Fenil's Library

Direct tax code will make TDS a tedious issue

noreply@blogger.com (Fenil) — Fri, 11 Sep 2009 06:40:00 +0000

A convoluted process to avoid deduction under the new code will increase paperwork for all parties

Sandeep Shanbhag

Most readers would be familiar with the concept of TDS or tax deducted at source.
TDS is tax deducted in advance — at the source of earning the income itself. At the end of the year, one aggregates one’s total income for the year and calculates the final tax thereon.

From such final tax, the amount of TDS is reduced and it is only the balance, if any, that is payable. Therefore, it is important that there is a nexus between the rates of final tax and TDS since the latter is a part of the former. Sadly, this doesn’t seem to be the case with respect to the new direct tax code (DTC) that seeks to replace the current Income-Tax Act, 1961.

For starters, the DTC has massive relaxations in the tax thresholds as they exist currently. Though the basic exemption limit is maintained at Rs 1.6 lakh, the 10% rate is applicable for incomes between Rs 1.60 lakh and Rs 10 lakh. The 20% rate is applicable for incomes between Rs 10 lakh and Rs 25 lakh. It is only for incomes above Rs 25 lakh that the highest tax rate of 30% is payable. Moreover, the equivalent of the Section 80C deduction the maximum ceiling for which is Rs 1 lakh has been tripled to Rs 3 lakh.

While the increased limits will give great relief to the average taxpayer, the problem is that the TDS rules do not seem to go hand in hand.

For example, the DTC has no provision for furnishing any declaration (as in current Form-15G for non-seniors and 15-H for seniors) for non-deduction of TDS. It will hurt all the investors earning income less than the tax threshold, particularly, senior citizens, widows, agriculturists and several others.

The only way of avoiding TDS is by making an application to the income-tax office (ITO). The rules regarding application and issue of such a certificate are as follows:

1 The DTC specifies that the deductee may make an application in the prescribed form and manner, to the assessing officer (AO), seeking a certificate for no deduction of income-tax from payments to be received by him. Similarly, the deductor may make an application, in the prescribed form and manner, to the AO seeking a certificate for no deduction of income-tax from payments to be made by him to a non-resident deductee.

2 The AO shall give to the deductee or the deductor, as the case may be, such certificate as may be appropriate, if he is satisfied that the total income of the deductee justifies no deduction of income-tax.

3 The deductor shall not deduct any tax until the certificate issued is cancelled by the AO or until the expiry of the validity of the certificate.
Obviously, the lawmakers are not in touch with the ground reality. Several questions needing clear-cut and realistic answers arise:

4 If all those who used to file Form-15G/H in ITA61 era make such applications and visit their ITOs in person, can the ITO handle this volume?

5 Even if one is successful in inducing the ITO to issue a certificate, will he give one which is valid for long? Improbable. This appears to be a yearly exercise.

6 Will he issue the certificate in good time to enable the assessee to send it to the persons responsible for applying TDS?

7 How can the individual send the original to two or more deductors?

8 Will a certificate of a notary be acceptable or will the ITO issue multiple certificates as requested by the applicant?

I have a suggestion for all those who are facing this peril. Distribute your investments in different avenues and ensure that the interest you earn is less than the prescribed limit for application of TDS.

Yes, this will increase paper work and your visits to the bank for crediting small amounts of cheques. This will also increase the cost of servicing your accounts.
The I-T Department is moving towards paperless regime to the extent possible. No annexures, not even TDS certificates, need be filed along with the returns.

The taxpayer is expected to hold these in his custody and present them to the ITO if called for. It is obvious that under the new regime, crores of additional TDS certificates will have to be issued by the deductors, increasing voluminous paperwork at their end. The department itself will be collecting money only to be refunded later, an activity which could have well been avoided. This will surely increase paperwork for the department by leaps and bounds. This is a national waste.

The only practical way out is to start filing your tax returns and begin praying for the refund due. Yes, this will create some liquidity problems for the assessee in addition to the fact that getting refund is associated with many hurdles.

The woes do not end here. The thresholds for application of TDS are contemptibly small amounts. The more common ones are of i) Rs 2,500 for interest on debentures, ii) Rs 10,000 for bank interest iii) Rs 5,000 for commission and brokerage vi) Rs 1.2 lakh for rent vii) Rs 1 lakh for acquisition of immovable property other than agricultural land and viii) Rs 5,000 for any other interest payable. The least they could have done was to increase these thresholds to a realistic level. Have you come across any immovable property being sold for under Rs 1 lakh? Why have such impotent provisions which will never come into the picture?

Schedule 3 lists the TDS rates for specific incomes. These are: — i) Salaries: rate applicable to the employee ii) Interest - 10% iii) Dividend which has not suffered DDT - 10% iv) Commission, brokerage, etc - 10% v) Rent - 1% for the use of machinery or plant or equipment and 10% for use of land or building and vi) Any other income - 10%.

This last item is a new residuary item. This is extremely frightful. It implies that any payment made for purchase of any goods or services or movable or immovable property, or for any item other than those listed above tax is required to be deducted at source and worse, there is no threshold. A strict reading of the above would suggest that TDS will also be applicable on day-to-day commerce and business income.

Hopefully the draftsmen of the code may not have realised the ramifications of some of the issues contained in the code. This article is dedicated to them with an earnest hope that corrective action would be taken.

Homeowners living in rented premises can get dual benefit

noreply@blogger.com (Fenil) — Fri, 11 Sep 2009 06:28:00 +0000

They can avail HRA exemption and deduct interest on home loans

Harsh Roongta

“Can I get both, exemption of HRA as well as deduction in respect of home loan?” This is asked frequently by homeowners living outside the town where the house is.
That’s because these days, it’s common practice for people to relocate to other cities for work, with the intention of coming back to our home city at a future date. If we relocate, we live on rent in the new city, and continue to own the property back home.

Even if we live in the same city where we work, travelling distances can be quite daunting. Imagine a two hour commute to work everyday — say, someone living in Dhanu Road but having office at Colaba, to give an example from Mumbai. How many of us will be able to last this regimen?

Hence, some of us live in rented accommodation near the workplace, even while keeping a house in the same city.

So, what if we want to claim tax benefits on the home taken, as well as claim exemption for our rented house?

The answer is yes, we can.

Claiming deduction for interest payable on a home loan and claiming exemption for HRA in respect of rent is completely de-linked. There is no restriction with respect to claims for both.

Exemption of HRA is covered under Section 10 (13A). The only conditions for allowing the exemption of HRA are:

l Rent must actually be paid by the assessee (legal term for the person whose tax liability is being worked out) for the rented premises which he occupies, the rented premises must not be owned by him.

2 As long as the rented premises are not owned by the assessee, the exemption of HRA will be available up to the limits specified in the relevant rules. There is no mention here about any effect on the exemption because of ownership of any other property.

Let us now turn to the deduction of interest payable on a home loan. The interest is not a straight deduction allowed from the salary income. The deduction is actually allowed while calculating the income from house property, although the effect in the case of self-occupied property is the same as allowing it as direct deduction from salary income. The relevant sections are Section 22 to Section 27. The calculation of incomefrom house property is done using the following calculation:

1 Rental income (net of municipal taxes) = Annual value (A)
2 Less: 30% of A as a standard deduction (S)
3 Less: Interest payable on any loan taken for acquisition or construction of this property (I)

l Income from house property = A-S-I (H)
The point to remember is that income can also be negative, or in other words, include a calculation of loss.

In the case of self-occupied property, the annual value ‘A’ is taken as nil. Therefore, ‘S’ automatically becomes nil (as 30% of 0 is 0) and ‘I’ is restricted to a maximum of Rs 1.5 lakh. Therefore, in the case of self-occupied property, the result of calculation of income from house property or ‘H’ will always be a loss to the extent of the interest payable on the home loan or Rs 1.5 lakh.

Where the owned property is given on rent, the annual value will be calculated based on the rental and the final income (or loss) from house property will be calculated as given above. Please note that in such a case, there is no restriction on the maximum amount of deduction available in respect of ‘I’.

Where the owned property is lying vacant and is neither rented out nor self-occupied, the rental that could have been derived has to be taken as the rental income and the calculation has to be done as in point 3 above.

The calculation of such a notional value has several difficulties. So, if a similar property in the neighborhood has been given out on rent, it can serve as a good basis to calculate this figure.

There are also a large number of case laws which have gone into the method of calculation of notional value. You may need expert taxation advice to calculate this figure.

“Income from house property” is taxed if it is positive and allowed to be set off against income from other heads if it is a loss. There is nothing in the section that affects exemption of HRA. Also, there are no restrictions against deducting interest in case the assessee is staying in any other premises in the same city, or in another city.

The principal amount repaid on all loans taken from specified entities such as banks/ employer companies, to acquire/ construct residential house property is allowed as a deduction under Section 80C up to the overall limit of Rs 1 lakh. This is not affected by the exemption of HRA. Thus, homeowners staying elsewhere can enjoy a dual benefit.

Note: The proposed direct tax code, if implemented, will make this issue irrelevant as it neither allows exemption for HRA nor deduction of interest payable on a loan taken to acquire a self-occupied property.

The world will continue to print more money

noreply@blogger.com (Fenil) — Fri, 11 Sep 2009 06:24:00 +0000

Governments will keep the press running to finance at least some portion of the fiscal deficit, as rising interest rates are not politically expedient

Vivek Kaul. Mumbai

It was one of those mornings. It had rained all night. There were puddles of water everywhere. The red gulmohar tree was in all its glory. And I woke up to a smell of strong filter coffee and a bright smiling face.

“I am confused,” she said.

“What’s new about that?” I retorted. “You are confused all the time.”

“Arre, I am not confused about us. But about something else.”

“Oh. Something else! And what is that something else?”

“Inflation and deflation.”

“But what is there to be confused about? Inflation is a situation when prices are rising and deflation is a situation where prices are falling,” I explained.

“V, having lived with you all these months, I know that much.”

“Then?”

“What I am unable to comprehend is that almost every big economy in the world is resorting to currency printing in an unprecedented way, something the world has not seen before. Conventional economic theory, as you have explained to me time and again, suggests that more money chasing the same number of goods leads to an increase in prices, and thus inflation. With all the currency that is being printed, the world should have been in the midst of hyperinflation by now,” she said, explaining her predicament.

“Do you understand the term velocity of money?”

“Oh. Physics in economics?”

“Yeah, physics in economics. Let us say a government prints $1 trillion and keeps it in its vaults. How much impact would this money printing have on inflation or price rise?”

“Zero impact,” she replied.

“Correct. Simply because all the printed money is in the vault and does not enter the economic system. Only when this money enters the economic system will it lead to a situation where in more money chases the same or even fewer goods, leading to a price rise. At the same time, it is important how fast does this money change hands, meaning how fast people receive and then go out and spend this money. The faster they spend this money, the more velocity money has and that, in turn, leads to a faster increase in prices and thus inflation.”

“Hmmm. So the question is why isn’t the money entering the system?” she asked.

“How does the printed money enter any economic system? I mean, no government prints money and then goes around dropping it down from a helicopter. Do they?”

“Stop being sarcastic. The money being printed enters any economic system through the banking system in any country.”

“Exactly. Now, take the case of United States of America. Commercial bank loans have gone down over a period of the last one, three, six and nine months. What does that tell you? As one economic commentator put it, ‘the bubble of trust has been broken’. Banks are no longer sure that what they lend will be repaid. So, it is better for them not to lend now, rather than be sorry later. Other than this, nearly 52 banks have closed down in the US and so have more than 300 home loan companies or mortgage finance institutions as they are called in the US. What does this do? The money remains in the vault, leading to a low velocity and thus, a situation where prices are not rising, but falling. In fact, the rate of inflation — or deflation, as we should call it, in the US right now is a negative 1.4%.”

“Is that the only reason for a low velocity of money?” she asked.

“In economics, there is never only one reason for anything. The other main reason for the low velocity of money is the fact that people are not spending it. In June, the U6 unemployment rate, which is the broadest measure the US has for measuring unemployment, reached an all-time high of 16.5%. This means one in six individuals has lost his or her job. In such an environment, people are obviously not going to go around spending the money they have. This again leads to a lower velocity and thus, no rise in prices despite the currency printing. Also, in an environment of such uncertainty, the rate of saving has shot up to around 5% of the gross domestic product from a near zero rate. People now realise they have huge debts to pay off and need to save money. Again, when people save, the velocity of money goes down, leading to a situation of constant prices or decrease in prices. The savings rate is only likely to increase in the days to come as people continue to save more. As they continue to save more, it implies they are highly unlikely to borrow money to spend as they had in the past. This in turn means velocity of money will continue to be low for sometime, and so inflation is not a threat for sometime at least,” I explained.

“But will the currency printing continue?”

“Yup, it will for some time. Governments, as I have told you, usually spend much more than what they earn. To make up the difference, they borrow. When they borrow, their outstanding debt goes up. As of end 2008, the US government debt stood at 41% of the GDP. This is expected to go up to anywhere between 71-80% of GDP over the next four years and around 100% of GDP over the next 8-10 years. This is a figure put out of the congressional budget office of the US. Now, it is highly likely the debt goes up at a much faster pace, given that tax revenues are slowing down big time. The US government’s tax revenues for April, which is the biggest revenue month, were down 34%. So the government will have to borrow much more than it is projected to borrow. And when that happens, the interest rates are likely go up, given that domestic as well as foreign investors may want a greater incentive to invest in debt issued by the US government. Rising interest rates is not a politically expedient scenario, given that US citizens have huge loans to pay off, as increasing interest rates will mean higher EMIs. So the easiest thing for the government to do is print currency to finance some portion of the fiscal deficit, instead of going out and borrowing the entire amount. And so the currency printing is likely to continue in the days to come.”

“Interesting. Anything else?”

“Some extensive research has been carried out on the topic of government spending and it clearly suggests that for every one dollar increase in government spending, private spending reduces by one dollar. In some periods, government spending does improve economic performance, but in other periods, it pulls it down. So net net, there is no impact on the GDP of the country, and at the same time, the government debt increases. This in turn leads to more currency printing to repay the debt. It also leads to increased taxes as the government tries to battle a slowdown in tax revenues as well as pay off its previous debt. One economic study even found that for every one dollar increase in taxes, private spending goes down by three dollars. Scary isn’t it?”

The example is hypothetical)

Of China, Ponzi scheme and the Panda put

noreply@blogger.com (Fenil) — Fri, 11 Sep 2009 06:15:00 +0000

China’s markets are up because everyone’s banking on the greater fool theory

Vivek Kaul. Mumbai

“Wisdom always comes late,” I told her rather philosophically early on Sunday
morning.

“Are you still hallucinating?” she asked, making a reference to the late night drinking binge we had indulged in.

“And by the time it comes, the damage has already been done.”

“What comes?”

“Wisdom.”

“Oh. But why are we talking about wisdom early morning?”

“Simply because we refuse to learn from our mistakes.”

“Can you stop beating around the bush and tell me what is on your mind.”

“Yes Ma’m! Basically I had China on my mind.”

“China?”

“Yeah, China. The stock market in Shanghai has gone up by a little over 90% since early November last year. Now what is surprising is that China, over the years, has evolved as an export-driven economy which is highly dependant on exports to the western markets. With western economies collapsing, Chinese exports have also collapsed. In the month of June, Chinese exports fell by 21.4% in comparison to the same period last year. This has had an impact on the earnings of companies. Profits of large scale industrial companies based out of 22 Chinese provinces fell by 21.2% for the first six months of 2009. But despite this, markets have been rallying. Why is that?”

“How would I know? You asked the question, you answer it!” she snorted.

“Well, the People’s Bank of China, which is the Chinese central bank, has been printing money big time. The Chinese money supply has gone up by around 28.5% from last year. This newly-printed money has found its way into the Chinese economy, with the government-controlled banks lending a record 7.4 trillion yuan ($1.2 trillion) of new loans in the first six months of 2009. Now, to give you a sense of proportion, these new loans are equal to almost one-fourth of the size of China’s economy and a little more than the size of the Indian economy. When such aggressive lending happening, a portion of these loans is being actively used to speculate both in the stock and the property markets, leading to both these markets going up so soon so fast, without any connect with the economic reality of the day,” I explained.

“And what is the economic reality of the day?”

“The economic reality of the day is that things are not good. As I explained, Chinese exports have fallen and so have company earnings, but the stock market is still going up. Or take the case of the Chinese property market. The average price per square metre in China is more or less the same as the price in the US. This, despite the fact that the per capita income in the US is seven times the per capita income in urban China. Property prices in the US have fallen dramatically in the last two years, but that still doesn’t justify similar prices. Basically, the Chinese economy has become a giant Ponzi scheme.”

“A Ponzi scheme? You love that phrase don’t you? To you everything looks like a Ponzi scheme!” she exclaimed.

“Actually, to tell you the truth, I did not figure this one out. Andy Xie, a former Morgan Stanley economist, who is now an independent economist based out of Shanghai, offered this insight around a week back. As I have told you earlier, the Ponzi scheme is named after Charles Ponzi, an Italian immigrant to the US. He launched an investment scheme in 1919, promising to double investors’ money first in 90 days, and later in 45 days. Investors got attracted to the huge returns the scheme promised. At its peak, the scheme had 40,000 investors who had invested around $15 million in the scheme. Ponzi had no business model in place to generate these huge returns. All he was doing was using the money brought in by the new investors to pay off the old investors. He ran his scheme till the money coming into the scheme was greater than the money leaving the scheme. One fine day, that stopped, and the scheme went bust.”

“But what has that got to do with the Chinese economy and stock market being a Ponzi scheme?” she asked.

“As I explained, the stock and property market going up has no link with economic reality. They are primarily going up because of all the money that is being lent and is finding its way into these markets. With all this new buying coming in, market prices are going through the roof. Such a market is akin to a Ponzi scheme. As a market starts giving good returns, more and more investors want to enter it. The money brought in by these new investors ensures that the price keeps going up and rewards the older investors, instead of any fundamentals, like in a Ponzi scheme. As Robert Shiller writes in his all-time classic Irrational Exuberance, ‘When prices go up a number of times, investors are rewarded by price movements in these markets, just as they are in Ponzi schemes.’ In addition, when the markets have been on their way up, investors tend to look at the recent past pattern and assume that the market will keep going up. They mistake probability for certainty.”

“Hmm. That makes some sense. But tell me something, what makes Chinese investors so convinced that the markets will keep going up?”

“Oh, that’s because of the Panda put.”

“Panda put?” she asked.

“Yeah Andy Xie, the economist, I talked about earlier, coined this term. It refers to the investor belief that the government won’t allow the markets to fall. The popular belief these days is that the Chinese government cannot allow the stock or the property market to collapse before October 1, 2009, the sixtieth anniversary of the foundation of People’s Republic of China. So, the bull run is on at least till then. The other major factor influencing this belief is the fact that taxes from property sales account for a major portion of the income earned by local governments in China. So, it is in their interest to sustain high property prices. With this belief in place, retail investors are getting into the market big time, hoping to get rich overnight, as they normally do towards the last stage of a bull run. Even informed investors are gambling on the hope that they will not be in the last wave of buyers. In modern parlance, this is known as the greater fool theory, wherein investors invest because they feel that some greater fool could be depended on to enter the market after they have, and this would give them handsome returns. This explains to a very large extent why Chinese foreign exchange reserves have gone up by $185.6 billion to $2.13 trillion in the first six months of 2009 — the foreign investors bringing dollars into China to invest in the stock market clearly seem to be hoping that they are not in the last wave of buyers. This is a mistake investors always make, when they become a part of a stock market or a property bubble. “

“Interesting as always… But till when will this last?”

“Oh that’ simple. It will last till banks keep lending and a portion of that money keeps getting diverted into the stock and property market for speculation.”

“And till when will that happen?”

“To get an answer to this question, you need to ask Zhou Xiaochuan.”

“And who’s he?”

“The governor of the Chinese central bank.”

“But what is the moral of the story?”

“Wisdom always comes late. Once a government starts a Ponzi scheme, it is very difficult for it to stop it. As Satyajit Das, the internationally renowned derivative expert said in a recent interview, ‘The only lesson learned is that no Ponzi game can ever be allowed to stop.’”

(The example is hypothetical)

In defence of entry load

noreply@blogger.com (Fenil) — Fri, 11 Sep 2009 06:12:00 +0000

Tensing Rodrigues

Sebi’s circular SEBI/IMD/CIR No 4/ 168230/09 issued on June 30, 2009, mandates two distinct changes in the selling of MF schemes:

1) There shall be no entry load for all mutual fund schemes (Clause 4.a)
2) Distributors should disclose all the commissions (in the form of trail commission or any other mode) payable to them for the different competing schemes of various mutual funds from amongst which the scheme is being recommended to the investor. (Clause 4.d)

Let us first look at ‘entry load’. The Securities & Exchange Board of India (Mutual Funds) Regulations, 1996, amended as of date, do not define entry load, but the term is explicitly used in regulation 49 in a context which defines its meaning.

Regulation 49 sets limits on pricing of units, thus effectively regulating entry loads. It requires that “the sale price is not higher than 107% of the net asset value”, and further that “the difference between the repurchase price and the sale price of the unit shall not exceed 7% calculated on the sale price”.

The regulations do not specify for what this difference between sale price and NAV (that is the entry load) may be used. But it looks obvious that the logic of charging entry load is to not burden existing unitholders with the cost of selling new units/ selling to new unitholders/ creating new accounts.

It is fair that these transaction costs should not be transferred to the existing unitholders. Obviously, the commission paid to the MF agent by the AMC for selling fresh units/ acquiring new unitholders is to be paid from this load.

However, the regulations are more explicit on the use of the ongoing fees to be charged by the AMC.

Regulation 52 (4) lays down: “In addition to the fees mentioned in sub-regulation (2), the asset management company may charge the mutual fund with the following expenses:
…
(b) Recurring expenses including:

(i) Marketing and selling expenses including agents’ commission, if any;
(ii) Brokerage and transaction cost;
(iii) Registrar services for transfer of units sold or redeemed;
(iv) Fees and expenses of trustees;
(v) Audit fees;
(vi) Custodian fees;
(vii) Costs related to investor communication;
(viii) Costs of fund transfer from location to location;
(ix) Costs of providing account statements and dividend/ redemption cheques and warrants;
(x) Insurance premium paid by the fund;
(xi) Winding up costs for terminating a fund or a scheme;
(xii) Costs of statutory advertisements;
…
It is obvious that the same would apply to the entry load. This makes it amply clear that entry load is to meet the expenses of the AMC towards selling new units, selling to new unitholders and creating new accounts; agent commissions are only one of those expenses. The current circular reinforces the above interpretation of the purpose of entry load: “Mutual fund schemes were allowed to recover expenses connected with sales and distribution through entry load” (Clause 1).

Sebi is perfectly within its powers to legislate on the entry load by amending regulation 49, which it seems to be intending to do now. But where Sebi clearly oversteps its jurisdiction is in assuming a quid pro quo relationship between entry load and agent’s commission. The AMC is free to pay any commission to the agent for marketing its products. This is purely its business decision and outside Sebi’s jurisdiction, as long as the cost is not charged to the fund beyond permissible levels.

This is made amply clear by regulation 52(5): “Any expense other than those specified in sub-regulations (2) and (4) shall be borne by the asset management company or trustee or sponsors.”

The fundamental question we need to debate is: Why is a MF agent paid commission? There are two possible answers to this question — therefore two interpretations to a MF agent’s commission.

According to one interpretation, the commission is the agent’s fee for the advice he tenders to the investor. Here, the AMC collects it on the behalf of the agent and passes it on to him.

The Sebi circular seems to have assumed this interpretation when it says, “though the investor pays for the services rendered by the mutual fund distributors, distributors are remunerated by AMCs from loads deducted from the invested amounts.” (Clause 2).
The other interpretation of commission is as a fee the AMC pays to the agent for selling its products. Which of these is the right interpretation?

The interpretation that is implicit in Securities & Exchange Board of India (Mutual Funds) Regulations, 1996 is the latter.

Regulation 52(4)(b)(i), mentioned earlier, explicitly lists “Marketing and selling expenses including agents’ commission” as an expense the AMC can charge to the fund. The current circular reiterates this interpretation when it says: “Sebi (Mutual Funds) Regulations, 1996 also permit AMCs to charge the scheme for marketing and selling expenses including distributor’s commission.”

It is obvious from this that Sebi itself considers agent’s commission as marketing and selling expense. Therefore, by no stretch of imagination, can it be fee for advising the customer.

Therefore, the statement “though the investor pays for the services rendered by the mutual fund distributors, distributors are remunerated by AMCs from loads deducted from the invested amounts” in the circular, is inconsistent with the rest of the circular and contradicts the Mutual Fund Regulations, 1996.

Therefore, Sebi’s claim that the circular is issued under regulation 77 “to remove any difficulties in the application or interpretation” of the regulations is untenable; regulation 77 does not give Sebi power to repeal or amend any part of the regulations through circulars.

Let us now turn to the second part of Sebi’s circular: “The distributors should disclose all the commissions”.

Sebi seems to continue its confusion over the interpretation of commission by clubbing together “distribution” and “advising”.

When you go to buy a toilet soap or a cellphone, the dealer does not disclose to you the commission that the manufacturer or the distributor pays him. And there is no reason why he should.

The customer has to evaluate and compare the value of the product in terms of service that it can render to him, with the price quoted by the dealer; and if the value-price equation seems favourable, buy the product. If he wishes, he can bargain to improve the equation. But he has no business to seek information on the commission the manufacturer or distributor pays to the dealer.

It is often argued that this model is not appropriate to the MF agent-investor relationship; a better model would be that of doctor-patient relationship. The reason being that a financial product is complex and beyond the understanding of a common investor, just like a sickness and the therapy for it.

The argument does not hold good. In case of a doctor, a clear distinction is made between “distribution” and “advising”. A doctor does only advising, or at least is bound by law to do only that; he does not do distribution. The distribution is done by a chemist.

Imagine a situation where an investor goes to a MF agent. The agent recommends funds A, B and C and he discloses that he earns 3.25%, 2.75% and 2.25% commission respectively, on the funds.

How is the investor to judge whether the recommendations are motivated by the suitability of funds or by the commission for the agent?

One way would be to ask the agent to disclose his commission on all the funds he sells. The customer may then find that there are funds which pay the agent only 0.25% or 0.50%. Should the customer buy these funds from the agent rather than the ones recommended by him? The assumption of investor ignorance leads to a contradiction.
The only way out of this situation is to assume that the investor is at least somewhat knowledgeable, can understand the financial products at least to some extent, and can know what is and what is not in his interest.

If that is the case, why does he need to know the agent’s commission to take his investment decision?

The point is, an agent’s commission is redundant information in investment decision making process. Even worse, given insufficient knowledge on the part of the investor, it is positively detrimental to decision making.

Before buying a stock, check for liquidity

noreply@blogger.com (Fenil) — Fri, 11 Sep 2009 06:04:00 +0000

Devendra Nevgi. Mumbai

Many a times, retail investors consider a host of factors before investing into the individual stocks or markets in general. Some of the major ones are the historical financials, company prospects, group to which the company belongs, past dividend record, the P/E ratio and so on.

A very important factor, “liquidity” is, in often ignored. Many investors might be surprised to know that the epicentre of the recent global financial crisis was liquidity: Initially the excess of it, followed by the scarcity of it.

What is liquidity? Why is it so vital to the economy and markets in general?

Liquidity often has different interpretations in different contexts. There are three
concepts in relation to liquidity:

* Monetary liquidity, which refers to the general monetary and credit conditions in the economy.

* Markets liquidity, determined by how easily financial assets (such as stocks) can be bought or sold without significantly impacting their price.

* Balance-sheet liquidity or funding liquidity, which is the ability of a corporate or bank to raise money at very short notice, either via availing credit or selling short-term assets that it holds on its balance sheet.

From an investment perspective, we will focus only on the monetary and markets liquidity.

Monetary liquidity includes the price of money (interest rates) as well as quantity and availability of money in the system, to the borrowers. The RBI, by its policies, influences the price and quantity of money available in the economy. This kind of liquidity is reflected in the monetary aggregates such as money supply (M3) and banks lending figures. Both of these figures are available on the RBI’s website.

A thumb rule to determine how much monetary liquidity is good for an economy is that money supply should grow at more or less the same rate as the real GDP growth rate plus the inflation (nominal GDP). If money supply is higher, it might lead to higher inflation and rise in asset values (such as stocks, commodities, real estate etc) in the country. If it is lower, it might choke growth and be deflationary.

Appropriate liquidity levels are necessary for sustained economic growth. In recent times, many central banks have been pumping money into the system to re-inflate their economies. Such liquidity often “spills over” to other countries, and creates demand for the assets in those countries. Many a times, such liquidity disappears at a very short notice too.

Market liquidity refers to the ability of the market (such as a stock market) or the financial system to absorb large buy or sell orders without significantly impacting the price levels. The speed at which a transaction can be executed without much movement (impact cost) in prices, the difference between buying and selling quotes at same time (breadth or bid/ ask spreads), how fast the prices return (resilience) to their fundamental levels after a large order is executed are all indicators of market liquidity.

Higher the market liquidity, better for the markets and vice versa, since it facilitates accurate price discovery of traded asset classes such as stocks.
Monetary liquidity and market liquidity are often inter-linked and have reasonable positive influence on asset prices, such as stocks or real estate, through the “risk appetite” and “confidence” channels.

Global monetary liquidity (FII inflows) has been an important driver of the Indian stock markets in recent years, both on the way up and on the way down. This is evident in the last few months, where Nifty levels have almost moved in tandem with the higher liquidity, thus creating higher volumes.

For investors, market liquidity remains a crucial input for buying stocks. Historical average volumes per day and the bid/ ask spreads are indicators of the same. Stocks with higher volumes and lower bid/ ask spreads should be preferred, as the influence of speculators and the impact of large orders on the stock is relatively lower.
Liquid stocks don’t rally on a large buy order, nor crash after that buy order is fulfilled, or if a large sell order is placed. Illiquid stocks are a speculator’s paradise and investor’s nightmare, and should be avoided by risk-averse investors, since they are susceptible to price manipulation.

Lower market liquidity increases the risks in stocks and distorts its factual realisable value.

Monetary liquidity can be easily tracked on the web on the RBI website and through periodical reports. And in general, the higher the liquidity, the better for risky assets, and vice versa. But there is a caveat — a sustained excess monetary liquidity can lead to asset price bubbles, wherein asset prices substantially deviate from their intrinsic values. And it does cause lot of pain when such bubbles ultimately burst.

To conclude

Investors should also take into account the market liquidity before buying into an individual stock.

This will prevent a situation of their being saddled with illiquid stocks in falling markets, which they can never sell at the right price. Illiquidity weakens the fair price discovery process.

When should you buy life insurance?

noreply@blogger.com (Fenil) — Fri, 11 Sep 2009 06:00:00 +0000

Life insurance is a necessity, not an investment. But it is required only if the demise of the breadwinner will put immense financial pressure on family members

Sandeep Shanbhag

I am often asked whether life insurance products are good investments. The following is my detailed answer.

Life insurance is a necessity and not an investment. There is no substitute for life cover, none whatsoever. It is the only means of providing security to your near and dear ones against your untimely death or to yourself against your old age.

The yield on investment per se, to that extent is of lesser importance. The ‘cover’ or ‘protection’ overrides all other considerations. However, note that it is a necessity, if and only if, the demise of the breadwinner of the family will put immense financial pressure on the family members left behind.

However, if that is not the case, you must reconsider your options. Every product has an associated cost and so does insurance. Do not buy a product you do not need. Excessive insurance injures financial health. It is very important to carry out a cost-benefit exercise before buying a policy.

Never ever buy an insurance product with the sole purpose of saving tax. That would be like meeting a short-term liability with a long-term obligation. The tax payable is your short-term obligation that you have to fulfil for that particular year.

However, insurance products are of a long-term nature and you may find that though you may have saved the tax for that particular year, you will be paying for it by way of future premiums for many years to come. In any case, with the introduction of the new direct tax code, permanent tax saving will not be any more possible, but more on that next week.

Coming back to our topic, look atinsurance like a life saving pill that is to be administered only when you need it. Otherwise, the side-effects of the pill may be worse than the imaginary disease.

Term insurance

Perhaps one of the best, least-promoted products of the insurance industry is term insurance. It is the most economical and efficient way to insure yourself. Those who find that they need life cover should compare and contrast the term insurance products offered by various insurers and opt for the one that most satisfies their needs.

Term insurance covers the policyholder for a desired number of years against death, accident, disability etc — the same as other policies. In contrast, it does not have any maturity, paid-up, surrender or loan values. On occurrence of the contingency, the beneficiary gets the sum assured but on survival, the insured gets nothing.
In the case of any other policy, with or without bonus, whole life or endowment, actually the return on assurance component is also nil. However, it gets mixed up with the return on the investment component which could be (depending upon the policy) lower than other comparable investment products. Take care of this.

Basically, all insurance policies have term insurance as their base with optional add-ons, allowing the proponent to formulate his own policy, consistent with his personal needs. Each rider has its own premium.

You can choose one or more riders (or none) as add-ons and should undertake a comparative analysis of such riders in the stable of all the insurers for choosing the one that has the best cost-benefit ratio. Some examples of riders are personal accidental death benefit, terminal illness, major surgical assistance, hike in sum assurance, spouse insurance, renew/ convert benefit, etc.

Tax benefits of life insurance

As some cynic said, “There are only two certain things in life. One is death, the other is income-tax.”

In India, death may be certain but income-tax, with its vagaries of rules, is certainly not certain. So let’s briefly examine the tax benefits associated with insurance. For starters, any sum received under a life insurance policy, including the sum allocated by way of bonus is totally exempt from tax under Section 10(10D).

There are 3 exceptions:

Keyman insurance.

Policies covered by Section 80DD.

If the premium paid, in any of the years during the term of the policy, exceeds 20% of the actual sum assured, the maturity value received by the policyholder will be fully taxable. However, any sum received under such policy on the death of a person shall continue to be exempt.

Also, a deduction under Section 80C up to Rs 1 lakh is available on premiums paid on policies in the name of self, spouse or children, major or minor, even married daughters but not parents, whether dependent or not.

Where a taxpayer discontinues an insurance policy before premiums for two years have been paid, the deduction allowed during earlier years shall be withdrawn and shall be deemed to be the income of the year in which the policy is discontinued.

In sum

Without the foundation of insurance, the grandest of the financial planning edifice is only a castle in the air. However, never lose sight of the fact that over-insurance and excessive protection is bad for financial health.

Life insurance is a haven of security, shielding the family against hardships in the event of the demise of the breadwinner. To give an analogy, if your child is ill and requires medicine, you should buy it regardless of its cost. Life insurance is an absolute parallel case in all respects except one. When you do not buy the drug, the suffering of the child is visible. When you do not buy the life cover, you are not there to see the suffering. In either case, the effect is the same.

But the drug should be administered if and only if the child is ill. If taken otherwise, its side-effects could cause untold harm. When your dependents are already well provided for, excess-covering your life has the same effect. You do not fathom the loss but it exists.

Quick ways to transfer money to your father

noreply@blogger.com (Fenil) — Fri, 11 Sep 2009 05:53:00 +0000

Khyati Dharamsi. Mumbai

People still using banks to transact cash might have found that banks have been charging higher than earlier on cash transactions at bank branches.

So, if you are looking to transfer funds to your father in your native place, handing over cash to the lady sitting at the bank counter and waiting for the transfer to happen might not be all that cheap. Bankers have made it clear that they want to eliminate cash in the system and hence charges for those making cash transactions are bound to go higher.

Of course, one can always use a cheque book, on which the charges might be lower or none at all. However, remember there are cheque-collection charges levied on outstation cheques.

Also, If you are not dealing in a large amount, or are based out of the National Capital Region, your money would reach your father’s account only after three days later, excluding public and weekly holidays.

The cheque truncation system, whereby an image of the cheque would just be sent to the bank from which money is to be deducted and cheques would be cleared within a day, will go live soon. Till then, there are other electronic options that banks offer. After perseverance from the Reserve Bank of India (RBI), banks have even lowered the charges that ran quite high during the initial days and deterred customers from using the facility.

Apart from phone and Internet banking, which are becoming popular, there are three other ways of transferring money at lower costs either to a bank account within your own city or outside, which help you save charges:

Electronic Clearing Service (ECS): If you wish to avoid issuing multiple cheques for transferring funds to your father at regular intervals like every month or year, you can use the ECS facility. There are no charges on this facility once a mandate is submitted, but incase there is not enough balance, there will be heavy charges.

This can also be used for other regular payments such as life insurance premium or mutual fund contributions. This saves you the trouble of remembering each month by what date a particular cheque is to be submitted. Some firms also penalise you for not using ECS for some services. For instance, ICICI Prudential Life Insurance’s Hospital Care policy charges 5% extra if monthly premium is not paid by the ECS route. In ECS, you can state the number of payments in advance and even discontinue the facility when you want. Similarly, an ECS application can be given for receiving funds, such as dividends.

Real-time Gross Settlement (RTGS): Here, the money is transferred on a real-time basis. The amount would be deposited to your father’s account as and when your bank processes and transfers the request. This has to be done between 9 am and 3 pm on regular days and 9 am and 12 pm on Saturdays.

Individual banks may have other deadlines so as to process the application before the RBI deadline. RTGS applications are settled on an individual basis and are the fastest way to transfer money. Banks will not wait for all applications to come in and then processed with transactions. If any transfer request does not materialise due to any complication, the bank is required to return the money to the customer within two hours. However, there is a minimum requirement of Rs 1 lakh for using RTGS facility. To transfer funds lower than Rs 1 lakh, one can use the National Electronic Funds Transfer (NEFT).

National Electronic Funds Transfer (NEFT): Under this facility, the amount is transferred within three hours of transacting. This happens as the funds are transferred electronically six times a day — at 9.30 am, 10.30 am, 12 noon, 1 pm, 3 pm and 4 pm and up to the first three batches on Saturdays. So, if you submit a request to transfer funds to your father via NEFT at 11 pm, the electronic message to transfer your money would be sent during the 12 pm cycle. RBI then segregates the requests bank-wise and tells each bank to either withdraw or deposit cash according to the request and the money will be transferred to your father’s account with the respective bank.

Things to remember

To transfer fund through either RTGS or NEFT you will need a few accurate details. These include the account number and bank name of the person sending the money, the account number, bank name, branch name, account type (savings/ current etc) of the person receiving the money.

While transferring money, you would also need something called as the IFS code, which is a number to identify a bank branch. If you know the bank name, branch and the city name, the bank official can help you with the IFS code. The system can also automatically update details when you provide other details.

The newly-issued cheque books of some banks contain the 11-digit IFS code on cheque leaves.

The above facilities are available at around 50,000 branches of around 98 banks, which have major banks and most of their branches in its ambit. A list of these banks and branches is available on the RBI’s website

http://www.rbi.org.in/Scripts/bs_viewcontent.aspx?Id=112 and

www.rbi.org.in/Scripts/Bs_viewRTGS.aspx.

In case your bank doesn’t offer the NEFT facility, you can transfer up to Rs 50,000 using a bank which offers the same.

The RBI website and some bank websites also provide application forms for NEFT and RTGS to be submitted at your bank branch. The application can also be submitted electronically by netbanking customers of some banks such as State Bank of India, Axis Bank, HDFC Bank, etc.

There is no acknowledgement given to the person who will receive funds (in this example, your father). The only way to check whether the funds have been transferred is to see the passbook or the account statement. In case your father hasn’t received the funds, you can contact the bank branch or the RBI general manager.

What’s oil got to do with the dollar and gold?

noreply@blogger.com (Fenil) — Sun, 26 Jul 2009 17:32:00 +0000

Vivek Kaul. Mumbai

Late evening. A little drizzle. Me and her sitting on a bench overlooking the sea, under a single umbrella.

“So?” she asked.

“This is nice,” I replied.
“Nice? That’s all? You use the word nice whenever you don’t know what you want to say!”

“Kind off.”

“I am bored,” she said coyly. “Since you claim you can link anything to anything. Let’s play a game. I will come up with three words and you link them.”

“Suits me.”

“So my three words are dollar, oil and gold.”

“You can’t think of anything but economics these days?”

“Chickened out already?”

“Not at all. But you should get ready to get back into history if you want to understand the link.”

“Yeah I am ready.”

“In the 1930s, Texas, the second largest American state, was producing so much oil that the price at times fell to as low as ten US cents a barrel (a barrel of oil is equal to around 159 litres). Now this was something that oil companies did not like. The Texas state government gave Texas Railroad Commission the power to regulate drilling of oil and thus set production levels. Once the commission could regulate the production level, it could regulate supply of oil and hence indirectly regulate the price of oil, as well. This price became to be known as the Texas price and over a period, the Texas price became the US price and the US price became the world price. This arrangement worked very well for the US companies, which till the 1950s produced nearly half of the world oil. Hope this part is clear?” I asked.

“Yeah. Till now I have understood everything.”

“In 1928, Saudi Arabia gave an exploration license to Standard Oil Company of California for around 35,000 gold sovereigns. The company stuck oil in 1937. After this, more and more companies stuck oil in the Middle East. In 1960, the Organisation of Petroleum Exporting Countries (Opec) was formed. Opec comprised largely of oil producing countries from the Middle East. It was formed so that the countries could take on the big international oil companies, who till then had been dictating terms. Juan Palo Perez Alfonso, the Venezuelan oil minister, was the brain behind Opec. And the irony was that he had studied the way the Texas Railroad commission works when he had been exiled to the US. He used the Texas model to establish Opec.”

“You really seem to have history and economics all figured out,” she said.

“Well with your increasing interest in economics, I need to be ready all the time,” I said. “Now let me explain a few things about the dollar. Between the end of World War II and August 15, 1971, the US dollar was pegged to gold, with one troy ounce of gold (around 31.1 grams) being worth $35. Meaning, the US was ready to convert dollars to gold at any point of time. This ensured the dollar became the international reserve currency with other countries carrying out trade with each other in dollars because it was convertible into gold. All this led to a lot of dollar pile-ups across the world. Also, the US itself printed a lot of dollars to bankroll the Cold War and the Vietnam War. This led to a situation where more and more countries started to exchange their dollars for gold. The amount of gold that the US government had was not infinite. So, on August 15, 1971 then-President Richard Nixon decided the US would no longer convert dollars into gold.”

“Aren’t you deviating from the point? Where is the link?” she interrupted.

“Have some patience my dear. Till August 15, 1971, the US dollar was essentially gold. After that, it became a concept, an idea or just a piece of plain paper which had the backing of the world’s biggest superpower nation. Also, during the first decade, Opec was not successful at doing what it was established to do. Between June 5 and 10, 1967, the Six-Day War broke out between Israel on one side and Egypt, Jordan and Syria on the other side. At that point, Opec had cut production by 1.5 million barrels, primarily to punish the US which was an ally of Israel. The production cut hardly mattered, because the US started to pump oil from its spare production capacity. Oil production in the US peaked in 1970, and has been going downhill since then. At the same time, the American addiction to oil has been on its way up. In October 1973, Egypt and Syria went to war with Israel. This war came to be known as the Yom Kippur War. Opec, knowing well that America’s oil production had peaked, imposed an oil embargo. From October to December the Opec price of oil increased from $2.20 per barrel to $11.65 per barrel. Why do you think Opec had the audacity to do that?”

“Because, as far as I can see from what you said, oil production in the US had peaked in 1970. So the US did not have any spare capacity to pump up production and meet the shortfall from Opec’s cut in production. And given America’s addiction to oil, they had to pay the price Opec demanded.”

“That’s right to an extent. The global demand for oil had gone up from 3.7 million barrels per day (mbpd) in 1950, to 25.6 mbpd in 1970. So, an increase in demand was a definite reason for demanding a higher price. But what one must remember is that by taking dollar off from the gold standard, the US had the ability to print as many dollars as they wanted to, as they did not have to bother about having to face the risk of converting those dollars into gold. And given their addiction to the so-called American way of life, they would print as many dollars as required to pay Opec’s price. Opec of course, understood this. If what you are earning is paper, then you’d rather have more of it than less of it. Once the US was ready to pay, the rest of the world followed.”

“Interesting. What happened after that?”

“Mohammad Reza Shah Pahlavi, the Shah of Iran, was overthrown by Ayatollah Khomeni on February 11, 1979. By May 14, 1979, the Opec price was at $13.34 per barrel. Oil till then was sold under long-term contracts. There was turmoil in Iran, causing its oil production to fall dramatically. This sent the spot price of oil through the roof, as Iran is the second-largest producer of oil within Opec after Saudi Arabia.”

“Spot price?”

“The day-to-day purchase market for oil was at Rotterdam in The Netherlands. Here, the price of oil shot up from $13.34 per barrel on May 15 to $34 per barrel on May 17. Iran cashed in on this and sold off their oil at the spot market. Soon, other Opec members followed. The spot price reached $40 per barrel and Opec raised its price to the same level. Opec again cashed in on the America’s addiction to oil and the fact that it could print as many dollars as it wanted to buy oil. With an increase in price, the inflow of dollars for the Opec nations shot up. Saudi Arabia and some other Opec countries started to use these dollars to buy gold and the price of gold also shot up through the roof, going from $258 per ounce in May 1979 to $678 per ounce in 1980.”

“But all that is history. What is the learning in the present day and context?”

“Well. I thought you would have got the point already. The price of oil fell to a low of around $30 a barrel, as economies all over the world crashed, reducing prospective demand for oil. But since then, the price of oil has been rising again and has risen to $60 a barrel. Opec of course understands that America can just print dollars to buy oil, as long as the international market for oil continues to be priced in dollars. Given that, why not have more dollars than less? So, production of oil by Opec members has been adjusted accordingly to ensure a good price. Other than this, if Opec countries start buying gold with the dollars that they are earning — as they have in the past — imagine what would happen to the price of gold.”

“But how can you be so sure?” she asked.

“Sure? In life, decisions are based on two kinds of guesses we make: wild guesses and educated guesses. I’d like to believe I’m making an educated guess!”

k_vivek@dnaindia.net

This article borrows heavily from ideas expressed originally in Gold, Oil and Money in the Free Market, http://www.usagold.com/halloffame.html #anchor318280 and The Last Oil Shock - A Survival Guide to the Imminent Extinction of Petroleum Man, David Strahan, John Murray Publishers, 2008.

Why the money printing’s not causing inflation

noreply@blogger.com (Fenil) — Sun, 26 Jul 2009 17:22:00 +0000

People aren’t willing to spend money — neither their own, nor borrowed

Vivek Kaul. Mumbai

“So where do we go from here?” she asked early one morning as I sat watching the rain falling outside, sipping my cup of coffee.

“Why do we need to go anywhere from here? You know, I remember reading somewhere, we are where we are because that’s where we are meant to be,” I replied with a grin.

“Smart reply. I will let you be for the time being. But tell me something, I read this small snippet in the newspaper today that the consumer price inflation in the United States for the month of June 2009 was only 0.7%.”

“So?” I asked.

“Well, the US has been printing dollars big time and hoping to spend it in order to revive the economy. The money supply in the US has increased by more than 100% in the recent past (See graph). History tells us increased money supply leads to a situation wherein a lot of money chases fewer goods, leading to increased prices or inflation. But that doesn’t seem to be happening. Why is that?”

“The conventional answer is that due to a recessionary situation, the increased money supply is not leaving the banks. That is, banks are not willing to lend, which means people cannot borrow to buy goods, as they had been doing in the past. Take the case of automobiles. The average price of cars being sold in the US before the recession set in was $30,000. The only reason most people could buy such cars is because they had easy access to debt. Now they don’t, so car sales have collapsed. And when cars aren’t selling, car manufacturers obviously cannot raise prices. Other than this, people have also realised the merits of saving money. Savings in the US are now at around 5% of the gross domestic product (GDP), in comparison to a negative savings rate till sometime back.”

“But why this sudden spurt in savings?” she interrupted.

“Well you need to realise that since the beginning of the recession in December 2007, around $13.87 trillion of wealth has been destroyed. Most of it, of course, has been due to a crash in housing prices. A fall in stock market levels has also added to this wealth destruction. What this means is that people are feeling poorer. And when people feel poor, they do not go out and spend. The tendency is to save and hold on to what you have. Other than this, a lot of people have been fired from their jobs. Official figures suggest that nearly 9.5% of the US population is unemployed, and around 6.5 million people have lost their jobs. These numbers do not include people who are working part-time, but want to work full-time, and cannot do that because there are not enough jobs going around. Now, I need not tell you that the last thing on anyone who has lost his job is spending money. And of course, even those who haven’t lost their job will be doubly careful about spending money when they see people around them being fired,” I explained.

“But isn’t the US government spending money to revive the economy? A stimulus package worth $787 billion is being executed to revive the economy.”

“Yeah, it is. But remember the wealth destroyed stands at $13.87 trillion and the money being spent is $787 billion. It is like you losing a hundred rupees and I giving you six rupees to compensate for it. Obviously, that is not enough. When wealth destruction has happened on such a massive scale, any stimulus can only have a limited impact. Of the total plan of $787 billion, $287 billion was in the form of temporary tax breaks. This has been partly negated as many American states on the brink of bankruptcy have started to increase taxes. Increased taxes mean lesser money in the hands of consumers to spend. As I have told you before, nearly 70% of the US GDP comes from consumption. If consumption doesn’t pick up, GDP growth doesn’t pick up. And for consumption to pick up, people have to borrow and spend money as they did in the past. This is rather ironical given that it was excess borrowing that caused all these problems in the first place. The solution is what caused the problem.”

“There you go getting all philosophical again!”

“What all this means is that people are not willing to spend their own money, nor spend borrowed money. Which means you can’t have a situation wherein more money is chasing few goods. Hence, there is no increase in prices, and a low inflation of 0.7%. But that, as I said, is the conventional argument that everybody seems to be making.”

“Oh. Kahani main twist!”

“Yeah. What everyone seems to be talking about is that an increase in money supply hasn’t led to an increase in prices. But what nobody seems to be talking about, is how an increase in money supply has ensured that the purchasing power of money hasn’t gone up.”

“Purchasing power of money hasn’t gone up? What do you mean by that?” she asked.

“Let me explain. Money has a certain purchasing power. Let’s say you can buy 2 kg of a fruit for Rs 100 on a certain day. Sometime later, you may be able to buy the same 2 kg of fruit for Rs 75. What does that mean? It means the purchasing power of money has gone up. Why? It has gone up because the price of what you are buying has fallen and hence you can buy more goods with the same amount of money or the same amount of goods with a lower amount of money.”

“Okay. So I understand what purchasing power means. But what is its link with what
you have been trying to say?”

“If the money printing wouldn’t have happened, money supply wouldn’t have gone up. If money supply wouldn’t have gone up, the prices of goods and services — which have held up more or less constant — would have fallen. So, an increased money supply has ensured that some amount of money has chased goods and services. This has enabled companies to either hold on to their prices, or to not cut prices as much as they would have had to, in case there was no money printing.”

“Hmmm. I guess I understand now. But what is the trouble with prices not falling?”

“It leads to a situation where the mechanism of price is not allowed to work and prices of goods and services don’t reach their correct level. They are propped up by the increased money supply. Now money printing cannot keep continuing for eternity. Thus, there is always a danger of the prices falling more in the future, whenever the currency printing stops. And that my dear is a scary thought.”

“Well like you keep postponing the answer to my questions, I guess economies work the same way,” she said, having the last laugh.

References:
Inflation: What You See and What You Don’t See, Thorstein Polliet, June 30, 2009
The Financial and Economic Argument for No Green Shoots: No Deus Ex Machina for the Economy. 10 Charts Showing why There will be no Second Half Recovery in 2009, www.usagold.com, July 8, 2009

This is the time to buy and forget

noreply@blogger.com (Fenil) — Sun, 26 Jul 2009 17:13:00 +0000

Ignore naysayers and stay invested in Indian stocks; the magic will work in the long run

Devendra Nevgi

The first Budget of the new UPA government was presented on July 6.
The buildup to the Budget included a sharp move in stock markets after the alliance’s strong majority in the general elections. The move was fuelled by expectations from the UPA of sweeping reforms and deregulation. The Economic Survey released earlier added fuel to this fire of irrational expectations.

Closer to Budget Day, the expectations marginally toned down. Nevertheless, on B-Day, the markets tanked by 870 points, around 6%, the largest fall in the history of Indian stock markets on Budget Day. Here, the first lesson is that Budget expectations could have been managed through the use of a more efficient communication policy.

Without going in the intricacies of the Budget, I would like to highlight the finance minister’s first few statements, on the fact that the Budget is not the only event where policies can be framed, nor is it a magic wand to trigger off instant results. Reforms are a long-term process.

Maybe investors in India have gotten used to a 20/20 cricket match when they should be looking to win the Test match series, and hence the knee-jerk reaction on July 6.
This brings up another issue — should the Budget be presented at 5 pm like in the earlier days, with no special Budget session, so that investors get a chance to react to it after due analysis?

Though the so-called “road map of deregulation, fiscal consolidation, and reforms” was missing in the Budget document — which was the major source of disappointment for the markets — there were many aspects which could benefit the country in the long run. Also, there was nothing in the Budget to lower the earnings expectations of corporates, except for companies which pay MAT, which was raised by 5%.

The focus of the Budget remained on bringing economic growth (9%) back on track by stimulating rural demand, creating jobs and boosting consumption by lowering direct taxes, which would leave more money in the hands of consumers.

Social and infrastructure sectors remained the focal points of the Budget. And note that excise benefits given earlier in the year as a part of the stimulus were not rolled back.

Another much-debated aspect of this Budget and the reason for the steep fall in markets was the ballooning central fiscal deficit which, now estimated at 6.8% of GDP, may be much higher if we add the state deficits and the off-balance sheet liabilities and be in the range of 11-12% of GDP.

I differ on this debate over the fiscal deficit. Let us understand that in the last 18 months, the world has gone through the worst financial crisis since the Great Depression, and that India is not insulated from its effects.

Globally, governments and central banks are working overtime to enact stimulus and policies to bring growth on track. Fiscal stimuli and lowering of policy interest rates has been an integral part of their moves.

What the FM is doing, is adopting an “anti-cyclical fiscal policy” (raising public spending in economic downturns and vice versa), which every authority in the world is doing now, and rightly so.

Many of the countries have increased their deficits closer to double digits in their bid to stimulate demand by increasing spending. In fact, India should also move to a cyclically-adjusted fiscal deficit target, where the deficit targets move according to the prevailing economic cycle.

If growth has to be a priority, the temporary higher deficit is bearable and the ensuing growth will help the government to scale back expenditure and the deficits in coming years. But yes, sustained higher deficits — if there is no revenue growth — do create problems such as choking up growth, crowding out private investments and taking interest rates higher, which governments have to be wary of.

But an astute monetary policy and RBI’s support to the government borrowing programme can counterbalance some of these ill-effects.

What is more important and relevant is that the deficits should not rise due to non-productive expenditure, viz, expenditure which cannot buoy growth in future. In the Budget, the significant rise in the allocations to infrastructure (up to 9% of GDP) and to the rural sector is an example of productive expenditure. And fiscal stimulus works through the real economy much faster than other policy tools like interest rate cuts.

Here, I wish to bring forward the economic theory of “Ricardian Neutrality”, which goes: During periods of higher fiscal deficits, private economic agents (individuals, households, firms, etc) expect that there will be a rise in the future tax burden (to reduce deficits). They accordingly save more of their current income to later offset the fall in the future income, which cancels out the negative effects of fiscal deficits on demand. For instance, the savings ratio in the US is at a 15-year-high now, when its deficit is rising.

If the global rating agencies move to downgrade India’s rating based on a standalone factor of higher fiscal deficits, the rating of many other countries would have to follow suit.

The current situation does demand priority to growth over the risk of a downgrade. Among the factors taken into account by rating agencies are:

The country’s openness to trade and capital flows and experience in adapting to associated fluctuations

The country’s stable political system with strong, long-established institutions, its ability to respond to changing economic and financial circumstances, and its transparency in policymaking

India has achieved some of these, such as a stable political system with strong, long-established institutions and its ability to respond to changing economic and financial circumstances.

Conclusion
The Budget is not the end of the world, since it’s only a projected statement of accounts of the government. It need not always be a long-term policy statement. Temporary higher fiscal deficits are not always bad in the short run, though if sustained, they can prove disastrous.

Reforms, divestments, fiscal consolidation and deregulation can follow and need not wait for Budget Day. India will continue to grow at 6-7% for the next few decades and hopefully, the FMs gamble of growth will work over the next few years.

There is nothing in this Budget to revise the corporate earnings growth lower. So why then did the stock market fall by 6%? Ask the short-term leveraged FIIs. Stay invested in Indian stocks and the magic will work in the long run.

The author is a qualified chartered accountant and an independentfinancial expert. He can be contacted at deven.nevgi@gmail.com

Why Pranabda can run a Ponzi scheme

noreply@blogger.com (Fenil) — Sun, 26 Jul 2009 17:07:00 +0000

With the money-printing press on its side, the government can keep borrowing money to spend more than it earns

Vivek Kaul. Mumbai

“With the monsoons arriving, the wet look among women is back, I guess,” I said.

“Don’t know about the wet look, but I had to wade through knee-deep water to get back home today. And Pranabda’s Budget was an exceptionally dry Budget. ‘Monsoon main sukha Budget,’ went the headline in a Hindi newspaper,” she replied.

“Yeah and more than that, the fiscal deficit numbers are getting scarier,” I elucidated.

“There you go again, trying to show off that you understand economics.”

“Why not? As the film heroines say “flaunt it, if you have it.””

“But why is the scenario scary?” she asked.

“Fiscal deficit, as you’d know, is the difference between what the government earns and what it spends. Typically, most governments spend more than what they earn, and hence the deficit. Now let us take a look at the Indian deficit numbers. In the financial year 2007-08 (i.e. between April 1, 2007 and March 31, 2008) the government spent Rs 1,26,912 crore more than what it earned. For the financial year 2009-10 (i.e. between April 1, 2009 and March 31, 2010), the government plans to spend a whopping Rs 4,00,996 crore more than what it earns.”

“Or 6.8% of the gross domestic product (GDP)?” she interrupted.

“Yeah. The GDP of India is assumed to be at Rs 58,56,569 crore for 2009-10. The projected fiscal deficit expressed as a percentage of this stands at 6.85% to be very precise. But this does not give the correct picture.”

“Then what gives the correct picture?”

“The fiscal deficit of India in 2007-08 stood at Rs 1,26,912 crore. In comparison to that, the projected fiscal deficit of Rs 4,00,996 crore for the financial year 2009-10 is 216% more. What that means in simple English is that the income of the government of India has been more or less constant over the last few years, though its expenditure has been going up. In 2007-08 the income of the government of India stood at Rs 5,85,759 crore. For the year 2009-10 the income has been projected to be Rs 6,19,842 crore. This means that the income has gone up by 5.8%. The expenditure for 2007-08 stood at Rs 7,12,671 crore whereas the projected expenditure for 2009-10 stands at Rs 10,20,838 crore or a whopping 43.2% more. The trouble with expressing fiscal deficit as a percentage of GDP is that we never really understand the enormity of a situation. In 2007-08, the government earned Rs 5,85,759 crore and it spent Rs 7,12,671 crore, which means it spent Rs 1,26,912 crore or 21.7% more than what it earned. In 2009-10, it is projected to earn Rs 6,19,842 crore and spend Rs 10,20,838 crore, which means that it plans to spend 64.7% more than what it earns. Now that better expresses the enormity of the situation,” I explained.

“But where will the difference come from?”

“Let me ask you a question. When in a given month your expenditure is more than your income, what do you do?”

“I dip into my savings,” she replied.

“What if you do not have any savings?” I questioned again.

“Oh then I use my credit card. I have one too many of them anyway.”

“Yeah you use your credit card, which means you borrow. Similarly when the government spends more than what it earns, it borrows by issuing financial securities known as treasury bills and bonds or government securities. So in the year 2007-08 the government borrowed Rs 1,26,912 crore to service its deficit. And in the year 2009-10, it will have to borrow Rs 4,00,996 crore to fund its deficit.”

“Hmmm. So what is the problem with that?”

“Hold on, babes. Let me complete. When you have to repay the debt you have taken on your credit card, what do you do? You either spend less in the months to come or increase your income.”

“Yeah, any logical individual would do that.”

“But you must remember that the government cannot suddenly increase its income to pay off its debt, neither can it cut down on its expenditure. So what does it do to pay off its debt or even servicing the interest on that debt? It takes the third way out.”

“The third way?”

“Yeah. Let us take your case. What if you did not have enough money to repay your credit card bill? What would you do? You would try and use your second credit card to pay off the amount due on your first credit card. And when things get difficult on your second credit card, you would use your third credit card to pay off the dues on the second card. And so the story would go on, till you run out of cards.”

“Yeah. Of course. But what has my ability to repay my credit card bills got to do with the government of India?” she asked.

“Like you, the government takes on more debt to repay its earlier debt as well as to repay existing loans. Let me explain. In the year 2007-2008, the interest payment of the existing debt of government of India stood at Rs 1,71,030 crore whereas it borrowed Rs 1,26,912 crore to fund its deficit. What this means in simple English is that some portion of the interest to be repaid (Rs 1,71,030 crore - Rs 126,912 crore = Rs 44,118 crore) was being paid out of actual earnings and not just by borrowing more. Now for 2009-2010, the interest payments of the government stand at Rs 2,25,511 crore whereas the projected fiscal deficit stands at Rs 4,00,996 crore. What this means is that nearly 56.2% of borrowed money is just being used to service past debt. The government does not earn enough money to pay back the interest on its debt. So what does it do? It takes on more debt to pay interest on its existing loans. A perfect Ponzi scheme! The word Ponzi comes from Charles Ponzi, an American-Italian, who in the year 1919, promised to double investors money in 45 days. What he essentially did was to create an illusion of a successful business by using the money brought in by new investors to pay off the old investors. Essentially, the capital of the scheme was used to pay interest as well as repay the money invested. This is what most governments which spend more than what they earn have been doing over the years, including the government of India.”

“So what you are effectively saying is that the government never runs out of credit cards?”

“Exactly.”

“But tell me something, don’t investors who buy bonds issued by the government to funds its fiscal deficit know this?”

“Of course they do. But governments have the right to print money which you and I don’t. So worst comes to worst, they can always print money to repay interest as well as principal. As the fiscal deficit increases the temptation for the government to print money and repay debt as well as interest on that debt, increases. In fact of the fiscal deficit of Rs 4,00,996 crore projected for 2009-10, the Reserve Bank of India will pick up half of the bonds being issued to fund the deficit. What this means in simple English is that big time money printing to fund the deficit has already started. Financial history tells us very clearly that high fiscal deficits have never been such a great idea. It ultimately leads to governments printing money big time, increased inflation and in some cases even the collapse of a currency. Pranabda should keep that in mind.”

Want easy money? See where you go

noreply@blogger.com (Fenil) — Fri, 26 Jun 2009 16:21:00 +0000

More often than not, schemes promising huge returns are Ponzi traps

Vivek Kaul. Mumbai

"Boy, I got vision, and the rest of the world wears bifocals." — Paul Newman, as Butch Cassidy, in the all-time classic western Butch Cassidy and the Sundance Kid

I walked out of the airport and into the rain. She was there, waiting.

"Did you miss me?" she asked as I got closer.

"Must you know?" I replied.

"Ah, let it be. You know, I wanted to talk to you about an investment I wanted to make," she said.

"What investment?"

"This friend of mine wants me to invest in an investment scheme that promises to double my money in six months. Isn't that exciting? A 100% guaranteed return in a year."

"But where will they invest your money to be able to give you that kind of return?"

"Oh, let them invest where they please. All I am bothered about is my 100% return."

"I wish life were as simple, my dear. Let me tell you a story."

"A story? Go ahead."

"Double your money in 90 days! That's what Charles Ponzi, an Italian immigrant to the US, promised investors way back in 1919. In August 1919, in the process of issuing an export magazine, Ponzi spotted a huge arbitrage opportunity. He made an offer to a person in Spain, requesting him to subscribe to an export magazine he planned to launch. The subscriber sent Ponzi an international postal reply coupon, which could be exchanged at the local post office, for American stamps, needed to dispatch the magazine to Spain. In Spain, the coupon cost the equivalent of one cent in American currency. But when he exchanged the coupon in America, Ponzi got six cents worth of stamps. Sensing the arbitrage opportunity, he decided to float an investment scheme."

"But what's this got to with my investment," she interrupted.

"Have patience. Ponzi's scheme promised to double investors' money in 90 days. Money started pouring in. Once the money had been collected, Ponzi planned to convert American dollars into foreign currency, buy international postal reply coupons from various countries, convert them into American stamps and sell them for a huge profit. The idea was brilliant. But Ponzi had not taken into account the difficulties involved in dealing with various postal organisations around the world, along with other problems involved in transferring and converting currency. Nevertheless, the investors got attracted to the huge returns the scheme promised. At its peak, the scheme had 40,000 investors who had together invested around $15 million in it. Meanwhile, Ponzi had started living an extravagant life, blowing up the money investors brought in. On July 26, 1920, the Boston Post ran a story questioning the legitimacy of the scheme. Within a few hours, angry depositors lined up at Ponzi's door, demanding their money back. Ponzi asked his staff to settle their obligations. The anger subsided, but not for long. On August 10, 1920, the scheme collapsed. The auditors, the newspapers and the banks declared that Ponzi was definitely bankrupt. It was revealed that only two stamps had been actually purchased. Money brought in by the new investors was being used to pay off old investors. Since then, this form of financial fraud came to be generically known as a Ponzi scheme."

"So?" she asked.

"Let us say I start a scheme promising to double money in six months. I can invest that money somewhere and hope it gives me enough returns in six months so I can redeem the amount I had promised the investors. But, generating 100% returns in six months is not easy and wasn't the idea in the first place. Taken in by the huge returns I am offering, people who invest in the scheme initially will go out there and tell other investors about it, so more investors will start investing in it. Six months later, when I need to pay off the initial lot of investors, enough new money would have come into the scheme to allow me to pay off the initial investors. And so the scheme keeps running."

"That's a dangerous game to play."

"So it is. It is important to note that in a Ponzi scheme no new wealth is created. Wealth gained by participants entering the scheme earlier is the wealth lost by those coming in later. Such a scheme can keep running only till the money entering the scheme is more than the money leaving the scheme. The moment the flow reverses, the scamster might vanish with whatever money he has left. Thus, the most vulnerable investors are those who come at the end."

"Are you saying my friend wants me to invest in a Ponzi scheme?"

"Without doubt. There is no other way to generate 100% returns in six months. If you have been reading the newspapers, there has been a spate of exposures of Ponzi schemes of late. Ashok Jadeja, a scamster, was caught for defrauding investors of around Rs 1,600-2,000 crore. If news reports are to be believed, he claimed he could triple investments in 15 days. In another case, in Delhi, Ranbir Singh Kharab, a former MLA, and one Subash Aggarwal, siphoned off Rs 3,200 crore from around 10,000 investors. "

"But how do these fraudsters pull it off?"

"Well, the most important part of a Ponzi scheme is assuring investors that their investment is safe. Early investors become the most important part of the scheme and meeting initial obligations is very important. Ironically, in many cases, it is the investors' own money that is being returned to them. Let us say someone invests Rs 100 in a scheme that promises a return of Rs 20 in 2 months. Now, even with no new money coming in, the scamster can keep returning the investor Rs 20 of his own money every two months, and keep the scheme running for ten months in the hope that the investor will go and tell others about the scheme and get them to invest in it."
"I must be a fool to have considered investing in such a scheme. But how come such schemes keep surfacing time and again?"

"The attraction of easy wealth is hard to beat. Ponzi Schemes offer huge returns in a short period of time vis-a-vis other investment options available in the market at that point of time. With good advertising and stories of previous investors who made a killing by investing in the scheme, investors get caught in the euphoria that is generated and hand over their hard earned money to such schemes going against their common sense. Greed also results when investors see people they know make money through the Ponzi scheme. As economist Charles Kindleberger famously wrote, "There is nothing so disturbing to one's well being and judgment as to see a friend get rich.""

(The example is hypothetical)

Who gained from the Sebi move on funds anyway?

noreply@blogger.com (Fenil) — Fri, 26 Jun 2009 16:15:00 +0000

The regulator could have done better for sure

Sandeep Shanbhag

Most equity mutual funds charge retail investors an entry load of 2.25% on their investments. This entry load is mandatorily payable irrespective of an investor's mode of entry. The total amount collected as load for each scheme, as per Sebi stipulations, has to be maintained in a separate account by AMCs and can be utilised to meet selling and distribution expenses. As per industry practice, the load is normally utilised for paying the agent/ distributor's commission.

Now, in an effort to bring about transparency in payment of commission to mutual fund distributors, Sebi has decided that there will be no entry load for the schemes, existing or new, of a mutual fund. The upfront commission to distributors shall be paid by the investor to the distributor directly. Moreover, the distributors shall disclose the commission, trail or otherwise, received by them for different schemes/ mutual funds which they are distributing or advising the investors

Sebi has over the years done an excellent job of regulating the mutual fund industry and making it adopt international best practices as far as possible. The waiver of load is a similar welcome step that will no doubt benefit the small but informed investor.

However, when I try and look beyond the obvious, I find certain creases should have been ironed out before implementing this move, which essentially facilitates a small minority to access a cheaper product that a vast majority has little knowledge of. While providing the informed investor with choice is a desirable objective, protection of the uninformed investor's interest is critical.

Also, is it appropriate that the load waiver is made applicable to mutual funds in isolation? There are other investment products, which for all practical purposes are mutual funds, only not called so.

Take the unit linked insurance plans (Ulips) of insurance companies. These are nothing but mutual funds that charge far higher loads (from 15% to 75%). Of course, the charges come down over the tenure of the investment, but the point is that those charges clearly exist. Moreover, of late, the way Ulips are advertised and promoted, it is difficult for an uninformed investor to differentiate and tell apart a mutual fund from an Ulip. Then there are structured products issued by portfolio managers and large broking houses, which too are nothing but mutual funds that offer substantially higher fees to distributors.

In such an environment, where products with similar functions co-exist, albeit with vastly dissimilar incentive structures, there is bound to be wholesale shepherding and forced migration of uninformed investors to such products. In other words, there is a clear and present danger that the mutual fund industry will end up subsidising competing investment products.

This is not to say that the load should not be waived. Only that it should be done across the board, not selectively.

Admittedly, this is easier said than done since the regulators of both industries (Sebi and Insurance Regulatory Development Authority, respectively) differ. However, if any practice is deemed desirable, it should be so notwithstanding the industry concerned. Efforts must be made by the respective regulators to impose best practices in respect of their products uniformly.

Secondly, the three affected parties basically are mutual funds (AMCs), distributors and investors, both informed and uninformed. Though the immediate interests of each of these constituents may differ, they do indeed have a common objective — that of growth and development of the mutual fund industry. The more the industry grows, the better the technology and skilled manpower that AMCs can afford, thereby engendering more competition and better returns to investors both uninformed and informed. However, if the pipe is made narrower only at the beginning, other (quasi) mutual funds will take over the market to the detriment of the uniformed investor.

The Sebi press release keeps it short and sweet by mentioning that the commission should be paid by the investor to the distributor directly. Is this practical? It is only in a perfect world that the uninformed investor will pay separately for the advice and service he is getting. More often than not, the uniformed investor is uninformed of the fact that he is uninformed. A fee structure open to negotiation will lead to fee shopping, with distributors indulging in blatant rebating just to get additional business and the associated trail commission.

That said, I cannot emphasise enough that it doesn't mean a knowledgeable investor is forced to pay someone for services he doesn't need. For such persons, the system of bypassing the distributor and investing directly is already in place. The only submission is that imputing the investor with the responsibility of compensating the distributor will confuse and corrupt the market place. In other words, prima facie, though the immediate effect of this move seems to affect only the distributors, over time it will hurt the mutual fund industry as a whole. Consequently, at the end of the day, it is the small investor who will be left disadvantaged — that's ironical, considering it is for his benefit that this entire fuss started in the first place.

As a consumer, I too look forward to cheaper financial products. However, I hope the authorities come to a decision after careful consideration of issues such as those laid out in this column. For, as an informed investor, I don't want to end up saving two but paying twenty.

The writer is director, Wonderland Consultants, a tax and financial planning firm. He may be contacted at sandeep.shanbhag@gmail.com

Tax-filing this time’s a tad more taxing

noreply@blogger.com (Fenil) — Fri, 26 Jun 2009 16:10:00 +0000

Govt seems hell bent on making the process more complicated

Sandeep Shanbhag

The July 31 deadline for filing taxes is drawing closer.

As readers would be aware, the old tax return form, SARAL, has been scrapped since last year and replaced with the new ITR series. There are eight forms in all, each applicable to a particular category of taxpayer (see table) and are classified as ITR series 1 to 8.

Simultaneously, e-filing of tax returns is now available for all categories of taxpayers, though it is mandatory only in the case of corporate taxpayers and firms which are liable to tax audit under Section 44 AB of the Income Tax Act (ITA). More on this later in this column.

On the new forms, the CBDT has spelt out clearly vide Circular no. 03/ 2009, dated May 21, 2009 that the tax return should not be accompanied by any attachment/ annexure. Thus, taxpayers should not enclose any statement along with the return such as the computation of income or tax, Form 16, copies of balance sheet, profit and loss account, TDS/ TCS certificates, proof of payment of advance tax or self-assessment tax, etc.

However, take care to maintain these documents on file as the same will have to be produced before the assessing officer upon a demand by him.

Though similar instructions were issued last year, taxpayers found there were several instances where the tax department staff and officials insisted on annexures being attached to the forms, especially Form 16 and TDS certificates. Therefore, this year, in case there is a refusal to accept returns without annexures, taxpayers can point out to the erring official the relevant provision of the above mentioned circular that clearly states that accepting a tax return with annexures is against the expressed policy of the government and is not in consonance with legal provisions.
Those who are computer savvy as also reasonably familiar with the tax provisions may opt for the simplicity of e-filing. This way, you can actually file your tax return without having to get up from your chair. Detailed information is available on www.incometaxindiaefiling.gov.in. The basic process may be summarised as follows:

l First, select the appropriate Return form (see table)

l Download the Return Preparation Software available on the site. This is nothing but a simple Microsoft Excel Utility

l Fill your return offline and generate an XML file

l Register and create a user ID/ password. In all cases, the taxpayer’s PAN is the user ID

l Login and click on the relevant form on the left panel and select “Submit Return”

l Select the XML file from your computer and click on “Upload” button

l Upon successful upload, acknowledgement details would be displayed. Click on “Print” to generate a printout of acknowledgement/ ITR-V Form

l In case the return is digitally signed, upon generation of the acknowledgement, the return filing process gets completed. You may keep a print of the acknowledgement for your record

l In case the return is not digitally signed, upon successful uploading of e-Return, the ITR-V Form would be generated, which needs to be printed by taxpayers. This is an acknowledgement cum verification form. Duly filled, this form should be mailed to “Income Tax Department - CPC, Post Box No - 1, Electronic City Post Office Banaglore - 560100, Karnataka” within 30 days of filing electronically.

Taxpayers may note that the above process is a major departure from last year where ITR-V was to be submitted with the local income-tax office within 15 days of filing electronically.

Several issues arise due to this newly instituted procedure.

First and foremost, if Form ITR-V is furnished after the 30-day period, it will be taken as if the return was never filed and the entire process will have to be repeated again.

Now, take a case where a taxpayer mails the form in time, but there is a delay at the postal department’s end. The assessee will be penalised for filing the return late for no fault of his.

Secondly, a stamped copy of ITR-V, which served as proof of having filed tax return, will not be available. Copies of tax returns are needed for many purposes, from applying for a visa to taking a home loan. Now, in the absence of a stamped acknowledgement from the tax department, it is not clear how the taxpayer can prove to someone outside the department of having duly filed the tax return.

It is because of such issues that electronic filing has not taken off in a way it should have. Yet, as if these weren’t enough, there is yet another issue this year —- with respect to claiming credit for TDS only by way of the system of Unique Transaction Number (UTN) on which there is much debate and controversy currently.
We shall take up that topic next week.

To sign off, how about marvelling at the irony that in a country where less than 3% of the population pays taxes, rather than lay out a red carpet for this minority, the government has been making the process becomes more complicated every year?

The writer is director, Wonderland Consultants, a tax and financial planning firm. He may be contacted at sandeep.shanbhag@gmail.com.

Why China can’t dethrone the dollar just yet

noreply@blogger.com (Fenil) — Fri, 26 Jun 2009 16:07:00 +0000

Currency swap with multiple nations is a good bet, but will take time working

Vivek Kaul. Mumbai

The Indian stretchable time was at work again. The Woodpecker Airlines flight I was supposed to board was late by an hour.

“Let’s have some coffee,” I said.

“Not a bad idea,” she said, leading me to the nearest coffee shop.

“Good coffee,” I said after taking my first sip and looked to her for a confirmation.

“Good as usual,” she said. “Now tell me what China is doing to bring down its dependence on the US dollar.”

“Oh, a number of things,” deciding to plunge headlong into a discussion so waiting for the flight became more bearable. “First, it has been buying metals like copper, aluminum, nickel, titanium and zinc. It has also been buying iron ore in huge quantities from Brazil since the beginning of this year with the intention of building a store house of real physical assets instead of having a major portion of the foreign exchange reserves invested in financial securities issued by the US government. It has also been buying gold. Since 2003, China has increased its holding of gold by 73% to 1,054 metric tonnes, valued at around $31.3 billion, which makes it the fifth-largest holder of gold in the world. Still, all these investments make up a very small part of the nearly $2 trillion foreign exchange reserves China has. A bigger game is being played somewhere else,” I explained.

“And what is that game?”

“China is trying to enter into currency-swap agreements with countries like Argentina, Brazil, Belarus, Hong Kong, Indonesia, Malaysia and South Korea. It has signed agreements worth $95 billion in the last four months.”

“What’s a currency swap agreement?”

“Let me give you an example. China recently overtook US as Brazil’s major trading partner. Up till now, they have been carrying out trade in US dollars, which means that if China buys something from Brazil, it pays Brazil in dollars and vice versa. The Brazilian President, Luiz Inacio Lula da Silva, better known as Lula, said in an interview recently, “Between Brazil and China, we need to establish a trade that is paid for in our own currencies. We don’t need dollars. Why do two important countries like China and Brazil have to use the dollar as a reference, instead of our own currencies? It’s crazy that the dollar is the reference, and that you give a single country the power to print that currency. We need to give greater value to the Chinese and Brazilian currencies.” If Lula and China have their way, China will pay Brazil in yuans when it buys something from Brazil and Brazil will pay China in real (the Brazilian currency) when it buys something from China.”

“And how will that help?” she asked, taking a noisy sip.

“It will take the US dollar out of the equation for China to some extent. Right now, when China exports goods and services, it gets paid in US dollars. Vice versa, when it imports goods and services, it needs to pay in dollars. If China can expand this currency swap system, it no longer needs to be dependent only on the US dollar for international trade. It will accumulate a lesser amount of dollars in the days to come by getting paid for exports in currencies other than the dollar as well. Also, China is a big importer of commodities these days and it can pay for those using its own currency, the yuan. And as China imports more in the days to come, countries around the world will start accumulating yuan, and that improves the chances of yuan becoming an international reserve currency like the US dollar currently is.”

“Interesting.”

“I’m not done yet. Nouriel Roubini, one of the few economists who correctly predicted the current financial crisis, recently wrote, “Traditionally, empires that hold the global reserve currency are also net foreign creditors and net lenders. The British Empire declined — and the pound lost its status as the main global reserve currency — when Britain became a net debtor and a net borrower in World War II. Today, the United States is in a similar position. It is running huge budget and trade deficits, and is relying on the kindness of restless foreign creditors who are starting to feel uneasy about accumulating even more dollar assets. The resulting downfall of the dollar may be only a matter of time… China has already flexed its muscle by setting up currency swaps with several countries.””

“So are you saying the yuan will displace the US dollar as the international reserve currency soon?” she asked.

“I am not saying that. All I am saying is China is trying to make yuan the international reserve currency.”

“Well, what’s the problem with yuan becoming the international reserve currency?”

“That’s because I have only explained the positive side of things. See, for a currency to become an international reserve currency, it needs to be extremely liquid.”

“Liquid?”

“Yes. When we say a certain asset is liquid, we mean it can be bought or sold at any point of time. That would mean there are buyers for the asset at all points. Take the China and Brazil currency swap plan. China accumulates reais (plural for real), when it sells goods and services to Brazil. It should be in a position to exchange the Reais it has accumulated to yuan at any point of time. But, currently, the Brazilian real is bought and sold only for a few hours every day, and these few hours are not at a point when the Chinese currency markets are open. So, currently, in order to change real into yuan, first reais will have to converted into dollars and dollars in turn will have to be converted into yuan. That’s a major weakness of the currency swap arrangement now, and it will take some time improving,” I said, emptying my cup.
“Oh, okay. Let’s go now. You need to check in now.”

k_vivek@dnaindia.net
(The example is hypothetical)

References: Brazil and China: Moves Towards a New Economic order?, Rachel Ziemba, www.rgemonitor.com, May 18, 2009; China Seeks to Dethrone the Dollar, Transforming the Yuan into the Dominant Global Currency, Keith, Keith Fitz-Gerald, May 27,2009; China and Brazil to Ditch U.S. Dollar? Hardly, Marc Chandler,www.seekingalpha.com, May 20, 2009.

Using the inverse of P/E to read markets better

noreply@blogger.com (Fenil) — Mon, 15 Jun 2009 12:48:00 +0000

Earnings yield helps identify mid-term turning points in the markets

Devendra Nevgi

With the local stock markets rallying more than 65% from the bottom seen in March 2009, the "valuation debate" is back in vogue.

Though absolute valuations are always debated, relative valuations are hardly discussed. We shall discuss relative valuations here.

But first some basics.

A traditional method used to value stocks for years now is the price to earnings (P/E) ratio. It is the multiple of the earnings the stocks or markets in general are valued at. The key question here is — how many times the earnings is the market willing to pay to buy a certain stock?

The P/E ratio may be based on historical or estimated earnings. Earnings can be estimated with minimum assumptions (such as GDP growth rate), historical data and growth rate. The current P/E ratio is then compared with its own historical averages to value the individual stock or markets.

Similarly, bonds (government) are valued based on their yield to maturity (YTM). That's the expected return if the bonds are held to maturity and the governments don't default. For instance, the most traded bond in Indian markets is the 10 year (long term) benchmark 'government bond'. Bonds are valued taking into account various macroeconomic factors such as GDP growth rate, inflation, currency, liquidity, central bank stance, supply and demand, etc. Historical averages of YTM on such bonds are used to value the yields on current bonds vis-a-vis the prevailing economic cycle.

Though the stocks and bonds have been historically valued independently, many a times investors don't realise that there is a strong link between the valuations of the two asset classes since in the long run, the macro economic factors influencing both the asset classes are very similar. For instance, cost of funds (interest rates) influences the earnings of companies and government bond yields set the tone for interest rates in India. Or GDP growth rate is a crucial input for valuing stocks as well as bonds. The interest rates are also used for discounting future earnings of companies in the now famous valuation technique, discounted cash flows (DCF).

Traditionally, stocks and bonds have always been valued on a standalone basis. But the link between stocks and bonds that we just discussed can be effectively used for "relative asset class valuation," viz, over or under valuation of stocks relative to bonds or vice versa.

We all know what dividend yield is; it is dividend received divided by the price of a stock.

If we presume that all the earnings of the company are distributed to shareholders as dividends, the dividend yield can also be termed as the 'earnings yield', which is nothing but the inverse of P/E ratio. For instance, if the P/E ratio is 20, the earnings yield is 5% (1/20).

Since future earnings are always uncertain, the earnings yield also carries some risk of not being realised. Since it is risky, the earnings yield has to be higher than the 10 year government bond yield, which is almost assured on maturity. The excess of the expected earnings yield over the 10 year government bond yield is nothing but the equity risk premium, or the extra returns to compensate the investors for the extra risk undertaken.

The difference in the earnings yield and the bond yields often gives a perspective of relative asset valuation, making either of the stocks or bonds relatively cheaper or expensive. Such relative valuation can be effectively used as additional input to value stocks.

Higher the difference in the earnings yield and the bond yields, cheaper is the relative valuation of stocks and vice versa, since the investors are getting compensated more for higher risks taken for stocks.

So, higher the difference, cheaper the stocks, assuming everything else remains the same.

In the Indian stock market context, historically (last 10 years) whenever the difference between earnings yield and bond yield (henceforth EYBY) has peaked at around 2-2.50% or higher, the Sensex has bottomed out and delivered good returns from there. And usually, whenever EYBY is low or negative at around minus 5% or lower, the Sensex has peaked and returned negative.

For instance, when the Sensex bottomed in March 2009 at around 8200, EYBY was at the higher end of the band at 2.1%. When the Sensex peaked at around 20500 in January 2008, EYBY was almost at minus 4.50%, closer to minus 5%.

This tool can be effectively used as an incremental or additional input, along with fundamental research, before buying/ selling in the markets. Historically, the tool has been useful in identifying the mid-term "turning points" in the markets. The data points for the same are easily available on the internet for retail investors to take advantage of.

A caveat: Liquidity (internal & external) can distort the indicator and the tool has to be used in tandem with other fundamental research.

The writer is a qualified chartered account

Long-term investing's the way to play equity

noreply@blogger.com (Fenil) — Sat, 06 Jun 2009 04:38:00 +0000

Or, why time in the market works better than trying to time it

Sandeep Shanbhag

On March 5, 2009, the Sensex closed at 8197 points. Cut to two-and-a-half months later. On Tuesday, the index closed at 14875, up a whopping 6678 points or 81%. Who could have thought this was possible?

This is precisely the reason I have repeatedly observed that the market is like a classroom where we are taught lessons. The same lesson is taught to you time and again till you learn it properly. Once you have finished your learning, you move on to the next classroom where you are taught another lesson. Successful investors are those who learn the most lessons along their investing life.

With the market in a free fall over the past few months, many investors had started questioning their conviction and wondering whether they would be better off selling lock stock and barrel, even at a loss sometimes, rather than having to bear this choppy volatile market. All ambitions and aspirations of being a long-term investor had fallen by the wayside. However, the events that have unfolded over the past few days are once again teaching us some lessons and hopefully some of us will learn these this time.

The first lesson repeatedly taught is that it is pointless, even impossible, to predict the market. But, we refuse to imbibe it. Investors tend to look towards experts, market gurus and other story tellers to give them a direction or even a prediction about the expected Sensex level. Currently, there are various predictions going around that the market will rise to a level of 19000 by December or that we will see a level of 17500 by Diwali 2009 and so on —- the actual number doesn't matter, the amusing thing is that none of these people were able to predict the 'fall' beforehand. However, once the market started falling, dire 'predictions' of doomsday started coming out thick and fast. And on the flip side, now that the fall has abated and the market has started its upward move, these very same people have started envisioning all-time highs and great achievements for the time to come.

Herein emerges another lesson that we can all learn. And this lesson is best summarised by the following quote by Bernstein William in the book The Intelligent Asset Allocator, "There are two kinds of investors —- those who don't know where the market is headed, and those who don't know that they don't know. Then again, there is a third type —- the investment professional, who indeed knows that he or she doesn't know, but whose livelihood depends upon appearing to

know." Truer words were never spoken.

History has repeatedly proven that it is impossible to time the market. National, international, political, geo-political, economic —- there are far too many factors which simultaneously affect the stock market and it is humanly impossible for anyone to forecast the index level.

Like I said, on Tuesday, the Sensex closed at 14875. But no human being is capable of knowing for sure where the market will close this evening, or the next week, or next month. So, if you invest or disinvest based on market movements or expected market movements, it amounts to speculation. And know this much —- you can either speculate or accumulate, but never both.

The second lesson flows from an interesting piece of analysis that has already been mentioned in a past column. I came across this study in The Wise Investor, the monthly newsletter from Sundaram BNP Paribas Asset Management. Take a look at the chart. It shows the value of Re 1 remaining invested at all times in the Sensex and what it would be worth if you missed the best days in the market. The numbers tell the tale. If you had stayed invested in the Sensex since launch, Re 1 would be worth Rs 161. If you had missed the best ten days, the value would be Rs 62 and this number declines significantly to Rs 10 if you had missed the best 40 days.

The key as we can see is to stay invested - for the simple reason that we do not know which would be the best days in the market. Of course, if you could sell only during the bad days and remain invested only during the good days, you would make more money. But that would mean predicting the future which is impossible. So the next logical thing to do would be to stay invested such that the good days are automatically taken care of.

The most relevant example of the above is the 17% rise from 12173 points to 14284 points on May 18, 2009 when the UPA won its overwhelming victory. Those who had stayed invested benefited; those who hadn't and thought they could outguess the market, lost out on an opportunity of a lifetime.

If there is any more evidence that you require about the benefits of long-term investing, see the table, which has a selection of a clutch of mutual funds that have stood the test of time. The market has fallen and risen multiple times since they were launched. However, had an investor held steadfast through it all, this is the kind of money that could have been made. Not for a minute am I suggesting that we can make similar profits going ahead. The return could be much lesser, or more. The point is, the only way to make a return —- any kind of return —- is to stay invested over the long term. All you need to ensure is that the vehicle (investment instrument) chosen is the correct one.

Despite all the upheavals and turmoil that we go through, at the end of the day, the world at large and India are progressing. And this progress will manifest itself in the stock market in one way or another. Timing is irrelevant —- that it will happen is certain. Whether you can benefit from it is up to you. The question is, are you up to it?

Get those annual tax statementsout now

noreply@blogger.com (Fenil) — Sat, 06 Jun 2009 04:32:00 +0000

The emails and letters sent by NSDL hold your tax deduction history

Khyati Dharamsi. Mumbai

It's that time of the year when filing income-tax returns attains primacy. If you haven't started

the relevant paperwork already, it's time you did, for time's ticking away.

Remember, the tax-filing process would be slightly different this year as new rules kick in from July 1, 2009 —- just 30 days before the deadline.

The income-tax department, through the National Securities Depository Ltd (NSDL), has been sending income-tax payers a document called the 'annual tax statement' for the past two years. If you have ignored these emails or letters from NSDL's Tax Information Network (TIN), it's high time you referred back to them. For, under the new rules, these are central to the tax filing process.

Here's a thorough once-over on the annual tax statement and what it means.

What is the annual tax statement?

The annual tax statement lists all the tax deducted at source (TDS) or tax collected at source (TCS) by the employer in case of salaried individuals or banks for fixed deposits, etc. This statement will tell you what is the tax deducted by anybody for your permanent account number (PAN) in a particular year. So, if tax has been deducted by someone in 2008-09, the letter from TIN will read Annual Tax Statement for Assessment Year 2009-10 (when you pay taxes for income earned between April 1, 2008 and March 31, 2009).

TIN creates the statement based on the information submitted by the person who has deducted or collected your tax, before handing over your rightful money to you. Companies, banks, etc file income-tax returns before individuals do and so the information submitted by them for your PAN has to be verified by you before filing your return.

Do you have to register to get your annual tax statement?

If you want to get the annual tax statement from the current financial year, you can register and also view your tax credits through a one-time registration. Registration details are available at www.incometaxindia.gov.in and www.tin-nsdl.com.

How to read the annual tax statement?

Also called your Form 26AS, the annual tax statement contains, all the TDS in Part A, while the tax collected at source TCS is covered in Part B. When you deposit tax in a bank as self-assessment or advance tax via a challan, the same would be reflected in Part C.

The status of the tax credit too would be mentioned, besides the tax entry, using three letters —- P for provisional, U for unmatched and F for final. Provisional would mean tax where the credit is effected on the basis of TDS/ TCS returns filed only. This would turn to final on verification. Unmatched would mean that the deductor has not yet deposited the taxes or has provided incorrect details of tax payment. Sometimes final status would not appear if the payment details in the bank match don't match with the details of deposit in the TDS or TCS return.

When and why was this exercise started?

This mailer is being sent to most tax payers for the past two years, when the income-taxdepartment moved to a separate system of filing and submitting returns without any attachments such as Form 16, TDS Certificates etc.

As there was no proof of tax deducted or collected without the attachments, the income-tax department was finding it difficult to process the returns.

Hence, the annual tax statement was initiated to tell individuals about the tax credits reported by their tax deductors or collectors and the tax deposited as self assessment tax, advance tax, etc. It is claimed that the process would help the income-tax department process returns faster like in USA, where refunds are given to the individuals within two months time.

Why must you check the annual tax statement?

The statement will be referred by theincome-tax department while processing your income-tax return. So, if the data provided by you doesn't match that provided by the tax deductors, then your return won't be accepted until it is corrected.

Only the deductor or the person who has entered the data has the right to correct it and not the individual on whom the data has been entered. The annual tax statement sent for this assessment year notes, "The statement is being sent to enable you to take up the matter pertaining to any deficiencies in your statement with your deductor at the time of taking the TDS certificate(s) at the end of the financial year. This would also ensure that complete and correct tax credit is available to you at the time of filing of the income-tax return for the A.Y. 2009-10."

How can discrepancies creep in?

Your tax credit could be erroneous if the deductor or collector has not filed its quarterly TDS/TCS return; has not quoted or has wrongly quoted your PAN in its return. It may also happen if the deductor has not paid the required TDS to the government account. If you have not provided your PAN details, the employer or bank may not be able to submit your tax details as PAN is mandatory. In case of any such errors, you must persuade the deductor to rectify the mistake.

What if you don't correct them?

The tax credits would be given to you only on the basis of the tax statement. The income-tax department has stated, "The same (tax credit) should be verified before claiming tax credit and only the amount which pertains to you should be claimed."

Will a fresh statement be sent in case the deductor revises his or her returns?

NSDL will provide you a fresh tax statement when the deductor revises his data.

Who to contact in case of queries?

In case you are still have queries on the annual tax statement you can call 020-2721 8080 or contact NSDL via fax at 91-20-2721 8081 or email them at reply@nsdl.co.in or tininfo@nsdl.co.in.

So, before the July 31, 2009 deadline for filing income-tax returns, make sure you ask your deductor to rectify any errors in your annual tax statement.

US dollar: Destination known, road unknown

noreply@blogger.com (Fenil) — Wed, 03 Jun 2009 13:57:00 +0000

The greenback is headed down for sure, one just doesn’t know when and how

Vivek Kaul. Mumbai

“The US dollar is not strong because people want to hold the dollar, but it’s strong because people have debt in dollars.”

—George Soros,renowned hedge fund manager

“You know, I have been here for almost a month now and still haven’t figured out what I want to do,” she said, late on a Sunday afternoon.

“When you don’t know where you are going, the journey is the reward,” I replied.

“So funny,” she replied rather agitatedly.

“OK, let’s go out somewhere,” I said, grabbing her hand and leading her out of the house.

“What’s on your mind? You know, you can be really weird at times,” she said as we reached the bus stop.

“We’ll take the first bus that comes here, wherever that goes,” I said, sounding weirder.

One did five minutes later; a 33 to somewhere. We hopped on and bought two tickets to the last stop.

“Where does this bus go?” she asked.

“I don’t know!” I replied.

“Is this some sort of a joke?”

“Like I said, when you don’t know where you are going, the journey is the reward. So, enjoy it.”

“Oh! I think I’ll flip the point you are trying to make. Take the US dollar, for instance. From what we have been discussing, we know it will ultimately crash —- when and how, we don’t know. Destination known; road unknown. You know where you are going, but not how and when you will get there. Is the journey still the reward?”

And I thought I had the penchant for linking anything to anything.

“Interesting,” I said. “But I think I have some idea of how the US dollar will get there. For 2009, the projected fiscal deficit of the United States is $1.85 trillion. That’s four times higher than the maximum deficit the US has previously run. This estimate has been made by the Congressional Budget Office (CBO). It also estimates that the deficit will be $1.4 trillion in 2010. Estimates made also suggest that between 2010 and 2019, the US will run a total deficit of $10 trillion. As you know, fiscal deficit is essentially the difference between what the government earns and what the government spends. And given that it plans to spend more than what it earns, the remaining money needs to be borrowed. Also, like most forecasts, this forecast is also a wee-bit optimistic, I feel.”

“As in?”

“See every forecast is made using some assumptions. The CBO has assumed an unemployment rate of 8.8% for 2009. The rate has already touched 8.9% at the end of April. Also, from the way it looks, unemployment in the US is only going to increase in the days to come. Other than this, CBO assumes that the gross domestic product (GDP) growth in 2010 will be 3.8%. Now, given that the GDP contracted by 6.1% in the first quarter of 2009, hoping it will grow at 3.8% the very next year is pretty optimistic. My view is the US fiscal deficit will be more than what it is being projected. And all this money will have to be borrowed.”

“Yeah, it will have to be borrowed. But with countries like China and Japan ready to lend to the US, where is the problem?”

“Hold on. In March, China and Japan were net buyers of $48.5 billion of financial securities issued by the US government. These financial securities pay a certain rate of interest and are issued to borrow money. Even Russia bought $8.3 billion of financial securities issued by the US government. Some experts have questioned the credibility of these figures, but assuming you and I trust these figures, there are some serious problems otherwise as well,” I said, looking out the window, and realising how little traffic the city had on a Sunday afternoon.

“And what are these problems, if I may ask.”

“Estimates suggest the US government needs to borrow $1 trillion by September. It will be very difficult to raise such humongous amount of money given that exports of the major buyers of these securities are falling. Chinese exports are down 41% and Japanese exports are down 38%. These countries earn US dollars through exporting goods and services.

These dollars, in turn, are used to buy securities issued by the US government. When exports fall, dollar earnings also fall. Given that, where will all the dollars to buy these securities come from? Also, we need to remember that the US is not the only country in the world that is running a fiscal deficit. Most of Europe is running a fiscal deficit, and so is Japan. And all these countries need to borrow. One estimate suggests the US, Japan and Europe need to borrow $5 trillion over the next two years. Now, let me be optimistic for a change and assume that there are enough buyers for these securities. But even with that, will the US government manage to find buyers for financial securities amounting to another $5 trillion, which it needs, over the next four years? This, given that the government will continue to spend more than it earns.”

“Hmmm... I see even optimism can lead to pessimism. So what is the way out?” she asked as a spurt of wind blew her hair on to my face.

“I guess the only way out is to print money. The Federal Reserve of the US is currently authorised to print $1.75 trillion. This money will be used to buy back financial securities issued by the US government. The theory is that more money in the economy will lead to people spending people more and that in turn will revive the economy. Most western economies are resorting to this in order to get their economies up and running again. Bank of England is planning to buy back bonds worth 75 billion pounds. And the European Central Bank, the central bank of the European Union countries, also recently announced that it would start printing money.”

“But wouldn’t all this money printing be disastrous?”

“Over a period of time? Yes. But right now, the impact of this has been extremely benign. See, the idea was that increased money in the economy will make people spend more and that in turn will lead to people spending more. But right now, people are tired of spending and not in the mood to spend. That cannot continue forever, and as and when they do start spending again, too much money will chase too few goods and inflation will start showing its ugly head.”

“I recently read an interview of Ben Bernanke, where he said, “When the economy begins to recover, that will be the time that we need to unwind those programmes, raise interest rates, reduce the money supply, and make sure that we have a recovery that does not involve inflation.””

“At the cost of repeating myself, economics is not an exact science and I am sure Bernanke also knows that, notwithstanding what he said in that interview. So assume prices start rising in the US and the US government along with the Federal Reserve to start reducing money supply. The simplest way to do it would be to start selling the financial securities they have been buying these days. Once they start doing that, they will be able to suck out money from the market, at least theoretically. But imagine what impact that would have. The biggest buyer of these financial securities would suddenly turn into the biggest seller. Given that, at that point of time, will there be enough buyers of these securities? The prices of these financial securities will crash, as there would be very few buyers at that point of time. Also, as inflation rises, investors who have bought these financial securities would want to sell out.”

“Why would they want to sell out?”

“Inflation reduces the value of the money and given that expectation, investors would want to get out and spend that money. All this will lead to the price of these financial securities crashing. And that will also lead to the US dollar crashing because countries like China, Japan and Saudi Arabia own most of these financial securities. Once they have sold off these securities, they would want to convert the dollars they have got selling these securities into their own currencies. A spate of dollar sales is likely to hit the market, and that in turn will lead to the value of the dollar crashing against other currencies.”

“And when will this happen? she asked.

“I wish I knew. But as renowned economist Nouriel Roubini, who predicted this crash, recently said, “This decline of the dollar might take more than a decade, but it could happen even sooner if we do not get our financial house in order. The United States must rein in spending and borrowing, and pursue growth that is not based on asset and credit bubbles. For the last two decades, America has been spending more than its income, increasing its foreign liabilities and amassing debts that have become unsustainable,” I said.

There was a tap on my shoulder. “Last stop,” the conductor said, asking us to get down.

“So where are we?” she asked.

“Goregaon,” I said, looking around. “Now that we are here, let us find a coffee shop first.”

Is hedging loss really the party pooper?

noreply@blogger.com (Fenil) — Wed, 03 Jun 2009 13:46:00 +0000

Hedging is supposed to bring certainty, so what gives?

Nikhil Rastogi

As companies report their results for the quarter ended March, one thing that is attracting attention is that a lot of companies are reporting reduced profits and ascribing some of it to the losses incurred on account of forex fluctuations.

Among others, Biocon reported sales of Rs 486.6 crore, profit after tax (PAT), excluding mark-to-market (MTM) loss of Rs. 74.9 cr and MTM losses of Rs 41.4 crore; Ranbaxy Laboratories reported sales of Rs 1,558.4 crore, PAT (excluding forex losses) of Rs 26.2 crore and forex loss of Rs 918.80 crore; HCL Technologies reported revenue of Rs 2,861.5 crore, net profit before forex loss of Rs 419.4 crore and forex loss of 201.3 crore; MindTree reported revenue of Rs 256.56 crore, forex loss of Rs 43.90 crore and PAT (after forex loss) of Rs 3.31 crore.

On the face of it, one would think the company could have done better but for the forex loss. But try asking the company:

Investor: Why did you have the MTM loss?

Company: Oh, we entered into a contract with a bank promising to sell dollars to it at Rs 40 one month down the line.

Investor: Why did you do this?

Company: Because we have revenues in dollars and we will receive these dollars at the end of the month. Now, if the rupee goes to Rs 35 from Rs 40 one month down the line, then we convert dollars at Rs 35 and not at Rs 40, thereby having a loss of Rs 5.

Investor: Smart move. So why are you having losses?

Company: The rupee actually moved from Rs 40 to Rs 50 to a dollar.

Investor: That’s good. Now you can convert you dollar revenue at Rs 50, so that’s a gain of Rs 10 per dollar, which is a profit.

Company: Yes. But since we promised to sell the dollars at Rs 40, and now it is at Rs 50, we are incurring a loss of Rs 10 on this particular transaction.

Investor: But, you are also getting a profit of Rs 10 per dollar when you convert dollars into rupees. So net-net it has had no impact as far as your operating efficiency is concerned. What you lost in the forex market, you made it up in the other market by selling your revenue dollars at a higher price. So what’s the fuss all about?

Indeed, it is common knowledge that when you hedge, you buy certainty. Had the rupee gone to Rs 35, you would have gained on the contract, but lost on the dollar-revenue conversion and vice-versa.

So the message for investors is, don’t think the company has lost money. It was a trade-off. It wanted to bring certainty to cash flows, which is what hedging is for. If the company makes the drug at Rs 38, then anything less than Rs 38 would lead to a loss. Now if it sells this drug at $1 when the dollar is Rs 40, it would earn a profit of Rs 2. But, this earned dollar would be received one month down the line. What if the rupee-dollar rate at that time is Rs 35? You incur a loss of Rs 3. To avoid such an eventuality, you sell dollar at Rs 40 one month down the line. If after the month the dollar is at Rs 35, you make a profit of Rs 5 since you can buy dollars at Rs 35 and sell it at the contracted price of Rs 40. However, you also receive your $1 from the international customer. You can convert it at Rs 35. So this Rs 35 and Rs 5 gives you a total of Rs 40, which is what you expected to get from your sales. If the rupee goes to Rs 50 to a dollar, you stand to loose Rs 10 since you will have to buy rupee at Rs 50 and sell it to the contracted party at Rs 40. But now, the dollar that you receive from your customer will be converted at Rs 50, so this Rs 50 and a loss of Rs 10 again results in your getting Rs 40 effectively. So, in all the cases, you would get Rs 40. Thus you are certain of getting this Rs 40 and thus certain of making a profit of Rs 2. So if the rupee increases to Rs 50, don’t say that your profits would have been higher but for the loss on the forward contract, but if the rupee goes to Rs 35, pat yourself on the back that you avoided a loss to the company.

We still haven’t discussed MTM, which involves marking your instruments to the market.

Let’s understand the concept through an example. Let’s say a company has made sales, which would be realised by April or May, and the company wishes to hedge this exposure since it would receive dollars only one or two month later. For this purpose, it has entered into a contract with a bank to sell the dollar one and two months down the line, at a particular rate, say Rs 46.

However, the company has to finalise its account for the period April 2008 to March 2009 and on March 31, it finds the rupee-dollar rate to be about Rs 50. So, as of March 31, the company is incurring a loss of Rs 4 on its forward contract (it sold dollar at Rs 46 and assuming it has to honour the contract on March 31, it would have to buy the dollar from the market at Rs 50, thus

incurring the difference as the loss).

This is MTM. It asks the company to show the net profit or loss on a contract at prices prevailing on the date of finalisation of its accounts. Thus, MTM is like a notional gain or loss since though the company has agreed to sell dollars at April end (say at Rs 40 for dollar), its actual profit or loss position can only be found by knowing prices at April end. If the dollar is less than Rs 40, the company would have a profit, and a loss if it is more than Rs 40. Thus, if the dollar-rupee rate at March end is less than Rs 40, the company can report a higher profit (which is on account of MTM) and pat itself on the back, but if it is more than Rs 40, then blame it on the MTM losses. Thus, the bottomline is that when a company hedges by selling dollars in future, it is sure what its net-net future profit or loss will be. You always know the result.

Sow well and thou shalt reap good

noreply@blogger.com (Fenil) — Wed, 03 Jun 2009 13:45:00 +0000

Or, why asset allocation is key to investing

Vivek Kaul. Mumbai

If you are a true blue retail investor, the kind who invests when the stock market is at its peak, and sells out when the market is at a low, chances are you would have missed the current rally.

Since March 9, 2009, when the current rally started, the Bombay Stock Exchange (BSE) Sensex has gone up by a whopping 75%. And most retail investors have missed this rally.

Even those who have stayed invested in mutual funds have lost out to some extent because a large number of equity mutual funds haven’t invested and are sitting on a large amount of cash.

Given this, how can a retail investor ensure that he does not miss out on future stock market rallies without taking on too much risk?

The answer, as always, lies in “asset allocation” —- one needs to maintain wealth across asset classes such as equity, bank fixed deposits, cash and gold.

What proportion of your wealth should be in stocks?

This is a proverbial question. Tie-wearing experts will tell you that in the long run, stocks are the best way of investing. But how long is the long run? Is it three years, five years or ten?

Anyone who invested in the stock market in April 1992, when Harshad Mehta’s euphoria was at its peak, would have not have recovered his money until July 1999, when investors had been taken over by the dotcom mania. The dotcom mania peaked around February 2000. Anyone who invested in the stock market around then would have had to wait till January 2004 to see his investment get into positive territory.

Given this, investment in stocks should always be to the proportion of your income on which you don’t mind losing money at a given point of time. If you are comfortable with facing losses on 50% of your wealth, that is the proportion you can allocate to stocks.

The easiest way to invest money in stocks is to invest it in a good index fund. An index fund is a mutual fund which collects money from investors and invests in stocks that make up a stock market index in the same proportion as their proportion in the index. In India, index funds are available on the two major stock market indices —- the Sensex and the Nifty. Since these funds track the broader index, the investor is immune to the active decisions of a fund manager.

Balancing is of utmost importance

Let us say you decide to have an allocation of 50% to equity and 50% to other assets. It is important that this asset allocation is maintained. So when stock markets fall, you buy stocks to maintain the allocation and when stock markets go up you sell stocks to maintain the allocation. This strategy will help you follow the quintessential market wisdom of buying low and selling high. Retail investors typically end up doing the opposite: buy high and sell low.

It is very easy for investors to believe during a bull run that they will continue to invest even when the stock market falls. It is only when there is a bear market is upon them that they realise how psychologically difficult it is to invest when a bear market is on, and when they can see the value of their investment continuing to fall. The balancing strategy ensures that investors can continue investing small amounts in a bear run, ensuring that once the market rebounds, the chances of making money are much better.

Investor greed is coming back

If you are the kind who follows the stock market closely, you would have realised that optimism is coming back to the market. A leading international financial institution now feels that the Bombay Stock Exchange Sensex may touch 19500 this year. Mutual funds which had not been launching new equity schemes have started launching new schemes again. At an individual level as well, investors are feeling more confident and some of them have even started sharing hot stock tips, once again.

The bigger question though is, if investors were not ready to buy when the Sensex was at a level of 8000, why are they ready to buy at a level that is nearly 75% higher? The law of demand tells us that higher prices dampen demand and lower prices increase demand. This seems to work everywhere except in the stock market. As the stock prices go up, the more stocks appeal to investors. And that explains why investors are coming back to the market.

The herd mentality

“A fundamental observation about human society is that people who communicate regularly with one another think similarly. There is at any place and in any time a zeitgeist, a spirit of times,” writes economist Robert Shiller in his book Irrational Exuberance.

A retail investor looking to invest largely looks at the situation around him. What he checks out is whether the people he knows, his neighbours, relatives etc are investing. If they are investing, he too invests; if they are not, he doesn’t. Confirming to the herd is the safer thing to do, even though it may not be the right thing to do.

As John Maynard Keynes famously wrote “Worldly wisdom teaches us that it’s better for reputation to fail conventionally than succeed unconventionally.”

Also, in uncertain situations, like the stock market, people tend to look at the familiar past pattern and assume that the future patterns will be identical to the past ones. Since investors do not know exactly what will happen tomorrow, it is easier for them to assume that the future will be similar to the recent past than to admit that it might bring in some unknown elements. So when the BSE Sensex was at a level of 8000, investors assumed it will continue to fall. And now, when it is at a level of 14000, the investors see that the going has been good in the recent past, and they feel this will continue in the days to come.

That’s why, if you are a true blue retail investor, you are more likely to have invested in the stock market in the recent past, rather than when the market was around 8000 levels.

An interest-free loan can invite gift tax

noreply@blogger.com (Fenil) — Wed, 03 Jun 2009 13:41:00 +0000

Govt brought back thetax through the backdoor in 2005

Sandeep Shanbhag

Did I tell you about this terrific book I have been reading? It’s got all the essential ingredients a potboiler needs to have —- drama, intrigue and suspense. The plots and sub-plots are so intricately woven by the author that each page will leave you guessing. I wont give away more, but I fully recommend reading The Income Tax Act, 1961.

This week, we are going to examine one of the sub-plots of this thriller, which deals with gift tax.

Actually, gift tax had been discontinued from October 1, 1998 to March 2005.

From April, 2005, Sec. 56(2)(v) was introduced, which basically resuscitated the earlier gift tax by way of a backdoor entry as income tax. In other words, gift tax was brought back by way of an income tax on the recipient.

Now, as per the law, if a sum of money over Rs 50,000 is received by an individual or an HUF without consideration, the aggregate value of such sum will be taxable as the receiver’s income. There are seven exceptions:

Gifts received:

a) from any relative; or

b) on the occasion of the marriage of the individual; or

c) under a will or by way of inheritance; or

d) in contemplation of death of the payer; or

e) from any local authority.

f) from any fund or foundation or university or other educational institution or hospital or other medical institution or any trust or institution referred to in Sec. 10(23); or

g) from any charitable trust or institution.

In fact, points ‘e’, ‘f’ and ‘g’ above were added in 2006 as an afterthought when it was found that as per a strict reading of the law, any scholarship, donations, medical grants, etc would be taxable since these were essentially sums of money received by an individual without consideration.

What about interest-free loans? What if you were to take an interest-free loan from a non-relative - say a close friend who would like to help you out but does not want to make it into a commercial transaction by charging interest. The absence of interest would make the transaction look prima facie as a gift given by a non-relative and hence taxable as per the above law.

Well, one Chandrakant Shah faced precisely such a situation. He had borrowed over Rs 50 lakh from close associates for buying a flat. Since the loan was interest-free, the assessing officer treated the transaction as a sum received without consideration and taxed it. Shah then approached the commissioner (appeals) but to no avail. Not someone who easily gives up, Shah then knocked on the doors of ITAT Mumbai.

Shah’s counsel reportedly argued that an interest-free loan could not be taxed under Section 56 (2)(v) as the repayment of the loan itself was the consideration between two parties. By referring to a decision of the Court of Appeal of State of California, the counsel maintained that it was inessential that an interest component should exist to make a transaction of extending money a loan transaction.

The Tribunal bench concurred with Shah and stated that the law needs to be followed in letter as well as spirit. Both aspects needed to be considered. The loans had been shown by Shah in the balance sheet submitted along with the return of income as loans and the lenders had also confirmed the same as such. Thus, it was a clearly a case of loan transactions and not a case of gift as held by the assessing officer.

The bench further went on to rule that a loan transaction should be examined in the light of the provisions of section 68 and not under provisions of section 56(2)(v). Sec. 68 basically states that where a certain sum is found to be credited in the books of the taxpayer and the taxpayer can offer no explanation about the nature and the source ther.

It’s Catch-22 for China now

noreply@blogger.com (Fenil) — Wed, 03 Jun 2009 13:29:00 +0000

Much as it may want to, the Asian economy cannot tear itself away from the dollar given the level of exposure it has to the US economy today

Vivek Kaul. Mumbai

I like to relive memories.

Memories of power cuts; the first drops of rain; the smell of wet earth; the red gulmohar in all its glory; Doctor Uncle calling us to receive a trunk call on what was the only phone in the locality; December 25, 1984, when Papa got us our first black and white Uptron TV and we excitedly discovered that Chitrahaar played on Fridays as well; Ameen Sayani host Binaca Geet Mala in his booming voice “bhaiyyon aur behno aaj chauthi payedan pe hai...”; watching Vinod Kambli score a century in an one-day international against England and India losing, with 28 days to go for my tenth standard exams...

I make it a point to visit the city I was born and brought up in every year, just to relive my memories. This year is no different.

“V, we are late,” she said, as I locked the door.

“Don’t worry, we will make it,” I said.

“So you will be away for two weeks. I am going to miss you and our discussions,” she said, as we got into a cab.

“You will? Well, why not start one right now? It’s at least an hour to the airport,” I said.

“Oh, OK,” she said, somewhat startled. “You know, for all your pessimism on the United States and the dollar, the Chinese still haven’t stopped investing in financial securities issued by the US government. In fact, I was reading somewhere that the Chinese government has bought financial securities worth $34.3 billion in the first three months of 2009. Now if China was so pessimistic on the US, it wouldn’t be buying financial securities issued by the US government in the first place.”

“Hmmm. “If you owe $100 to the bank, it is your problem. But if you owe $1 million to the bank, it is the bank’s problem,” John Maynard Keynes once said.”

“So?”

“China is the bank here and the US the customer. The US government has been spending more than it earns and China has been lending it money by investing in financial securities. As of end-March, 2009, the Chinese had invested a little over $750 billion in financial securities issued by the US government. This year, the US government plans to spend $3.6 trillion, though its expected earnings are at $1.75 trillion. This means they will have to borrow the difference of $1.85 trillion, by issuing financial securities. China has in the past been the biggest buyer of these securities. Now if they were to suddenly stop buying these securities, what do you think will

happen?”

“I don’t know.”

“First, the demand for these financial securities will fall. Once demand falls, the US government will have to offer higher rates of interest on these securities to make them attractive for other buyers. This interest rate, in turn, will set the benchmark for the interest rate US banks charge their consumers. And if banks charge a higher rate of interest, people who have taken home loans, personal loans or have credit card dues outstanding would have to pay higher equated monthly instalments (EMIs) to repay these loans. A higher EMI would mean lower savings. Lower savings would in turn hurt China, as US consumers would have lesser money to spend on Chinese goods, which are exported to the US. The Chinese economy is dependent on US consumers, with nearly 50% of its exports going to the US.”

“Does that mean China is mindlessly buying financial securities issued by the US government?”

“Of course not. In fact, China is buying more of financial securities maturing in a short period of time, usually less than one year. In the first three months of 2009, of the total of $34 billion of financial securities they bought, $15 billion was long term and $19 billion short term. And why are they buying more of short-term securities, if not for the fact that there are doubts over the US government’s ability to repay its debt over a longer term? With short-term securities, chances of getting back the money invested are much better. In fact, it is largely because of this change in China’s stance that the return on long-term financial securities issued by the US government has gone up to 4.56% from around 3% a year back.”

“I’m listening.”

“In fact in the 12 months from April last year to the end of March this year, China bought around one sixth of the financial securities issued by the US government. Now compare this with the situation two years back, wherein purchases of fresh and existing financial securities by China were more than what the US needed to borrow. To that extent, they are incrementally buying lesser amount of financial securities issued by the US government.”

“Interesting. So things aren’t what they seem like. But I still haven’t understood why the US government plans to spend $3.6 trillion this year when its expected earnings are only $1.75 trillion. The difference of $1.85 trillion is huge, considering the total world savings in a year are around $2 trillion and of course, all of it cannot go into buying financial securities issued by the US government. Even China, despite the Catch-22 like situation it is in, cannot lend such humongous amounts to the US. So where is the money going to come from?” she asked.

“Good question. Let me deviate a little here. See, the US is now saving 4% of its gross domestic product. In dollar terms, these savings amount to around $550 billion a year. Typically, a miniscule portion of these savings go into buying securities issued by the US government. Now let us assume that all of it goes into buying these financial securities. Even that would not be enough given that the US government needs to borrow $1.85 trillion. So China cannot rescue the US; nor can its own citizens. So what does the government do? It prints the money it is not in a position to borrow. Like that,” I said snapping my fingers.

“I should have guessed. But how long can the US government keep spending twice what it earns? And how does China hope to reduce its dependence on the dollar?”

“Keep that for after I return. We are almost at the airport. As Vikram Seth put it, I can already feel “The peace of loneliness. The scent of imminent rain.””

Will political stability revive the economy?

noreply@blogger.com (Fenil) — Wed, 03 Jun 2009 13:20:00 +0000

Govt will have to induce demand through infrastructure projects, attract foreign investment and revive exports

Soumendra Dash

After the Congress party scored its biggest electoral win in two decades in the polls held in the just concluded polls, the need of the hour is to set the directions and limits of the electorate’s expectations in terms of the prospects and the challenges that the government is likely to face.

A continued tenure of the United Progressive Alliance (UPA) coalition brings with itself a much needed political stability, which would now loosen the political shackles that have restrained the country’s economic growth.

While the government’s fiscal & monetary measures towards resurrection of the ailing economy would continue undoubtedly, the Congress party has also announced a series of reforms in its manifesto.

With the focus on socio-economic development, the party plans to build further on the scheme based on the National Rural Employment Guarantee Act, which provides 100 days of work at a real wage of Rs 100 a day to all entitled.

On similar lines, the enactment of a National Food Security Act too has been announced.

Affordable quality education also continues to be on the government’s agenda.

Focusing on the security aspect, efforts would be expected on comprehensive national security, and other provisions for health security and insurance.

However, the immediate need of the government is to uplift the morale of the Indian economy and put it back on high-growth trajectory. This would be possible through inducing demand (domestic as well as international) by implementing huge infrastructure projects and in the process attracting foreign investments, taking measures to revive the export sector by making them more price-competitive and through other policy incentives to the exporters.

Earlier, there was an emphasis on infrastructure projects including initiation of the Golden Quadrilateral Project as part of the National Highway Development Project, and the Jawaharlal Nehru National Urban Renewal Mission project to improve city infrastructure. Also, IIFCL has been sanctioned to raise funds worth Rs 10,000 crore to implement projects in sectors such as roads, ports and airports.

However there is a need for enormous investments to meet this, for which the government needs to encourage private investments and develop projects on public private partnership (PPP) basis. There is a need to implement PPP projects more aggressively in the immediate future.

Post liberalisation reforms in 1991, which is seen as the economic independence of the country, Indian economy has accommodated an unprecedented amount of foreign investment. This led to an increase in growth in IT and ITES sectors, telecommunication and other infrastructure projects, resulting in robust GDP growth in the past few years.

Foreign direct investment up to 100% is permitted in most of the infrastructure sectors. A similar liberal stance could benefit sectors like insurance, pension and retail.

Domestic investors should be able to access international markets easily for the necessary funding.

As for accessing external commercial borrowings (ECBs), under the existing guidelines, ECBs can only be obtained from eligible lenders such as shareholders, international banks and multilateral financial institutions such as the Asian Development Bank and the International Finance Corporation. A more liberal approach by the government could make India an attractive destination for investments.

Liberal policies in terms of opening up of various sectors for foreign funds would not only boost economic growth, but will also support the rupee. Official data had also shown that foreign institutional investors remained net buyers for most days in May, signalling renewed investor confidence in India as a safe investment destination compared with other countries. On the whole, sentiments for the local currency remain bullish.

However, given the strong correlation between Indian equities and local currency, volatility in the rupee movement can’t be ruled out. The rupee would move within the band of 46.50 - 48.00 in the near future.

Moving to the bond markets, gilt yields are driven mainly by surplus liquidity in the system, understating the effect of frequent auctions of government securities and T-bills.

Given the requirement of huge market borrowings, the Reserve Bank of India has been maintaining adequate liquidity in the system. As a result, the UPA government’s huge borrowing plan would have muted impact on bond yields in the near future. The 10-year benchmark bond would trade with a yield of 6-7%.

The overall gloomy picture projected by Indian exports in the past few months with March reporting a negative growth of 33% (in US dollar terms); there is a dire need to focus on the revival of this sector. Our export sector faces some laggards in its growth process, such as the need to exhibit improved cost competitiveness given strong competition from countries like China and South Korea. A lowering of import tariff on raw materials, a considerably less-volatile exchange rate and boosting the export sector through stimulus packages may help in reviving the demand for Indian goods and services in the world.

However, India will face a trade off between a number of stimulus packages offered by the government for restoration of confidence in the economy causing widened fiscal deficit and the subsequent deterioration of India’s sovereign rating. This would cause a significant deviation from the Fiscal Responsibility and Budget Management (FRBM) targets, making the country’s future sovereign rating outlook uncertain. This makes it important for the government to revisit the FRBM targets as one of the important concerns to come out with a renewed roadmap for achieving fiscal consolidation after making the required amendment in the existing FRBM Act. This will help in maintaining the country’s credit rating with optimistic prospects and garner a steady and larger amount of foreign funds to complement the domestic investment resulting higher growth rates in the times to come.

The writer is chief economist, CARE Ratings. Views expressed are personal.