Selling Air India Will Be a Real Test for Modi Govt

The government owned airline Air India has been losing a lot of money over the years. Take a look at Table 1, which lists out the losses of the airline over the last few years.

As can be seen from Table 1, over the last seven financial years, the airline has made losses of Rs 39,535 crore. Over the years, many experts have attributed different reasons for the airline doing so badly. While we can keep debating about these reasons, what is more important is that the government stops supporting the airline now and use that money in other more important areas like education, health, agriculture etc.

Table 1:

Air India Losses (in Rs crore)
2010-2011 6,865
2011-2012 7,560
2012-2013 5,490
2013-2014 6,280
2014-2015 5,860
2015-2016 3,837
2016-2017 3,643
Total Losses 39,535

Source: Public Sector Enterprises Surveys and Loksabha Questions PDF 

In 2012, the government had approved a turnaround plan for Air India. It entailed an equity support of Rs 30,231 crore from the government, over a period of ten years. Of this amount a total of Rs 26,545.21 crore had already been released by the government to Air India, as of December 2017. Given that the airline continues to lose money, it is important that the government stops investing more money in the airline.

As on September 30, 2017, the airline had a total debt of Rs 51,890 crore. Of this working capital loans amounted to Rs 33,526 crore. A reasonable question to ask here is why are the working capital loans of the airline so high? Given that the airline has been making huge losses over the years, it has needed loans to keep afloat.

The next question is why have banks lent money to an airline which has lost so much money over the years? The answer lies in the fact that lending to Air India, is like lending to the government and governments typically don’t default on the money they borrow. (At least that is what the financial markets tend to assume most of the time).

Also, in order to keep repaying working capital loans over the years, the airline has had to take on more loans. Of course, the only institution which can keep taking new loans to repay old loans, without being questioned, is the government.

To its credit, the Narendra Modi government has initiated the strategic disinvestment plans for Air India (strategic disinvestment is a government euphemism for privatisation). In May 2017, the NITI Aayog recommended the disinvestment of Air India and its subsidiaries. In June 2017, the Cabinet Committee on Economic Affairs (CCEA), gave an in-principle approval for considering strategic disinvestment of Air India and its five subsidiaries.

Further, last week the government allowed 49 per cent foreign direct investment in Air India. This means that foreign airlines can now team up local players to buy the airline. Up until now, foreign airlines were allowed to buy up to 49 per cent of a local Indian airline, but this wasn’t allowed for Air India.

There are a number of issues that still remain and need to be handled smoothly and successfully, if Air India has to be sold.

1) The airline has a debt of close to Rs 52,000 crore. No airline is going to buy Air India along with this debt. The CCEA which gave an approval to privatise the airline in June last year, also decided to constitute an “Air India Specific Alternative Mechanism (AISAM) to guide the process on Strategic Disinvestment of the same.”

As the minister of state for finance Pon Radhakrishnan told the Lok Sabha in a written answer in December 2017: “AISAM decided for creation of a Special Purpose Vehicle (SPV) for warehousing accumulated working Capital Loan not backed by any asset along with is four Subsidiaries, noncore assets, painting and artifacts and other non-operations assets of Air lndia Limited.”

This basically means that in order to sell Air India, the government is ready to take on the working capital loans of Air India.

2) If the government is ready to take on the working capital loans of Air India, amounting to Rs 33,526 crore, then the unions of Air India might have a question or two for the government. As a Business Standard report points out: “The Air India unions have represented to the government that if the government writes off the Rs 30,000 crore debt, which is the key to the financial problem, there is no justification to privatise the airline. Surely they will not take it lying down.”

It remains to be seen how does the Modi government handle the nuisance value of the trade unions.

3) Further, Air India has aircraft loans of Rs 18,364 crore. It remains to be seen whether prospective bidders for the airline would want to start their business with loans of more than Rs 18,000 crore. If they do take on this debt, the price they will be ready to pay for the airline won’t be very high. It remains to be seen if this will be acceptable to the government, which tends to treat its ownership in public sector enterprises as family jewels (By government I mean any government and not just the current one. This attitude of treating public sector enterprises as family jewels has cost the nation so much. But that is a topic for another time and another day).

One way to handle this would be to handover Air India to another airline or a company, at a nominal price, on the condition that they take over the debt. The Business Standard report quoted earlier points out: “Look at how the government in Malaysia sold the debt-ridden Air Asia to Tony Fernandes at just one ringgit, and he took over the debt. That has to be the approach because you are not going to make money for your disinvestment target through the Air India sale.” This makes tremendous sense, but given the family jewels point, I am not sure how realistic it is. Also, in this case, the government can retain some minority stake in the airline and if and when the airline starts to do well that stake can be encashed (Precisely like it did in case of Maruti).

4) Most importantly, what happens to all the employees of Air India. As per the 2015-2016, annual report of Air India, the airline had 19,285 employees (this does not include the people working for its subsidiaries). While, the airline seems have the right number of pilots and air crew, it is particularly bloated when it comes to maintenance and ticketing and sales divisions.

A December 2017 report in the Mint points out that the airline had 5,931 employees in its maintenance division and 4,221 employees in its ticketing and sales division. In comparison, Indigo, had 739 and 69 employees in these divisions, respectively.

It remains to be seen how does the government handle this. Any airline which wants to acquire Air India is not going to employ 4,221 employees in the ticketing and sales division.

That much is very clear.

So, what happens to these and other employees? “Various options are under consideration to protect the interests of the employees,” civil aviation secretary R N Choubey told PTI. Last week, minister of state for civil aviation Jayant Sinha had told CNBC TV18, “We will make every effort to protect Air India staff.”

In an answer to a Lok Sabha question, Sinha denied any plans to offer a voluntary retirement scheme to around 15,000 employees of Air India, before the disinvestment of the airline.

Handling the employees of Air India, will be the most significant challenge for the government in the run-up to the sale. In the past, when government owned airlines have been sold in other parts of the world, the number of employees working for the airline has come down considerably, for the airline to be viable for the firm buying it.

Once we consider all these factors, the privatisation of Air India will be a real challenge for the Modi government. I sincerely hope that they are able to push it through and the money thus saved is better spent somewhere else. Also, once Air India is privatised, the chances of the government getting out of many other businesses, will go up dramatically.

The column appeared originally on Equitymaster on January 15, 2018.



Why Income Tax Will Stay

Every year, before the annual budget is presented, suggestions are made to scrapthe income tax paid by individuals. The economist/politician Subramanian Swamy has also said so in the past. The logic typically offered is that the individual income tax forms a very small part of the total taxes collected by the government, and hence, it should be scrapped.

Let’s look at Table 1, which

Table 1:

Assessment year Individual income tax as a proportion of total taxes collected by the government Individual income tax as a proportion of GDP
2012-2013 12.67% 1.24%
2013-2014 13.52% 1.38%
2014-2015 16.86% 1.68%
2015-2016 15.18% 1.50%

Source: Author calculations on data from 1 has data up to assessment year 2015-2016. Income tax for the money earned in the financial year 2014-2015, would have been paid in the assessment year 2015-2016. The budget documents of the government of India do not list out the total income tax paid by individuals, separately. Hence, the latest numbers for the total income tax paid by individuals, isn’t available in the public domain.

These numbers are separately declared by the income tax department, on a non-regular basis.

What does Table 1 tell us? It tells us that the income tax paid by individuals, forms a small portion of the total tax collected by the government, during any given year. This is the logic offered by those who say that individual income tax needs to be scrapped. More than this, once the taxes are scrapped, people are likely to spend the money not paid in the form of income tax, in various ways. They might decide to go on a holiday or redo the house or go out and eat more often.

Hence, when this extra spending happens, the incomes of many other people will go up and they are also likely to spend more as well. Thus, the multiplier effect will work. This will ultimately benefit businesses, which will make higher profits, and hence, pay more income tax on their profits. Further, the government is also likely to collect more indirect tax. And net net, scrapping income tax for individuals won’t make much of a difference, for the government.

Also, this is likely to force the government to cut down on frivolous expenditure. It is also likely to force the government to get rid of many loss-incurring public-sector enterprises, which continue to bleed. Basically, it will force the government to cut down on what I have been calling Big Government in many of my previous pieces.

All this makes perfect sense, but in theory. Now let’s take a look at Table 2, which basically lists out individual income tax in rupee terms.

Table 2:

Assessment year Total individual income tax (in Rs crore)
2012-2013 1,12,112
2013-2014 1,39,500
2014-2015 1,91,208
2015-2016 1,88,031

Source:, income tax from individuals, might look very small as a proportion of total taxes collected by the government, but the absolute amounts on their own are not small at all. In fact, let’s take a look at the assessment year 2015-2016. The total income tax from individuals during this year stands at Rs 1,88,031 crore. This money is enough to finance the budget of many departments of the government of India. And this is money that the government is collecting for sure.

If the government scraps this, where will it get this money from? By now, the income tax paid by individuals must have easily touched Rs 2,50,000 crore. As supporters for scrapping individual income tax point out, the government is likely to earn more money from corporations paying higher income tax on their higher profits. Also, it is likely to collect more indirect tax as people end up spending more money.

The word to mark here is likely. No government is going to want to take such a big risk. Every government likes some amount of certainty when it comes to the taxes that it collects. Also, it has been suggested that if scrapping income tax for individuals is not possible, income tax can be done away at the lower levels of income.

This is where things get even more interesting. Take a look at Table 3. Table 3 basically plots the total taxes paid by individuals paying an income tax of greater than zero but lower than and equal to Rs 1,50,000. This is the lowest bracket for which the income tax department provides data.

Table 3:

Assessment year Total income tax paid by individuals paying an income tax of > 0 and <=1,50,000 (in Rs crore) Total individual income tax (in Rs crore) Proportion of total income tax
2012-2013 23,551 1,12,112 21.01%
2013-2014 37,107 1,39,500 26.60%
2014-2015 43,964 1,91,208 22.99%
2015-2016 44,615 1,88,031 23.73%

Source: Author calculations on data from, the individuals paying an income tax of less than or equal to Rs 1,50,000, pay a very low average income tax every year (around Rs 25,000 in assessment year 2015-2016), on the whole it adds up to a substantial amount. This is what Professor CK Prahalad called the fortune at the bottom of the pyramid. For assessment year 2015-2016, it amounted to a total of Rs 44,615 crore, which would have again enough to finance the budgets of several government departments.

Also, at lower levels, the idea is to get people to start paying income tax. Once they start doing that, they are more likely to continue doing it, in the years to come. Further, given that a major portion of these taxes are directly cut from salaries by companies and handed over to the government, the government has to do very little in order to collect this money. Hence, there is no reason for the government to scrap individual income tax, though theoretically it might make immense sense.

Also, the things that the government will have to do if it scraps individual income tax would require much more work than it is currently used to. And we all like to take the easy way out.

The column originally appeared on Equitymaster on January 16, 2018.

India’s New Subprime Home Loan Problem

In the early 1990s, a new kind of lending euphemistically termed as “specialized finance”, started to develop in the United States. This specialised lending involved, small, little-known firms basically lending money to cash-strapped Americans.

A large part of this lending was home loans and home-equity loans. Gradually, bigger banks and financial institutions became involved in this lending. This lending to cash-strapped Americans came to be known as subprime lending. The word “prime” is typically used in banking terminology with reference to the best customers of the bank.

As a part of subprime home lending, many Americans who did not earn enough to repay loans, were given home loans. Some of these loans started of with low interest rates and some with very low EMIs. As high EMIs kicked in, in the years to come, many individuals who had taken on subprime loans were not in a position to repay it. This problem peaked in 2007 and 2008, and very soon, the defaults started and as these defaults spiralled, they very briefly threatened to bring down the entire American and European financial system, in late August and early September 2008.

Subprime lending was one of the major reasons behind the financial crisis which broke out when Lehman Brothers, the fourth largest bank on Wall Street, went bust in mid-September 2008.

Dear Reader, you must be wondering why am I talking about this crisis more than a decade later. It looks like India might be moving towards its own subprime home loan problem, though the quantum of the problem may be nowhere as big as the one the United States faced, nearly a decade back. Nevertheless, there is a problem and it needs to be pointed out and acknowledged.

A little over a week back, the Reserve Bank of India, released a document rather nondescriptly titled Affordable Housing in India. The report has an extremely detailed section dealing with home loans in general and home loans of up to Rs 10 lakh in particular. Let’s look at Figure 1, which basically plots out the growth in home loans of up to Rs 10 lakh, given by public sector banks as well as housing finance companies (for reasons not explained, similar lending carried out by private sector banks has not been taken into consideration).

Figure 1: 

On the whole, loans of up to Rs 10 lakh grew by 23.5 per cent in 2016-2017, which is significantly higher than the 12.6 per cent growth in 2015-2016. In fact, when we take the number of home loans of up to Rs 10 lakh, then the rate of growth is even faster, as Figure 2 points out.

Figure 2: Home loans disbursements in terms of number of accounts. 

As can be seen from Figure 2, the total number of home loans have grown the fastest in the up to Rs 10 lakh segment. Now take a look at Figure 3.

Figure 3: 

As can be seen from Figure 3, the proportion of non-performing assets (where the borrower has stopped repaying the home loan) is inversely proportional to the value of the home loan. Hence, the lower the value of the loan, higher the rate of default on it. That seems to be the trend.

For home loans of up to Rs 2 lakh, the rate of default is as high as 10.4 per cent. But for loans of higher than Rs 25 lakh, the rate of default falls to as low as 0.9 per cent. The data here raises a few points:

1) Why are so many home loan defaults being seen for lower home loan values? Take a look at Figure 1. In 2015-2016, the home loan growth of public sector banks for loans of up to Rs 10 lakh was just 0.1 per cent. In 2016-2017, it was at 30.6 per cent. This is a clear indication that in 2016-2017, there was pressure on public sector banks to disburse more home loans of up to Rs 10 lakh. Under this pressure, it seems, home loans have been given to many people who are not in a position to repay them. This is one conclusion that can be drawn from this data, given the greater than 10 per cent rate of default in home loans of Rs 2 lakh.

2) The government launched the Pradhan Mantri Awas Yojana in 2015-2016. Under this scheme the government offers an interest subsidy of 6.5 per cent to those of income of up to Rs 3 lakh. Of course, this subsidy has pushed banks and housing finance companies to give out home loans of low values. At the same time, it has led to a deterioration in the quality of lending.

3) One question that needs to be asked for sure, has the waive-off in farms loans, across different states, also had an impact on an increase in home loan defaults. This is something only banks and housing finance companies can tell for sure. Nevertheless, it is a question worth asking because any loan waive off increases moral hazard.

4) How much of a problem are these defaults? The total home loans of up to Rs 10 lakh, given by public sector banks and housing finance companies, during the last three financial years stands at Rs 1,08,732 crore. With a default rate of a little over 2 per cent (for loans of up to Rs 10 lakh as a whole), this is clearly a problem banks and housing finance companies can easily handle as of now. But as loans under the Pradhan Mantri Awas Yojana grow in order to achieve the vision of Housing for All by 2022, this can clearly become a problem for public sector banks and housing finance companies.

5) Interest rates are now expected to rise in the days to come. This will mean higher EMIs and that can possibly increase defaults further. Also, it needs to be noted here that the RBI report on affordable housing does not give out the total amount of home loans given for amounts of up to Rs 2 lakh.

All in all, there are no reasons to worry on this front as of now. But this is a problem, which needs to be nipped in the bud, to avoid future problems.

The column originally appeared on Equitymaster on January `18, 2018.

Mutual Funds Clearly Point to a Stock Market Bubble


One sign of the stock market being overheated is when retail investors start entering it, dime a dozen. One way of checking this phenomenon out is looking at the kind of money coming into equity mutual funds, month on month.

So, let’s look at the total amount of money coming into mutual funds every month since January 2013 (I am not using an arbitrary cut off point here. The database that I use has monthly data from January 2013 onwards). The total amount of money coming into equity mutual funds is basically referred to as net investment, which is the total sales of equity mutual funds minus the total redemptions from these funds.

Take a look at Figure 1. Figure 1 basically plots the net investment into equity mutual funds month on month, over the last five years.

Figure 1: 

What does Figure 1 tell us? It tells us that a lot of money has been invested into equity mutual funds in the current financial year (i.e. between April 2017 and December 2017). In fact, 40 per cent of the money that has been invested in the equity mutual funds from January 2013, has been invested in the current year.

This, when the price to earnings ratios of stocks have been considerably high. At the beginning of April 2017, the price to earnings ratio of the Nifty 50 stocks was at 23.4. By end December 2017, it was close to 27. This means that at the beginning of the financial year, an investor was ready to pay Rs 23.4 for every rupee of profit that the Nifty 50 companies made. By the end of the year, this had jumped to Rs 27.

The average price to earnings ratio of the Nifty 50 stocks since January 1999 is 19.1 (again this is the data that is available in the database that I have access to).

This basically means that while stock prices kept rising, the earnings of companies, of which stock prices are ultimately a reflection of, did not rise at the same speed. The same logic stands for indices other than the Nifty 50 as well.

Let’s take the case of Nifty 500. The price to earnings ratio of Nifty 500 which was at around 26.8 at the beginning of the financial year, rose to 32.6 by the end. This basically means that as the stock market has become more expensive, it has attracted more and more retail investors, who have invested their hard-earned money, through the equity mutual fund route.

The law of demand basically states that there is more demand for something when prices are low and vice versa. This clearly does not work in case of the stock market. A bulk of retail investors get attracted to it, only after the market has become fairly expensive, which has clearly been the case since April 2017.

Let’s look at a little more mutual fund data. Figure 2 basically plots the yearly net investment in equity mutual funds since financial year 2003-2004 (again this might seem like an arbitrary cut off, but the database I have access to, has yearly data from 2003-2004).

Figure 2: 

As per Figure 2, the maximum amount of money that ever come into equity mutual funds has been in 2017-2018, and we aren’t done with the year as yet.

In fact, what is also clear from the table is that, as the stock market goes higher, more money comes into equity mutual funds. This trend is clearly visible between the years 2005 and 2008, also. Close to Rs 40,800 crore came into the stock market in 2007-2008, when the stock market was fairly expensive for most of the year. On January 8, 2008, the price to earnings ratio of the Nifty 50 touched a high of 28.3. The next couple of years, when price to earnings ratio of the Nifty stocks was in fairly inexpensive territory, barely any money came into equity mutual funds.

This tells us very clearly that retail investors buy when the markets are fairly expensive, instead of doing the other way around. The same story that played out between 2005 and 2008, is playing out all over again. Hopefully, a new set of investors will learn the same set of lessons, all over again. Meanwhile, the fund managers of mutual funds continue to remain bullish on the stock market. But they more or less always are. It’s worth remembering here that a mutual fund makes money as a proportion of the total amount of money it manages. And a bull market remains the best time to raise money.

Of course, all this comes as always comes with the caveat of John Maynard Keynes, “the market can remain irrational, longer than you can remain solvent”.

Postscript: I am happy to share with the readers of the Diary that the Business Standard newspaper has carried a review of my book India’s Big Government-The Intrusive State and How It is Hurting Us.

“India’s Big Government: The Intrusive State & How It’s Hurting Us is an unconventional, interdisciplinary book that cuts across sectors of banking, infrastructure, education, manufacturing and industry, land, taxation, and employment in post-Independence India, underscoring the necessity for the state to more effectively address critical matters, rather than attempting to do “too much,”” the review points out.

You can read the full review here. (To read the review open it in the internet explorer browser).

You can buy the book here.

The column originally appeared on Equitymaster on January 12, 2018.

Retail Investors or Chickens Waiting to Get Slaughtered in the Stock Market?

Every year, for the last eight to ten days of the year, I try and take a reading holiday. In this time, I try and read a lot of crime fiction which I absolutely love, and non-fiction, which I would normally not read.

This year was no different. I took my regular reading holiday and ended up reading a fairly interesting set of books. All this set me thinking about the current state of the stock market in India. But before I get to that, let me describe what provided the cue for that.

One of the books I read was titled Police at the Station and They Don’t Look Friendly. This is an Irish crime fiction book written by Adrian McKinty. The lead character in this book is named Detective Sean Duffy, who somewhere in the book says: “I went out to the BMW and checked underneath it for bombs. No bombs but I’d always keep checking. As a student I’d listened to an aged Bertrand Russell’s thoughts on the fate of turkeys being fattened for Christmas, the turkeys subscribed to the philosophy of inductivist reasoning and didn’t see doomsday coming. I will.”

The book is set in the late 1980s, when the Irish Republican Army used to be a terror in Ireland. Hence, Inspector Duffy, was in the habit of checking for bombs, every time he drove his car. In the paragraph quoted above, Duffy also talks about the British mathematician and philosopher Bertrand Russell, turkeys and inductivist reasoning. What does he mean?

This is where things get interesting and need some elaboration. Another interesting book that I happened to read was Everything and More-A Compact History of Infinity by the American writer David Foster Wallace. The book is a fascinating history of the mathematical concept of infinity, which anyone without any background in Mathematics can also read and enjoy.

Among other things, Wallace in this book also discusses the principle of induction (the same as inductivist reasoning which Inspector Duffy talks about). As he writes: “The principle of induction states that if something x has happened in certain particular circumstances n times in the past, we are justified in believing that the same circumstances will produce x on the (n+1)th occasion.”

Wallace then goes on to say that the principle of induction is merely an abstraction from experience. He then goes on to give the example of Mr Chicken (you can replace it with Mr Turkey and come up with what Inspector Duffy was talking about). As Wallace writes: “There were four chickens in a wire coop of the garage, the brightest of whom was called Mr Chicken. Every morning, the farm’s hired man’s appearance in the coop area with a certain burlap sack caused Mr Chicken to get excited and start doing warmup-pecks at the ground, because he knew it was feeding time. It was always around the same time t every morning, and Mr Chicken had figured out, (man + sack) = food, and thus was confidently doing his warmup-pecks on that last Sunday morning when the hired man suddenly reached out and grabbed Mr Chicken and in one smooth motion wrung his neck and put him in the burlap sack and bore him off to the kitchen.”

So, what happened here? The chickens in the coop received food at a certain point of time every day. This led them to believe that the future will continue to be like the past and every day they will continue to receive food. Or to put it mathematically, just because something had happened n times, it will happen the (n+1)th time as well.

But what happened the (n+1)th time was that the chickens were killed to be cooked as food. As Wallace puts it: “The conclusion, abstract as it is, seems inescapable: what justifies our confidence in the Principle of Induction is that it has always worked so well in the past, at least up to now.”

This is a concept that Nassim Nicholas Taleb also explains his book Anti Fragile“A turkey is fed for a thousand days by a butcher; every day confirms to its staff of analysts that butchers love turkeys “with increased statistical confidence.” The butcher will keep feeding the turkey until a few days before thanksgiving. Then comes that day when it is really not a very good idea to be a turkey. So, with the butcher surprising it, the turkey will have a revision of belief-right when its confidence in the statement that the butcher loves turkeys is maximal … the key here is such a surprise will be a Black Swan event; but just for the turkey, not for the butcher.”

As Taleb further writes: “We can also see from the turkey story the mother of all harmful mistakes: mistaking absence of evidence (of harm) for evidence of absence, a mistake that tends to prevail in intellectual circles.”

So, I guess by now, dear reader, the link between chickens (or turkeys for that matter) and the principle of mathematical induction must be very clear. But what is the link with the stock market investors? The Indian stock market investors since November 2016 have been like chickens and turkeys, where they have been well-fed in the form of good returns. And this has led them to assume that the good returns will continue in the time to come. At least, this is the feeling that I get after having spoken at a few investor conferences lately, and yes, the data suggests this as well. The logic as always is: “This time is different”. But is it?

Let’s look at some data which clearly shows that the stock market is clearly in a bubbly territory now. Figure 1 plots the price to earnings ratio of the Nifty 50, which is a reasonably good representation of the overall stock market, from January 1999 onwards.

Figure 1, clearly tells us that the price to earnings ratio of the stocks that constitute the Nifty index are at an extremely high level. The highest price to earnings ratio in the current rally was on December 26, 2017, when it touched 26.97. This means that investors are ready to pay Rs 26.97 for every rupee of profit that the Nifty companies make.

Figure 1: 

At the beginning of the year, the price to earnings ratio of Nifty was around 22. From there it has touched nearly 27. This basically means that while the price of the stocks has gone up, the net profit that these companies make, hasn’t been able to rise at the same pace. The average price to earnings ratio since January 1999 has been 19.1. This also suggests that we are clearly in bubbly territory now.

There are 35 other instances of the price to earnings ratio being higher than the 26.97. All these instances were either between January and March 2000, when the dotcom bubble and the Ketan Parekh stock market scam were at their peak, or between December 2007 and January 2008, when the stock market peaked, before the financial crisis which finally led to many Wall Street financial institutions going more or less bust, broke out.

The highest price to earnings ratio of the Nifty was at 28.47 on February 11, 2000. As is clear from Figure 1, after achieving these peaks, the stock market fell dramatically in the days to come. As of March 31, 2017, the market capitalisation of Nifty stocks made up 62.9 per cent of the free float market capitalisation of the stocks listed on the National Stock Exchange. The point being that it is a good representation of the overall


Lest, I get accused of looking at only the best stocks in the market, it is important to state here that price to earnings ratio of other indices is also at very high levels. Take a look Table 1.

Table 1:

Name of the index Price to Earnings Ratio as on January 1, 2018
Nifty 100 28.1
Nifty 200 30.32
Nifty 500 32.36

Source: Ace EquityThe price to earnings ratio of the indices in Table 1 is at a five-year high. Table 1 tells us very clearly that the price to earnings ratios of the other indices, which are made up of small as well as midcap stocks, have gone up at a much faster rate than the Nifty 50.

This isn’t surprising. Every bull run sees the small and midcap stock rallying much faster than the large cap stocks which constitute the Nifty 50. And given this the fall as and when it happens, always leads to greater losses.

Investors, especially retail investors, continue to bet big on the stock market. Let’s look at Figure 2, which basically plots the total amount of money coming into equity mutual funds (i.e. net investment, which basically means the total amount of new money invested in equity mutual funds during a month minus the total amount of money that is redeemed by investors from these funds).

Figure 2: 

Figure 2 basically plots the total net investment in equity mutual funds since December 2012. As is clear from Figure 2, as the stock prices have gone from strength and strength and their price to earnings ratios have gone up, the net investment in equity mutual funds month on month has gone up. In November 2017, Rs 1,95,080 million of net investment was made in Indian equity mutual funds.

This is an excellent example of retail money coming into the stock market, after they have rallied considerably. Will the stock market fall from here? History suggests that the Nifty 50 price to earnings ratio has never crossed a level of 28.47, and we are very close to that level. Having said that I do need to state something that the economist John Maynard Keynes once said: “Markets can remain irrational longer than you can remain solvent”. So, timing the market remains a tricky business.

Also, it is worth remembering here, that while the fund managers would like you to believe that this time it is different, it never really is. And when markets crash after such highs, they do so very quickly.

Let’s take a look at what happened in 2008. Take a look at Figure 3, which basically plots the closing level of Nifty 50, between November 2007 and December 2008.

Figure 3: 

On January 8, 2008, the Nifty 50 reached a level of 6,287.85 points. More than 9 months later on October 27, 2008, it had fallen by nearly 60 per cent to a level of 2,524.2 points. Given that the stock market investors have a very short memory, Figure 3 is a very important chart. This happened just ten years back.

Of course, the retail investors who come in at the peak, get hurt the most, during such falls. What all this suggests very clearly is that the retail investors in the stock market are essentially chickens who are currently being fattened with good food in the form of returns. They are also assuming that this will continue. But what history tells us very clearly is that they are waiting to be slaughtered. And given that they will be caught unawares as and when the stock market falls, the bloodbath that follows will be ‘as usual’ extremely deadly.

Vivek Kaul
Vivek Kaul

This originally appeared in the Vivek Kaul Letter dated January 4, 2018. It was also published on Equitymaster on January 9, 2018.

GDP Data Brings Us Back to the Basic Question: Where Are the Jobs?

Late last week, the central statistics office of the government of India declared its forecasts for the gross domestic product (GDP) growth for 2017-2018. The GDP is a measure of economic size and the GDP growth is a measure of economic growth.

The GDP growth for 2017-2018 is expected to be at 6.5 per cent. It is the slowest economic growth that the country will see after Narendra Modi took over as the prime minister. Take a look at Figure 1, which plots GDP growth.

Figure 1: 

This slowdown is a clear impact of the negative impacts of demonetisation continuing into 2017-2018, which was followed by the terribly botched up implementation of the Goods and Services Tax (GST).

Take a look at Figure 2, which basically plots the growth of various sectors.

Figure 2: 

Figure 2 tells us that agriculture and industry in 2017-2018, will slow down considerably in comparison to 2016-2017. Within industry, manufacturing will slow down considerably as well. The growth of the services sector continues to remain robust. Within the services sector, the public administration, defence and other services, which is basically a representation for the government, grew the fastest at 9.4 per cent (though it slowed down in comparison to last year).

What this basically means is that a fast growth in government expenditure in 2016-2017 and 2017-2018, pushed up economic growth, otherwise the economic growth would have been lower than what it finally turned out to be.

Now let’s take a look at investment to GDP ratio in Figure 3.

Figure 3: 

For the year 2017-2018, the investment to GDP ratio is expected to be at around 29 per cent of the GDP. This ratio has been falling since 2011-2012 and there have been no signs of improvement since then. I have taken data from 2011-2012 onwards because the new GDP series data being used since January 2015, has a back series starting from 2011-2012 only.

In fact, the data from Centre for Monitoring Indian Economy suggests that new projects announcement in the period of three months ending December 2017, came in at a 13-year low. Take a look at Figure 4.

Figure 4: 

The new investment projects announced during the period of three months up to December 2017, were the lowest since the period of three months ending June 2004. This is a clear indication of the fact that the industry is not betting much on India’s economic future because if they were they would be expanding at a much faster rate and announcing more investment projects than they currently are. The industrialists may say good things about India in the public domain and in the media, but they are clearly not betting much of their money on the country.

Unless, investment picks up, jobs can’t be created. And without jobs the one million youth entering the workforce every month or India’s so called demographic dividend, is likely to turn into a demographic disaster. Indeed, that is a very worrying point.

To conclude, the GDP data for 2017-2018, brings us back to that basic question: Where are the jobs?

The column originally appeared on Equitymaster on January 8, 2018.

It’s Surprising That More People Aren’t’ Moving to Urban India


Filmstar and member of parliament, Hema Malini, blamed the recent Kamala Mills fire tragedy, on India’s population and migrants. She was quoted in a Zee News report as saying: “The population is so high. When Mumbai ends, another city should begin. But the city keeps extending. Uncontrollable… The administration has allowed every migrant to live in the city. However, looking at the wide population in the city, the authorities should have brought in some restrictions here to control the population.”

Of course, migration and population, had nothing to do with the Kamala Mills fire. It had everything to do with the collapse of governance that Mumbai (or for that matter most Indian cities) has seen over the years.

Having said that migration is a huge issue that many Indian cities are facing. In fact, as a recent discussion paper titled Changing Structure of Rural Economy of India Implications for Employment and Growth, authored by Ramesh Chand, SK Srivastava and Jaspal Singh, and published by the NITI Aayog, points out: “As per the 2011 Census, 68.8 per cent of country‟s population and 72.4 per cent of workforce resided in rural areas. However, steady transition to urbanization over the years is leading to the decline in the rural share in population, workforce and GDP of the country. Between 2001 and 2011, India‟s urban population increased by 31.8 per cent as compared to 12.18 per cent increase in the rural population. Over fifty per cent of the increase in urban population during this period was attributed to the rural-urban migration and re-classification of rural settlements into urban.”

The question is why is this happening. The answer is fairly straightforward. Agriculture, as a profession, is not as remunerative as it used to be. The average size of the land farmed by an Indian farmer has fallen over the decades and in 2010-2011, the last time the agriculture census was carried out, stood at 1.16 hectares. In 1970-1971 it had stood at 2.82 hectares. This has happened as land has been divided across generations. This fall in farm size has made farming in many parts of the country, an unviable activity, leading to the size of agriculture as a part of the economy becoming smaller and smaller, without a similar fall in the number of people who continue to be dependent on it.

In fact, the situation could have only got worse since 2010-2011, as farm sizes would have shrunk further. Further, there are states like Kerala and Bihar, where the farm sizes are smaller than the average 1.16 hectares across India.

The NITI Aayog discussion paper points out that in 2011-2012, agriculture contributed 39.2 per cent of the rural economic output, while employing 64.1 per cent of the rural workforce. In 2004-2005, agriculture had contributed 38.9 per cent of rural economic output, while employing 72.6 per cent of the rural workforce.

What this basically means is that between 2004 and 2012, many rural workers essentially moved away from agriculture to other areas. Many would have migrated to cities for better opportunities as well.

What it also shows is that way too many people continue to remain dependent on agriculture. The sector has what economists refer to as huge disguised unemployment. If we look at the national level, agriculture contributes around 12 per cent of the gross domestic product (a measure of economic output), while employing 47 per cent of the workforce.

This clearly means that those working in agriculture are worse off than those not working in agriculture. In fact, the NITI Aayog discussion paper points out that the average urban worker made around 8.3 times the money an average agricultural worker does. The average urban worker makes 3.7 times the money an average cultivator does.
Given this, huge difference in income, it is not surprising that people want to migrate from villages to cities. Another data point that adds to this trend is the fact that only around half of the rural workforce looking for a job all through the year, is able to find one. In urban India, this is more than 80 per cent.

Given this, many people need to be moved from agriculture into other activities. The NITI Aayog discussion paper points out: “To match employment share with output share of agriculture another 84 million agricultural workers are required to quit agriculture and join more productive non-farm sectors. This amounts to about 70 per cent increase in the non-farm jobs in rural areas.”

What all these factors come together to tell us is that it is surprising that more people not moving to urban areas from rural areas, given the huge difference of income between rural and urban workers and the fact that there is a huge disguised unemployment in agriculture. Given the limitation of data (with the Census only being carried out once every 10 years), we will come to know the real situation only once the next census is carried out in 2021. But seeing how things are currently, it is safe to say that more people will move from rural to urban areas, than was the case in the past.

The column originally appeared in Daily News and Analysis on January 7, 2018.