Actionable insights on equities, fixed-income, macros and personal finance Start 14-Days Free Trial
Actionable investing insights Get Free Trial

When does the Government Start To Hurt?

So we have a recession coming up, all these jobs lost, all these industries gone and so on. At some point this has to have an adverse effect on the government budget – revenues not quite coming close to the budget requirements. Salaries have just been hiked, retrospectively, so there’s that additional outflow.

A recession causes unemployment. Lost jobs means lost personal income taxes, which form a substantial part of the budget revenue. With losses hitting companies as well, the overall direct tax revenue will come down.

With fear of unemployment, and lost jobs, comes the battening of hatches; people spend less and use meagerly. That means a loss of indirect taxes – sales tax, VAT, service tax etc.

When production drops in response to the lack of demand, we are in more doo-doo. Excise duties and import duties reduce, and this further reduces jobs.

Real estate drops means lesser transactions, lesser state government revenue, lesser capital gains taxes and a loss of a large number of unrecorded jobs in the form of real estate brokers – who don’t count as “employed”.

Given we don’t have much of a bond market, there’s no stopping this through lower interest rates. Unofficial borrowing happens at 2% per month or more in India, and most of the moneyed people are happy to lend through this route, which means there’s not much use to deploy capital. Though, to be honest, it’s a good thing to reduce rates anyhow; our country needs a lot more risk capital. (People don’t take risks when the interest rates they will get are higher than inflation)

But the problem of lower government revenue means the government needs to borrow, and borrow hard. Currently, because gilts aren’t traded much other than in esoteric (read: invite-only) circles, there is easy cartelisation and gilt prices can be manipulated to come down just before a big issuance, meaning the government needs to pay higher interest. We don’t have a structure like the Fed which has a seemingly unlimited balance sheet, and will buy treasuries to keep the yield down to what they think is right.

Maybe it’s time to introduce a Fed – I don’t know. But it definitely is time to get more people involved in our bond markets. Get this going big time – it’s a risk investment (meaning prices can come down) but there is so much opportunity, because securities can be lent, borrowed, shorted and traded; in fact the opportunities here are much more than the equity markets – a lot lesser factors impact bonds. If the government shut out capital gains taxes on bonds, and incentivised banks and players to trade outside the NDS, and let FIIs in, we might just have it. What better time than now?

Municipalities too will face a funding shortage. Running to politicians is an inefficient, and largely corrupt exercise. Bond markets should help these as well. But there are toxic problems – like Auction rate securities or short-term rollovers which get destabilised when there is no liquidity; this is a challenge to be addressed. (Perhaps the need will be to increase short term bond disclosure requirements, match fund-use terms and have serious enforcement; but we need political will for that).

Still, this is just debt; we need to figure out if revenue can be upped, and for that growth is a necessity. We aren’t going to grow much in the near term – I even think we’ll go negative – and it’s important to take the lead when the tide turns worldwide.

We must remove obstacles to entrepreneurship (like ridiculously complex company incorporation procedures, FBT on stock options, Foreign debt regulations etc) and promoting a lower tax regime – it may be counter-intuitive, but getting taxes down to 20% will make businesses far more viable.

We have to let in more foreign capital; instead of working only through some silly FDI limits, I’d say let in foreign individual investors enter directly (rather than through FIIs). On a smaller note, allow system trading and encourage traders; a large number of the unemployed can become traders and it’s an enabling self-employment exercise.

But overall, the lack of government revenue sources should not come as a surprise. The way we generally react is knee-jerk, so expect sudden increases in traffic violation bookings, real estate taxes, municipality charges and such. The government is a huge machine and can be a real pain in the neck. And a new one, after the elections, will do all evil possible if it knows it has a sure 5 years in power. With a shelf life as short as 5 years, I expect no government to take big steps forward. But I fear we will stay in the same place, or worse, go in the opposite direction.

  • Anonymous says:

    >Does the govt have the will?
    i doubt from all that comes out routinely …

  • Anonymous says:

    >Glad that you wrote about this. Its about time we had a bond market. But I feel given our political structure its very difficult for that sort of a thing to happen. Muni bonds mean local gov’ts have control, which big brother wont like 🙂
    But all over the world change is going to be forced on us, if we dont do it by ourselves. This global drama can’t keep on going much longer.
    BTW what are your thoughts on Rupee, given that a yuan deval is coming? TNX has started moving up…

  • Siddharth says:

    >Foreign investment. Institutional Investments apart non residential investments are ridiculously complicated to start with.

    No single portal providing complete know-how in that. So many idiots in most of the banking/amc with incomplete or no knowledge at all. From my experience I would say times it feels like NRI investment is not welcome. not in this not in that bl^&* heck. I have seen this is why many nri's using their parents accounts to do the investments as such I know its not legal or ethical but hey I am still getting my T-shirt going thru all the BS to get the formalities completed. whew just wanted to vent. sorry guys.

    And apart from that govt revenues, march end is coming and all the RTO offices will be in full swing doing long duties completing the targets. So be ready to pay if you dont have one indicator or this guard or number plate not in proper size!!

    You missed one thing Deepak. Politicians will also be affected due to recession, how they will get the monies to run their business?
    Patience is a virtue, and I am still trying learning this…