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Investment, not Saving, Improves Living Standards

I’m reading this splendid book called “The World is Curved” by David Smick.

It’s about why the world, in a crisis, is actually not flat – taking off from Friedman’s book. Things that happen in China impact America in ways we couldn’t have earlier (pre-80s) imagined. If the Japanese housewife stops saving, it impacts global trade and capital flows; why the sovereign wealth funds wield more power than we give them credit for.

It’s an amazing read already and one of the points in there got me thinking.

Many of these [non-American] countries have excess saving because they limit domestic investment opportunities through taxation, regulation, a lack of financial transparency and the rule of law. It is important to note that it is investment, not saving, that improves living standards. Saving without investment is impotent.

This struck a chord. I’ve always found it disconcerting that even when India saves so much, why are we so far behind?

The limiting of domestic investment is evident. In the last 15 years, we provided exporters with huge subsidies – from taxes to duty exemptions. Specifically the IT companies. Now, they have become behemoths and still get tax advantages. The unintended consequence of this is that hardly any software got developed and marketed in India, for lack of investment – who wanted to bother investing in India specific software when you had the lucrative tax free export market? Look really at the local language software, accounting, estate management, tax filing areas etc. Or the hardware section – there are so many custom built hardware elements specific to India (high heat, no power etc.) , but they require scale and investment that wasn’t quite there.

Other professions suffered too – while I was a CS graduate, most of my graduating batch went into IT rather than their fields of study, because it was more lucrative. Until the global boom in everything, there was a lull in the market for mechanical, civil and commerce branches. The BPO boom took away a lot of people who would usually intern at law or accounting firms, and that hurt industry. Now I’m all for competition but the BPOs had the unfair tax advantage.

Plus, we have tax arbitrage. Invest in the stock market, zero tax. Invest in housing, you get tax rebates. These propel bubbles and more importantly, move capital away from avenues they would have otherwise gone into – like entrepreneurial ventures, or small business funding, or local/semi-urban development. These areas have lagged behind; and even today, have less prominence. (Though they probably employ a lot more people)

Regulation restricts things further. The “venture capital” model is broken in India; everyone is just a glorified stock market punter and at smaller capital requirements you can’t find anyone willing to fund. The government created VC funds are actually more useful in this context than privately gathered money pools. Which is strange, but it’s a result of high regulatory action and tax rules – you have specific limits for what you can do with VC money to qualify for the tax criteria that benefit them, or to even operate in India. FIIs can’t even invest much in Indian government bonds – that money, therefore, has to be sucked out of the savings of the common man (bank SLRs, insurance/pension money) and crowds out private sector investment at the small scale which FIIs can’t do anyhow.

Lastly, the lack of financial transparency rings home. Banks needn’t disclose much. Public companies don’t have to disclose their balance sheets and cash flow once a quarter – once a year is the limit. By the time you get the news it’s already six months old. RBI is quite transparent at its end, but institutions and companies get away with “we don’t reveal this data”. We don’t even invest in transparency – for all the brouhaha, SEBI has hardly the bandwidth to investigate the multiple small frauds that happen in the market regularly, and to reveal the data they collect in an informative manner. (Having said that the government is one of the best sources of data in India)

Some of these rules and structure need to change to encourage domestic investment. And by that I mean reducing the tax benefits for housing and increasing home loan provisioning (both keep real interest rates too low for housing and make it a bubble). And removing zero tax on investments in certain areas (stock market capital gains were not taxed) – the DTC will fix that. Levelling the playing field between exports and domestic – for instance giving SEZs the complete right to sell within India and making size a sunset clause (read 1000 cr. turnover, no tax-free operation etc.). Letting FIIs take on larger positions in government bonds so that banks can put more into the local economy instead. Introduce transparency by forcing all public companies to reveal Balance Sheet and Cash flow data quarterly; banks to reveal full status (not just risk weighted assets or fair value accounting, but mark to market). And finally, make law enforcement tougher – invest in detecting and punishing high-street frauds.

It’s important to make India a good place for domestic investment by Indians; people from abroad will follow, but there’s enough saving here already that can move.

  • Anonymous says:

    >Isnt saving also investment ? I mean my bank FD is lent to some one and they in turn invest that money in a business. Or it is given to government borrowing which finds it way back to the market ( leaky but it does find its way back)
    But you are right about sops for housing and IT/ SEZ should be reduced, it is unbelievable that a small business is expected to full tax but a company like Infosys with 15000 Crs in cash gets tax sops !!!