It is widely accepted that Indian economy is recovering, albeit slowly, from the disruptions created by demonetization (November 2016) and implementation of GST (July 2017). The GDP growth is forecast to recover from below 6% in FY17 to more than 7% in FY19. At this rate, India will be the fastest growing economy amongst all major global economies. The positives are all well known and appreciated by markets and global agencies, as the entire government machinery is busy marketing these. Nonetheless, for investors, it is important to take a note of the red flags that are too conspicuous and could have serious repercussions on the sustainability of the economic recovery and hence corporate earnings.

1. Union Budget 2018-2019
An investor's prelude
Wednesday, 31 January 2018 Opinion
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Future tense
As the finance minister prepares to present his last full budget for the
current term of the incumbent government, he would a worried man.
Regardless of the brave disposition, the government knows very well that
they may have fallen short on people's expectation; especially because they
are only responsible for raising the aspirations and expectations.
The finance minister will be presenting the budget for FY19, with the
following in the background.
(a) The economy is recovering slowly from the disruptions created in past
couple of years by poor monsoon, demonetization of currency,
implementation of GST, etc. However, the nascent recovery is seriously
threatened by rising energy prices, elevated food prices, rising wages,
and high real rates.
The global trends in inflations and rates are not at all comforting, and
could potentially hurt the growth materially.
Moreover, the window to consolidate the domestic economy is narrow,
before the global growth fatigues.
(b) The finance minister is under tremendous pressure to devise new
avenues to raise resources. There is little scope for hiking tax rates.
Hiking service charges for utilities and drastically cutting subsidies may
not be politically advisable ahead of elections. Selling assets may also
get tougher if markets turn bad.
(c) So far the government has been brave in taking tough economic
decision. But given the packed election calendar for next 15months,
totally avoiding political considerations may not acceptable to the party.
(d) The honor of being the fastest growing economy in the world may be
meaningless, as fastest may not be the fast enough to employ the
burgeoning workforce.
(e) The rise in tax payer base post DeMo and GST need necessarily not be a
good thing. So before celebrating, the finance minister may want to
evaluate the incremental tax contribution from these newly added
assessees versus the cost to administer them.
(f) There is unusually large focus on financial markets in the government
commentary.
(g) Despite having taken an audacious decision like DeMo, the government
is actually not thinking in terms of any non-linear solutions to the
current problems.
No Research. No
Advice.
We simply state what
we see while exploring
the vast treasure, you
know as India.
Team InvesTrekk
investrekk@gmail.com
(For private circulation only)

2. 31 January 2018
2
Economic Survey 2017-18 (Part 1)
The government presented the annual economic survey for the financial year
2017-18 on Monday. The 525 page document divided in two volumes and
several appendices, reads like the political statement of the ruling party.
The following three characteristics of the Economic Survey, clearly highlight
the path, the government is treading.
(a) Rather than highlighting the state of economy per se, and the short,
medium and long term economic trends, the document tries unusually
hard to highlight what has been different during the term of the
incumbent government, i.e., since FY15.
It clearly highlights the government's attempt to show the period since
2014 as a watershed in Indian economy, in the analysis.
The fact may however be far from whatever is trying to be projected.
Despite the audacious attempt to break status quo through DeMo and
success in finally implementing GST, there is little happening in the
economy that is not a part of the continuous series of development
effort that started in 1990s.
(b) There is an unusual focus on financial markets in the Economic
Survey.
This clearly highlights that the government is market oriented and looks
at financial markets as an important source for resource generation and
achieving its economic targets.
This also highlights that now a much greater role is being played by the
market economists in the policy formulation and administration.
Historically, the left leaning development economists have dominated
the policy domain in the country.
(c) The document reads more like a undergrad dissertation. It relies heavily
on theoretical research by western experts, with naive attempt to
garnish it with Bollywood and literary quotes.
This highlights the fact that NITI Aayog and Finance Ministry may be
relying too much on the research scholar with mostly academic
experience and virtually no exposure to the real economy.
For example, despite devoting so much space to the topic of
employment, the document nowhere mentions that in past one decade
it is not the farming, textile, railways, or SME but the telecom sector
which has provided maximum incremental employment opportunities to
youth. And it all has happened in spite of the government.
The document projects the rise in the share of stocks and mutual fund
units in the financial savings of the households as a positive
development, despite recognizing that the Indian equities may not
cheaply valued. It raises no red flag on the fact that this has happened
at the cost of lower bank deposits (when real rates have risen sharply
over 2%) and investment in housing. The risk profile of the Indian
household has thus worsened materially, at a time when personal loans
are rising the fastest.

3. 31 January 2018
3
Economic overview and outlook
Overview
Two major reforms were undertaken over the past year.
1. The transformational Goods and Services Tax (GST) was launched from
July 1, 2017.
2. The long-festering Twin Balance Sheet (TBS) problem was decisively
addressed by sending the major stressed companies for resolution
under the new Indian Bankruptcy Code and implementing a major
recapitalization package to strengthen the public sector banks.
As a result of these measures, the dissipating effects of earlier policy
actions, and the export uplift from the global recovery, the economy began
to accelerate in the second half of the year.
Outlook
The reform measures taken so far by the government should allow real GDP
growth to reach 6.75% for the year as a whole, rising to 7-7.5% in 2018-19,
thereby re-instating India as the world’s fastest growing major economy.
Key risk factors
Against emerging macroeconomic concerns, policy vigiliance will be
necessary in the coming year, especially if high international oil prices
persist or elevated stock prices correct sharply, provoking a “sudden stall” in
capital flows.
Agenda for the future
The agenda for the next year consequently remains full
(a) Stablizing the GST,
(b) Completing the TBS actions
(c) Privatizing Air India, and staving off threats to macro-economic
stability.
The TBS actions, noteworthy for cracking the long-standing “exit” problem,
need complementary reforms to shrink unviable banks and allow greater
private sector participation.
The GST Council offers a model “technology” of cooperative federalism to
apply to many other policy reforms.
Over the medium term, three areas of policy focus stand out:
Employment: finding good jobs for the young and burgeoning workforce,
especially for women.
Education: creating an educated and healthy labor force.
Agriculture: raising farm productivity while strengthening agricultural
resilience. Above all, India must continue improving the climate for rapid
economic growth on the strength of the only two truly sustainable engines—
private investment and exports.

4. 31 January 2018
4
Investors are worried
that India may not stick
to its fiscal consolidation
path. Whereas Stock
market investors seem
bullish about rapid
growth going forward.
The result – prices of
bonds and stocks have
headed in opposite
directions.
The demonetisation
exercise and the
implementation of the
Goods and Services Tax
has led to a sharp
increase in the number of
new tax filers.
In the last four years, the
level of real agricultural
GDP and real agriculture
revenues has remained
constant, owing in part
to weak monsoons in two
of those years.
Indian economy in eight charts

5. 31 January 2018
5
Real policy interest rates
in India were following
the global trend
downward till the middle
of 2016. Since then,
however, the downward
movement has continued
in most other countries,
in India, on the other
hand, average real
interest rates increased
by about 2.5 percentage
points.
The Economic Survey
estimates that
demonetisation has led to
a reduction in the
amount of cash in
circulation by Rs 2.8
lakh crore and a decline
in high denomination
notes by Rs 3.8 lakh
crore in terms of value.
Rural wages, which
accelerated sharply
through much of 2016
aided by an increase in
activity on the back of a
strong monsoon,
decelerated just before
the kharif season this
year. The rate of growth
is still higher than much
of the last three years.

6. 31 January 2018
6
Indian companies are
spending a lot more as
legal expenses.
The Economic Survey
also suggests that India’s
formal sector
employment, especially
the non-farm payroll,
is substantially
larger than earlier
believed.
(Bloomberg)

7. 31 January 2018
7
Capital raised relative to
GDP almost half of 2008,
despite much cheaper
cost of funds (PER of 25
means 4% cost of funds)
Flows into mutual funds
cross 1% of GDP, 8x from
FY12
Financial markets
Amount raised by companies highest ever
...but on relative basis much lower than 2008

8. 31 January 2018
8
GST: A New paradigm
India has recently created one of the most effective institutional mechanisms
for cooperative federalism, the GST Council.
At a time when international events have been marked by a retreat into
economic nativism and the attendant seizing of control, Indian states and
the center have offered up a refreshing counter-narrative, voluntarily
choosing to relinquish and then pool sovereignty for a larger collective
cause.
It is a critical complement, needed to tackle a wide array of difficult
structural reforms that involve the states.
For example, the “cooperative federalism technology” of the GST Council
could be used to create a common agricultural market, integrate fragmented
and inefficient electricity markets, solve interstate water disputes,
implement direct benefit transfers (DBT), make access to social benefits
portable across states, and combat air pollution.
...but enthusiasm over new assessees may be little overdone
As the data in following table suggests that 17% of the new assesses might
be adding to the tax kitty.
Out of the 3.4million new registrations - B2B (34%), Exporters (29.8%), and
Nil turnover (19.4%) are the assesses which would only add to the
administrative cost. Only 16.8% new registrations are for B2C businesses
that may be adding to the tax kitty.

9. 31 January 2018
9
Investment and savings slowdown
India’s unprecedented climb to historic high levels of investment and saving
rates in the mid-2000s has been followed by a pronounced, albeit gradual,
decline. This current episode of investment and saving slowdown is still
ongoing.
The global experience suggests that the investment slowdowns have an
impact on growth but not necessarily saving.
The recoveries from investment slowdowns, especially those associated with
balance sheet difficulties--as in India--tend to be slow. Notably, mean
reversion or some degree of automatic bounce-back is absent so that the
deeper the slowdown, the slower and shallower the recovery.
Therefore, urgent policy initiatives may be needed to prioritize investment
revival to arrest more lasting growth impacts, as the government has done
with plans for resolution of bad debts and recapitalization of public sector
banks.
...outlook not very bright
India’s investment slowdown is not yet over although it has unfolded much
more gradually than in other countries, keeping the cumulative magnitude
of the loss – and the impact on growth – at moderate levels so far.
India’s investment decline seems particularly difficult to reverse, partly
because it stems from balance sheet stress and partly because it has been
usually large. Cross -country evidence indicates a notable absence of
automatic bounce-backs from investment slowdowns. The deeper the
slowdown, the slower and shallower the recovery. At the same time, it
remains true that some countries in similar circumstances have had fairly
strong recoveries, suggesting that policy action can decisively improve the
outlook.

10. 31 January 2018
10
Indian economy faces strong global headwinds
The first order fact about the developing world today is that this is an era of
unprecedented prosperity.
This is true about India too which has been one of the most dynamic
economic performers in the world.
A major driver of these good times, is “economic convergence,” whereby
poorer countries have grown faster than richer countries and closed the gap
in standards of living.
The convergence process has been broadening and accelerating for the last
20-30 years.
However, while fears of a middle-income trap are overblown, could there be
a slowdown in this process for lower-middle-income countries such as
India.?
The possibility of such a “Late Converger Stall” arises because of the
following four possible headwinds in the post-Global Financial Crisis era
that were largely absent for the early convergers such as Japan and Korea.
(a) The backlash against globalization which reduces exporting
opportunities;
(b) The difficulties of transferring resources from low productivity to higher
productivity sectors (structural transformation);
(c) The challenge of upgrading human capital to the demands of a
technology-intensive workplace; and
(d) Coping with climate change-induced agricultural stress.
India has so far defied these headwinds but can continue to do so only if the
challenges are decisively addressed.

11. 31 January 2018
11
The nominal per capita
income in India is
growing @9% for past few
years. At this rate
doubling farmers' income
in 8yrs (2014-2022) is no
big deal. It is just the
trend.
Challenges of climate change
A study of district-level data on temperature, rainfall and crop production
shows a long-term trend of rising temperatures, declining average
precipitation, and increase in extreme precipitation events.
A key finding of the study—and one with significant implications as climate
change looms—is that the impact of temperature and rainfall is felt only in
the extreme; that is, when temperatures are much higher, rainfall
significantly lower, and the number of “dry days” greater, than normal.
A second key finding is that these impacts are significantly more adverse in
unirrigated areas (and hence rainfed crops) compared to irrigated areas (and
hence cereals).
Applying these estimates to projected long-term weather patterns implies
that climate change could reduce annual agricultural incomes in the range
of 15 percent to 18 percent on average, and up to 20 percent to 25 percent
for unirrigated areas. Minimizing susceptibility to climate change requires
drastically extending irrigation via efficient drip and sprinkler technologies
(realizing “more crop for every drop”), and replacing untargeted subsidies in
power and fertilizer by direct income support. More broadly, the cereal-
centricity of policy needs to be reviewed.

12. 31 January 2018
12

13. 31 January 2018
13
R&D spend needs to double
Innovations in science and technology are integral to the long-term growth
and dynamism of any nation. The pursuit of science also creates a spirit of
enquiry and discourse which are critical to modern, open, democratic
societies.
Historically, India can point to many contributions to global scientific
knowledge and technological achievement.
However, India under-spends on research and development (R&D), even
relative to its level of development.
A doubling of R&D spending is necessary and much of the increase should
come from the private sector and universities.
To recapture the spirit of innovation that can propel it to a global science
and technology leader from net consumer to net producer of knowledge
India should invest in educating its youth in science and mathematics,
reform the way R&D is conducted, engage the private sector and the Indian
diaspora, and take a more mission-driven approach in areas such as dark
matter, genomics, energy storage, agriculture, and mathematics and cyber
physical systems. Vigorous efforts to improve the “ease of doing business”
need to be matched by similar ones to boost the “ease of doing science.”

14. 31 January 2018
14
Union Budget - A marketing event, no less, no more
The finance minister is like CFO of a business corporation. His job is to keep
account of the receipts and expenditure of the government; manage
resources necessary for executing the plans approved by the Cabinet;
ensure optimum utilization of available resources; and keep adequate
provision for meeting contingencies.
He is accountable to all the stakeholders, insofar as the transparency of
accounts is concerned. His discretions are however limited to choosing the
sources of revenue needed for executing the plans of the government.
In specific Indian context, FM has to decide how much resources to raise
from (a) taxation; (b) sale of national assets; and (c) borrowing.
In taxation, a balance has to be maintained between direct and indirect
taxes to keep the incidence of tax just and equitable.
Sale of national assets (mines, airwaves, PSE shares, land etc.) has to meet
the criteria of sustainability, development, transparency, viability, socio-
political expediency; etc. and depends heavily on the current market
conditions.
Borrowing depends on consideration of fiscal discipline, servicing capacity,
and market conditions. Historically, we have borrowed from domestic
lenders only. However, in recent years the role of foreign lenders has been
rising; the exchange rate volatility has therefore become a consideration.
The FRBM Act also guides the extend of borrowing.
The importance, or otherwise, of the annual budget presentation must be
seen within this framework. Although, the attention that is paid to the
annual budget speech has diminished in past decade or so. GST has further
diminished the scope of budget materially. Nonetheless, it has still evoked
intense interest from the financial market participants. I feel it has more to
do with the marketing success of business news channels rather than
anything else. A number of TV shows are hosted to propagate an
environment of expectation, hope and fear amongst market participants.
The anticipation, that is sometimes far beyond the realm of reality, guides
the market volatility. The representatives of various interest groups and
lobbyists for pressure groups demand from FM, what he has no jurisdiction
to give. For example, someone asks FM to allocate more money for
infrastructure spending. Whereas, this request should logically be made to
the concerned ministry and departments, which shall make a plan, and get
approved by the cabinet. FM will be obliged to provide resources for a plan
approved by the cabinet. A defiance could see him losing his job.
I believe that it is high time that the development agenda of the government
be completely separated from the budget presentation. Let budget be an
accounting exercise with a reasonable degree of predictability and
transparency.
Let public appraisal of the development agenda be a continuous process
through regular reporting by the concerned departments and ministries.

15. 31 January 2018
15
LTCG an anomaly, may be corrected, sooner than later
In our view exemption to the listed equities from LTCG (provided STT has
been paid on the sell trade) is an anomaly that would need to be corrected at
some point in time, sooner than later.
Tax break on LTCG defy logic
Evaluating holistically, the activity of buying and selling equity shares in
secondary market per se does not provide any risk capital to the underlying
businesses.
It in effect just changes the beneficial owner of the business. Prima facie it
sounds illogical why should someone who is actually transferring his risk,
be rewarded with lower (or no) taxes?
...argument in favor weak
It is extremely difficult to support the argument that holding a listed stock
for more than one year in any way helps the economy or the markets.
The logic of holding a security for longer term, if at all, enhances the
chances of higher returns for the investor. Why should the investor be given
tax breaks for enhancing his return prospects?
One could appreciate the "development of capital market" argument in case
of investing in IPOs, PE funds, or venture funds etc., as in such cases the
businesses get the much needed risk capital. But the secondary market
transactions do not pass this muster.
The incentive for longer term holding period has, in our view, failed
miserably in improving market liquidity or minimizing market volatility.
...has been "misused" more than "used"
It is common knowledge in market place that the LTCG exemption for tax
has been abundantly misused for money laundering purposes.
In fact in last two years, the regulator and taxation authorities have also
initiated action in many cases for misuse of LTCG taxation provision for
money laundering.
Day traders, jobbers and unsecured creditors deserve it more
In fact, to the contrary, the day traders, jobbers and market makers who
provide the much needed liquidity to our shallow markets, and hence
motivate risk taking, deserve serious tax incentives.
Abolition of Securities Transaction Tax (STT) may actually lead to material
rise in daily volumes and deeper markets, thereby materially lowering the
transaction cost.
Similarly, providers of unsecured debt take much higher risk and therefore
deserve more tax incentives.
In absence of a functional retail debt market, companies depend heavily on
"fixed deposits" from household investors for meeting their working capital
requirements. These deposits are fully unsecured and entail high risk for
investors, in lieu of marginally higher interest rates as compared to bank
lending rates.

16. 31 January 2018
16
Reforms go much beyond New ITR forms
We have been insisting that "reform" must be distinguished from mere
administrative correction. A policy measure in order to qualify as "Reform"
must change the status quo materially.
Reform do not mean higher profit or higher Sensex
The businesses, investors and consumers need to assimilate that economic
reforms do not necessarily result in more profit in the immediate term. To
the contrary, economic reforms are more likely to cause pain and
inconvenience in the immediate term as these involve fundamental changes
in the processes and practices of doing business and consuming goods &
services.
Reforms must change status quo materially
From this view point, I suggest the following 10 illustrative reform measure
that may change the status quo materially. If you find these are highly
idealistic, and impractical to implement, I beg to differ.
(1) To exploit the demographic dividend fully and generate demand,
accelerate the wealth transfer process. Defining the upper bound of
wealth and introduction of material estate duty on people above the
upper bound could be one method.
(2) Transfer the power to impose direct taxes, to the local governments.
(3) Transfer the ownership of natural resources to local governments.
Encourage industry and investors to partner with local governments for
setting up business ventures.
(4) Introduce competition in Railways. To begin with allow point-to-point
private railways for intercity travel up to 100kms.
(5) Transfer all PSUs under a listed holding company. Majority voting
power in this listed holding company may be owned by Indian citizens
with no individual owning more than 1%. All these companies should be
professionally managed with no intervention from the government
whatsoever.
(6) Allow and encourage the federal states to have bi-lateral trade, labor
and resource (water, energy, logistics etc) sharing treaties.
(7) Bring the Return on Investment (ROI) for elected representatives close
to Zero level, by stripping all their discretionary powers.
(8) Constitute a Clean India Regulatory Authority (CIRA). Make all elected
representatives from local government level to the members of
parliament accountable to this authority. Each member should be
mandated to submit a quarterly return of cleanliness in their respective
constituency to this authority. The authority should cause an
independent audit of such certificates. A wrong certificate should
disqualify the person from contesting elections for 25years.
(9) Enhance the Right to Education (RTE) to the Right to Uniform
Education (RTUE).
(10) Reorganize farm sector with "collective farming", "cooperative food
processing" and "national market" at the core.

17. 31 January 2018
17
Important disclosures
It is important to note that InvesTrekk does not offer any portfolio management , brokerage,
money management, equity research or investment advisory services of any kind. Please take
advise of a qualified and registered investment advisor before taking any investment decision.
InvesTrekk Reports provide generalized business strategy to its readers based on our social,
macroeconomic and technical studies. Neither the information nor any opinion expressed constitutes an
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