Why We End Up Buying Things We Normally Wouldn’t

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When I visit a supermarket or a large store to buy grocery, I inevitably end up buying stuff which I wouldn’t otherwise. On some days, it can be products like muffins or a chocolate bar, placed strategically near the billing counter. On other days, it can be a new flavour of ready to eat noodles.

What is happening here? Human beings look at purchasing decisions from the relative value lens. The question is, relative to what.

I buy grocery around once in three weeks. And on most occasions, I end up with a bill of around Rs 4,000-5,000. When I am buying something like a chocolate muffin which costs around Rs 100, it feels like a very small part of the overall bill. (Rs 100 is only 2 per cent of Rs 5,000). It is basically a useless unhealthy purchase, which one can easily buy at an outside bakery for Rs 30-40. But given that it feels like a very small part of the overall price, I simply go ahead and buy it.

The same stands true for the chocolate bars which supermarkets and large grocery stores tend to stock near their checkout counters. As Dan Ariely and Jeff Kreisler writes in Dollars and Sense: Money Mishaps and How to Avoid Them: “Supermarket checkout queues dare us to resist trashy tabloids and sugary sweets, using the same approach.”

This approach is also at work in hotel rooms where soft drinks which are placed inside the refrigerator in the room, are expensively priced. On a visit to Pune earlier this year, I paid around Rs 100 for a soft drink can which at that point of time was generally priced around Rs 30. My calculation was the same. The per day room rent was around Rs 5,000 and a charge of Rs 100 more wasn’t going to make a significant dent to it. Having said that, I would have never paid Rs 100 for a soft drink can, otherwise.

In fact, the same approach is at work in a restaurant, where soft drinks, water bottles and even bottles of wine, are more expensively priced. In fact, wine in a restaurant costs much more than in a wine shop.

As Ariely and Kreisler write: “It’s logical to pay more for the convenience of wine with dinner – we don’t want to take a bite, then have to run to our car to [take a ] swig… – but it’s also a tribute to relative versus absolute value.”

In all these situations we tend to find value in something, which we otherwise wouldn’t, by comparing it to the overall cost. Marketers make use of this and try to sell us things we wouldn’t have bought otherwise. This plays out almost every time one buys electrical goods like a washing machine or a refrigerator or a television or even a laptop.

The salesman on such occasions always tries to sell us something known as an extended warranty. This is a warranty over and above the one which is offered by the manufacturer of the product that we have bought. It is pretty much useless in most cases given that electrical goods these days tend to function well and rarely go bad.

But the pitch is that now that you are spending so much money, why not spend a little more and get yourself an extended warranty.

This approach is also at play when buying a car. As Ariely and Kreisler write: “Car dealers… know that when we’re spending $25,000, additional purchases, like a $200 CD changer, seem cheap, even inconsequential, in comparison. Would you ever buy a $200 CD changer? Does anyone listen to CDs anymore? No and no. But at just 0.8 per cent of the total purchase price, we hardly shrug.”

The overall point being that marketers are a devious lot and if there is a trick out there they can use to sell more, they are most likely to find it and use it. Beware!

The column originally appeared in the Bangalore Mirror on November 22, 2017.

 

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One Example of How a Good and Simple Tax Should Work

Late last week I was paying the Goods and Services Tax (GST) I had collected on behalf of the government, to the government.

In the process of payment, I made a mistake, which, with the benefit of hindsight I can say was a rather silly one. Basically, the entries for the state GST and integrated GST got interchanged. In the process, I ended up paying more integrated GST than I had to and less state GST than I had to.

Integrated GST is a tax which the seller must collect from the buyer on the inter-state supply of goods and services. State GST and central GST are taxes which the seller must collect from the buyer on the intra-state supply of goods and services.

Let’s understand this through an example. I am based out of Mumbai in the state of Maharashtra. I write a column for a magazine, which is based out of New Delhi. In this case, when I bill the magazine (the buyer), I will raise an invoice with an integrated GST of 18 per cent.

If I write a column for a website (it could even be a magazine/newspaper) based out of Mumbai, then I will raise an invoice with a central GST of 9 per cent and a state GST of 9 per cent. The point to be noted here is that the overall rate of tax in both the cases (interstate and intrastate) is the same. Only the division is different.

Anyway, getting back to my story. Given that I hadn’t paid the right amount of state GST, this meant that I had logon to the GST portal once again and pay the state GST I hadn’t. The integrated GST I had already paid will now get adjusted against the payments that I will make in the months to come. The money is safe. There is nothing to worry on that front.

Of course, I didn’t realise I had made a mistake while paying the GST. It was only when my chartered accountant started filing the GST return, this mistake was noticed. After this, I frantically logged on to the GST portal in order to pay the state GST, I hadn’t. In fact, I almost ended up paying the integrated GST all over again. Thankfully, I noticed the mistake this time around.

In the process of making this mistake I had a rather obvious realisation. As someone who is collecting GST on behalf of the government, it doesn’t matter to me whether I am collecting state GST or central GST or integrated GST. This is something that should work at the backend of the system that has been created to implement GST.

How the GST collected by the government is split between the different governments (central and states) is not something I am really bothered about. Once I have upload my returns and have paid the right amount of GST, the system should be able to figure out, using GST numbers which have state codes and the PAN number of buyer as well as the seller built into it, what proportion of the GST should go to the central government and what proportion should go to the state governments.

Given this, I as a user should simply be making an entry for the total GST that I need to pay. The GST system can then easily figure out, the various kinds of GST, given that each buying-selling transaction along with the value, is reported as well.

But that is not how the current GST system works. The backend has become the front end as well. That is how the system has been designed.

It is well worth asking why? Dear Reader, if you have ever filed an income tax return form on your own even once, you would already know the answer. When the government designs these forms, it does not keep the ease of use of the end user in mind. That’s the idea with which the government has always operated. This has seeped into the GST system as well.

The success of any government system (or for that matter any system) also depends on how easy it is to use. This ease of use will make GST a good and simple tax, which it currently isn’t. In case of the GST, the government has just made the laws. The actual taxes need to be collected by the seller from the buyer. The seller then needs to hand the tax over to the government. The seller also needs to file returns. Currently, this entire process that has been made extremely cumbersome.

I am no GST expert, but I am sure that if some thought was given to the entire process of filing GST returns and paying GST to the government, it could be simplified. But for that to happen, first and foremost what is needed is bureaucratic will, even more than political will.

Indian bureaucrats have never liked to make things simple for the citizens of this country, because a simple system would discourage rent-seeking, which many of them excel in. And therefore, I feel that the GST will continue to be as complicated as ever.

The column originally appeared on Equitymaster on November 21, 2017.

 

 

The Javed Akhtar Syndrome in Real Estate

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Poets usually write poems on love, breakups, betrayal, friendships, alcohol, the women serving alcohol, the world at large, politics and so on. But very rarely does a poet write a poem or a couplet on the unaffordability of real estate in India. But Javed Akhtar has done that:

sab kā ḳhushī se fāsla ek qadam hai.
har ghar meñ bas 
ek hī kamra kam hai

A loose translation of this in English would be as follows: “Everyone is just one step away from happiness; Every house has just one room less”.

Given the fact that Akhtar has spent a large part of his adult life in Mumbai, the above couplet reflects or rather captures the sensibilities of the city that never sleeps, very beautifully.

Dear Reader, you must be wondering, why am I talking about a couplet written by Javed Akhtar on a rather muggy Tuesday in Mumbai. Allow me to explain.

Over the weekend, I met a friend who wants to sell his one-room-kitchen (a very Mumbai thing) apartment and buy a one-bedroom-hall-kitchen (one BHK) apartment. Basically, he feels his current apartment has one room less and he wants an apartment which has one room more than his current one.

Of course, the transaction cannot be carried out, unless he is able to sell his current apartment. The money generated from that will partly be used to pay off the current home loan. The new apartment will be bought with whatever remains after selling off the current apartment and repaying the home loan; along with this a fresh larger home loan will have to be taken. Over and above this, some financial savings accumulated through investing in mutual funds through the SIP route, will also have to be used.

My friend had bought the apartment for Rs 50 lakh, nearly three years back. He is looking at a price of at least Rs 60 lakh. In fact, more than looking, he is specifically anchored on to that price and won’t sell for anything less than that price.

As Garly Belsky and Thomas Gilovich write in Why Smart People Make Big Money Mistakes and How to Correct Them: “Anchoring is really just a metaphoric term to explain the tendency we all have of latching on to an idea or fact and using it as a reference point for future decisions. Anchoring can be particularly powerful because you often have no idea that such a phenomenon is affecting you.”

This is not the first time I am discussing the phenomena of anchoring in real estate, nevertheless, this example is interesting and different, because anchoring, as we shall see, is happening at multiple levels.

My friend is anchored on to a price of Rs 60 lakh because he feels that at that price he will be in a situation of no-profit no-loss, while selling his current apartment. The extra Rs 10 lakh, over and above the price he bought the apartment for, should take care of the home loan EMIs and the maintenance charges paid, over the last three years. This is his logic for being anchored on to a price of Rs 60 lakh.

The trouble is that at that the few buyers who have approached him do not want to pay more than Rs 55 lakh, while my friend remains stuck on the Rs 60 lakh figure.

In this case, the transaction is what we can call a relative transaction. The money that my friend gets for selling the current apartment will be used to buy a bigger apartment in the same locality that he lives in.

If he waits too long to get a price of Rs 60 lakh, chances are that the price of the bigger apartment that he wants to buy will also go up. Currently, the bigger apartment is available for a price of around Rs 80 lakh.

I tried explaining this point to him without much success. In fact, after I explained this point to him, my friend told me that he had a buyer who was willing to pay Rs 60 lakh. The trouble was that this prospective buyer needed to sell an apartment in another city to be able to raise the amount.

This buyer, because my friend had become anchored to a price of Rs 60 lakh, was also anchored to that price. Given that he was a senior citizen, he was not in a position to raise a home loan. Hence, he needed someone to pay Rs 60 lakh for his flat to be able to purchase my friend’s flat.

No one was willing to pay Rs 60 lakh for the flat. In this case, the prospective buyers were willing to pay anything in the range of Rs 55-60 lakh. But that was clearly not enough. And given this, the sale of both the flats remained stuck.

This example clearly shows as to how anchoring works at multiple level and not just at one level, as is often believed. This anchoring essentially stops the market from working. The more general conclusion from this example would be that anchoring working at multiple levels, is one of the reasons why the buying and selling of real estate has slowed down majorly.

The sellers (not necessarily the builders) are still expecting prices that their homes were worth until a few years back. But the buyers, who have paid more than their fair share over the years, are currently not willing to pay the price that the sellers want.

Ultimately, this anchoring on to a specific price will break down. It’s just that it won’t happen overnight and will take some time.

Until then writers like me will have enough masala to keep writing on real estate.

Keep watching this space!

The column originally appeared on Equitymaster on November 14, 2017.

The Govt Can’t Do Much, If Restaurants Don’t Pass on Benefits of Lower GST

Dear Reader,

If you are on WhatsApp, I am sure you would have got a forward by now, which basically shows that eating out at a restaurant hasn’t become cheap, after the Goods and Services Tax (GST) was cut to 5 per cent.

In fact, there has been a lot of hungama (for the lack of a better word) around this issue, with people demanding that the government take action against the restaurants. Let’s try and understand this issue in detail.

The GST on restaurant bills was recently cut to 5 per cent. Earlier it was 18 per cent or 12 per cent depending on whether the restaurant was air-conditioned or not. Hence, the expectation was that the cost of eating out will come down, with the rate of tax being slashed. Nevertheless, nothing of that sort has happened in many cases. Hence, people have taken to WhatsApp, Twitter and Facebook to highlight this issue.

Before going further, it is important to understand that there is one basic difference between the new GST rate and the earlier GST rates of eating in a restaurant.

The new rate is a flat tax of 5 per cent (and that makes me wonder as to why is it still called GST). This means that no input tax credit is allowed. In case of earlier rates, the tax was a value added tax i.e. input tax credit was allowed. This basically meant that restaurants could claim a set off for the goods and services tax they had paid on their inputs. The inputs in this could be tax paid on dairy products, meat, vegetables etc.

But input tax credit is not allowed now. Hence, the new 5 per cent GST is not a value added tax. It’s just another tax.

Now with the input tax credit not allowed, some restaurants are claiming that the cost of running their business has gone up. This has meant that the pre-GST price of the food products they sell, needs to go up, and in the process, there is not much of a difference in the end price that the consumer is paying for the food products.

McDonald’s India says that with the input tax credit being withdrawn their operating costs have gone up by 10-12 percent. And after taking this increase in cost into account, the effective tax benefit due the lower tax rate of 5 per cent, “would have been less than a per cent.” As the Business Today magazine puts it: “A few restaurant owners… pegged a spike between 7 per cent and 10 per cent in costs.”

The fact that input tax credit is no longer available, hence, there can’t be much of a difference in the final price paid by the consumer now, as against earlier, is a perfectly valid argument to offer, on parts of the restaurants.

This hasn’t gone down well with many people and they have taken to the social media urging the government to take action. They are not convinced about the validity of the input tax credit argument. They feel that this is just an excuse on part of restaurants not to cut prices and increase their profitability. Hence, the government needs to investigate and take action.

The trouble is that the capacity of the Indian government to do anything is fairly limited, let alone going around investigating so many restaurants. Also, it has other more important things to do. Given this, it is not in a position to check the books of accounts of the large number of restaurants. And more than that, it should not even try to entertain any thought of doing this.

What I am saying is that if a restaurant chooses not to decrease price now, it can always offer this explanation of lack of availability of input tax credit, and there is no way to contest the explanation. The government cannot go into the accounts of each and every restaurant in the country in order to establish whether the explanation holds in their case or not. Of course, many restaurants obviously will look at this as an opportunity to make more money and which is precisely what they will do. There is no denying that.

So, what is the solution to this? If you as a consumer feel a restaurant is expensive simply don’t go there. If enough people do that the restaurant will automatically have to cut prices. If people continue going, then the higher price doesn’t really matter to them and they shouldn’t be really complaining.

Also, these are the unseen effects of starting with high tax rates. The trouble with bad economic policy (while GST is not bad policy per se, but its implementation clearly is) is that its ill effects are not always clear from the very beginning. This is now starting to come out in case of GST.

The column originally appeared on Equitymaster on November 20, 2017.

Of Falling Real Estate Prices, Dr Arvind Panagariya and the Art of Continuing to Suck Up

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Dr Arvind Panagariya, the former vice-chairman of the Niti Aayog, today in a column titled Demonetisation: Evaluating the Critics, in the Business Standard, writes: “The second avenue through which demonetisation has directly expunged unaccounted wealth is real estate…Unsurprisingly, an attack on unaccounted cash struck at the heart of this black wealth by cutting real estate prices by a quarter.”

There are multiple questions that this statement raises:

1) What is the source for this data? This isn’t exactly a conversation between two property dealers, or two prospective real estate buyers, who can quote any offhand numbers, while having a conversation. This is a statement being made by someone who was at the top of an economic institution run by the Indian government. This is a statement by an economist working in a top university in the United States.

Also, if real estate prices have fallen by 25 per cent after demonetisation, why isn’t this visible in official data sources. Take the case of Reserve Bank of India’s All India House Price Index, which has been plotted as Figure 1.

Figure 1: 

Figure 1 clearly shows that housing prices across the country have been on their way up. There has “clearly” been no dip, as Dr Panagariya claims. How do things look if we plot one-year return instead of index values? Let’s take a look at Figure 2, which does that.

Figure 2: 

Figure 2 tells us clearly that the one-year return in real estate has been falling over the last six and a half years. This trend started much before demonetisation took place. Also, how have the returns been post demonetisation? Between the end of December 2016 and June 2017 (the latest data available), real estate prices as per the All India House Price Index have gone up by 4.3 per cent. The returns between September 2016 and June 2017, have been 6.9 per cent.

Other than RBI’s All India House Price Index, there is NHB’s Residex. As of now this index has data only up to March 2017. And the one year median return between March 2016 and March 2017, as per this index, across 49 cities, was 2.8 per cent. This is very low. But where is the 25 per cent fall that Dr Panagariya has written about?

2) For a moment let’s assume that Dr Panagariya is right and real estate prices have fallen by 25 per cent. If real estate price all across the country have fallen by 25 per cent on an average, then there will be cities/town/localities where the price has fallen by more than 25 per cent. Which are these places? Can Dr Panagariya provide us with a list? This would make for a super investment right now.

Let’s say there is this town where real estate prices have fallen by 50 per cent post demonetisation. It is worth remembering that a 50 per cent loss wipes off a 100 per gain. (If the price of an asset moves from Rs 50 to Rs 100 that makes for a 100 per cent gain. When it falls back to Rs 50 that is a 50 per cent loss). If there exists such a town, it would make for a great real estate investment right now. Can Dr Panagariya provide us with names of a few such places?

3) Also, if prices have fallen by 25 per cent, why are real estate transactions not happening? Why has the total number of unsold homes of real estate companies, only continued to grow? It is worth remembering here that a 25 per cent fall within a time period of a year, is a huge fall. Falls like these in case of real estate, only happen once in a few decades. And if something like this has happened, as Dr Panagariya claims, then why aren’t people buying? Interest rates on home loans have also fallen post demonetisation.

Take a look at Figure 3. It plots the growth in home loans outstanding with banks.

Figure 3: 

Figure 3 clearly shows that the growth in home loans outstanding has fallen post demonetisation. What this means is that people are not buying as many homes as they were in the past. If prices have fallen by 25 per cent post demonetisation, people would have bought homes and the curve in Figure 3 would slope upwards i.e. people would take on more and more home loans to buy homes.

4) Further, if real estate prices have fallen by 25 per cent, as claimed by Dr Panagariya, it is time that the state governments cut the ready reckoner rates on which stamp duty needs to be paid, by a similar proportion. This should be fairly easy given that BJP governments govern most of the big states across India and a direction from the PMO should be suffice to get them to do the needful. But nothing of that sort has happened. Why hasn’t this been done till date, is a question that only Dr Panagariya can answer.

5) To conclude, it is safe to say that Dr Panagariya has just made up this data, in order to justify demonetisation. It’s a sad day today, when an Indian economist, working in one of the best American universities has had to fudge data in order to please his former political bosses.

The irony is that Dr Panagariya is no longer a part of the government. And he doesn’t really need to say things which do not hold up against data, unless, he is looking for another stint with the Modi government. That changes things.

The column originally appeared on November 13, 2017.

Demonetisation–The Unanswered Question

Time flies.

It has been one year since that fateful day last year, when prime minister Narendra Modi, suddenly announced that Rs 500 and Rs 1,000 notes, would be useless, in a matter of few hours.

Modi was lauded for this “brave” decision. In a country, where politicians do not like to take decisions, here was one politician who had decided to make one.

The trouble is that nobody told us on what basis had the decision been taken. Every decision, has consequences, especially a decision as disruptive as demonetisation turned out to be. And given this, there has to be some logic behind why the decision was made in the first place.

It doesn’t take rocket science to understand that if 86.4 per cent of the currency in circulation is made useless overnight, in a country where 80-98 per cent of the transactions happen in cash (depending on which estimate you would like to believe), the buying and selling of things is bound to crash. When economic transactions crash, it leads to a slowdown of the overall economy, which is precisely what happened in India.

As Jean Drèze writes in Sense and Solidarity—Jholawala Economics for Everyone: “For instance, a study by Nidhi Aggarwal and Sudha Narayanan… shows that mandi arrivals of non-perishable agricultural commodities crashed across the board within a week of demonetisation. The declines range from 23 per cent for cotton to 87 per cent for soybean.”

This happened because agricultural markets in India operated in cash and with no cash around, the farmers were in no position to sell what they had produced. The onion market in Lasalgaon (near Nashik, and India’s largest onion market) continues to face this problem, a year later.

Many informal markets crashed in the aftermath of demonetisation and haven’t been able to revive again. The growth of the non-government part of the economy, which forms close to 90 per cent of the economy, for the period April to June 2017, fell to a little over 4 per cent, in the aftermath of demonetisation.

On top of that the total amount of deposits with banks increased dramatically and because of that the interest rates crashed. This hurt many people (especially senior citizens) who depend on interest from deposits for their survival. It also hurt those who use fixed deposits to save for the long-term. At the same time, the fall in interest rates did not lead to an increase in bank lending. In fact, bank lending in the aftermath of demonetisation has crashed.

The question that remains is on what basis was the decision to demonetise taken? Was there any logic to it or was it just taken on a whim? The closest answer to this has come from Arjun Meghwal, a junior minister in the Modi government. He told the Lok Sabha in February 2017: “RBI held a meeting of its Central Board on November 8, 2016. The agenda of the meeting, inter-alia, included the item: “Memorandum on existing banknotes in the denomination of Rs500 and Rs1000 -Legal Tender Status.””

Meghwal passed the buck on to the Reserve Bank of India (RBI). A Right to Information query was filed with the RBI by a correspondent of the Press Trust of India (PTI). In the query, the central bank was asked to provide the minutes of the meeting in which the decision to demonetise Rs500 and Rs1,000 notes was taken. Over and above this, it was also asked to share its correspondence with the Prime Minister’s Office (PMO) and the Finance Ministry, on the issue of demonetisation.

The RBI replied: “The information sought in the query carries sensitive background information including opinions, data, studies/ surveys etc. made prior to the completion of the process of withdrawal of legal tender character of Rs500 and Rs1,000 notes… Disclosure of such information would detriment economic interest of the country from the viewpoint of the objectives sought to be achieved by such decision.”

Basically, the RBI refused to answer the RTI query. And a year later, we still don’t know on what basis was demonetisation carried out.

The column originally appeared in the Bangalore Mirror on November 8, 2017.

Demonetisation’s negative impact on economy is not done yet, it will continue; be warned

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In a few days, the first anniversary of demonetisation will be here. The Narendra Modi government will continue doing what it has done in the last one year—give demonetisation a positive spin.

But how can a decision which made 86.4 per cent of the currency in circulation, useless overnight, in a country where 80-98 per cent of the transactions were carried out in cash (depending on which estimate you would like to believe), be a positive one?

Let’s take a look at Figure 1. It basically plots the annual growth in non-oil non-gold non-silver imports.

Figure 1:
Vivek story chary1

What does Figure 1 tell us? First, it tells us that the annual growth in non-oil non-gold non-silver imports had been rather subdued since January 2015. In fact, it has been in the negative territory several times, especially in a few months before November 2016, when demonetisation was announced.

But after November 2016, the growth in non-oil non-gold non-silver imports simply took off and reached a peak of 42.5 per cent in April 2017. This basically means that these imports where 42.5 per cent higher in April 2017 in comparison to April 2016.

What does this tell us? It tells us that a significant portion of the consumer demand post demonetisation has been fulfilled through higher imports. So far so good.

Demonetisation basically disrupted and destroyed supply chains, both in the formal as well as the informal economy. With supply chains being destroyed, the supply of domestic goods has been replaced by imports and has not been fulfilled through the production of domestic firms.

It is worth remembering here that imports are a negative entry into the gross domestic product (GDP) formula.
Y = GDP
C = Private Consumption Expenditure
I = Investment
G = Government Expenditure
NX = Exports minus imports

Hence, if imports grow at a faster pace than exports, they pull down the GDP to that extent. Exports during this year (between April to September) have gone up by around 10.9 per cent in comparison to last year. Imports are up by 22.3 per cent. Given this, it is not surprising that the economy has slowed down. The economic growth for the non-government part of the economy, which forms around 90 per cent of the economy, was around 4.3 per cent, for the period between April to June 2017. This was more than 9 per cent in early 2016.

Hence, demonetisation has played a huge role in slowing down economic growth. And this is tragic given that one million Indians are entering the workforce every month. In fact, it has also rendered a standard tactic in reviving economic growth, pretty much useless.

Allow me to explain. When countries are not doing well on the economic front, the standard prescription offered by economists is for the government to spend more. When the government spends more, the extra spending becomes somebody’s income. When that income is spent, businesses benefit, and the economy revives.

The trouble is that in the current situation if such a prescription is applied on India (actually to some extent it already has been), the government spending will eventually create consumer demand, a substantial portion of which will be fulfilled through imports. Imports, as we have already seen, are a negative entry into the GDP formula. Given this, a fiscal expansion instead (the act of government spending more) of creating faster economic growth might just slow it down.

The point being that we aren’t done yet with the negative effects of demonetisation. There’s more to come.

The column originally appeared on Firstpost on November 3, 2017.