Best investment options in the real estate sector

This article was first published in the business section of www.rediff.com on July 18, 2014; Co-Author: Pooja Bajaj

http://www.rediff.com/business/slide-show/slide-show-1-column-best-investment-options-in-the-real-estate-sector/20140718.htm

This rise in urbanisation and economic affluence supported with significant infrastructure developments, government initiatives and demand-supply gap has triggered development across real estate spectrum says Pooja Bajaj and Nupur Pavan Bang.

India, the world’s fourth largest economy with 1.2 billion people, has steadily emerged as one of the most preferred destinations for global business. 

Consequently, this has fuelled demand for real estate across verticals viz residential, commercial and hospitality.

On account of globalisation, favourable socio-economic profile, natural features, demographics and government initiatives, the Indian realty sector is being viewed as one of the most favourable destinations for investors and developers globally. 

Increase in the natural and migrant populace in cities in search of jobs and business opportunity who are keen to invest in real estate, coupled with rising per capita income, have given a major demand boost in the sector. 

According to the United Nations estimates, India leads in the rate of change of urban population amongst all the BRIC nations (Brazil, Russia, India and China). 

It is estimated that 843 million people will reside in cities by 2050 in India, which is equal to combined population of the US, Brazil, Russia, Japan and Germany. 

Favourable government reforms and policies such as repealing of Urban Land Ceiling Act, altering FSI rules, allowing 100 per cent FDI in the construction development through automatic route, approving the recent Real Estate (Regulation and Development) Bill, 2013, have further strengthened confidence of investors in the sector. 

This rise in urbanisation and economic affluence supported with significant infrastructure developments, government initiatives and demand-supply gap has triggered development across real estate spectrum. 

Apart from residential, commercial and hospitality, development of educational and healthcare institutions has further widened the scope of opportunities for the sector. This development is now not restricted only to metropolitan cities but is quickly gaining momentum even in Tier II and III cities as well.

As per an IBEF report on the sector, “the second largest employment generation sector after agriculture, real estate contributes about 6.3 per cent to India's gross domestic product (GDP). The real estate sector of India is projected to post annual revenues of $180 billion by 2020 against $66.8 billion in 2010-11, a compound annual growth rate (CAGR) of 11.6 per cent.  The foreign direct investment (FDI) in the sector is expected to touch $25 billion in the next 10 years from its current $4 billion”. 

The construction development sector, including townships, housing and built-up infrastructure garnered total FDI worth $22,671.95 million in the period April 2000-August 2013. Construction (infrastructure) activities during the period received FDI worth $2,280.95 million, according to the Department of Industrial Policy and Promotion (DIPP).

The real estate prices over the past decade has increased manifold across cities. During the period Q2-2009 to Q3 -2013, India has witnessed an increase in residential apartment prices by over 50% on an average.

As per Knight Frank Research, since 2009, IT/ITeS driven markets of Bengaluru, Pune and Chennai have witnessed a minimum of 38 per cent increase in weighted average price.

However, currently it’s mainly the affluent investors who are able to reap the benefits of high return in the sector. 

Despite the desire to invest in realty, the mid-income-segment populace of the country is not getting the right opportunities primarily on account of large ticket size, transaction costs coupled with high home loan interest rates.

For example, the overall ticket size of an apartment may vary from about Rs 3.6-3.8 mn (considering an average 2 Bedroom, Hall and Kitchen apartment of 1200 sq.ft.) in business districts such as Madhapur, Kondapur and Gachibowli situated at a distance of about 8-12 kms from prime residential areas in Hyderabad.

From investment perspective, an amount of about Rs 4 mn for direct purchase of property is not only a large ticket size for a small investor, but this option involves several risks related to title of the property and furthermore benefits of diversification are also not available. 

While housing loans are available, the high interest rate regime in India, makes taking loans against property a less attractive option. 

Investment Vehicles

Real Estate Fund is a vehicle that can bridge the gap between properties and investors.

A real estate fund is a professionally managed portfolio of diversified real estate holdings which invests pooled funds in residential, commercial, corporate or rental properties. 

Globally, in the recent years, different types of fund vehicles available to, and chosen by, sponsors and managers of real estate funds have proliferated. 

HDFC, Birla Sun Life, Kotak, ICICI Prudential, ASK, Piramal Group, Milestone etc have introduced real estate funds through the Portfolio Management Services (PMS) route or the Venture Capital route or the Private Equity route which primarily raise funds from Indian HNIs. 

However, most of these funds came into existence before the Alternate Investment Fund (AIF) guidelines were implemented by Securities and Exchange Board of India (SEBI).

AIF, notified by SEBI in May 2012 in India, allows pooling of funds from Indian and foreign investors for investments in areas like real estate, private equity and hedge funds.  

As per the guidelines, AIFs shall be close-ended funds and have tenure of atleast three years with a maximum number of 1000 investors. Further, the minimum investment to be accepted by AIFs from a single investor is Rs 1 crore (Rs 10 million), thereby differentiating retail investors and long-term high-net-worth individual (HNI) investors.

Another popular vehicle for investment is Real Estate Investment Trust (REIT). To enable real estate investors reach capital markets, in 2008, SEBI had issued certain draft regulations for introducing REITs and later in October 2013, SEBI announced the draft consultation paper on REIT Regulations. 

As per the regulations, REITs in India would issue securities, which would be listed on stock exchanges and will invest 90 per cent of the net asset value in completed rent generating properties in India and remaining in developmental properties, listed/unlisted debt of companies, mortgage backed securities etc.

They may raise funds from any investors, resident or foreign. It is proposed that initially the units of the REITs may be offered only to HNIs/institutions and therefore, the minimum subscription size shall be Rs 2 lakh.

REIT shall provide investors a real estate investment vehicle which has characteristics similar to mutual fund and Exchange Traded Fund structures for stocks, bonds and other securities. 

REITs offer several benefits as they will be listed, will provide regular and stable source of income for investors with least project execution risk. However, the proposed initial investment requirement of INR 2 lakhs may be high for some retail investors, though they are much lower than the minimum required investments in AIFs.

In 2008, SEBI issued guidelines for Real Estate Mutual Fund (REMF) in India. Similar to a Mutual Fund, a REMF is a scheme of a trust fund set up to manage pooled money of unit holders by investing in real estate projects, mortgage-backed securities as well as equity/debt/debentures of real estate companies.

These funds are close-ended and listed on stock exchanges. In addition to earning returns from properties by way of rents and capital appreciation, these funds also get interests, dividends and share price appreciation from securities of real estate companies.

Issues related to valuation, lack of clarity and uncertainties have deterred players from launching REMFs till now in India. However, with strong fundamentals and improving transparency in property market, REMFs are expected to make it easier for an average investor to invest in real estate. 

With such funds, even by investing an amount of say INR 10,000 - 20,000, investors may be able to own a small portion in a high value property.

It will also provide significant benefits of diversification as investors may be able to invest in different types of properties across different cities without getting into cumbersome paperwork.

There are certain critical differences between a REIT and REMF. REITs have to invest 90 per cent of the net asset value in finished real estate projects and not more than 10 per cent in developmental properties.

However, REMFs have to invest at least 35 per cent in finished projects and at least 75 per cent of the corpus in real estate or related securities, and therefore they can invest in under-development properties to a large extent. 

While REITs offer investors a regular income, REMFs gives capital appreciation too on account of investment in under-construction projects.

Conclusion

Indian real estate is one of the most sought after investment destinations for both HNI investors and retail/small investors. 

However, currently most of the investment vehicles – direct purchase or AIF available are primarily targeting or can attract only HNIs on account of huge ticket size for investment. 

REITs have also been proposed to target HNIs initially. For an average investor, investments can be routed through REMF or Real Estate ETF. Both these options are currently either not available or not successful.

The government should consider the need of these investors who wants to participate in the sector. This will provide further impetus to the sector by supplying additional source of capital via retail investors' money.

This might also reduce black money in the sector significantly by making operations of various stakeholders involved more transparent and accountable.

Why India can't do away with taxes

This article was first published in www.rediff.com on June 10, 2014

http://www.rediff.com/business/slide-show/slide-show-1-perfin-why-india-cant-do-away-with-taxes/20140610.htm

The idea of no taxes certainly brought a spark in the eyes of middle class Indians in the last couple of months as Prime Minister Narendra Modi mulled reforming the tax system by abolishing direct taxes (income, excise and sales) during his election campaign. The very prospect of spending the spring doing better things than worrying about the optimal amount of savings to save income tax is thrilling. Particularly, after a year of high inflation that put many holes in the pocket of middle class, the idea of doing away with taxes seems to be a magnificent idea.

The Bhartiya Janta Party (BJP) later clarified that they did not mean abolition of direct taxes. They are really pitching for major reforms in the ‘taxation regime’ in its current form in India. The statements however have opened up a Pandora’s Box over the merits and demerits of a no-direct taxes regime for India.

Half of the Indian government revenues in a year come by way of tax collection. Of this half, one third comes as corporate taxes and remaining two third by way of indirect taxes and taxes on personal incomes (Figure 1).

Figure 1: Break up of Tax Revenue to Government of India (Assessment Year 2013-14)

Source: Income Tax Department, Government of India

This is a huge chunk of government revenue. So there has to be a recovery plan for this forgone revenue. As an alternate to the present taxation system, ‘Banking Transaction Tax’ (BTT) is being proposed under which a flat percent will be charged whenever an amount is credited to a bank account. Under this system, it is argued, the government will generate more revenue than the present taxation system, the problem of tax evasion and black money will be solved, and an easier way to collect taxes will be devised.

This already attracted opposition from within for BJP earlier. Senior party leaders like Arun Jaitley and Yashwant Sinha had opposed the proposal as it shifts the tax base to the entire population which has a Bank account. In addition to middle and high income class, low income class would also be subject to BTT. Also, the implementation of BTT would essentially mean that all transactions be done electronically. Let us not forget the level of financial inclusion in India. India has 10 commercial bank branches per 100,000 adults and 7.29 ATMs per 100,000 adults. Less than 60% of total households in India have access to banking services. Implementing BTT would mean leaving out the balance 40% of the households which need not necessarily comprise of poor people.

Even if we take the case of only personal income tax being abolished, it will lead to giving up 10% of the total government revenue. If no income tax were collected in the current fiscal year 2013-14, the fiscal deficit will widen from an estimated figure of 4.8% to 6.9%. This will have to be sourced from somewhere else, mainly by increasing indirect taxes and excise duty of some goods. Therefore, the common man is going to pay taxes on way or the other.

Now, let us also take a look at the countries which do not have taxes. According to a survey of 114 countries by KPMG in 2012, ten countries didn’t charge any income tax (does not include corporate income) and indirect tax (Table 1).

Table 1: Countries with no tax on personal income and indirect taxes

Source: CIA World Factbook, Various articles

Most of these countries belong to the Middle East and are rich in oil and gas resources, while remaining depend on tourism and international business. Another common feature of these countries is that most of them have monarchy as a system of governance. As regard taxes, Bahamas, Bahrain, Bermuda, and Cayman Islands do not even have taxes for corporate income. While these countries do not charge tax on personal income of individuals, all of them mandate a social security tax ranging between 4-9%. Employers are also made to contribute in certain proportion towards a pension scheme for the employees.

However, none of these countries is comparable to India. Nine out of these ten countries have population less than 1% of that of India (Saudi Arabia excluded). Seven of these countries have land area less than 1% of that of India (Saudi Arabia, Oman and UAE excluded).

Not only demographics, but India differs from these countries on major economic indicators (Figure 2).Due to their smaller population base and rich natural resources, these countries have per capita GDP which is manifold of that of India. On the other hand, India, being the fourth largest economy in the world in terms of GDP and second largest in term of population, has to deal with high inflation and budget deficit which are at convenient levels in most of these countries.

Figure 2: Economic Indicators of Zero Tax countries and India (2012)

Source: CIA World Factbook

With a large economy, very low per capita income, high inflation and budget deficit, India can’t possibly copy the taxation system of these small countries that rely on natural resources for government revenue and are among richest countries in the world.

Among these countries, many are facing problem of sourcing funds already. Qatar was considering introducing a Value Added Tax system to increase the government earnings. Kuwait was warned by International Monetary Fund in 2012 for possible shortage of public finances and had suggested introduction of direct and indirect taxation system. Bahrain was also facing problems with public finances in 2012 as increase in wages and public spending during the year had led to shortage in available funds.

It seems that the spark in the eyes of common man has to fade as of now for abolition of taxes in India will need a lot more thinking before it can be sustainably implemented. Till then, all eyes are on Mr. Arun Jaitley!

Top Reasons Indian Election Is Important to Global Investors

An article by Savita Iyer-Ahrestani, for the Investment Advisor magazine of Franklin Templeton Investments.I have been quoted in the article.

http://www.thinkadvisor.com/2014/05/05/top-reasons-indian-election-is-important-to-global?page_all=1

Be smart with your money and you will see best results

This interview was first published by www.rediff.com on May 03, 2014
http://www.rediff.com/business/report/interview-be-smart-with-your-money-and-you-will-see-best-results/20140503.htm

To set up any business in India may be little time consuming, but it is not so difficult as it is conceived to be. Raamdeo Agrawal, joint managing director of Motilal Oswal Securities also not had it easy when he co-founded the firm in 1987. Agrawal follows some simple but very important fundamentals that have helped him steer his business through thick and thin.

Along with handling prime responsibilities at Motilal Oswal, Agrawal is an Associate of Institute of Chartered Accountants of India and also a member of the National Committee on Capital Markets of the Confederation of Indian Industry. He is the recipient of several accolades for his contribution to the capital markets.  

In a free wheeling conversation with Nupur Pavan Bang of the Insurance Information Bureau of India and Vikram Kuriyan of the Indian School of Business, Agrawal talks about his journey, investment process that he adopts and his faith in the Indian economy.  

You have built Motilal Oswal from the scratch. It is not easy to build a financial advisory firm in India as people do not want to pay for such services. Tell us about your journey, about the challenges.

In1987, Motilal Oswal and I started a sub-broking firm. The initial few years were a struggle. But we always insisted on research. The Harshad Mehta scam happened in 1992. The scam resulted in the Sensex touching 4,500 but it was a fantastic business opportunity. Volumes exploded and we made a lot of money and re-invested them into the market which further appreciated multiple times. Then the market crashed around 50 per cent. By 1993-94 we made a few crore.

We kept on building our research team and ventured into Institutional broking. Morgan Stanley became our first client. By 2002 we were the best Indian local brokerage house and since then we have maintained the number one or may be second position in research.

In 2003, Motilal Oswal had a topline of Rs 10 crore (Rs 100 million) and a bottomline of Rs 2 crore. The bull phase from 2003 to 2008 saw the firm growing 90 times to Rs 900 crore (Rs 90 billion) and pre-tax profit of Rs 300 crore (Rs 3 billion) respectively. We paid Rs 100 crore ( Rs one billion) in taxes in 2008.

When we got listed on NSE and BSE in 2007, our market capitalization on the day of listing was close to Rs 2000 crore (Rs 20 billion). In three months it crossed Rest 6000 crore (Rs 60 billion) indicating the confidence of the investors in the company. Complete client satisfaction and research are the basis of our business.

Focus on research must have been difficult way back in late eighties, as the World Wide Web and internet were not available then. How did you manage to research?

The absence of or limited access to resources had both advantages and demerits. I went to the US and walked into a Barnes and Noble book store and found many good books. But I could not buy them as I did not have the money. Up until 1994, there was a scarcity of resources. So what we did was that we physically went and collected almost 200 to 300 balance sheets each year. The biggest disadvantage then was that we did not have historic data.  

We examined ratios like the EBITDA margin, cost margin, etc. Very few other competitors had the kind of edge (competitive advantage) that we built in understanding corporate India. I had a good feel for numbers. I would remember everything for every company because my brain was empty. Today everyone’s mind is full of all irrelevant things due information flowing in from all corners. The biggest challenge is to focus your mind on getting what is important.

Where does one begin to look, in order to invest in the stock markets?

Before one starts investing, always look at the business of the company. Invest in a business you understand. 99 per cent of the job is in understanding the business. If someone tells me about VSNL, I leave. It’s a complex business and I don’t understand it. You cannot evaluate a company unless you understand it. For most people, a company is just a number. Most people don’t know what Reliance actually does.

Once you understand the business, see if the business is good or bad. Is the long term economics of the company favorable? Is management trustworthy and able? Figure out if the company actually makes money or not. Making an investment comes later.

You must also look at what the company does with the money that they make. Do they distribute [dividends], re-invest or destroy? Lots of companies do not allocate capital. Even Infosys is sitting with crore of cash. We saw a leading telecom company mis-allocating funds and buying businesses that did not add value. The stock has not done well for a few years.

When QGL : Quality, Growth and Longevity, all three come together, the company will make money. Invest in such companies and let compounding do its job.

How does one acquire the skills to evaluate the business? Stock markets are risky and people can lose money.

Start investing in the market with small amounts. When you lose, you will realise your mistakes. Value derived from small mistakes is huge. Those lessons will not be forgotten. So it is necessary to start investing in small amounts.

Invest time in reading. If you don’t have the reading habit then you are out. That habit cannot be cultivated. The urge to learn more should be there. It’s about understanding and not information. Investing skill is a global skill, same in any market, same across time series. You have to learn and acquire those frameworks. A beginning has to be made by actually entering the markets.

You are a proponent of equities. But in India, people prefer to invest in fixed deposits or gold. Retail investors mostly lose money inequities.

Warren Buffet defines Investing as foregoing current purchasing power now for a greater purchasing power in future. The first big anomaly is inflation. In the last 34 years, India has recorded consumer price inflation of about 8.4 per cent. You have to earn at least post tax 8-8.5 per cent to stay where you are and fixed income [deposits] delivers that. So basically you are running very fast to stay where you are standing.  

Till 2005, gold was as good or bad as fixed income. But in recent times it has done better. In India, it also has to do with the culture rather than the notion of investing.  

Equities are one asset class where you can beat inflation and by a large margin if you make the right decisions. There are two emotions in the market: greed and fear.

People come only out of greed. Greed is highest when market is at the peak of the bull phase. That is the time when 80-90 per cent of the investors enter the market, when actually no one should come close to it. They sell when fear is the dominating emotion, that’s when the market is at the bottom. So they buy at the top and sell at the bottom. It will keep happening. You have to master these emotions. Buy when everyone is selling and sell when everyone is buying. If you do that, you will not lose money.

How do you see the next 25 years unfolding for India?

When we became independent in 1947, our population was 330 million and our GDP was $10 billion. It took 60 years (2007) for the country to become a trillion dollar economy. When a country becomes a trillion dollar economy, it starts getting noticed. In 2013 or 2014, it will be a 2 trillion dollar economy, despite the rupee depreciation. The time taken to achieve the 3rd trillion mark will be even shorter.

Magic is in the $1000 per capita figure. $900 is non-discretionary. It is needed for food, shelter, etc. Anything beyond that is discretionary. As of now, we have only about $100 as discretionary. The journey has just started. In 1987 this journey was blank. The market capitalisation of Cipla was Rs 5 crore ( Rs 50 million). Today it is a Rs 30,000-40,00 crore (Rs 300-400 billion) company. Reliance would be a few 100 crores at that time. Scale has changed in the last 25 years and will be bigger in the next 25 years.

Doubling of GDP means exponential opportunity for various businesses. One must prepare for it and participate in it. Foreign Investors are already investing in India. We are looking at the present but they are seeing the future. Why does Walmart want to come? Because India will be one of the largest market in the next 25 to 40 years for brands or logistics.

Why Etihad? Why P&G? In the future, entry barriers will be much higher than it is now. Lots of businesses will become almost monopolistic and that’s where the opportunity for investing lies.

In 1991, we had a billion dollar reserve. The country did not have a credit rating. We are in different times now. We have $280 billion of foreign currency reserves. The next 25 years will be very exciting.

You mentioned about the $280 billion of foreign exchange reserves that we have. Since the Federal Reserve in the US is tapering off quantitative easing, we have a widening current account deficit, dwindling foreign portfolio investments and a currency that has depreciated more than 25 per cent in a year, would you say it would be prudent for the Reserve Bank of India (RBI) to fire fight and sell dollars in the open market to bring the exchange rate to 2011 levels?  

We now have Raghuram Rajan at the helm of affairs at RBI. He is a much acclaimed person and he will do his job. He understands what is required locally and also how to meet the global challenges.

The fear for the worse has resulted in the Rupee depreciating to Rs 65 against the dollar. Before opening up the capital accounts, he is using the challenge to get ample liquidity.

Lots of weapons are available. There is no crisis. There was bad currency pricing. For 10 years, we had inflation differential of 5-6 percent but the currency did not depreciate. So what happened is that existing companies kept on losing their competitiveness and it became difficult for manufacturing companies to conquer the Chinese threat. It is good that the currency has depreciated now and people have understood the implications.

Which other factors will have an impact on the Indian markets and its performance?

Governance is a key factor. A period of five years of good governance will change everything. Today, investment in India forms just less than 1percent of global equity portfolio. That figure can double if governance is good. The amount of money which the world can send to India is humongous. The question is, do we deserve it or not? We area capital scarce nation. So we must play the game and attract capital.  

Moves by the Chinese is something that we should be aware of. Till 1998china was like India, after which it emerged. From 1997-98 it is a trillion dollar economy. Since 2009 it is growing by trillion dollars every year with little appreciation of currency. The world economy including India, will be far more impacted by what China does in comparison to the US.

India is far behind in development than China. GDP has slowed down to sub 5percent levels. Why would capital flow to India? Is there any source for optimism?

Well, we can talk about the negatives in the economy. But let there be balance. It should not be that we overlook all good that has happened. There have been major improvements in road networks, telecom networks, infrastructure, in the last 10-15 years. Public-private partnerships have evolved. iPhones are launched in India at the same time as in the US. We may not be happy with the pace of it. But there has been development.

The strengths of this country are very different. I am not undermining the difficulties but let’s not be bogged down by them. I have seen the Mumbai riots, the balance of payments crisis, and the sanctions that followed the nuclear tests in Pokharan. This generation takes the internet as a given. I did not have electricity when I went to school.  

We are impatient. We want all our cities to be like Shanghai. What we should realise is that we don’t have capital. If we see it as a challenge, we will overcome the problem. The challenges have kept changing over time, but as a country, we have always emerged triumphant.

How deleveraging affects economy

This article was first published in the business section of www.rediff.com on April 23, 2014; Co-Author: Khemchand H. Sakaldeepi

http://www.rediff.com/business/report/special-all-about-deleveraging-and-fiscal-deficits/20140423.htm

In the first article in the series of understanding how the economic machinery works, we introduced transactions, credit, interest rates and inflation (the article can be read here). In the second article, we dealt with the importance of credit and introduced deleveraging (the article can be read here).  In this part (third), we will delve into the impact of deleveraging and introduce fiscal deficit and quantitative easing. The concluding part would weave all the different parts of the economic machinery together to help the readers take a view on the current economic scenario in India.

Impact of deleveraging

In the previous articles we saw that deleveraging happens when the rate of increase in debt outpaces the rate of growth of income. Incomes fall, people and organizations cut spending or austerity measures are taken up, such as projects halt, pay cuts for employees, bonuses come down and unemployment increases.

Asset prices drop, credit disappears, stock market falls, the banks try to reduce debt – restructuring of debt, writing off defaults, deposits into banks fall and default rate goes up.

Then the government tries to redistribute wealth by increasing its spending for generating employment. The spending of the government more often is larger than the income in such scenarios. This creates fiscal deficits.

During deleveraging the income falls more than reduction in debt due to the austerity measures. This is deflationary and painful. It may even lead to an extreme case of recession, also known as depression. This is a classic case that has repeated many times in history. For example, even Hitler came to power because of the social disharmony created by depression.

In such scenarios, many economies resort to printing more money. The central bank buys financial assets from the government, who in turn engages in spending to generate employment and lift demand. This is called quantitative easing.

Printing money has an impact on the exchange rate as the supply of currency being printed increases in the market.

The central bank must play very safe and must strike a balance such that the income growth is larger than the rate of growth of debt. Once deleveraging begins, going back to the boom periods usually takes 7-10 years. Hence, it is called “the lost decade”.

Source: http://planningcommission.nic.in/data/datatable/1612/table_23.pdf

The debt to GDP ratio of India stood at around 68 percent in 2013. While this ratio is much lower than in countries like US and many European nations, the interest payments and principal repayments make India very vulnerable. The fiscal deficit of India has been on the rise since 2008 and reached alarming levels in 2011-12.

This also had an impact on the exchange rate. The Indian rupee started to depreciate again the dollar as the fiscal deficit widened, the GDP growth rate started to come down, and inflation was at an all time high. The flight to a safer currency (US Dollar) meant that the Indian currency depreciated. This caused great deal of concern to importers as their imports, which are often priced in US Dollars, became more expensive in terms of Indian rupees.

In fact, The Indian economy has an underground economy, with an alleged 2006 report by the Swiss Bankers Association suggesting India topped the worldwide list for black money with almost $1,456 billion stashed in Swiss banks. We are not only a rich country, but we can actually take on more debt if we had that money in India and really wipe the tears off every citizen and more. 

The above is a pretty complex but easy to understand story of how the economic machine works. We as citizens often get lost because we look at things at the microcosmic level and hence react emotionally. But if we were to see the big picture then we can play really smart in more ways than one. 

In the next piece we shall delve deeper into the state of the Indian economy currently and the uphill task the next occupants of the North Block face.

What do a PhD scholar and an entrepreneur have in common?

This article was first published in www.yourstory.com on April 11, 2014

http://yourstory.com/2014/04/phd-scholar-entrepreneur/

I am a PhD in finance with a stable job and the assurance of a fixed expected salary every month. My husband is an entrepreneur, and worries daily about weather, inventory and changing prices. To use a cliché, we are as different as chalk and cheese.

Yet, there is something that binds us. Our journeys. His journey comprised of leaving a comfortable job and creating something of his own. Mine comprised of devoting about six years of my life to doing a PhD, after having already spent 19-20 years studying.

While doing a PhD is not often compared to being an entrepreneur, there are more comparisons than meets the eyes.

The investment in terms of time and the opportunity cost of not taking up (or leaving) a job is huge as the stipend paid to a PhD student is far below what he or she would earn by working in the industry, just as the first few years of an entrepreneur is spent thinking about every penny. On top of it, the horror tales of endless hours one has to put in, the ever shifting finishing line, and the failures dissuade many from taking up a PhD program, just as the same reasons prevent many from leaving their jobs.

There are many who take up a PhD program but abandon it midways. Excessive reading, long hours, low pay, when other batch mates from graduation and post graduation days go for long foreign holidays and eat at expensive places, wear expensive clothes, it keeps reminding you of the life that you could have had! Sure enough, I keep reminding my husband of all the foreign vacations that we could have had!

Then there are others who take it up and stick to it till they finish. Once they decide to stick to the program, it does not take long for them to realize that they have made an investment which would change the way they think forever. The key is of course to get into a good PhD program which gives you rigorous training. A startup’s story is pretty much the same. Once it survives a few years, the chances of its success are high.

The coursework in a PhD program intellectually stimulates, teaches one to learn beyond the superficial and to dig below the surface. An entrepreneur goes beyond the theory and thinks out of the box to reach its customers. He must always innovate and improvise.

Next comes the periods of independent study. Most of the PhD programs have long periods of independent study, where the candidate is given time to read, formulate the hypothesis, review the literature etc. It is easy to keep postponing all this as there may not be anyone watching or asking for progress at frequent intervals. Discipline and self-motivation is the key here. Without discipline, one may take eight to nine or may be more years to complete their thesis.

When I complain about the long hours that my husband spends in the office, his reply is usually, “if I don’t do it, who will?” Since an entrepreneur is his own boss, spending that extra hour in the office takes a lot of motivation.

An important milestone is getting the proposal ready. Curiosity to find something, to discover something new, or to fill an important gap in the existing body of literature results in a good defendable proposal. Some people are born curious but others acquire the curiosity when they repeatedly read about a single topic and related work. Similarly, for the entrepreneur, that first product or the first order is the most important milestone. It can be the defining moment for the venture.

The process of writing a thesis is actually a process of self discovery. The journey itself seems like the destination. The quest for accuracy, for measurement and deduction, the single minded pursuit of data collection, learning to write and run codes (which have become an integral part of doing a PhD now a days) which one earlier thought one was never capable of doing, are all activities which stretch the boundaries of learning.

An entrepreneur also discovers that while his core competency might be marketing or finance, he is an office boy to a CEO, an accountant to a strategist, all rolled into one.

Then comes the stage where the comments of the supervisors, advisors and friends start coming in. Incorporating changes and going through the drafts of the thesis numerous times needs patience. There is no choice. If one does not have this trait, they simply have to acquire it, just like an entrepreneur keeps revising his product and strategies as the business progresses.

When the thesis is submitted after all the years of hard work, the feeling is unbeatable. The defense of the thesis and the award of the degree is the stepping stone to a career in academics and lifelong learning. Similarly, when a venture succeeds, it brings immense joy and wealth to the entrepreneur.

So, if you are passionate about something, either do a PhD in it or become an entrepreneur with a venture revolving around your passion!

Why is credit so relevant to India's economy?

This article was first published in the business section of www.rediff.com on March 12, 2014; Co-author: Khemchand H. Sakaldeepi

http://www.rediff.com/business/report/special-why-is-credit-so-relevant-to-indias-economy/20140321.htm

In the first article in the series of understanding how the economic machinery works, we introduced transactions, credit, interest rates and inflation (the article can be read here). This part will deal with the importance of credit and introduces deleveraging. The third part will talk about the impact of deleveraging and introduces fiscal deficit. The concluding part, weaves all the different parts of the economic machinery together to help the readers take a view on the current economic scenario in India.

But why is credit important?

Credit allows the borrower to increase his spending today. Remember that the borrower is required to improve his productivity so that he can pay for his past expenses in the future. Credit is good because spending drives the economy. One persons spending is income for another.  It is the fuel to the engine.

When someone’s income rises he can borrow more and spend more as his creditworthiness increases. Creditworthiness is made up of two things – his ability to repay and his real assets that he bought from his rising income. This process continues until the spending at the origin stops. This whole process is cyclical. Hence the short term credit cycles are formed.

Credit is relevant in the short run but what actually matters is productivity in the long run. That is the amount of goods and services our country produces. This is measured by GDP. The credit created just acts as the motivational force to improve our productivity.  It helps businessmen to compete in the market and produce more efficiently.

In fact, credit is an outcome of human behavior. We want to spend more that our neighbors. Sometimes greed and envy take over the thinking process, making people irrational.

In a country like ours, the culture can actually help us be better economists. Our wisdom of ages teaches us not to be overly greedy and not overly materialistic, as is evident from the high savings rate of our households. If we all were to work rationally then our country will automatically become more productive in the long run.

The only problem with credit is that it forces us to consume or spend more when we acquire it and it forces us to spend less than we produce when we have to pay it back. Hence if we take credit, it is of utmost importance that we also produce more so that we can maintain our spending status when we have to repay.

This does not always happen. An example is the US housing bubble when people borrowed more than they could produce. This bought the lenders to their knees.

This does not mean that credit is bad. It is bad only if you borrow to consume but do not increase your productivity. Credit does create inflation due to more money coming into the market and creating more demand for goods and services.

Now let us talk about credit cycles that are long term in nature and the most dangerous. The short term typically lasts for 5-8 years but the long term cycle lasts for 75-100 years.  This happens because people are more willing to borrow and spend than to pay back and assume that productivity will naturally increase. They think that things will forever be great and that credit will always be available.

Now imagine a weighing machine. On one hand we have income (productivity) and on the other hand we have debt. When debt is increasing and incomes rise with the same rate then we have little to worry. In such an environment assets value soar and inflation is observed (Inflation is a proxy of growth here). But this environment does not last forever.

When the debt repayment increases more than the income we must believe that recession is at hand.

But there can be a worse scenario.  In the developed world in the years 1929 and 2008, the rate of increase in debt had outpaced the rate of growth of income. This led to the peak of debt cycle and recession. The consequences are as expected. Incomes fall, people cut spending, asset prices drop, credit disappears, stock market falls, social tensions rise, people feel poor. This scenario is called – Deleveraging

Deleveraging

A vicious cycle begins –This is different from recession because interest rates cannot be further reduced.

If the interest rates are already very low (even close to 0%), lenders stop lending, borrowers stop borrowing. The economy comes to a halt. This is something that has not happened in India since 1991, just before the financial reforms. We as a country have this opportunity to learn from others’ mistakes as well as our past and can actually be careful in creating CREDIT BUBBLES.

In 1991, the government of India was close to default. The central bank had refused to new credit with which the country runs and foreign exchange reserves had dried up. Remember this was a world where the government used to run all the businesses and there was little private participation. We had to airlift our gold reserves as a pledge with IMF.

Debunking the Indian economy machine

This article was first published in the business section of www.rediff.com on March 12, 2014; co-author: Khemchand H. Sakaldeepi, Swiss Re

http://www.rediff.com/business/slide-show/slide-show-1-special-debunking-the-indian-economy-machine/20140312.htm

The subject of economics has always been very fascinating and yet confusing. Many curious and critical minds find it difficult to actually understand the state of our economy. We all understand the meaning of GDP, IIP, inflation, interest rates and intervention of central bank, that is, the RBI, to control money flow, the volatility of Indian rupee etc. But it is very difficult to join all the dots.

The media and academia are ripe with reports, articles and peer reviewed papers. All of these are many times contradictory and have their own school of thought, and for a common man it is difficult to comprehend.

In this article we will attempt to put the conceptual pieces together. This article is divided into four parts. The first part introduces transactions, credit, interest rates and inflation. The second part will deal with the importance of credit and introduces de-leveraging. The third part will talk about the impact of deleveraging and introduces fiscal deficit. The concluding part, weaves all the different parts of the economic machinery together to help the readers take a view on the current economic scenario in India.

How the Economic Machine Works

Let us begin by summarising the framework created by Ray Dalio of Bridewater Associates. He presents a very robust framework to understand 'How the economic machine works'. If one understands this well, the rest will be just nuts and bolts to play with.

Let us begin by imagining that the economy works like a simple machine. This is something that many people do not understand, or if some do understand it, then they are at disagreement over how it actually works. This is the exact reason why policy-makers and economists just cannot come to a conclusion when taking critical decisions. Therefore Dalio presents a simple template that can help us in more ways than we can imagine.

The economy is made up of simple parts called ‘transactions’ that come together and is repeated over and over again. These transactions, above all, are driven by human nature. Some assume that they are rational and others say they are irrational. These transactions create three main forces that drive the economy:

·                     Productivity growth

·                     The short term debt cycle

·                     The long term debt cycle

The transaction here refers to quid pro quo where the Numéraire (unit) is usually the currency (due to historical reasons) issued by a statutory body of the government of various countries (There are other interesting forms of money but we shall not deal with them in this article).

In any transaction we have a buyer paying for goods and services using money (store of wealth) and/or credit (store of expected future wealth) to the seller.  This summation drives the economy. If we can understand transactions then we can also understand the economy.

The biggest participant in these transactions is the government. It consists of the central and state governments and the central bank, the RBI in our case. The government collects money in the form of taxes (direct and indirect) and the RBI controls the flow of money in the country.

The RBI has two basic tools to influence the flow of money and credit in the economy -- interest rates and printing new money. We must now pay attention to credit.

Credit

This is the most important and least understood concept. It is important because it is a really big and volatile part of the economy. Credit can be created out of thin air. All we need is a buyer (borrower) and a seller (lender).

The buyer in principle borrows to pay for his present needs and the lender just acts as a facilitator for the prospect of increasing the value of their excess money. Here come the interest rates.

When the interest rates are low then people are more likely to borrow than when the interest rates are high. The RBI controls the interest rates that it charges the banks for giving them money (repo rate).

The historical interest rates and inflation rate in India are shown in the chart below. One can note that the rate has gradually been increasing since 2010 to curb inflation in India.

When credit is created it becomes debt. This is an asset for the lender but a liability for the borrower. When the debt is settled then the asset and liability both disappear.

The Debt to GDP or the level of credit with respect to the assets and goods that produced is given below. Fortunately we are well off here as compared to other countries like Japan (214.3%), Singapore (114%) and USA (72.5%).

Yet, they are supposedly (based on some mathematical default models) more likely to pay off their debt in the long run than India. India at 67.57% lags behind China (31.7%), Brazil (54.9%) and Russia (12.2%).

India's largest and most profitable airline!!!!!! INDIGO

Indigo Flight 6E354 from Kolkata to Hyderabad, departure 8.30p.m., February 24th 2014

At 6.30p.m. I got a message which said that the flight had been rescheduled to 11.15p.m.

There was no explanation for the rescheduling at the airport. There was no indigo staff at the airport who was designated to alleviate the concerns of the guests.

At 9p.m., two indigo kids [staff] came and asked the guests to collect dinner. Dinner was a cheese sandwich, a muffin, a kachori and buttermilk. I wonder what percent of the Indigo staff eat such sumptuous dinner! I beg ignorance, but I did not know that the four assorted, dumped, cold, dry, something, thrown together in a box, items could classify as dinner.

In the meanwhile, we got another message from Indigo saying that the flight was now rescheduled to 10.40p.m. There was a change in gate number, which was not announced.

The two kids who were distributing the so called dinner disappeared. While everybody waited for someone to come and announce boarding for 10.40pm departure, 10.40p.m. came and went and there was no sign of any indigo staff. The kids came back at 11p.m. and sat down and chatted and laughed, while the tired guests watched. A few of us had woken up at 4a.m. or 5a.m., had full day meetings, had kids waiting at home, were concerned about our safety upon arriving at Hyderabad airport and taking the cab home, the kids laughed and chatted.

A few guests had had enough and demanded that a supervisor come and explain the situation. Another kid came at 11.15p.m. (supposedly senior to the other two), and to silence the crowd, announced boarding and then made the guests wait in the bus.

Finally we boarded the aircraft at around 12.00 midnight. Airhostesses [kids again] were laughing away with absolutely no sense of the grim situation or the discomfort of the guests. The aircraft had mosquitoes. Not one, not two, but the aircraft was full of mosquitoes. The way you find them hovering over a drain or in slums. When a guest asked one of the airhostesses to spray the repellant, she just ignored. When the request was repeated again, she gave the logic that if she sprays the repellant, we will all breathe it and it’s not good for our health. While technically I agree with her, shouldn’t the airhostesses, or who-so-ever is responsible for preparing the aircraft, take care of such details earlier? Do we pay thousands of rupees to travel in such conditions?

The flight finally took off at 12.30a.m. and reached Hyderabad at 2.30a.m. A few other women and I made our journeys home, in cabs, alone. Does Indigo care? No. Did the incidence even register with the management? No. 

How India prevents money laundering

This article was first published in the business section of www.rediff.com on February 19, 2014; Co-author: Harkishn Mourjani (Quadrisk Advisors Pvt Ltd)

http://www.rediff.com/money/slide-show/slide-show-1-column-how-india-prevents-money-laundering/20140219.htm

India has been classified as high risk zone in terms of money laundering. Out of 140 countries, India was ranked 70th in 2013 and 93rd in 2012, by the Anti Money Laundering (AML) Basel Index. 

This clearly shows that India, in the present-day scenario, is very vulnerable to money laundering activities. Many acts exist in India, which directly or indirectly curbs money laundering activities. 

A few of such acts are:

·         The Conservation of Foreign Exchange and Prevention of Smuggling Activities  Act, 1974 

·         The Income Tax Act, 1961 

·         The Benami Transactions (Prohibition) Act, 1988 

·         The Indian Penal Code and Code of Criminal Procedure, 1973 

·         The Narcotic Drugs and Psychotropic Substances Act, 1985 

They proved to be inadequate in the treatment of money laundering matters. To curb the instances of Money Laundering, the Prevention of Money Laundering Act (PMLA) was introduced in the Lok Sabha on 4th August 1998 and was ultimately passed on 17th January 2003.  

Apart from the PMLA, there are other steps taken by the government to ensure that the instances of money laundering are prevented. A few of them are discussed here:  

Financial intelligence Unit (FIU)

The Financial intelligence Unit (FIU) operates in the legal framework established by the PMLA. FIU performs the basic functions of receipt, analysis and dissemination of information in accordance with the international standards set up by the Financial Action Task Force (FATF) and Egmont Group of FIUs.

As prescribed under the PMLA, FIU receives reports on cash transactions, suspicious transactions, counterfeit currency transactions and funds received by non-profit organisations. 

These reports are filed by reporting entities i.e. banks, financial institutions and capital market intermediaries, casinos, private locker operators, registrar to an issue of shares and dealers in precious metals. 

FIU maintains a database and shares these reports with various agencies.

Know your Customer (KYC) Guidelines

The objective of KYC guidelines is to prevent banks from being used, intentionally or unintentionally, by criminal elements for money laundering or terrorist financing activities. 

In order to prevent identity theft, identity fraud, money laundering, terrorist financing, etc., the RBI had directed all banks and financial institutions to put in place a policy framework to know their customers before opening any account.

The KYC guidelines were introduced by RBI in 2002, and all banks were instructed to be compliant by 31st Dec 2005. 

This involves verifying customers' identity and address by asking them to submit documents that are accepted as relevant proof. Mandatory details required under KYC norms are proof of identity and proof of address.

There have been many instances of KYC norms being flouted and there is need for the RBI to make the system more robust. 

A few examples of such instances are:

An individual investor, Roopalben Panchal, opened as many as 6,315 demat accounts with the National Securities Depository Ltd (NSDL) in benami names. 

She received 150 shares each from 6,315 allottees through off-market transactions, 9,47,250 shares in aggregate, which were subsequently transferred to six accounts, five of which sold the shares on listing to make a handsome profit of Rs 1.37 crore.

Similar modus operandi was used by certain investors during the IPO of Infrastructure Development Finance Company (IDFC).

Recent Changes in Prevention of Money Laundering Act (PMLA)

Definition of “Activities of Terrorism” was not present in PMLA 2002, however the same was included in 2010 as “Transaction involving financing of the activities relating to terrorism includes transaction involving funds suspected to be linked or related to, or to be used for terrorism, terrorist acts or by a terrorist, terrorist organisation or those who finance or are attempting to finance terrorism.” 

Until 2010, the enactment allowed protecting identity of beneficial owners, who could be represented by lawyers and accountants. However, it has been abolished as a part of the recent amendments made to the act in 2013.

RBI and IRDA did not have any provision to address cases for filling Suspicious Transaction Report to Financial Monitoring Unit. Circulars have been issued by both institutions to address the deficiency.

The earlier provisions of the Act lacked the prowess for due legislative action. Hence, the scope was broadened in 2013 to include concealment, possession, acquisition or use of property, and projecting or claiming it as untainted property. Commodity future brokers have also been included within the scope of the Act now.

The recent changes in the PMLA are welcome as a report from Global Financial Integrity, published in December 2013, reported that the total black money outflow from India was nearly $343 billion during 2002-2011.