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“The king shall bestow on cultivators only such favour and remission as will tend to swell the treasury, and shall avoid such as deplete it.”

This dictum from Kautilya’s 4th century BC Arthashastra has circumscribed much of the thinking in today’s Budget making. Arthashastra has not been more fully read, nor the principles of modem public finance more fully understood.

Taxation has a legitimate basis, but the tax policies are set more by political economy constraints and less on rationality of their macro-economic and micro-economic effects. Hopefully, two recent research papers of National Bureau of Economic Research (NBER) would afford Budget makers another chance to consider the possible consequences of their deeds and misdeeds.

The first of these is by Martin Feldstein, who is currently the President of NBER, as also the Professor at the Harvard University. Feldstein says changes in tax rates does not just change realisation of capital gains, or portfolio composition between tax and tax-exempt financial instruments, but also alters supply of labour or the level of real income. It is important to understand the change in labour supply for it affects revenue estimation as well as work effort, occupational choices and if the fringe benefit tax (FBT) is not appropriately set, even the mix between taxable cash wages and lower-taxed FBT.

Alternatively, the FBT can reduce work efforts. There are several policy implications of what Feldstein has said for our Budget making. One simple thing, which needs to be considered, is that initial GDP forecast numbers can be taken as baseline numbers, on which the effects of proposed tax changes can be superimposed. The GDP number used in the Budget should not merely be a forecast based from CSO’s Advance Estimates, but should be set after careful deliberation of experts over what their tax proposals would do the growth rate. The FRBM targets would need to evolve in this milieu of dynamic relation between taxes and GDP. The impact of taxes on reducing work effort, saving and risk-taking need to be clearly understood as part of our Budget exercise.

The second of the NBER papers, deals with effect of corporate taxation on investment and enterprise. Rarely do as many as five economist co-author a research paper these days. But this one has two leading Harvard University professors - Andrei Shleifer and Tim Ganser, joining hands with three World Bank experts - Djankov, McLiesh and Ramalho to provide telling cross-country evidence on adverse impacts of corporate income tax on aggregate investment, foreign direct investment (FDI) and entrepreneurship.

They provide new data on effective corporate income tax rates in 85 countries in 2004 based on the survey conducted in January 2005 and 2006 jointly by the World Bank, Harvard University and PricewaterhouseCoopers.

Djiankov, et al (2008) findings show that a 10% increase in effective corporate tax rates reduces:

(i)    Reduces aggregate investment as % of GDP by 2 percentage points from an average of 21. 5 % for the sample countries,

(ii)   The PDI rate more sharply by 2.23 percentage points from an average of 3.36%,

(iii)            business density by 1.9 firms per 100 people (average of 5.0),

(iv)            Entry rate by 1.4 percentage points ‘(average of 8.0).

These results point to much larger adverse impacts of corporate income taxes on investment and enterprise than has been indicated so far in the literature.

In January alone, strategic investors and PE funds struck 116 deals worth $5 billion or at the rate of one every six hours. But the overvalued IPOs, in the recent past, could impact foreign investments fairly soon. Private equity players think valuations are skyrocketing, and are waiting for this irrationality to come down.

According to industry experts, this irrational exuberance is overshadowing reality. Giving time-honoured traditions of thriftiness a back seat, Indians are increasing their appetite for risk. Ownership of stock has increased among Indians. It is an important element of wealth management since understanding of equity has gone up. It is a new style statement.

 The craving for real estate ownership too is showing no signs of abatement. For instance, the going rate for apartments in NCPA building in Mumbai’s Nariman Point is Rs 75,000 per sq ft, compared to Rs 30,000 two years back. The realty boom is largely driven by youth who have a cosmopolitan outlook and money to spend. Others invest in commercial property because they think there is no hope of real estate price rationalisation in the near future.

Talking about hyper valuations, cricket’s latest circus, IPL is in a league of its own. Although its promoter BCCI and other direct stake holders are talking up the prospects of the greed-is-good league, the chorus of naysayers is growing faster than rookie bowler Ishant Sharma’s “brand value”. The valuation of everything about IPL is far from rational. The reality of IPL will dawn later. What’s driving these valuations skyward are vanity and ego and not sound business potential.

As its moniker suggests, Messers Modi & Co at BCCI seem to be heavily influenced by the English Premier League. But, financially, they’d be hoping to copy American sports models such as the National Basketball Association (NBA), Major League Baseball (MLB) and National Football League (NFL). All of them are sports leagues that have very little global appeal but can thrive just on the back of huge domestic following. The MLB for instance, whose audience is limited to the US, Japan and few Latin American countries is a multi-billion dollar business and can afford player wages of up to $30 million (Alex Rodriguez of the New York Yankees is the lucky one there). But EPL or other popular European football leagues are proven money spinners with the kind of global appeal the IPL cannot even dream of.

Moreover, dubs such as Liverpool, Manchester United or Real Madrid have a strong, emotional connect with the local communities built over the last 100 years. But for a newborn, one-market sports league both the franchise and indeed the player valuations seem iffy if not outrageous. India Cements’ Narayanaswami Srinivasan is no Roman Abramovich, but he doesn’t mind coughing up a staggering $31200 for an hour of match play for Dhoni, while the most expensive EPL footballer, Chelsea’s Michael Ballack with a weekly wage $260,000 gets roughly $18000 an hour on the pitch. However, I thing, IPL is nothing but one big joke. Except BCCI and the players, no one else is going’ to benefit from this model. Let this game start and people will realise they have burnt their fingers.

If someone’s interested, it is Warren Buffett who said, it’s only when the tide goes out, that you discover who has been swimming naked. We hope skinny dipping doesn’t become India’s national sport.

Friday, 14th March, 2008

On December 2007, according to government of India said that Indian banks had Rs.127 lakh crore exposures to derivatives. This has surely set alarm bells ringing, as the ICICI bank declaring mark to market losses on foreign credit derivatives and fixed income investments and L& T declaring that it could be taking Rs 200 crore hit on its commodity hedges.

It is difficult to quantify the exact risk though this is for sure that the entire amount is not at risk. There is an exposure to plain forex hedges out of this reported 127 lakh crore and it is a substantial portion.  A large chunk of the headline figure are bank-to bank derivatives, i.e., a bank writing a derivative contract for a corporate does a back -to-back contract with another bank.

There may be a hit on the corporate profit growth in the coming quarters as non-operating income falls because of derivatives losses. Well the brighter side, if one can call it that, is that corporate balance sheets are strong and in most cases losses won’t be crippling. Next time banks and corporates should be more circumspect as the reality of overseas derivatives cannot be wished away. India’s increasing integration with global markets - through trade, global sourcing of inputs, and overseas investments by corporates, foreign borrowing and expansion of Indian banks overseas - means that exposure would have to be hedged. What is needed is a better system of controls. Banks should think twice before selling exotic derivatives to customers who have no clue about the risks. Companies need to put in place systems to ensure speculative investments are authorized and within prudent limits.

“Dil” was a 1990 blockbluster Hindi movie starring Aamir Khan and Madhuri Dixit which was produced and directed by Indra Kumar and the music direction was done by the famous team of Anand-Milind. Other significant roles were those of Anupam Kher and Saeed Jaffrey as Aamir’s and Madhuri’s fathers.

The movie deals with the age-old story of class difference between two lovers as the father of the female protagonist (Madhuri) is a millionaire whereas Aamir’s father is a miser and is so greedy that wants to marry his son in a family which is richer than his. In his pursuit to achieve such goals, he pretends to be a millionaire to fool Saeed Jaffrey in believing the same. Meanwhile, Aamir and Madhuri meet each other in college where they do not start their acquaintance on the friendliest of terms but soon, pranks on each other makes way for love to happen. But Aamir and his father’s family status gets revealed which results in they being publicly insulted by Saeed Jaffrey. The engagement is broken off and the young lovers have no other option but to elope and marry. While working as a day laborer, Aamir meets an accident and has to fight a battle between life and death. Torn between helplessness, Madhuri strikes a deal with Anupam Kher to leave his son’s life for ever if he paid for his medical treatment. A confused Aamir forms wrong impressions about her but the end of the movie see them reuniting with both their families accepting their mistakes.

The film was well received by the audience with good college humor thrown in the movie for a majority of the first half. The story was a no surprise package but definitely a very entertaining one. The music of the movie was fresh and made the movie even more appealing.