The argument that Congress should have made and the media should have covered

And once in a while everyone staying in a democracy has this urge of wanting out- witnessing the past week in the parliament was that moment for me.

Why a fugitive from justice governs the debate (or the lack of it) in our parliament-baffles me. Why a leading news reporter that wishes to place India above all, give importance to such a person by traveling ten thousand six hundred and twenty eight kilometers to interview him-confounds me. I guess it really does go to show that in India, cricket is a religion.

The discussion should have been focused on the contents of the GST bill. Unless they were auditioning for one of the many reality television shows in our country, the legislators should not have resorted to vicious personal attacks instead of talking about the appropriate rate of tax under GST? The economic participants it would impact? And the degree of that impact? The ruling party cites a benefit of two percentage points of GDP growth on successful implementation of the GST bill. If this was the case- why did they let India sacrifice six percentage points of GDP growth and raise opposition to the GST proposal in 2012. And why is the opposition currently succumbing to the same tactics that resulted in inefficiency during their years of governance. Why is no one asking for the basis of this two percentage point incremental growth estimation? Why are we not questioning if the supposedly proposed 25-27% GST rate is going to deliver additional growth?

Approximately half of the domestic indirect taxes are collected on goods (taxed at 30% roughly). The other half comes from services (taxed at 14%- raised from 12.5% in anticipation of GST). To impose a common tax-rate on goods and services such that the rate of inflation is not impacted by the same, 21.25% (based on 12.5% VAT)- 22% (based on 14% VAT) should be the ideal range to focus on. The government's proposal on 25-27% is significantly higher than the inflation neutral rate. It is therefore tough to imagine how tax induced higher prices for goods and services are going to result in additional two percentage points of growth for India. The proposal of 18-20% GST may not be revenue neutral but may have advantages in spurring growth. Why was this difference in approach not the focus of the debate? And why did the media not force the legislators to such a debate by ignoring the comments of a person who wants to assume importance by causing chaos.

We, the people of this nation deserve better. Our intelligence deserves more respect than what we were shown this past week. Our legislators need to be more in awe of the place they work in and the constitution that has given them this right. This may sound preachy and unlike the other posts on this blog- but the level of debate in our country needs to be raised.

Disclaimer: The IIP may not be what you think it is.

I wish I had written the following article a month ago. I, for some time, have been a believer that we are going to see an inflection in the business cycle of India. But every time I would utter such a view point I would be met with an onslaught of sell-side and media reports talking of how corporate India is bleeding. The key metric that traders await to affirm this negative view is the monthly Index of Industrial Production (IIP). Until Friday June 12^th, the numbers for this year have been disappointing and non-indicative of any real activity growth in the economy. (I am a non- believer of the index but do not intend to change your stand on it).

For a number that is quoted very often in leading financial newspapers and used frequently by traders to move markets in either direction, very little reporting is done on the method of arriving the number. Below is the disclaimer that any report judging the economy’s strength on the IIP, should contain.

“The all India IIP is a composite indicator that measures the short-term changes in the volume of production of a basket of industrial products during a given period with respect to that in a chosen base period.” So in other words, the IIP is an abstract number which represents the magnitude of the production in the industrial sector for a given reference period. The IIP index published in India by the Central Statistics Office (CSO), however, only deals with registered manufacturing units. By definition this includes those manufacturing units that employ 10 or more workers and use power; and 20 or more workers but use no power. On an average, the entire manufacturing sectors accounts for 16% of India’s GDP. 10 percentage points of that comes from registered manufacturing units but 6 percentage points of that comes from the non-registered manufacturing units, which get ignored in the IIP calculation. Therefore, the indicator the market uses to gauge the manufacturing strength in India in fact ignores 37.5% of the manufacturing in the country.

Also, the United Nations Statistics Division expanded the scope of the index to include Mining & Quarrying, Manufacturing, Electricity, Gas steam and Air-conditioning supply, Water supply, Sewerage, Waste management and Remediation activities. Due to constraints of the data availability and other resources, the present general index of industrial production compiled in India has in its scope limited to Mining, Manufacturing and Electricity sectors only. Thus of the 10 percentage points, a few registered manufacturing units are still not covered in the Index given the limited scope of the survey.

It is difficult for the CSO to standardize the data even within this limited scope. With 16 different sources contributing to the index, standardization of data collection across the nation becomes an even more of an impossible task.

This difference in data collection could result in the index portraying a different picture of the ‘ground reality’ than the true facts. For example the sample size for data collection for the different components is decided by the respective source agency. The only guideline stated in the CSO handbook says, “Generally, efforts are made to cover all the major units”. The definition of major is however left up to the source agency and it has changed with time depending on whether the department is understaffed or overstaffed.

“The basic data used for compilation of the index is the production in terms of quantity. However, there are certain items especially capital goods such as Machinery, Machine Tools, Ship Building etc. on which the production data is furnished in value terms. In order to remove the effect of price rise from the index, the production figures of such items are deflated on the basis of Wholesale Price Indices (Base 2004-05), compiled by the Office of Economic Adviser, Ministry of Commerce and Industry, before compilation of index.”  This is yet another example of how the different sources of data can lead to discrepancies owing to differing methods of data collection.

Given the size of the undertaking, and the varying sectors covered by the index, it would be nearly impossible to conduct the operation without different sources. It is however the lack of standardization across departments and the consequent lack of data validation checks that require this to be highlighted as a glaring drawback in the quality of the data point released every month.

Before releasing the data, the CSO confirms the accuracy of the data points with the source agencies if there is a significant deviation from the data point in the previous month.  The underlined word in the previous sentence demonstrates the peril of using such an index.

The intention of this article is not to convince people to ignore the IIP numbers altogether but rather to provide a disclaimer for those ‘consuming’ this index. Put in a cliché manner, the intention is to provide one with the grain of salt to ‘consume’ this data with. 

Maybe there is still some lustre in gold

Given the performance of the equity markets in India, most financial newspapers are gung ho about how retail investors should invest in mutual funds or SIP's and not even consider real estate or the eternal global currency, gold, as a form of investment any more. But maybe there are a few gains to be made by investing in Aurum.

Overall thoughts on the commodity

Fundamentally speaking the gold markets seems to be in balance. The degree of imbalance in the short term would at most be demand falling by 1% causing a temporary imbalance but otherwise I do not believe that there is an imbalance in the physical market. With capacity additions now tapering off into H215, as per the new mine addition schedule, I think there could also be a slight tightening in the market. In terms of flows- currency uncertainty, the fall in Chinese markets witnessed last week and the risks of a Greece default and delays of a fed rate hike given US GDP shrinkage numbers being released last week- all lead me to believe that gold is positioned to correct upwards soon.

I don’t know if we will see the 40%+ recovery we have seen in oil prices since they have bottomed but I would not be surprised. I have realized that in the most traded commodity markets- oil and gold- the market imbalances don’t have to be great for there to be an immense pressure on prices induced by financial liquidation. Even with oil the imbalance was of just over a percentage point that precipitated into a 55%+ decline.

Risks to my view

There are two fundamental risks to my view. One would be rising retail domestic investor involvement in the stock markets in India. Jewelry demand in China fell by 10% in Q115. Though this was in comparison to a historic high in first quarter demand in China in 2014 and though the demand was still 27% above the 5 year demand average in Q1, a part of this decline can be attributed to rapid rise in the domestic equity markets. Gold is looked at as an alternative investment by many retail investors. If domestic participation by retail investors in the local stock market rises, some demand for gold would be lost. 8 million new accounts (DMAT) were opened in China in Q115; a 433% increase y-o-y. Given the rising involvement of retail investors in the domestic market in India, jewelry demand supported by need for alternative investment could take a hit.

Another risk to my view is the surge in recycling of gold in Turkey. Given the slowing economic growth, rising unemployment and growing political risk in Turkey, we witnessed the Turkish Lira plunging in Q1. This propelled the price of gold locally to 100 Lira/ kg with gold. This caused a lot of people to cash in their gold for currency and led to a rise in recycling supply for the metal.

How the flows work in Gold’s favor now?

Investors turn to gold, the eternal global currency, when paper currency markets register volatility or in cases of geo-political instability. The world seems to be ripe for both of those to occur now. Currency volatility has dominated 2015. The one popular trade- long dollar- is also lightening up now with people unwinding their long positions owing to uncertainty of a fed rate hike.

Movements in real rates are inversely related to movements in price of gold. With the shrinkage in US GDP noted last week it seems even more unlikely that the Fed will raise rates in their June meeting. This coupled with the rising risk of default in Greece as well as the uncertainty of the future of Chinese markets given the over 9% drop in the Chinese A Shares within two days last week- will force some retail investors into gold.

Moreover the relative strength of the underlying commodity to its miners’ stock price seems to be at a historic high. My guess would be that should there be a correction we would see miners correct a lot more than the commodity price itself.

How do the fundamentals hold up?

Globally, Q1 demand was only slightly weaker than last years’ with most of the fall caused by the increased domestic participation in the equity markets in China. Given the move last week, some of the fringe investors will be drawn back to gold. Moreover growth in demand in India, SE Asia and the US should offset the fall in demand in China.

The key fundamental factor supporting my view on gold is the supply curve. Not only are the mine capacity additions tapering off in H215 but we also see the cost curves adjusting to the lower gold prices having faced lower prices since mid-2013. A correction in gold prices will therefore create increased cash flows per ton for miners who have devoted a lot of the operational energy on lowering costs and adjusting to the new price levels over the past few quarters. 

The Indian consumer story is not lost

It is strange that the day one of India’s leading financial newspaper chooses to print a bearish front page warning of the “Storm of Worries” that lie ahead in its growth trajectory based on qualitative responses, a very bullish (and almost real-time) data point gets hidden and lost in the same publication’s Page 12.

Indirect tax revenue collections rose 46.2% in April Y-o-Y, from Rs. 32,661 crore to Rs. 47,747 crore.

Table 1: Indirect Tax Revenue Collections in April 2015 by segment

Indirect Tax Component	% increase Y-o-Y	Nominal Value
Customs Collections	23.6%	Rs. 14,286 crores
Service Tax Collections	21.2%	Rs. 15,088 crores
Central Excise Collections	112.3%	Rs. 18,373 crores

Increase in the collections of indirect tax revenues speaks to the strength of the consumption power in the country. Customs collections speak to the strength in imports whereas both service tax revenue and central excise tax revenue speak to the domestic consumption of services and goods. The potential of the Indian consumer is highlighted in this data release especially given the magnitude of the increase and the fact that it occurred in April. Historically, April has seen weak collection numbers owing to higher tax payments made in the month of March resulting in refunds being issued in April.

A portion of the increase in service tax revenue collections can be attributed to the increase in the tax rate from 12.36% to 14% in the budget for FY16. However the tax rate has increased by 13% whereas the service tax revenue collections are up 21.2%.

The staggering jump in central excise collections is especially surprising given that these numbers were announced following data on retail inflation being released. Retail inflation in India eased to 4.87% in April, the lowest it has been this year. Both this and the consumer food price inflation numbers came in below analysts’ predictions. Consumer food inflation slowed to 5.11% in April from 6.14% the month before. Last April retail inflation and consumer food inflation came in at 8.38% and 9.21% respectively. Therefore the pickup we see in this year’s collections is not a result of price increases. There will definitely be an element of consumers using more cards in transaction or asking for a receipt of their purchase diminishing the consumption with unaccounted for cash (which cannot be taxed by the government). However that cannot be the only factor contributing to the magnitude of this increase.

The government has been able to generate such a growth in tax revenues despite having VAT and other indirect tax rates be lower than other major economies in the world. Only Switzerland and most states in the US have a tax rate lower than India’s.

Table 2: VAT Rates around the World

*USA does not prescribe tax rate at a federal level but at an individual state level.

Source: IBFD Tax Research Platform

With the publication prophesizing the storm and HSBC downgrading India to underweight, this crucial data point maybe overlooked or be considered the peak before the fall. However the marginal propensity to consume is lower in India than in other major economies and consumption still accounts for a lower percentage of the GDP (approx. 55%) versus the 70% witnessed in the US or the UK. With rising incomes as well as rising propensity to consume, indirect tax revenues will also continue to rise.

This is one of the better ways to track the strength of the consumer in India and would remain a key metric going forward.