Ken Weekend newsletter

Good Morning Dear Reader,

Welcome to The Nutgraf, your weekly newsletter that explains and expounds the most important events of the previous week in India. Right now, we are independent, but we expect to be merged with a public sector bank anytime soon.

Let’s dive in.

The Great Fiscal Magic Trick
If you aren’t keeping track, three huge events took place this past week:

The Indian government finally went from talk to action. Last week, the Finance Ministry unveiled a set of reforms to boost growth. And yesterday, it did a lot more. To its credit, there’s consensus that these are mostly welcome moves. Above all, it’s a sign that the government is doing something and taking things seriously.

A lifeline was thrown by the Reserve Bank of India (RBI), India’s central bank, which transferred a record Rs. 1.76 lakh crore (~$25 billion) of its reserves to the government.

Then the latest GDP numbers came in. They don’t look good. India’s growth crashed to 5%, the lowest in six years. This makes it two consecutive quarters of sub 6% growth.

These are important events. I’m not an economist, so I’ll refrain from weighing in on whether these numbers are good or bad, and where we go from here.

Instead, today, The Nutgraf is about the numbers themselves. Specifically, three numbers. What they reveal, and more importantly, what they conceal. For reasons purely because I have a weakness for good drama, Dear Reader, I am going to explain it like it’s a magic trick.

And like all great magic tricks, it’s in three parts.

(This is overly simplistic. I am not an economist. Angry emails from i-bankers will be immediately forwarded to law enforcement authorities.)

First, the budget camouflaged something very important

Every great magic trick consists of three parts or acts. The first part is called “The Pledge”. The magician shows you something ordinary: a deck of cards, a bird or a man. He shows you this object. Perhaps he asks you to inspect it to see if it is indeed real, unaltered, normal. But of course… it probably isn’t.

Imagine you are a regular guy. You earn money. You spend some. You save some. If you spend more than you earn, you borrow to make up the difference. Everyone knows this.

Now, let’s assume that for some reason, your earnings drop. What do you do? Well, you either spend less or you borrow to make up the difference. It’s evident when this happens. You tell your friends you can’t afford that expensive coffee anymore. Or you borrow – you ask them to foot the bill to maintain your current lifestyle.

But what if you said nothing? And pretended that everything was fine?

That’s more or less what happened in this year’s Union Budget.

The budget is two things: a plan for the forthcoming year and a report of the accounts for the previous year. The account for the previous year is based on the previous budget estimate presented by the government compared against the actual accounts published by the Economic Survey.
In other words, the budget estimate is what the government intended – with an opportunity for a revision in the middle. The Economic Survey says what actually happened. Also, and I can’t stress this enough, both numbers are published by the Government of India.

So what did it say? Take a look. The first three sets of columns are relevant.

Look at the dip in expenditure, revenue and tax. Clearly, the government didn’t get as much revenue as it expected. Mostly because it didn’t receive as much tax revenue as it expected. It didn’t borrow more than it said it would. Hence, it had to cut expenditure.

And how much was this shortfall?

Nearly Rs 1,70,000 crore (~$25 billion). Or 1% of the GDP.

That’s a massive number. But why were tax revenues lower than expected?

Well, the newly implemented Goods and Services Tax (GST) isn’t generating enough revenue to replace the previous tax structure.

Why didn’t we know about this?

It wasn’t mentioned in the Finance Minister’s speech. And it wasn’t in the ‘Budget at a Glance’—the main summary document published after the budget.

Why didn’t the newspapers talk about this instead of nonsense like briefcase and red cloth?

Excellent question.

Didn’t you say you weren’t an economist?

Correct. So instead, listen to Rathin Roy, the director of National Institute of Public Finance and Policy and a member of the Economic Advisory Council to the Prime Minister. He calls it a ‘silent fiscal crisis’, and says that the revenue performance is ‘dismal…unprecedentedly dismal’. He says he’s never seen anything like it. He sounds like he knows something about this. I know because I watched him give a talk called ‘The State of the Indian Economy’, organised by the Observer Research Foundation.

I think you should listen to him. It’s an hour long. But it’s a video that deserves far more than the 10,000 views it has right now.

Second, most people are missing the real point of the RBI transfer

The second act is called “The Turn”. The magician takes the ordinary something and makes it do something extraordinary. Now, you’re looking for the secret… but you won’t find it because, of course, you’re not really looking. You don’t really want to know. You want to be fooled.

Fine. Tax revenues are down. So what do you do? You have three options.

Increase taxes or collections.
Reduce expenditure.
Borrow more

All three have their cons. Increasing taxes is impossible to sell politically. Reducing expenditure is a bad idea at a time when banks are stuck with bad loans and are desperately seeking a bailout. Borrowing more has implications on India’s fiscal deficit, and international ratings.

So what do you do?

Option 4.

4. You go to your friend’s place, look around, point at things and yell, HEY! THAT’S MINE.

Some of these claims are a stretch.

But some of these things are yours. Maybe. Possibly. Reasonably.

That’s more or less what the government did with the RBI. It looked at how the RBI was handling its surplus, disagreed on some provisions, and claimed that the RBI had to transfer a lot more to the government than it had previously.

It mostly did this by the book.

One Governor’s tenure wasn’t extended. And another resigned over it, but that apart, a committee was set up, which set a reasonable limit for what the RBI could hold, with the rest to be transferred to the government. Deepak Shenoy, CEO of Capitalmind, in two fabulous pieces, explains this well, and argues that this large an amount should never have been with the RBI in the first place:

“I can tell you that you need to have something for a rainy day. That doesn’t mean you buy an umbrella factory”

What happened as a result?

The RBI transferred a total of Rs. 1,76,000 crore (~$26 billion) to the government last week. Now, the government had already received Rs. 28,000 crore (~$4.2 billion) earlier; it had already estimated it would receive an additional Rs 90,000 crore (~$13.5 billion) already accounted for in the budget. So it’s now richer by Rs. 58,000 crore (~$9 billion). That helps. That really helps.

But the real story is that a big part of the RBI’s transfer, around Rs 22,000 crore (~$3.3 billion) was thanks to a change in accounting.

It’s complicated. It involves how forex is managed and recognised between the time it’s bought and sold. In fact, some people think the new way is the right way to do it.

But still…Rs 22,000 crore from a change in accounting is slightly unnerving, I think.

Because, of course, you aren’t really looking.

Third, a falling GDP has a larger concern

Remember the graph above? Let’s look at it again. Now pay attention to the right-most set of columns.

It’s one thing if you missed your target last year and tried to pretend it didn’t happen.

It’s another thing to set a more aggressive target next year.

But you wouldn’t clap yet. Because making something disappear isn’t enough; you have to bring it back.

The government is basically saying—we will spend more than we expected to last year and we will collect more revenue as well. Measured against the actual numbers, for this to happen, it requires revenues to grow this year at 1.1% of India’s GDP—a rate faster than at any given point of time in India’s history.

That’s hard enough. Now let’s make it harder.

Take a look at what the numbers in the graph are based on. These aren’t absolute numbers. These are all measured as a percentage of the GDP.

That’s why every magic trick has a third act, the hardest part, the part we call “The Prestige”

The government knows how much it needs to spend next year to fund its planned expenditure. Salaries. Defence. And things like bank bailouts. It pegs this as a ratio of the GDP—which is also expected to increase. The government makes assumptions about this and uses it to balance its books. If the GDP increases at a faster rate than what’s assumed, that’s good, because you are more likely to hit those numbers.

But what happens if your assumptions are off? And not by a little. But by a lot.

The GDP growth last quarter was 5%.

In its budget, as a basis for all its calculations, the Finance Ministry assumed a nominal GDP growth (which includes inflation) over the year at…11%.

Fasten your seatbelts. It’s getting real.

A subscription for an electric bike
Revolt, India’s first electric motorcycle, launched its first set of variants and unveiled its pricing last week.

Interestingly, you can’t buy the bike. You can get it as a subscription, though. For prices ranging from Rs 2,999 ($42) to Rs 4,999 ($70) a month. This has interesting ramifications because it converts all the parts that auto-companies typically use to make profits, like servicing, into cost-centres.

For those who don’t remember, Revolt is funded completely by Rahul Sharma, one of the four co-founders of Micromax, once a wunderkind in India’s smartphone space but increasingly at sea in a market dominated by Chinese brands.

Last week, more PE players exited Micromax and sold their shares to the promoters. As the Economic Times reported:

Micromax Informatics’ valuation has crashed about 93% in roughly four years from a peak of Rs 21,000 crore in 2015 to less than Rs 1,500 crore now, with major private equity investors including TA Associates and Sandstone Investment exiting the Indian handset maker.

Good luck, Revolt.

Last week…in Softbank
In Masters of Business, a podcast by Bloomberg, Josh Wolfe of Lux Capital made the following observation in a long discussion about venture capital.

“…in the private market, a single price-setter can come and just decide what the price of something is. They can create the market clearing price, there is no short-selling, no counter-offer; there is very little liquidity, so SoftBank has come and created all of these unicorns and decacorns, and what’s crazy is the money that they are putting to work, and in some cases, they are pricing up their own investments.

Now put on a tinfoil hat for a moment. I have a more slightly nefarious view that a reason that SoftBank is doing this, understanding the motive, is that they are doing this to be able to create paper assets and increases in paper valuations that can serve as collateral against indebtedness, that’s north of $140-150 billion. So by being able to invest in WeWork at $10 billion, and then pricing it up to 20, you just showed that you had a 100% gain in your one to two billion dollar investment. And if you look at their earnings over the past 1-2-3 quarters, a significant portion of the profits they have reported is from these paper gains – illiquid.

And then when one of these companies actually exit, and you have liquidity, like an Uber, they take those proceeds and instead of distributing it to investors, they say you know we are going to borrow against this, we are going to issue debt…so for venture capital, this is a systemic risk, and one of the poster children for illiquidity …for SoftBank and SoftBank investors, I’d be very very nervous”

The host, Barry Ritholtz, responded:

“So SoftBank is a Ponzi scheme quote-unquote, says Josh Wolfe, I’m going to put those words in your mouth…haha”


Looks like others are finally catching on.
That’s it from me.

Have a wonderful week. It’s a long weekend. What plans? Let me know.

Praveen Gopal Krishnan