Stay in touch

Dear Friends,

It's been a wonderful summer. I started this blog a couple weeks after graduating from business school in order to stay on top of the news. I never could've imagined how many fascinating conversations would arise, on Facebook, on messenger, and in person, with you, my friends. I'm starting a new job on Monday, and will be closing this blog tonight. But I hope you will reach out anytime you want to discuss, debate, or just talk about what's happening in the world. My email is matthewgschwarz@gmail.com, and you can always find me on Facebook. Thanks again for taking the time to read, consider, and respond to my ideas on leverage. I sincerely appreciate it.

Sincerely,
Matt

The Good, the Bad, and the Ugly

This is a guest post from Vivek Gupta, following his excellent analysis of the major challenges facing India

I am not a big fan of the Indian Budget process. A simple exercise, designed to present the statement of accounts, has mutated over the years into a once in a year policy statement that has the whole nation and capital markets waiting with bated breath. Such immense signaling power creates problems around expectation management, resulting in a pressure to announce “big bang reforms” rather than gradual changes that are required in a country still coming to terms with globalization. But the Budget is likely to dominate economic policy-making for some time to come, so without further ado, here is my analysis of this year’s Budget.

The Good

• REITS: The government announced a major push for REITs  (including Infra REITs). While this asset class had been talked up earlier, this time the intent seems to be more serious.  Implemented well, this will not only give real-estate crazy Indians a opportunity to hold this asset class in a liquid form, but also prevent them from taking on onerous debt burdens to build a real estate portfolio.

• Tax Settlement for firms: Taxation has been the bane of the Indian industry for the last few years, with some tax issues likely to persist for many years. The widening of the scope and powers of the Settlement commission will cut down the legal red tape and provide a fair system for companies to address their grievances.

• The Startup Fund:  The world seems to be divided on this one and many would have me put this in ugly. With almost $2Billion in capital, the Government’s proposed start-up fund will be one of the top 10 VC firms in the world (by AUM). While many feel that this will be another avenue for politicians to distribute money to their kids – I am inclined to take a more charitable view. Indian VC firms (or Indian arms of Silicon Valley VCs) are still fairly conservative and focused on a few ‘safe’ trends (look at the herd trampling into ecommerce). A government VC fund, with a greater risk appetite, may actually play the role that DARPA and other agencies played in kickstarting the Silicon Valley tech revolution. Only time will tell, but as a policy this is a good move.

• Multi-Use “know your customer” and integrated online account to store all investment data.  This seemingly innocuous procedural change has the potential to drive financial sector reforms in a big way. Simply put, these two changes will make it easier to open a bank account and manage investments. With customer verification and fragmentation of data being the major customer challenges, these seemingly cosmetic changes can increase financial inclusion and deepen capital markets further.

The Bad 

• Retrospective Taxation and GAAR: Probably the biggest policy pain inherited by the government - most investors were looking for an outright repeal of the policy. The markets reacted negatively to the Minister’s assurance that this law will not be aggressively pursued. This goes to highlight the problem I mentioned above. With a multi-billion dollar tax dispute under arbitration, there is no way a rational government would give up its negotiating leverage by repealing the law today. The markets seem to have interpreted a company specific issue as a general policy decision. I am still confident that given the all round criticism, retrospective taxation will die a natural death and the much necessary GAAR will be implemented at a future date.

• Fiscal Deficit: The Government not only accepted the 4.1% target set by the previous minister but also promised to lower the deficit to 3% within two years. Honestly, it did not have much choice. Caught between the hammer (read: Institutional investors and rating agencies who look at this as a headline number) and the anvil (read: welfare policies and a drought like situation), some creative accounting should take the government close (if not to) the target. Bloomberg seems to attribute this as the reason for lower Indian bond yields. I am more circumspect and would look to the government’s performance towards lowering the deficits in the next financial year before popping the champagne.

• 49% FDI in insurance and defense:  Why bad you ask, when the whole world is cheering? I believe that just allowing foreign investors to put in money does not mean that they WILL put in money. These two sectors suffer from BIG policy problems – investment problems are secondary. Take the loony defense procurement procedures as a case study, or consider the fact that after initial losses, the market share of the state insurer LIC has never gone below 60%+. Unless the underlying structural concerns are addressed - by a more enlightened DPP (Defence Procurement Procedure) and an insurance regulatory restructuring - this FDI boost will remain a paper tiger.

The Ugly

• Capital gains tax increase for Debt mutual funds: The Indian government’s relationship with Debt markets is like that of a hormonal teenager. It wants to propose and woo the “deep debt market” lady and makes elaborate plans, but every time peer pressure forces it to break her heart. Proposed under the garb of removing a tax anomaly, this proposal not only increases the capital gains tax rates to 20% but also increases the tenure for eligibility to 3 years. For investors getting their taste of the debt markets through FMPs, this is a double whammy. Why would anyone want to invest in a more risky basket of corporate debt, with somewhat uncertain returns, when they can walk into a government owned bank and get a term deposit at assured returns and zero risk? Couple that with the weak Debt Recovery Tribunal system and debt increasingly seems like “equity with lower returns and no tax benefits”. Yes, agreed that Debt mutual Funds have not gathered sufficient traction and have often been sold by advisors for dubious reasons, but it is now time for the 66 year old teenager to now make up its mind - does it want a vibrant debt market supported by domestic capital?

• The missing devil:  India has no shortage of brilliant Oxbridge + Ivy economists, what it lacks are on ground execution specialists. And execution requires detailing. This is where the new government promised to be different so it was disheartening for me to see that this budget also had many proposals, without surrounding details. Maybe this was not the place for it, maybe it will come later – but I would like to see more of the details before I believe the story further.