review: Family values seen in entrepreneurship tales


The Inheritors: stories of entrepreneurship and success- Sonu Bhasin


This review was first published in Business Standard on April 06, 2018
Image result for the inheritors book 
Penguin Random House India Pvt. Ltd.
7th Floor, Infinity Tower C, DLF Cyber City,
Gurgaon 122 002
First edition (2017)
Rs 299/-

It is easy to feel that the protagonists are sharing their fears and their deepest, heartfelt emotions with readers

Family businesses have been the backbone of the Indian economy since Independence and played a significant role in nation-building even before that. However, in the era of the Mallyas, Modis and Choksis they have received bad press, a few rotten apples impairing public perception about the rest. Positive stories are hard to come by. Sonu Bhasin’s The Inheritors fills this gap by narrating the stories of grit, gumption and guts of the next generation of some of India’s well-known family businesses. The exception being Motilal Oswal and Raamdeo Agrawal, who are the founders, not inheritors, of the Motilal Oswal group.

The book is an easy read and the narrative is interesting for the most part, and would engage the layperson as well. The interviews are detailed, insightful and reveal many unknown aspects of the family, the business, successes, failures and strategies. It is easy to feel that the protagonists are sharing their fears and deepest, heartfelt emotions with readers.

Consider the following examples:
Replying to then Hindustan Unilever Chairman Kaki Dadiseth’s overture to Marico to buy out the profitable Parachute brand of hair care products, Harsh Mariwala said, “Mr. Dadiseth, you may think I am a nut but you will find out that I am a tough nut to crack. Thanks, but no thanks”.

Then there is the very human insecurities of a daughter-in-law, now a successful lawyer in her own right, marrying into a prominent family of lawyers. “It was not something that I had ever thought that I would do…I used to look at all the lawyers and my in-laws and feel somewhat intimidated”, said Saloni Shroff who married Rishabh Shroff, the fourth-generation scion of the law firm Amarchand Mangaldas (or Cyril Amarchand Mangaldas as it became after the brothers split in 2015).

Many of the groups and the next-generation leaders whom Ms Bhasin has interviewed for this book are well known and widely covered by the media, so some of the stories may be familiar. It was refreshing to read about the ones that aren’t as well known- such as Agastya Dalmia of Keventers, a hundred-year-old brand that he revived with two partners, or Arjun Sharma of Select group. Both created new ventures to revive and advance the family business.

The weakness of the book lies in the fact that Ms Bhasin has missed several opportunities that would have given it a longer shelf life. One of them would have been to synthesize the learnings from the leaders’ experiences. This would have been very helpful for the next generation of the thousands of business families in India. Ms Bhasin also missed the opportunity to weave together a roadmap for the next generation for successfully establishing themselves. For example, succession challenges plague most family businesses at some point in their life cycle. What was done right in the companies that Ms Bhasin chose for the book?

Another big gap is the lack of an explanation for the choice of companies and leaders featured in the book. Was the choice dictated by convenience, availability or was there a pattern or a logic for selecting the people she did? To be sure, there are plenty of fascinating stories in the book: The account of Dabur and Amit Burman exemplify professionalisation and separation of ownership from the management; how Pooja Jain found the perfect mentor in her father; why the Dhingras believe that harmony amongst family members is key to the success of the business; how Tara Singh Vachani is proving her mettle through her passion for “senior citizen living”. But why has the writer chosen these groups and not some of the others?

The production also left much to be desired. Pulitzer Prize-winning author Jhumpa Lahiri calls the cover of a book its “clothing”. “If the process of writing is a dream, the book cover represents the awakening,” she writes. I am not sure if enough thought has gone into designing the cover of the book under review. It is not appealing enough to entice anyone into picking it up at a bookstore. Also, the editing is poor and there are typos. It is to be presumed that these can be taken care of in the future editions and in the digital versions of the book. Lastly, the Foreword by Anand Mahindra could have been longer.

To summarize, the book is well worth a read, not least because with a staggering 90 per cent and more businesses in India being family businesses, success stories need to be told. A little more rigour in the production values and framework may have made it a great book.

Monday, March 12, 2018

The CEO at home


This article was first published in ISB Spandan, Vol. 2, Issue. 2, February 2018; http://flipbook.isb.edu/pages/Spandan/Vol2-Issue2-Feb-2018/html5/index.html?page=1&noflash

“I have been inspired by her. What little success I have achieved, should be credited in large measure to my wife’s influence.”- A rare legacy- Memoirs of Basant Kumar Birla
“Please understand. If I don’t do it, who will? The buck stops at me”. The buck is supposed to stop at both of us with regards to our child. But it usually stops at me because you are not around!
“I will be leaving at 4am tomorrow and will be back at around midnight”. But you just came back from Uganda? Must you travel again immediately?
“Anything urgent? I am in a meeting”. Can I only speak to you when there is an urgency?
“Please sleep, I will not be able to call today. Will get free only after 11pm. It will be 2am for you”. But we have just spoken 4 words since you left 4 days back.

These are snippets of regular conversation at home between my husband and me. My husband is a serial entrepreneur. Even as one business is getting established, he moves on to the next one. When I think of the life that we could have had if he decided to take up a regular job- foreign vacations, attending parents-teachers’ meetings and social outings together and so on- the grass definitely looks greener on the other side and I must admit that the sacrifices do not seem worth it at times.

It is said that behind every successful man, is a woman. I would say that behind every successful man is a wife who spends hours worrying about the time her husband would be back home, managing the family while he travels extensively, taking flak for his absences from the extended family and sometimes not even being able to talk on the phone while he is firefighting.

The journey of an entrepreneur is laced with passion, hence seems pleasurable to the entrepreneur. The wife need not share the same passion and it is difficult to understand the long hours, the ever-shifting goal posts, the failures and hence the opportunity costs.

The role of the wife of an entrepreneur is as important as the entrepreneur himself in the success of the enterprise. She is the Chief Emotional Officer (CEO) who works tirelessly, with patience and perseverance, to maintain stability at home, inculcating the right values in children and their overall upbringing, keeping the communication flowing, being the cheer-leader in an environment of chaos and uncertainty and listening to the stories of challenges at work that never seem to end.

The CEO at home is invisible, plays subtle and less formal roles of supporting, advising, listening and at times emphasizing on the humane aspects of business decisions. Their observations, emotional capital and intuition go a long way in shaping the big picture for the entrepreneur.

Whether a wife is a home-maker or working, it doesn’t matter. Being married to an entrepreneur is not easy, yet exciting. So cheers to the entrepreneurs’ wives and to women in general who have the uncanny ability to handle a variety of situations with aplomb.

Let’s give them a dream who help us achieve our dreams!


This article was first published in ISB Spandan, Vol. 2, Issue. 2, February 2018. It won the second place in a woman’s day special contest.

“She isn’t coming tomorrow. You can’t travel on a day she’s not coming”, I said. “But my tickets are booked for a 6.30am flight”, replied Pavan. “Postpone it. Take a post noon flight”, I retorted, clearly irritated. “Ah alright! Your LSS-2 will be at your service till 10am tomorrow. Happy?” said Pavan, in an attempt to lighten the mood. “Good”, I replied, feeling relieved, and walked out of the room.

By nature, I worry a lot. I find it difficult to leave unwashed utensils in the sink or clothes lying on the bed or toys spread out in the living room. Her presence ensures that I am not constantly worried about the household chores while at work. I am assured of entering a neat, clean and orderly home in the evening and finding my kid well fed and in a state where I can still recognize her. Behind my success at work and a happy peaceful life is a good LSS-1 (well, even LSS-2. But this article is about LSS-1. So, another day, another article on LSS-2).

In case you are still wondering about what is LSS-1 and LSS-2, no they aren’t the latest offering from the stable of ISRO or NASA, LSS stands for Life Support System. Pavan, my husband, calls himself my Life Support System-2 and our domestic help as my Life Support System-1.

For many of us, the urban-working-women, our domestic help is an important part of our lives. They are a category of women who see affluence closely and daily, with little hope to experience it themselves. This is unlike the other category of workers- be it a labourer on a factory site or employed in an infrastructure project or the bottom most in the pyramid employee of a hospital- who do not really see the rich and their lifestyle so closely.

Most of these women are not supported or are left by their husbands to fend for themselves and for their children. They tolerate the abuse at home and often indifference at their work place, while staring at an endless tunnel with no light. They work for mere survival from one day to the next, to put a roof over their heads and some food in their belly.

What are their own aspirations? What is their aspiration for their children? Don’t they deserve a better life? A better future? They are not even recognized by the Government. There are no set wages, no regulations regarding the hours of work, about the scope of work, leaves or pension. There is a draft Act on the anvil but it is yet to see the light of the day!

Drawing an analogy with the Gallup State of the American Workplace study- “people leave managers, not companies”, I can say that the poor performance of the domestic help and their frequent job changes has as much to do with us. They were not born to be domestic helps. Circumstances have made them so. They too need training, empathy, support and security, just like we do in our jobs.

This is a tribute to all domestic helpers who make our lives easier and allow us to pursue our dreams while not having any of their own. As women who have moved up the social ladder and are blessed to be where we are, let us all, in whatever capacity we can, make this world a better place for them as well!

Monday, March 5, 2018

India’s Far-Reaching Tax Reform


This article was first published in GARP Risk Intelligence on March 02, 2018; Co-author: Anisha Sircar and Nitya Bodavala

The objectives of the Goods and Services Tax are clearly stated, but the implementation is complicated

On July 1, 2017, the Indian economy experienced its second historical policy overhaul in under 12 months (demonetization being the first). The Goods and Services Tax (GST), the most dramatic tax reform in the country since 1947, had been under way in parliamentary dialogues for almost a decade – in contrast to the sudden implementation of demonetization. Seeking to unify many central and state taxes and streamline the existing indirect tax system, GST had ambitious goals mapped out for the country’s economy.

The potential positives of GST have been well-touted: the common tax system will reduce the incidence of double taxation, lower business costs across sectors, bring India’s informal sector into the mainstream, and increase exports, benefiting the overall fiscal health of the country.
But there are several issues related to the implementation of the GST, among them: reliability of the information technology, documentation hassles, potential revenue losses, and an abstruse anti-profiteering clause.

What is GST?
The Constitution Amendment Bill for Goods and Services (GST) was passed on August 3, 2016 by the Rajya Sabha, upper house of the Parliament. A single, uniform tax levied across India, on all goods and services, GST was proposed to sew together a common market by removing fiscal barriers between states. It was anticipated that India’s tax structure would become more comprehensive, a common market would develop, and the cascading effects of multiple indirect taxes on the movement of goods and services would be reduced.

In theory, GST is simple. The government charges a series of indirect taxes (alongside direct taxes) to raise revenue for public expenditure. Under GST, at least ten types of “indirect taxes” are subsumed under a single system, putting an end to the hitherto several levels of taxes levied on commodities as they move through the production cycle. Taxes under the system are collected on a “value-addition” basis, at each stage of sale or purchase in the supply chain.

Impact on the Economy
GST is viewed as a game-changing reform because it impacts the structure, incidence, computation, payment, and compliance of indirect taxes, as well as credit utilization and reporting. Its main purpose was to eliminate the compounding effect by combining central and state indirect taxes and fixing a final tax rate, where all goods and services would fall into five distinct tax categories, and where value-added tax laws did not differ across states, thus making it less problematic for both the producer as well as consumer at each stage of in the supply chain.

Before, myriad taxes were applied at the central and state levels. After the implementation of GST, only three types of taxes are applied:
  • Central Goods and Services Tax (CGST), levied by the center on intra-state supply.
  • State Goods and Services Tax (SGST), levied by the state on intra-state supply.
  • Integrated Goods and Services Tax (IGST), levied on goods and services for intercourse trade or commerce, imports, and exports.

Under the new system, transactions have “slabs” of tax rates, depending on the nature of the good or service. All items, ranging from agricultural and necessity goods to luxury goods and consumer durables are categorized in the five major tax slabs of 0%, 5%, 12%, 18%, and 28%. The range is from zero on items deemed as essential or necessity, 28% on goods deemed as luxury.

‘Level Playing Field’
With this system replacing the multiple-tax structure, a more uniform regime has been implemented, state-specific advantages and disadvantages are set to diminish (because smaller businesses now get to make higher profit margins, and offer lower prices than their competitors, thus “leveling the playing field”); the average costs of goods and services across the country are reduced with the elimination of double taxation; inflation may decrease in high-productivity categories; and commodities can easily move across the country, with reduced transaction costs and transportation inefficiencies for businesses.

An ancillary benefit is that the threshold for companies exempt from paying indirect taxes has been reduced from Rs. 15 million to Rs. 1 to 2 million, depending on the location of the company, thereby attempting to bring the informal sector into the fold of the formal sector of the economy.

Further, taxes paid by the consumer are not only structurally straightforward and transparent (as opposed to a slew of overlapping and elusive taxes), but the final tax itself is set to reduce, thereby having a positive effect on consumption and boosting the economy at large. In this way, the simplicity of the tax structure appears set to bring about greater tax compliance, increasing the tax base and, in turn, revenue for the government.

With an overall decrease in production costs, and with GST not levied on exported goods and services, India’s international competitiveness is expected to increase.

From a macroeconomic perspective, then, the long-term impact of GST on the economy seems favourable: improving efficiency, widening the tax base, narrowing the gap between the informal and formal sector, and increasing overall fiscal health.

Technology and Other Challenges
One of the hallmarks of this tax reform is the introduction of the Goods and Services Tax Network (GSTN), which records all GST transactions and is supposed to be conducive to seamless documentation, debit recording, and credit disposal.

However, a lack of timely migration into the network can be detrimental to the viability of the tax program, because the IT infrastructure is the only means to track and implement the new system.
Also, verifying and legitimizing the data provided online is a mammoth task, given its estimated 70 million users. Because GSTN has refused the Comptroller and Auditor General of India access, citing its “private entry status,” there is little scope for auditing the authenticity of GSTN information, which could compromise public trust.

Additionally, particularly in the short-term, small and medium-size businesses are facing difficulties in integrating and transitioning to the new system, in terms of cumbersome documentation requirements, complex and unaudited IT systems, and adapting to the new taxation on their businesses. There have been day-to-day business disruptions and revenue losses during the transition phase. And lower thresholds for tax exemption imply that a manufacturer, service provider, or retailer who did not face a tax levy, will now enter the GST network, which could increase their costs.

The fundamental drawback with the tax code is that the onus is placed on the purchaser, who is responsible for filing all documentation on behalf of the supplier, in order to acquire input tax credit. Problems could arise if inconsistencies are found in suppliers’ documentation at later stages, in which case the buyer would end up having to pay for not only his/her share of tax, but also for the supplier’s share – or be forced to pay back the tax reimbursement to the government with interest. This problem could be fixed in the long run by market forces, which ensure non-compliant suppliers lose out on customers; and by a government mechanism to allow customers to pinpoint such defaulters, which is expected to take effect in the future.

Finally, the anti-profiteering clause requires that businesses pass on any benefits of the changes to the final consumer. However, because of ambiguity in the framing of this clause, firms might be affected as tax authorities will be given the leeway to make arbitrary judgments about whether a business is engaged in profiteering or not. Simultaneously, consumers will be affected because of the lack of transparency in the ruling, giving rise to fears that political connections or corrupt practices will affect these judgments. Again, this ties in to a compromise in the public confidence in GST – a fundamental determinant of the success or failure of the new tax regime.

Course Corrections
The GST Council, empowered to oversee tax rates and regulations, and composed of finance ministers from the states and center, has been meeting monthly to take stock and propose alterations with respect to the implementation of GST. The council has lowered the rates on several items to help distressed industries and eased the burden of compliance in response to problems faced by traders. The deadline for firms to file their forms was also extended, which was welcomed as a huge relief for businesses.

While these are welcome alterations, several issues remain unaddressed. The GST system is expected to span the country by April 2018. It remains unclear how inter-state business interactions will be impacted, and industries have good reason to worry about extant as well as fresh complications. But amidst the flurry of documentation requirements, IT adjustments, and anti-profiteering provisions, it would bode best for the government to work to bring more clarity to the remaining grey areas and instill a stronger sense of confidence, for both producers and consumers, in the theoretically promising policy endeavor. Most strikingly, the issues surrounding GSTN and auditing the complex IT infrastructure remain a fundamental barrier to all-important public confidence.

If implemented correctly, the outcomes from the reform will reflect its much-needed economic rationale. Eliminating double taxation and multiple tax hassles, increasing efficiency, assimilating the informal sector, lowering transaction costs and product prices, and intra- and inter-state movement of goods and services could be overwhelmingly positive boosts for Indian markets. Perhaps with a committee to oversee complaints, a more comprehensive auditing system, more specific delineation of what is “anti-profiteering,” and more widespread educational efforts, much-needed corporate and public confidence in GST could be instilled.

Thursday, February 22, 2018

The rise and rise of family firms

Though late on the scene, standalone family firms have established themselves as formidable players

This article was first published in Forbes India magazine, Issue: March 02, 2018; Co-author: Kavil Ramachandran

The year 1991 ushered in a new dawn for the Indian economy with economic reforms across sectors. The entrepreneurial spirit among Indians took advantage of the opportunities, and a new class of family businesses—the standalone family firms (SFFs)—emerged.

In a paper titled Family Business 1990-2015: The Emerging Landscape published by the Thomas Schmidheiny Centre for Family Enterprise at the Indian School of Business in July 2017, we said that by 2015, SFFs accounted for 57 percent of the 4,809 listed firms studied. Close to 73 percent of these were incorporated between 1981 and 1995. SFFs were, in a sense, a creation of the new reforms.

Prominence in the ecosystem
Though SFFs emerged late in the entrepreneurship ecosystem, they soon established themselves as an integral and leading player, belying worries about the potential of family firms to withstand competition. Evidence suggests that the removal of restrictions and controls led to this spurt. Several factors have shaped the destiny of SFFs.

New opportunities: Post-1991, structural changes in the economy and industry provided multiplier effects. Many entrepreneurs were either from business families or became one because of ownership structures. Reduced controls enabled the entry of first-generation-entrepreneurs-turned-SFFs into new territories. Ease of access to the capital markets enabled them to raise funds early on. The average difference between their listing year and their incorporation year was 10.01 years, much lower than business group-affiliated firms or MNCs. 

Need for scale to be competitive: The removal of ceilings on capacity and investment, the need to improve efficiency, and scale up led SFFs to focus on a single firm with related products, services and markets. Entrepreneurs did not need to diversify and establish multiple firms to grow, as was the case earlier.

Break-up of the joint family: Historically, business groups had flourished under the ownership of joint families. The emergence of nuclear families meant there was room for next generations to get involved in the same business, without the need to incorporate multiple firms for the members of the next generations.

Unique value creation by SFFs
SFFs have long-term orientations towards success across generations; rarely is enterprise exit an option.

Most successful SFFs have a strong synthesis of entrepreneurial energy, professional discipline and organisational governance. Promoters with sound family governance provide a strong platform to build the enterprise on a rich resource pool of emotional support, committed manpower and continued purpose.

One of the compulsions faced by SFFs is to remain together for economic reasons, if not for emotional reasons.

Emerging challenges
More than half of SFFs are less than 30 years old, with the founders still actively involved in most. Many would be staring at a change of guard soon. It needs to be seen if these firms survive the change.

SFFs have to pay greater attention to their future strategy, professionalisation and governance at family and business levels. There is every chance of a well-run SFF getting into a growth trap unless proactive action is taken on strategy, professionalisation and governance.