Welcome to the Machine: America and Money

I wrote a while ago of my first brush with America's financial system as a fresh-off-the-boat expat applying for a credit card. Thanks to a career mostly pivoted on financial services, however, my experiences with the world's largest economy run broader. These have only deepened in the last couple of years building a life in the country, but continue to leave me perplexed on more than one count.

Of my subsequent wanderings, I find the average American's attitude vis-à-vis the stock market the most peculiar. One might verily imagine investors lining up outside the door given its extraordinary breadth (in offerings), depth (of liquidity) and information access (implying transparency). Yet, in reality, retail participation in the NYSE-Nasdaq is unlikely to make India's NSE jealous. Broader still, it appears linked to the outlook around Money.

Some facts for starters. Wealth-accumulation is, in many ways, an inveterate part of the 'American dream'. Next, unlike the land of my birth, inflation has mostly been in check since the Supply Shocks of the 70s. Finally, median incomes have almost doubled in the period. Statistics, therefore, point to significant investible surpluses. Yet, reams can rightly be written about burgeoning US household debt as much as the general disaffection of its populace in matters financial. It takes us back squarely to saving discipline.

To unravel this, consider an analogy from another bane of modern human existence, namely lack of fitness. Be it a shudh desi tond or American overweight, we know that exercise is key. Indeed, that rush of endorphins at the end of a workout is the glow of champions. Watch what happens next, as the hungry, proud-as-Punch body heads out to eat. How often do we overestimate calories burned; gorge on 2X the amount we typically need; and feel no qualms therefrom? And then we bemoan fitness levels, go jumping from one fancy exercise plan or fad diet to another, and hurtle towards the eventuality of a large medical bill.

Just as the gap between calories burned and replenished drives success in a weight-loss regimen, so a saving habit determines financial well-being. So why the proclivity for conspicuous consumption that fells the average American? Answers are at hand. Akin to the rush post a rigorous workout, income growth also stokes an increased propensity to spend. Cast under its 'have-earned-this' spell, Americans splurge guiltlessly on indulgences. Luxuries of today turn into necessities of tomorrow, and wallets continuously seek new extravagances to feed the sense of entitlement. A social-media-centric existence plays no small part in this frenzy, with lifestyle expectations driven by peer benchmarks, resulting in a vicious dance of debt.

Culturally overindexed on wealth, America can only be happy when the cycle of overcompensating rising income with indiscriminate consumption breaks. The solution is obvious, but fundamental. From chasing the tangible and easy (spending), the Average Joe or Jane needs to be inspired towards the intangible and difficult (saving, directed towards goal-focused investment). Apps that demystify wealth by making its creation and tracking ubiquitous shall pave the way. Celebrate, therefore, the tingle of income more than the whoosh of the credit card, virgin or otherwise, as the real money machine. Godspeed.

Cards, Cars and Gold Czars

"Lucky you; a Credit Card in hand fresh off the boat!" or words to that effect. Thus went the refrain, notably from friends having made a similar India-to-US move mid-career; and thereafter grappled with the task of rebuilding a financial profile from scratch.

Fact is that, absent a Bureau score, many of us who wash ashore have to face the rather mortifying experience of credit denial(s). Some are forced to resort to Secured cards to build payment history. Therefore, the modest $1500 limit from BofA (I had higher in my first credit card as a mere student graduating from IIFT 20 years ago) felt like an occasion to celebrate!

Part of the distress, to be fair, comes from the dissonance between the erstwhile financial standing in India (while no HNW, one had the pick of financial products; and a feeling of being chased rather than chasing) to newbie status in the US of A. Mind you, this would be equally true even with a global bank; one you had used in India for years; and carried some priority status. Your creditworthiness is reset perforce.

So, with prospective landlords looking askance and utilities insisting on bank auto-debit of monthly bills, a credit card felt much like being granted the Moon. Why not use your India plastic, you ask? Unfortunately, that would be akin to kicking the can down the road. Even if you found a way past the international usage surcharge with an appropriate card, it would still not solve for the need to have usage and payment history domestically to build your credit profile (circular logic, did you say?).

Thankfully, there is a potential hack, and a doubly sweet one at that. AMEX, as I found out last week, could give you a charge card based mostly on your India relationship (albeit driven more by their customer service ethic than hyper-connectedness of the world)! Equally, this 'no limit' card saves me from needing to pre-pay my original credit card multiple times intra-month (when paltry limits meet large household set-up expenses). Note, therefore, my unequivocal endorsement for the 'Gold' in its name!

Next pit-stop in the finanical reset journey, is a car. Once again, as I shortlist, it is evident that usurious rates of interest await me on the loan. Neither will the humbling experience end quite there. Given recency of relocation, a lack of intimacy with domestic stocks is only to be expected. Ergo, I have miles to go to attain the next goal (of high-conviction stockpicking ideas). Till then, we soldier on, as we must.

Teesri Kasam

Investing as a theme pops up periodically here, a testament to my abiding interest therein. Success here can have a fairly direct correlation with material well-being. That said, in matters financial, it matters more what not to do than otherwise. In this, I am reminded of Teesri Kasam and its quintessential Bihari ethos.

Flashback 1966. Mare Gaye Gulfam, penned by the indomitable Phanishwarnath Renu, was turned to a film by some of Indian cinema's tallest. On camera were Raj Kapoor and Waheeda Rehman, but also Iftekhar, Keshto Mukherjee, AK Hangal and Asit Sen: names that veritably lit up the silver screen much as they did the faces of cinemagoers for generations. Rest of the crew was no less luminous: Renu himself, Basu Bhattacharya, Shankar-Jaikishan, Lata Mangeshkar, Manna Dey, Asha Bhosle, Mukesh etc. Perhaps above all was Shailendra, this being the only movie the lyricist extraordinaire ever produced. Thus, we got Teesri Kasam.

So how does Teesri Kasam connect to my investing experience, personal or observed? Simply that Hiraman, its bullock-cart-driving protagonist — idealist yet unafraid to try the new — makes mistakes in his pursuit of life's affairs, swearing each time never to repeat them. And in a fashion, his three blunders, which lead to the eponymous three vows, mirror my view of the most common slips in financial matters.

Perhaps unsurprisingly, Hiraman stumbles first in ignoring the risk-reward equation. His simpleton character tries to make a fast buck ferrying smuggled goods, managing only to land a brush with the police, and promising himself a long-term focus thereafter. Many of us, myself included, start life at the other end, content with managing money near-term and confusing a bank balance for financial security. We fret about market risk but assume inflation immunity. Consequently, savings go to FDs, PF contributions stay at a minimum, and equity action is confined to a rushed, year-end Sec 80 investment at most. Thus, the power of compounding is missed for years.

Hiraman's second folly is not planning for oversized loads. He picks up a consignment of bamboo, and — being inexperienced — rams it into a horse-cart, earning a royal thrashing. His kasam: avoid 'long poles'. Of such cargo, real estate is the most ubiquitous in our lives and the cause of much financial misery. I didn't buy my first until 12 years into my career (missing two Gurgaon booms); yet others buy too early, or too much, and some simply a 2BHK that they outgrow in no time. A similar case could be made for Insurance. The point is to tackle the big rocks as soon as one is able, which requires a financial plan.

Twice singed, Hiraman is then felled by the most confounding folly of 'em all. Tasked to transport Hirabai, a performer in the Great Bharat Nautanki Company, to the village fair, he is smitten by her beauty and (in his eyes) apparent virtue, during the course of their day-long journey. His consequent conflict with zaalim zamana and zamindar is typical filmi (the denouement is anything but), culminating in his third and final vow: say no to nautanki-walis. Cut to our financial lives; and how often have we similarly lost when appearances and emotions outbid logic and facts?

A tad more on that last-named. Its typical setting, interestingly, involves folks who spend a lifetime mistaking investing to be a spectator sport. They watch the market ceaselessly, debate it tirelessly, and wait for the 'right level' endlessly. Then suddenly one day, armed with an ostensibly hot tip (delivered over sips of 'Glen' perhaps), they rush in to bet the ranch. They may get lucky, but mostly they don't, only to slink back into the corner, cursing their luck, the market, or both.

Be it rooted in any of these mistakes, it is the dud that we carry too long that has the biggest bite (I have never lost as much money as I have selling late). Through pigheadedness, optimism, or sloth, we only invite peril home when the basic principle of stop-loss goes amiss.

These experiences aside, like most walks of life, success in investing must rest on the bedrock of hard-won lessons. "The four most dangerous words in investing are — this time it’s different", as one of the greats so adroitly put it. It remains a game where discipline and math plainly trump creativity and chance. Ignore this, and one is left to rue mare gaye gulfam.

Investor as a Split Personality

"Be ye of reasonable means, with intent to secure thy future, thou canst afford nought to be in stocks." There, I quote myself (Shakespearean merely for effect)! Truly, the merits of equity investing are beyond doubt. Even more certain is that they are ill-understood. "The real key to making money in stocks is not to get scared out of them" is how Peter Lynch, one of the gurus of the craft, put it admirably.

So why this reticence that, in the face of voluminous data on the benefits of stock-picking, makes even the well-heeled go weak in the knees? Market evidence shows that the issue is not opportunity. Nor is it barriers to entry, lack of visibility, or absence of ambition. And very rarely, contrary to popular belief, is it ability. For today, let us dwell on that last-named, for it is the one I find most difficult to fathom.

In context, ability could be thought of in two ways: the capacity to invest; and skill therein. Not that I choose my company specially, but enough investible surpluses (after emergency cash or fixed income commitments) exist around me. However, they find their way into real estate, almost without exception. I don't discount residential or commercial realty being part of a well-designed financial plan (though my personal experience of returns isn't much to write home about). However, I do take issue with overexposure to this asset class, notably when at the expense of equity.

Nothing brings this better to light (to the mythical point on ability) than the dramatically different approaches folks follow while investing in stocks versus real estate. Most realty shopping, perhaps on account of packet size, is backed by effort, discipline and rules. However, the same individuals behave in a diametrically opposite manner when picking stocks. For instance:

• Look before you leap?: You buy an apartment in DLF after arduous research, talking to the world and their mother before you commit. Stocks you buy because you got a hot tip with a shot of Jack Daniels last night!
  
• Shylock or Great Gatsby?: You bargain down to the last thousand, even hundred, in buying property: negotiating terms, comparing freebies and so on. Stocks you buy in a bull market, when the local barber is dispensing investment advice, with nary a care about valuation!
  
• Till Debt do us part?: You negotiate mortgage rates down to the last bp, manage monthly EMIs with an appropriate down payment, and pre-pay whenever you can through the tenure — all to keep debt under control. Stocks you rush headlong into F&O or complex margin positions with little regard for complexity or leverage?
  
• Ain't it a team sport, baby?: You are happy to employ and pay for real estate expertise with agents, lawyers, architects, interior designers etc — anything to ensure asset acquisition and management are optimal. Stocks you trash financial planners and avoid research advice, preferring hunches and going solo?
  
• Time in market vs timing the market?: You invest in property for the long term, commitments that typically last years; and exit only when goals are met, or as a last resort (if faced with hardship). Stocks you look for upsides in days or weeks, often selling for small profits in a bull market, or a huge loss when bears rule.

I will not even start the argument that disciplined equity investing can bear returns superior to real estate. Or that the property market is far less transparent and much more illiquid. Least of all that smaller packet size and SIP possibilities make equity an easier option to manage risk through market cycles. All of these are true; yet they are just facts. The crux here is behaviour. And hence another homily with a touch of of Will Shak: "Stay ye considered, consistent, and committed; and abiding wealth shall be thine." Amen!

Inflation Bonds: Flatter to Deceive

Months in the making, the Reserve Bank of India has finally launched consumer inflation-linked bonds. Going under the moniker of 'Inflation Indexed National Saving Securities - Cumulative' (a mouthful, if ever), these bonds have been the subject of much anticipation. Alas, the fine print finds them coming up woefully short.

The biggest stumbling block lies in the product design and its consequent tax treatment. In most countries with such bonds, the formulation goes broadly thus: pay the investor a nominal interest rate on Face Value while letting the FV float in line with the linked inflation index. It is a simple structure that pivots on gains from the inflation-driven FV increases, which are treated as capital gains in the eyes of the taxman.

To take a line from the fabled Maggi sauce commercial, the IINSS is different. It has been structured as a bond paying interest, the rate of which is pegged to the Consumer Price Index. By implication, the entire interest earned qualifies as income, to be taxed at the marginal rate. To be fair, if only the inflation-compensating portion had been subject to capital gains, it could have benefited from indexation. Clearly, the powers-that-be at FinMin and RBI thought otherwise.

Several sticky points other than taxation come up too. The typical desi fixed-income investor, mostly given to income, may not line up in droves for the compulsorily cumulative IINSS. To boot, the lock-in period itself is rather long at 10 years. Such an extended tenor may only accentuate inflation and interest rate uncertainties that scare away investors. Early exit is possible, but only after 3 years, and with a penalty. Finally, there is an unfathomable ₹5-lakh investment cap. All told, I don't see investors being inexorably drawn to IINSS (versus, say, infrastructure bonds with a friendlier format and better post-tax returns).

Be that as it may, one could still have rooted for distribution success. We know only too well that, in the Indian context, financial products need to be actively sold (occasionally with little correlation to merit, ULIPs being a case in point). I wouldn't hold my breath for this though — these bonds are to be sold only via banks, and their low commission structure is unlikely to be incentive enough for them.

Perhaps I am being overly cynical. Maybe IINSS is a step forward, but it could have been so much more. Certainly, days into his tenure, our rockstar RBI Governor had himself talked a big game as to its market-making potential. At least on that count, if not more, this is an ahem.

The Son of Cash

Cash is King. Or, in the context of our Government's benefits structure, "cash is leaking". This has long been understood: I vividly recall dissecting the ills of India's subsidy framework as part of the Economics curriculum in college in the 1990s; it was a well-worn fact even then. Commentary focused on flaws in the mechanism and the mushrooming of vested interests that were bleeding the system dry. Indeed, the latter had grown so well entrenched, and critical voices so muted, that the infirmities had become part of the accepted, expected ways of working of mai-baap sarkar.

Little wonder then that, far from being shown the door, the subsidy framework has continued to flourish to this day. Consider the math: the GOI spends an estimated ₹3.65 for every rupee of benefit to reach its intended recipient. The resultant fiscal burden across the 3Fs — food, fuel and fertilizer — is clearly already unsustainable. Yet, there is every indication that the Government, reeling under the influence of NAC-chhaap Welfare State model, will escalate these economic costs further.

Before turning our attention to the future, it may be instructive to examine the design and delivery challenges that plague our distribution architecture today. First, the design itself is inherently faulty. For instance, food subsidies are funneled through the PDS, pivoted on the identification of the Below-Poverty-Line population. This tagging has been a corruption magnet. An inability to pay bribes for BPL ration cards means large swathes of genuine beneficiaries remain denied benefits, even as the state's subsidy bill continues to burgeon.

Next, lets talk about the delivery architecture. Staying with the food example, there is little control over the diversion of subsidised grain meant for BPL households to the open market by avaricious ration shop owners profiting off the price differential. Likewise, practices like adulteration, ghost BPL cards, and deliberate stockpiling lead to rampant leakages. Upstream too, we have distribution losses in acquisition, storage, and transport due to inadequate infrastructure and systemic corruption. Finally, the state is drained by an ever-increasing administrative overhead merely to keep this unwieldy apparatus afloat.

Now, the mammaries of our welfare state are expected to grow further (the GOI seems serious about the Food Security Bill). This makes the case to overhaul the entire benefit distribution process even more compelling. Simply put, the need of the hour is to replace the corrupt and convoluted PDS with direct cash transfers to the target population. Life changes dramatically at the consumption end, with a promise to empower the needy, bid goodbye to the ration-wallah's corruption and coercive power, and incentivise quality supply. Likewise, the state's unproductive subsidy burden shrinks by dismantling the PDS and leveraging technology to plan, monitor and reduce sourcing and storage expenses.

One cannot, of course, expect it to be a walk in the park. The most critical element is target identification. UID is trying to solve this tagging problem multi-dimensionally across technology, process, controls, and change management. Helmed by Nandan Nilekani since last year, one can expect a good outcome here. Next, the farmer lobby must be managed: anything seen as encroaching on the MSP and GOI's grain offtake is a political hot potato. It remains to be seen how much political will UPA-2 possesses to tackle this. At another level, the availability of cash in a lump sum has been flagged as a potential hazard. Fears are that menfolk would drink the 'windfall' away. Not for this reason alone, but as a broader social empowerment and financial inclusion measure, the GOI would do well to channel Lakshmi directly to the Lakshmi instead.

Cash, in any event, is likely to make a return, if only in a new avatar. Even if not perfect — and we do not yet know all the questions, let alone the answers — it cannot fail to be an improvement on the mess we have today. Much of this will play out at the level of policy, even more in execution; we have seen the UPA botch both on numerous occasions. Yet, given the high stakes here, let us remain hopeful.

Microcredit Miscarriage

Following a rather spirited discussion last week on the economics and politics of interest rate ceilings — albeit in a Malegam Committee context — I was directed to a recent NYT piece by Prof Muhammad Yunus (Sacrificing Microcredit for Megaprofits). In it, Yunus, Grameen Bank founder and Nobel laureate, lamented recent trends in microfinance, calling special attention to developments in India to highlight the sector’s missteps.

The Prof's premise is summarized thus: the model evolved in the 1970s in poverty-stricken Bangladesh as an alternative to the usurious stranglehold of moneylenders. Over the years, its success spawned emulators beyond its birthplace. However, the past decade’s structural shift in many parts of the world from non-profit to commercial lenders — he notably cited SKS Microfinance and its famous IPO — has resulted in "a new breed of loan sharks", striking at the sector's very raison d’être.

As arguments go, there is some merit in what Yunus postulates. One doesn't need to be a Mother India buff to be familiar with the shenanigans of the Friendly Neighbourhood Lala – he was the ogre of choice till Hindi Cinema discovered the hate potential of the political class. Replace him with a faceless corporation and supposed implications are shareholder avarice, dubious sources of funds, and rising operating expenses. All told, this image doesn’t sit well with poverty alleviation shibboleths.

Equally, the issue of lender profitability — the ostensible driver for the 'mission drift' — is hardly resolved. An impersonal intermediary like a corporation may not intuitivels understand the borrower’s financial lifecycle. Such compromised credit decisioning inherently increases risk of default. Worse, the absence of community relationships impairs the ability to manage delinquency, further skewing the risk equation. The cascading impact on interest rates creates a vicious cycle, potentially leading to lender collapse.

It is a grim picture. At the very least, this model shift requires all stakeholders to tread with extreme care, given its impact on the wider ecosystem. Certainly the last we need is sundry politicians fishing in troubled waters, à la AP. Yunus recommends an interest rate cap alongside a dedicated microcredit regulatory authority to oversee administration, accredit specialized microfinance institutions, and enforce] transparency in lending and collection practices. These sound sensible, in my view, but one major caveat: overzealous governments do not overreach, as is their wont, or misuse increased oversight to dole out favours to a chosen few.

Beyond these conditions lies the not-entirely-theoretical question of whether the intermediary must necessarily operate as a non-profit. Here lies the rub — the Indian experience has been most unfortunate. Simple, straightforward products (or agencies) have gotten twisted into something completely antithetical, hopelessly losing their purpose in a web of intrigue and shortcuts. Consider, for instance, the Money Matters fiasco where housing loans were subverted into a tool for highly leveraged speculation; or how the entire insurance industry got sidetracked into ridiculously-priced ULIPs instead of addressing the core opportunity in inadequate cover for the average Indian etc.

At the heart of these BFSI snafus is the buyer-seller information asymmetry — so designed less by accident and more by intent to keep the buyer in the dark. Microcredit has merely followed this trend. January, however, is too early to give in to cynicism wholly. Indeed, hope shines bright through the mutual fund example — an industry forced to pivot to retail equity investment instead of short-term corporate paper or load-driven easy pickings. Needed, it seems, are a few regulatory nudges. Keep the chin up, folks.

Damp Squib

Months ago, the draft of a new Direct Taxes Code for India had drawn much public acclaim, including in these pages. This was not without reason. For starters, the existing system was visibly knocking on the doors of obsolescence. Hence, any review intended to simplify its archaic tenets (thereby reducing repeated recourse to judicial interpretation) was hugely welcome. Next, a forward-looking document shorn of its predecessor's dotage could enable the taxman to better engage and deploy New Age tools. This promised a sea change in efficiency and effectiveness of Direct Tax administration (on counts like evasion detection, internal security etc) making it a progressive legislation worthy of a budding economic superpower billing. Last and not least, the very idea of promoting larger debate prior to finalization bespoke intellectual honesty and inclusiveness rare in our policymaking experience. A thumbs-up for this wiki approach was much in line.

However, implicit in all these arguments (in fact providing them overall credence) was the game-changing nature of actual changes proposed to the tax framework. If it were to fall prey to back-room intrigue and lobbying, as the more cynical amongst us foretold, it would be a real pity in the face of path-breaking promise. Even as these fears lurked, the revised discussion paper one heard of a few months back also sounded headed in a compromise-riddled direction. And sadly that is exactly what has finally come home to roost in the proposal formally introduced in Parliament this week.

So how has the cheer of the finest toast for Pranab-da soured into old-wine-new-bottle despair? Selfishly or otherwise, my first disappointment is in the largely superficial personal taxation changes. In fact, perusing the reams of newsprint dedicated to laud the 'extra income' (a princely INR 24,000 at the upper end) through marginally tweaked tax slabs, one wonders when our mainstream media will mature beyond cliché. (To avoid sounding like a stuck record, we steer clear of media-bashing — richly deserved as it may be. There is zero surprise in our Fourth Estate's centrist and arguably pro-Congress slant.) In any event, basic math of inflation on the cast-in-stone slab values itself beats hollow the DTC's pithy positioning as a taxpayer windfall.

Going beyond this, one must rue the lost potential of a truly simplified tax framework. With 6.5% incidence sacrificed at the altar of exemptions and political expediency, the Government had a clear shot at reducing cost and complexity. Removal of potentially distortionary criteria would have improved investment decision-making for aam aadmi and HNI alike. Equally, a move to EET could have boosted long-term savings (PF withdrawal is an example). All that has been belied. Perhaps most importantly though, the survival of the exemption regime has reduced the leeway to lower rates and punt on increased adherence, ultimately limiting the ability to fund GOI's ambitious developmental agenda.

The saving grace has been the refusal to tinker with Capital Gains Tax that would have created an artificial portfolio churn opportunity (en masse profit-booking in March, followed by resumed longs in April, a cost minus any economic value add) that has been avoided. (In lighter vein, the DTC is also the government's first assertion of having achieved its gender equality goals. So the deduction differential allowed for woman taxpayers stands withdrawn, unless merely saved for a subsequent budget to reinstate!)

Elsewhere, the other notable revision in the Bill versus its draft is the compromise on corporate taxation. It is an easy argument that GOI frittered a chance to overhaul capital allocation in our economy. The erstwhile proposal to predicate MAT on gross assets vs book profits represented a fundamental change in the much-misused play of lowering tax liability via investment-led depreciation. From being a tool to manage tax, investments could have emerged into the light, to be evaluated for true CBA. The Big Business lobby however (including relatively genuine voices in its capital-intensive cohort) ensured we are left with Photoshop-type interventions to lower tax rates through elimination of cess, surcharge etc. If these were temporary inclusions in our tax regime, as successive FMs gave us to understand, it hardly needed a large-scale DTC exercise to get rid of them. Equally, there is no surety that some other flavour suiting the incumbent political mood will not 'force' the government of the day to resurrect these ostensibly stopgap devices.

All told, this residual pot of half measures still sets the Taxman back 1% of their INR 5.8 lakh crore annual kitty, without any redeeming expectation of increased adherence. A solitary hope remains — with the suspense of end-Feb Budget jitters gone, we could leverage a long-term Tax structure come 2012. If only the redoubtable Mr Mukherjee had been inspired by the spectacular doomsday caper of the same name, the changes would be a bit more appreciable...

U(r)LIP or Mine?

A couple of smug rookies posturing as 'Relationship Managers' at my bank, an almost equally minuscule clique that seeks me out for investment advice, and hordes of DNC-dismissive telemarketers peddling insurance — all can stand testimony to my ULIP-agnostic personal finance strategy. My stance is hardly original — most experts of any standing shun ULIPs in their shopping cart must-haves. Despite this rare unanimity and strong arguments against the product class, it has drawn investor interest consistently. Reasons behind this ostensible anomaly, or the product's long-term prognostications, have assumed centrestage with recent developments in the shape of a SEBI-IRDA jurisdictional battle. At the heart of this are changed regulations that address opacity and investor-unfriendly practices that ail ULIP sales and service, or inherent design.

To appreciate the context of the proposed changes, one must recognize that ULIPs have been sold in a manner completely antithetical to the fundamentals of the family to which they ostensibly belong. (Most people one knows, when buying a ULIP, actually believe they are taking 'smart' life cover.) The lure of entering an asset class where 'your money is not idle' but 'deployed to maximize returns' and offer 'better term cover', has been irresistible for the typical gullible investor, fed on years of stodgy state-run insurance firms’ (often unfairly so dubbed) unimaginative offerings and dull salesfolk. A general expectation of market efficiency over public sector sloth thus plays into the aggressively positioned ULIP schemes promising lay investors the moon.

Again, an investment offering of this kind, with significant dependence on market performance, usually comes into its own in the long run (and this is not 3 or 5 years that qualify as 'lifetime' to 25-year-olds nowadays). Think 10-15 years, or 20 if not more, and cyclical noise is factored out of markets and sensible stockpicking yields results fully. Admittedly, this is market investment spiel (for, say, equity MF) but unfortunately not what many newbie investors readily bite, obsessed as they are with 'timing' the market. The same investor, when thinking term cover, expects longer tenors in line with life expectancy. The resultant surge of patience, sweetened with promise of exceptional returns, draws savings to ULIP schemes by the boatloads.

Of course, it is obvious that such troths of exponential growth do not sit well with life cover. Yet, spurred by extraordinary incentives that can only come from heavily front-loaded cost structures (45% of Y1 premium, no less!), a bevy of insurance salesmen position ULIP as a best-of-both-worlds insurance product generating assured returns over months and years. The post-sale dissonance that naturally results (it is difficult to think a worse period of investor sentiment and market return than the last two years) leads to massive exits. Yet, unlike market instruments where such attrition is visible (and actionable), ULIP truancy figures are hardly the most advertised. Hence the ecosystem of under-informed investors, malintentioned agents, and lazy insurance firms continues to flourish unashamedly.

At another level, ULIPs represent a large (if invisible) problem for private sector insurance companies. There is a highly credible school of thought that unravels what drives this disproportionate focus on the win-today-worry-tomorrow rat race for the investable rupee. The motivation seemingly comes from higher capital adequacy norms for guaranteed (term insurance) vs market-linked (investment) assets. This makes minimization of life cover (per rupee vested) a lucrative short-term strategy. Unfortunately, this evanescence creates not merely an economic but a potentially significant social issue that can wreck us in the long run. In an under-insured nation like India, with rising healthcare demand (and costs) yet inadequate social security structures, such mis-selling of investment in the garb of insurance can lead to consequences far more dramatic than most of us care to think. (Term cover, after all, is for those eventualities of life that leave us at our most frail and disturbed.)

All this has been known for a while. Yet, aside from individual decisions like mine (big picture-inconsequential, likely), not much was attempted to correct this systemically (or if something was in the works, it was certainly not PDQ pace!). To this extent, the very public spat between our hyperactive market regulator and their largely somnolent insurance cousin was most welcome. In characteristic Bhave fashion, SEBI initiated measures to clear the mess under an investor friendly bias. In the ensuing turf battle, however, the IRDA came up trumps (SEBI's knock on the Supreme Court’s doors was in vain: GOI nipped it in the bud with an IRDA-primacy ordinance before milords could weigh in — all while CBB was away on business in Canada!).

Cynics in our midst ought to be unsurprised - the venerable J Hari Narayan has impeccable credentials to win any back-room battle. Years spent in the government have admirably equipped the ex-IAS officer to work the Establishment. (Interestingly, despite similar pedigree, Bhave does not have the same reputation.) Equally, while missing the visible zeal of his no-nonsense SEBI counterpart, the charitable can point to JHN’s record of not shirking from a tough stand in the face of controversy. In any case, he has Pranab-da’s mandate.

Regardless, the verdict in the territorial fracas is hardly the key issue. Of essence is whether and how the Govt and its now unequivocally empowered regulator finally set the house in order. Even if one were to ignore my arguably over-pessimistic predilections on the social impact of messing with the small saver, there can be little doubt that Shri Hari Narayan presides over a window of opportunity — to serve the lay investor well, while providing an overdue lifeline to ULIPs. Else, the victory, so to speak, may remain Pyrrhic.

A Follow On Inning

For a prolonged period in the Nineties the powder keg of India's growth story provided a discernible fillip to equity values, including a booming primary market. To boot, some aggressive issue pricing meant even neophyte investors made a fair killing through a buy-IPO-sell-listing strategy. It was too good to last, and the market eventually turned a great leveler as it must. Despite this, some hangover of those glory days seems to pull the retail investor (sample the now-thankfully-dear-departed 'MF IPO' mela) even to this day.

As it turned out, my college wallet was hardly corpulent enough to afford any investible surplus in this happy period. The result was that my initial flirtations with stock-picking missed any skew or confident swagger from tenderfoot success. Yet, learning the hard way (and armed with pearls from two notable masters in Messrs Buffett and Lynch), my confidence gradually crept up enough to venture opinion on the table. And when for a few years my portfolio reflected better returns on direct equity investments vis-a-vis the Sensex (or via the Fund route), a tendency to play to the gallery won me to freely dispense stock advice!

Unfortunately, lately my acquaintance with that familiar spoilsport: Time (or more accurately, its paucity), grew by leaps and bounds. Consequently, most of my theories were tested vicariously — and though the results were not entirely discouraging, the discipline to tend consistently to my portfolio was found wanting. It is in this backdrop (and to accompanying bugle calls from a generally bullish market) that NTPC announced its mega FPO. Persisting with the axiom of my stock-picking being based on more mature considerations, this is how the issue appeared to stack up:

• NTPC easily stood out as the largest Indian power utility, with reasonable historical revenue/profit track record and operating efficiency in load/ availability factor terms
• The firm boasted a healthy topline growth with plans to ramp up capacity by ~10K MW (over a third), assuming timely execution and minimal equipment delays or risk (important also given a somewhat sub-optimal debt-equity ratio, with scope for putting more equity to use)
• Significantly it was an infrastructure major with very low liquidity pressure atypical of the long gestation in the sector; and a comfortable funding position (~INR 17.5K Cr in cash alone) that weighed on its ROE as much as providing opportunity for backward integration
• Raw material pipeline looked robust — a new 20 yr coal supply agreement with Coal India for 12 of existing 15 units, supplemented by captive coal mines and KG basin gas (in next 2 years). Possible overseas mining acquisitions would provide additional flexibility
  
• From a product mix perspective, hydro projects could be a concern but strong partnership potential in 2000 MW nuclear power JV and ventures with BHEL and Bharat Forge to manage engineering and equipment needs provided a cushion
• Potential upside also existed from sectoral deregulation, specifically unallocated power sale, short term trading (#2 player), and the 3P modernization/ life extension practice.

Yet, for the retail investor, the icing on the cake could only come from price. Indeed, it was key to whether the issue would draw more than institutional interest. The latter, some argued, would commit anyhow, a volume player being inelastic to entry point in view of the overall mood and potential. Given the value-unlocking protestations in UPA 2.0 policy (disinvestment being no more a dirty word), it was critical and expected for the floor to be suitably defined to set the right tone for the aam aadmi.

Unfortunately, by any reasonable yardstick, the pricing and the issue came up short, saved the blushes only through 'motivated' subscription from SBI, LIC and other PSU players. The drama in the FPO (and my own morbid interest) were served well by a simplified version of this script (rob Peter to pay Paul etc) but the back-room shenanigans transcended the discreet approach that the Govt and its hired guns usually adopt in such situations. In fact, despite commonly held misgivings on price, PSU entities actually bid at the high end, much in excess of the market or floor price (and that when FII interest was almost nonexistent)! Extending the line was a series of seemingly unorchestrated sound-bytes (Goebbelsian devices that would have done any crafty market manipulator proud — case in point: Reliance Power) hinting at bear cartels at work to drive price below its 'natural' 230 levels! And if any argument were left to be had, one merely had to look at the complete absence of commitment from NTPC employees. They knew!

In short, the promoter, the Govt of India, obviously needed the money — and as appears in retrospect, badly enough to brazenly flirt with the grey in a manner unprecedented. Be that as it may, it is obvious that such insidious conveyances could be a short term tactic at best. Over the course of what promises to be a long summer, FinMin mandarins would do well to truly imbibe their much-professed principles of policymaking (public sector = public ownership). Not only is the capital requirement in the current Grand PSU Sale way too high to afford being limited to incestuous bargains, but there is real fiduciary merit in spreading the family silver over a larger investor base. To boot, there may be electoral arithmetic benefit in promoting an aam aadmi (or middle class, at the very least) lilt in any future auctions (at the cost of a marginal discount).

For now though the NTPC FPO kissa does leave more questions than it did answers, such was the Government's conduct. And one thought the ignominy in a follow on was restricted to cricket.

No More (Hopefully) Tax!

Some people are difficult to please. And when they belong to the tribe of left-leaning issue-hunting chatterati of our country, woe betide those that seek to propitiate them. So ran my thoughts on getting a buzz from the same Economics Einstein friend of mine who had played catalyst to my last post. He was incensed by my conciliatory gesture of a post — and the suggestion of using a credit-debit card driven payment system as antidote to the cash impelled parallel economy. He called it many names — but the tags principal to his argument were three: it was effete, elitist (Long Live Comrade Dasgupta!) and uni-dimensional.

To the last of these, let me plead guilty immediately — the idea of a carded economy was admittedly an appetizer to deeper policy action. As such, other thoughts that came to me at various times this week:

• Speedy adoption of VAT and GST, something that has been argued in these pages earlier, underscored here since they track the production process through the value chain and hence enable significant MIS
• Comprehensive implementation of UID (linked with PAN) — with all registrars computerised across asset classes as well as company registration, customs and excise, tax, passport, licences etc — and cross-tabbed as needed with HNI indicators like asset ownership and lifestyle spends
• Better enforcement of annual personal tax returns and perhaps early bird incentives, not merely penalty for delay or default. (No doubt my friend would be happier to hear words around greater powers to agencies but very rarely have our national issues been about legislation instead of execution, and we perennially run the risk of bad intention.) My only exception would be for relatively high visibility downstream impact like on personal rights of holding elected office, driving licence etc
• Clarity and continuity in wording rules and regulations, limiting the need for judicial interpretation that may be time-taking and (occasionally) contradictory. One can extend this to talk of faster determination of tax disputes but the need for specialized courts and higher judge-population ratio is a more widely-felt and urgently-needed action

Now, the other two charges. At the core of my premise of effectiveness in advocating an electronic payment system was its ability to capture information in a digital form, coincident with the actual transaction. Equally, the effort in its transmission, storage or retrieval would be marginal save for the investment in scaling up transaction infrastructure in a country as vast as ours (but which, in my defence, shibboleths of Financial Inclusion and Productivity would any ways force on the banking system). The data thus recorded could be mined to model smarter risk-based pricing solutions to help customers and banks, while sharpening the I-T department’s claws (with less false-positive).

Almost in anticipation of this, my friend had pointed me to the PAN/ AIR project and its relative failure in achieving similar results — at least at the government end. He sent me an article from HT on 24 Aug too, with analogous lamentations. The sum and substance of this report went thus:

• Compulsory PAN citation for all high-value transactions has not worked. Of the INR 55.7 Lakh Cr total value reported in 2007-08, 30% were missing PAN. For instance, in realty deals (a known home of Black Economy) of declared value over INR 30 Lakh, capture was ~25%; saving bank deposits of INR 10 Lakh plus, it was one-third etc (Folks with dark humour will savour the fact that ~10% of 3100 RBI bond sales over INR 5 Lakh got away without a PAN); and
• Cases of fake/ multiple cards abound, limiting the department’s ability to trace any transaction back to beneficiary. It is any ways over its head in water on the high-value AIRs for investigation/ matching with IT returns (rumour has it that the department has been trying to build 360 degree profiles of HNI’s — politicians, bureaucrats, corporate honchos, high-growth businessmen AKA people with flashy lifestyle not commensurate with known income sources etc) using AIR data for over three years).

But perhaps we write the epitaph of this effort too soon. One can equally note that high-value transaction capture was up 2X between 2007-08 and its preceding year — indicating detection success more than economic boom. Equally, the march of technology in the banking industry is relentless, making the switch to electronic financial administration easier by the day. Or, for that matter, let us not ignore the large-scale adoption of computers by Indians at large. Mind you, we speak not merely of super-bright precocious pre-teens of the current day; this trend is discernible across age and economic strata. (My father, loath to the PC most of his life — or perhaps never having needed to take to one, courtesy a sarkari lifestyle — is now not only a ‘Friend’ on my social networking account, but preaching the virtues of Skype to me the other day!)

The fun times, however, are yet to roll. To my mind, far more than banking industry paradigms or designs of FinMin mandarins — or even technology’s constant down-spiral of prices and advances in user-friendliness — the real clincher is, literally, in our hands. The convergence of mobile-phone and computing is where my oracular protestations will be put to test. As more and more of India takes to the ubiquitous phone for functionalities beyond voice, they will buy in to its convenience for financial transactions too. If this adoption gets sweetened by promises of greater speed, increased transparency, and lower transaction cost (why ever not, one would think), then the inclusion revolution shall fly bottom upwards.

Empowered handhelds will thus achieve what its voice cousins have already done — bridge divides that most thought an impossibility in our context just years ago. Not only will this spread make the ‘card’ all pervasive, it will put pressure on high value transactions to conform and drive an enormously shrunk cash economy in the future. Hence, card, we dream… Goodbye elitism, farewell effete :D