The Important Proposals

The Union Budget presented yesterday was keenly watched to find out if the government sticks
to the path of fiscal prudence, or makes populist announcements. The speech, while making
some important and pathbreaking announcements, thankfully, did not go overboard with its
proposals. It has recommended a total expenditure of INR 27.8 lakh crore during 2019-20, an
increase of more than 13.3% over revised estimates of INR 24.6 lakh crore in 2018-19.

The three most important proposals of this year's budget are introduction of minimum income
support to small/marginal farmers, introduction of pension scheme for unorganized sector
employees, and introduction of the concept of "rural industrialization".

Here are the details on these, and other budget proposals.

The budget this year generated a lot of interest on whether it would be a full budget or an
'interim" one. "Interim", or "vote on account", means the government is not seeking funds from
the Parliament to meet its full year's expenditure but only for four months. The full budget will
be presented after the new government is formed at the center.

In a first initiative of its kind, the government has proposed to provide an income support of INR
6,000 per person to all small and marginal farmers. The move will cost about INR 72,000 crore
annually, as the estimated number of such farmers is about 12 crore. While the political angle of
the move is debatable, the scheme would go a long way in helping these farmers meet their basic
needs. Further, this should also act as an opportunity to look at the efficacy of another similar
mega scheme, MGNREGA, and tweak it to make it more productive.

The pension scheme is largely similar to the one existing for the organized sector employees; and
proposes a monthly pension of INR 3,000 to workers in the unorganized sector on attaining the
age of 60. However, it will be applicable only for those earning up to INR 15,000 per month. The
scheme is not free, but based on contribution by the worker concerned to the tune of INR 100 per
month (if his age at the time of joining the scheme is 29 years) and INR 55 (if the age is 18
years). The Government will contribute an equal amount to the scheme; and the total sum
involved could be about INR 15,000 crore.

It is expected that about one-fourth of the 43 crore workers engaged in the unorganized sector
will enroll for the scheme, which is certainly far-reaching, as it provides a much-needed safety
net to these small-time workers. It may be further tweaked to provide an option to the workers to
deposit amounts in excess of the minimum for additional benefits (like those available in the
current PF scheme), loan against these deposits, lumpsum payment in case of untimely death of
the worker, and so on.

The budget speech talks about 10 dimensions, which would propel India's growth over the next
decade to help it become a $10 trillion economy. The most important of these is introduction of
the concept of "rural industrialization", which would not only help generate employment and
provide a fillip to the rural economy but also prevent the exodus of population to urban centers.
MSME industries at the grassroot level, comprising agro-processing, other village specific
industries, etc., are critical to meet the basic level of rural income and wean people away from
agriculture. Public sector enterprises, which helped India develop competency in heavy
industries can act as engines of growth here too. The initiative can be clubbed with rural
digitalization initiatives to help rural India emerge also as digital service providers. However, it
is just a concept at the moment; and will need a focused strategy so that it does not get lost like
the concept of 'smart cities'.

An important element of budget announcements used to be changes in the indirect tax rates. GST
seems to have taken away the charm from budget speeches, where consumers and corporate alike
watched keenly to know these changes, and whether the stock market would react to likely
winners and losers!

However, some changes in direct tax regime were brought in this year, the most important one
being rebate to taxpayers with income up to INR 5 lakh (from the earlier INR 2.5 lakh). Since,
this is a tax rebate, and not a change in the tax slab, tax payers with income over INR 5 lakh get
no direct relief.

Among other segmental initiatives is the provision of 2% interest rebate on loan of up to INR 1
crore to SME units, which are GST registered. The measure is a smart one, as it not only
provides an incentive to the segment, but also pushes them to register and enter the formal
economy.

Agricultural Distress: Challenges & Remedies

The distress being faced by India's agricultural sector has become a part of the mainstream
agenda; and rightly so. Despite supporting almost half of India's population, the rural economy
remains in a dire state, and policy initiatives have failed to provide any breakthrough. The report
published by the Swaminathan Committee more than 10 years ago remains the most
comprehensive document dealing with the issue.

Here is a brief attempt to understand the issues, taking inputs from the report. The growth rate of
agriculture has always lagged behind that of the other sectors. Against GDP growth rate of about
7.5% over the last 10 years, agriculture has grown at barely 3.5%. As a result, its share in the
GDP has come down from about 19% to just about 12%.

The decline is agriculture's share would not have been a problem if it had been accompanied with
sufficient increase in employment opportunities in the other sectors. However, that has not
happened; leading to continued high dependency of population, and therefore, higher distress.
Measures required to reduce agricultural distress can be clubbed into three broad groups:
increasing productivity of farmland, increasing profitability of farm produce, and most
importantly, reducing the number of people dependent on agriculture. Productivity improvement
is directly linked to investment in fixed assets, like in any other industry. This, itself, is linked to
availability of credit.

Nearly 65% of fixed assets created in the industrial sector has been financed with bank credit. In
case of agriculture, not only is the share of credit low, that of long-term credit is even lower. As
per an RBI report, share of agriculture in total loan disbursed is just 7%, of which share of long-
term loan is less than 1%. Clearly, the focus has been on firefighting, rather than on capacity
building.

Agriculture is dependent on a large number of factors, such as availability of land, water,

fertilizers & other input materials, access to finance, crop insurance, access to market and
pricing, mechanization, soil health, and so on.

Water is the most critical resource for agriculture. The impact of irrigation on agricultural
performance is evident from the fact that regions such as western UP, Haryana, and Punjab
which have achieved 80-100% irrigation have a cropping intensity of 160-180%. Cropping
intensity refers to the number of times crop is planted in an area during the year. On the other
hand, Maharashtra, Jharkhand, and Chhattisgarh have less than 20% irrigated area; and therefore,
are prone to maximum agricultural distress.

However, productivity enhancement has its limitations; and small farms cannot achieve the
productivity level of large farms. The issue has ramifications, since almost 80% of the farm
families belong to the marginal and small farmer categories.

The issue can be addressed by developing Self Help Groups (SHGs), which can bring together
small holdings into an Estate model covering both the production and post-harvest phase,
incentivizing agri-processing industries to tie up with these farmers, and more importantly, wean
away these households to other occupations, such as livestock rearing.

A NABARD report on rural income pattern provides an interesting perspective. While

households with less than 0.01 hectare of land derive about 17% of their income from livelihood,
the share is only 8% for the 0.01-0.4 ha group. The impact of this income supplementation is
such that households with smaller land have higher income than the next group!

The second group of intervention involves improving profitability, calling for reducing the
length of supply chain, better price discovery, and reducing middlemen's margin. The current
government intervention revolves around fixing a minimum support price (MSP), which,
however, is not applicable to all crops, and is physically not possible for all farmers to access.

The role of the Agricultural Produce Market Committee (APMC) Act across the states needs to
be understood in this context. It was enacted during the times of scarcity to keep a tab on the
quantity of food being produced, and to ensure optimal distribution within a state. With increase
in food production, the shortages have largely disappeared. However, farmers were - until
sometime back - forced to sell their produce through the APMC, where they also had to pay a
substantial amount of fees, making it a buyers', rather than a sellers', market.

States have woken up to the inefficiencies caused as a result; and most of them have
repealed/modified the Act in the last 2-3 years. While private procurement has been picking up,
these are still localized, and do not seem to be geared towards becoming national agencies. To
enable better price discovery, and develop the entire nation as one market, the central
government had launched the eNAM portal (electronic National Agriculture Market) linking all
the APMCs. Another innovative intervention is Bhavantar Bhugtan Yojana, introduced by the
Madhya Pradesh government in 2017, whereby the farmer is paid the difference between his
actual sale price and the notified price, thus eliminating the price risk. While the scheme has
significant potential, it is still early days.

However, farmers are not able to derive full benefit of the schemes due to lack of knowledge and
limited perceived power to command prices. About half of the surplus of small/marginal farmers
is disposed of in distress sale, where he gets a lower price. As per various estimates, farmers get
no more than 10-25% of the final price of their produce. The issue needs to be addressed through
local bodies, which would play the role of middlemen. The Swaminathan report calls for at least
one female and one male member of every one of about 250,000 Panchayats to be trained by
district/state-level professional management; and help them play this role. Similarly, farmers'
organizations should be promoted to facilitate direct farmer-consumer linkage. These
organizations should also be trained to handle all issues, such as choice of crop, sourcing of
seeds, use of technology, handling losses in farm storage, packaging, transportation, and so on.

Yet, none of these interventions can really work unless the number of people dependent on the
farmland is reduced. The problem is more acute in case of landless labor, who are reliant on
farming. However, that is an issue the entire nation grapples with; and achieving a breakthrough
is difficult to visualize.

ONGC: A Look at its Businesses, Financials, and Strategy

Last year, ONGC (Oil and Natural Gas Corporation Ltd) acquired government's majority stake in
Hindustan Petroleum Corporation Ltd (HPCL). The company, with consolidated revenue of INR
3.6 lakh crore and assets of INR 4.6 lakh crore in FY18, seems to have moved away from its
original objective of exploration and development of oil resources. Whether the diversification
helps it de-risk its business and undertake exploration work more aggressively, or diffuses its
attention from the core objective would be interesting to watch out for.

ONGC is a diversified oil sector company, originally formed as an Oil & Gas Exploration and
Production (E&P) company. Oil exploration is a challenging and risky business beginning with
study of seismic data, which gives an initial idea of presence of oil/gas underground. Actual
exploration begins with digging of wells approximately 40-50cm in diameter and at least 2,000m
in depth. If no oil/gas is found in the well, the amount spent is accounted as 'sunk cost', to be
recovered from revenues generated from other operating wells. It is to be noted that exploration
business can be carried out only in the area for which license is given by the government, either
on nomination basis or through auction.

Other than domestic E&P, it has a foreign subsidiary, ONGC Videsh Ltd (OVL), to participate in
oil blocks available in the international market. Since its inception, total investment in OVL is
almost INR 1.5 lakh crore, a substantial amount. The company also acquired Gujarat State
Petroleum Corporation's (GSPC) exploration assets in KG basin during FY18 for a consideration
of INR 7,700 crore.

Besides the core business, it has substantial exposure to downstream refining & petrochemicals
business also. This is managed by its subsidiaries Mangalore Refining & Petrochemicals Ltd
(MRPL) acquired in 2003, and Hindustan Petroleum Corporation Ltd (HPCL) - majority stake
acquired in FY18. MRPL is expected to be merged with HPCL to create a single refining entity
with total capacity of nearly 40 MTPA. With the acquisition of HPCL, contribution of refining
business to total revenue has gone up to almost 50% with core E&P business accounting for
nearly 30%.

The company also has subsidiaries ONGC Petro additions (OPaL) involving an investment of
over INR 30,000 crore and ONGC Mangalore Petrochemicals (OMPL) engaged in
petrochemicals business, largely to process by-products produced by the company which is not
fetching enough value otherwise. The strategy, or compulsion, of entering into a non-core
business is visible in another subsidiary, ONGC Tripura Power Company (OTPC), the power
generation JV, which operates a 726 MW gas-based power plant. The plant has been built solely
to utilize the gas produced from its fields in North-East, which was, otherwise, getting flared.

ONGC has total 2P (proven and probable) reserves of 800 million tons of oil and 1,000 million
tons of gas. Of these, about 40% is owned by OVL. The company produced a total of 35 million
tons of oil and 29 billion cubic meters of natural gas during FY18. Share of ONGC Videsh Ltd
(OVL) stands at roughly 40% in oil and 20% in gas. The company also receives about 4 MMtoe
from its JVs. Despite efforts, the company has not been able to achieve any breakthrough, either
domestic or overseas, in enhancing its production. Its efforts are reflected in the fact that total
capex stands at almost INR 2 lakh crore over the last five years.

ONGC's consolidated balance sheet shows total assets of INR 4.6 lakh crore, which is much
larger than Indian Oil, the public sector giant engaged in the oil refining segment. Of this, almost
INR 2.2 lakh crore has come in the form of equity, implying a comfortable debt-equity ratio.
Assets are spread across a number of heads, with oil & gas assets accounting for INR 1.4 lakh
crore; and other property, plant & equipment accounting for INR 70,000 crore. Almost INR
40,000 crore is invested in wells under exploration, classified as "intangible assets". This is the
amount at risk, since exploration may not necessarily lead to finding an oil or gas reserve.
Investment under development work, the phase after exploration and finding gas, is relatively
low, at INR 20,000 crore, possibly a result of relative ease of development in comparison to
exploration.

Total income for the company stood at INR 3.6 lakh crore in FY18, nearly a 10% increase over
the previous year. However, this includes INR 1.2 lakh crore of purchase of stock-in-trade,
largely a pass-through item without much value addition. The major cost item is production,
transportation, selling & distribution, clubbed together at INR 1.75 lakh crore. The cost,
including change in inventory, has risen from INR 1.2 lakh crore in the previous year. An
important item in the expense side is "exploration cost written off" at about INR 7,500 crore.
This is the amount spent, but has not yielded any gain to the company. Interest cost is quite low
at INR 5,000 crore as a result of limited borrowings. Net profit for the company stood at INR
22,000 crore, a decline of 10% due to higher costs.

ONGC has come a long way from its original mandate, with its core business now accounting for
just about 30% of its revenues. While there is nothing seriously wrong with moving up the value
chain - most of the world's mega companies in the field do that - it is important to ensure that the
diversification does not diffuse its attention from the core objective. The concern carries more
weight since the company has not been able to add much to its oil production over the years. The
diversification may help it add to the bottom line and save it from having to answer for not
enhancing oil production.
Operationalizing Brexit - What is at Stake?
The process of withdrawal of the United Kingdom from the European Union has become nerve-
wracking, with the British Parliament expressing serious reservations. While the negotiations
between the EU and the UK had not been as tough as in the earlier case of the much-feared
Greek exit, the deal seems to have got stuck in the British Parliament. As per the current legal
statute, the UK would exit the EU on March 29, 2019; and both the parties have to enter into a
deal before that to avoid disruption to businesses and life, in general.

Here is a look at the economic aspect of the withdrawal, and why an orderly withdrawal matters.
The economic separation could be classified into three groups: separation of trade in goods, trade
in non-financial services, and trade in financial services. A look at the goods trade shows that it
is the EU, which stands to lose more from the separation, contrary to general perception that the
UK would be affected more.

This is because the EU's export to the UK is more than the imports. As per a WTO report, the
EU accounts for 53% of $644 bn of goods imported by the UK. Against this, of the total goods
export of $445 bn from the UK, only 48% goes to the EU. This implies a trade surplus of about
$130 bn for the EU, which may partially come back to the UK after the withdrawal.

However, trade in total commercial services (such as travel, transport, financial services, services
linked to goods, etc.) gives a small surplus of $23 bn to the UK. While the UK exports 37% of
$347 bn of services to the EU, it imports half of $210 bn from the EU.

Within commercial service comes financial service, which is small in value but is the most
complicated of the three segments (while a separate figure for exports to the EU is not available,
it could be about half of $83 bn of total exports of financial services from the UK). This is
because the integration is much deeper; and unlike other segments, it is largely B2C. More
importantly, the net value of exports does not indicate the total exposure, which is capital in
nature, or notional in value.

To begin with, as per an IMF report, the UK banks provide around half of banking services to
EU customers. Similarly, UK-based insurance companies have liabilities of £55 billion towards
nearly 4 crore customers in the EU, whereas EU-based companies' exposure in the UK stands at
£27 billion and 1 crore customers.

The capital nature of exposure is reflected in the fact that the total Assets under Management
(AUM) in the UK for EU clients is close to $1.4 trillion (as per the latest Financial Services
Trade & Promotion Board, UK's report). It is the fear of outflow of this capital, which drove
down the British currency after the referendum; and continues to put pressure even now (the UK
has total AUM of close to $7 trillion, which includes UK, EU, and rest of the world clients). The
notional exposure refers to the servicing of derivative contracts, which is the most complicated
of all. As per the IMF report mentioned above, contracts with a notional value of around £16
trillion maturing after March 2019 is being handled in the UK for EU clients. Similarly, UK-
based clearing agents handle nearly 90% of euro-denominated interest rate swaps with a notional
amount of around £38 trillion for EU customers. In the absence of clearly defined permission,
the validity of these contracts could be in jeopardy.
An important risk-mitigation measure undertaken by the UK government is that it has agreed to
bring in stopgap legislation. That would give temporary permission to EU-based financial
companies to continue providing financial services to UK citizens. That would help avoid
disruption of services being received by UK citizens from EU companies.

Even after the agreement is reached, both sides would need to get the necessary legislation
passed by their respective Parliament, and operationalize the agreement. Subsequently, the
companies operating across the border may accordingly need to secure permissions,
registrations, and so on. The sequence of events before implementation of GST could give some
idea of what to expect in the months to come.

And at the end of this all, one is left wondering, was the separation worth all this?

Industry Analysis: Dynamics & Financials

The Indian automobile industry witnessed subdued sales during November and December 2018
due to the slowdown in NBFC's loan disbursal and certain other issues. If the trend persists, that
could be one more setback for an industry already bracing itself to meet the BS-VI norms from
April 2020. This is over and above the potential disruption that may be caused by electric
vehicles and changing customers' preferences. These factors, together, pose substantial
uncertainty, especially in the passenger vehicle space, even though the industry has been
performing reasonably in recent years.

The automobile sector is classified into the following segments: 2/3-wheelers, 4-wheelers (PVs),
and commercial vehicles (CVs). As per SIAM (Society of Indian Automobile Manufacturers),
sales during FY'18 stood at a little over 2 crore units for 2 wheelers, 33 lakh passenger vehicles,
8.6 lakh commercial vehicles, and 6.4 lakh 3-wheelers. Interestingly, all the four segments
recorded sales growth in the range of 7-8% during FY'14-18. Other than domestic consumption,
the industry is quite active in exports market also, especially in the 3-wheelers segment, where
almost 40% of production is exported. The share of exports in PV segment is 20%.

Despite being clubbed together, each segment has its own unique dynamics and market drivers.
While the rural income is a primary determinant for 2-wheelers' sales, 4-wheelers are almost
wholly dependent on urban disposable income. On the other hand, commercial vehicles are
driven by aggregate economic activity, whereas 3-wheelers are driven by economic activity,
increasing urbanization, and lately, entry of app-based aggregators, which are changing the
dynamics of the market. The entry of these players and scrapping of the permit system for
running 3-wheelers across major cities in Maharashtra and some other states in 2017 have given
a major boost to this segment.

Even though the industry is dominated by a few large players, it is highly competitive in nature.
So much so that even attempts by players from one segment to enter another have not been
significantly successful. For instance, Tata Motors has been struggling in the passenger vehicle
segment with less than 5% market share despite having 45% share in the commercial vehicle
segment. The competitive nature of the industry is more evident in case of the passenger vehicle
segment due to presence of a number of smaller players backed by global majors. In fact, the
failure of these companies to create a position for themselves in the market could be an
interesting case study.

While there could be a variety of factors, the most important one is not ceding the market by the
market leader which has leveraged its first mover's advantage beautifully. While many of them
tried to crack the market through a JV with domestic players, it did not give them any real
breakthrough; and a large number of these JVs were terminated. With increasingly more
stringent regulatory norms, it would not be surprising if some of them exit the market, like in the
case of the telecom sector.

A look at the financials shows that the total domestic sales of the industry were over INR 3.5
lakh crore in FY'18 with net profit of about INR 28,000 crore (this figure does not include JLR
sales owned by Tata Motors). Sales show an impressive growth of 11% CAGR during FY'14-18.
More importantly, profits have risen at an even better 19% CAGR.

However, as they say, one person's profit is another person's loss. Large part of this improved
profitability is attributable to the decline in steel prices, as a result of sharp increase in imports
from China. Raw material cost for the sector grew by barely 8.7%, leading to 5 percentage point
decline in RM/sales ratio. While the operating margin for the sector is a modest 16.7%, due to
low interest and depreciation (I&D) charges, just 5.4% of the sales helped it record a net profit
margin of 7.5%. I&D charges for steel industry stands as high as 12.5%, and is 8.2% for the
cement industry. Even though the segment does invest a good amount of money in product
development, the capital investment required for actual production is somewhat low, leading to
low I&D charges. Even though the third quarter is looking challenging, results for half year
ending Sept'18 was even better than the previous years' performance. While sales rose by 21%,
profits recorded an even higher growth of 34%. The profit growth has been aided by the
performance of Tata Motors, which moved from a loss of about INR 700 crore to profits of INR
1,300 crore this half year.

While the near-term growth of the industry looks reasonable, the passenger vehicle is staring at a
significantly challenging future in the medium term. The biggest of these is the change in the
very notion of 4-wheelers carrying aspirational value, and the consumer shifting from ownership
to on-demand transportation. As per a report quoted in Tata Motors' annual report, millennials in
the Asia-Pacific region are 49% more likely to use shared mobility solutions. This, coupled with
increasingly more stringent regulations, emphasis on stronger public transport system, etc., can
change the industry structure in unimaginable ways; and it would be interesting to watch out for
that!

The Journey So Far

The Goods & Services Tax (GST) has completed 18 months of its implementation; and the
developments so far have been encouraging. After the initial months of excessive hassles related
to filings, complaints of high tax rates, inconvenience to small entities, and so on, the taxation
regime appears to have reduced these glitches substantially. Still, it is a work-in-progress - both
operationally, and in terms of its potential to enable formalization of economy, widen tax base,
and most importantly, bring about a cultural change from tax avoidance to tax compliance.
The tax information is also expected to help banks assess the credit worthiness of a business
(especially small entities), and make lending more efficient and less risky. This should also,
going forward, help assess the economic growth in a more effective manner.

Here is a look at its progress and the changes after implementation. Other than the technical
glitches, the bigger worry was high tax rates, which threatened the survival of many small
businesses. The GST Council has acted quite proactively on this matter; and received substantial
praise by cutting rates liberally.

Almost 75% of items saw their tax rates come down from the initial 28% to 18% slab in Nov.
'17, providing a huge relief (the initial rate was based on the then-existing effective tax rate). The
Committee has been pruning the list in almost all of its meetings; and just about 27 items remain
in the top slab of 28% - from the original 200+ items.

Items, such as, washing machine, small TVs, air-conditioners which cannot exactly be called
common-use items, have also seen the tax rates come down from 28% to 18%. Most of the items
remaining in the 28% slab are what are called 'demerit goods', such as tobacco, etc., and luxury
items.

An interesting drawback of GST is that the tax rate looks quite high, especially in the case of the
28% slab, even though this is less than the effective tax rate of 40% earlier (as in the case of
automobiles). Since the taxes were levied at different stages, the aggregate tax impact was not
getting reflected.

The tax rate cut was followed by measures to ensure that the benefits are passed on to the
consumer. GST has a unique anti-profiteering provision, whereby it can levy penalty on a
company if it does not pass on the gains of lower tax rate to its customers. Even though it may
not be easy to use this provision effectively, it acts as an important deterrent. The anti-
profiteering agency has imposed a penalty on a leading FMCG company recently and the case is
under litigation currently. The special focus of the GST Council has been to ensure that the gains
arising out of GST percolate to the consumers; and do not get cornered by the business entities.
This is evident from the modification related to taxation on restaurants. The original scheme
involved 12/18% tax rate, with the restaurants getting the tax credit on inputs (this means that in
a bill of, say, INR 1,500, if the cost of input was INR 600, the restaurant would have to pay tax
on INR 900 only, and not on INR 1,500).

However, this benefit was not being passed on to the consumer. To ensure that restaurants do not
get this undue benefit, the tax rate was reduced to 5% WITHOUT giving them the benefit of
input tax credit. The measure was a smart one; and shows the alacrity with which the Council has
been managing the transition.

[Note: The objective of this post is to provide elementary information about GST, primarily to
beginners. A business entity must consult a GST practitioner to understand the fine prints on
actual compliance requirements]

Tax on under-construction property is another case similar to restaurants. While the tax rate here
is 12%, the effective outgo would be lower, as builders should pass on the tax credit received on
input material. However, builders have not passed on the benefit; and therefore, buyers prefer
buying resale properties, which do not attract this tax. The Council is actively considering
levying a flat 5% tax, without any input tax benefit.

To reduce the hassles of maintaining records and filing returns for small entities in the
manufacturing industry, the Council has increased the minimum turnover limit eligible for the
composition scheme. As per this scheme, a business entity does not need to maintain (or file)
detailed entries; and can just pay a fixed rate of tax, currently 2%, if its turnover is below the
threshold. However, in that case, the business cannot collect tax from its buyers, nor can it claim
input tax credit.

The current threshold stands at INR 1.5 crore, revised upward from INR 75 lakh earlier. While
the scheme is not available for suppliers, the next Council meeting is expected to take up this
proposal. The scheme has drawn attention as a convenient and hassle-free option; and almost
20% of the registered businesses have opted for it.

However, from a tax collection perspective, the tax rate may need to be increased, as the tax
mobilization through the scheme is very low. As per data released by the Press Information
Bureau (PIB), GST collected through the scheme was just INR 580 crore in April'18, against a
total collection of over INR 1 lakh crore.

GST also has an arrangement called reverse-charge mechanism. applicable when the seller is not
liable to collect tax (as mentioned in the case above), or if the seller is not a registered entity. In
that case, the buyer has to pay tax through this mechanism. To help the economy get used
adequately to the taxation, the tax has been postponed to Sept'19 (from Oct'18).

Other than the operational issues, the Council has also taken an important decision of taking
control of GSTN (GST Network). GSTN is the IT backbone, which stores the data of all
registered entities; and through which, all tax payments and returns filing are done. GSTN was
earlier registered as a private limited company in which the government had partial stake. The
change was felt necessary, considering the sensitive nature of task being handled by it.

GST has, indeed, made substantial progress towards the objective of formalization. Other than
about 65 lakh businesses, which migrated from the earlier indirect tax regime, another nearly 50
lakh entities have registered for GST, implying significant increase in formalization. While there
is a chance that these entities have registered only as a legal requirement-and are not making any
significant contribution to the revenue-yet, it is an important development.

Despite the substantial rate cuts, GST collection has moved up from an average of about INR
90,000 crore in FY '18 to over INR 96,000 crore in the current financial year, so far. The revenue
collection has exceeded the projections (based on earlier collection pattern) for many of the
states.

However, some important issues are still pending. One of these is bringing petroleum products
under the purview of GST. Since the government derives substantial revenue from oil taxes, it
would be interesting to see at what rate slab these products are brought in. Another issue relates
to maintaining and filing returns.
To conclude, despite all the changes, the system still has inadequacies; and may need some more
tweaking to stabilize.

[Note: The objective of this post is to provide elementary information about GST, primarily to
beginners. A business entity must consult a GST practitioner to understand the fine prints on
actual compliance requirements]

Sept. 2018 Quarter: Performance Analysis

After hitting a high of 8.2% in the June'18 quarter (Q1 of FY'19), the GDP growth of India has
slowed to 7.1% in the Sept.'18 quarter (Q2 of FY'19) as per data released by MOSPI recently.
GVA growth rate is also along the same lines: at 6.9%, as against 8.0% in Q1.

Even though the rate has moderated over the previous quarter, it is the fourth quarter of 7%+
growth, providing a sense of stability to the economy that went through adjustments due to
demonetization and GST. However, issues like sharp rise in crude price or disturbance in the
financial market may keep the growth rate under check in the current quarter. In terms of
absolute value, GDP at constant price is INR 34 lakh crore and INR 45.5 lakh crore at current
prices. GDP estimation (it may not be correct to call it 'calculation') is a complex exercise, which
begins with calculation of the GVA. GVA is separately reported for eight sub-segments, namely,
agriculture (etc.), mining, manufacturing, electricity & other utilities, construction, trade (and
other services, such as, hotel, transport, communication), financial (and real estate &
professional services) and finally, public administration, defence & other services.

The financial services group has nearly 23% weightage, whereas trade and manufacturing have
17% each. Agriculture and public services account for 10-12% each; and the rest have less than
10% weight.

The GVA calculation is based on data inputs, such as agricultural production, financial results of
listed companies, central & state government expenditure, performance of key sectors (like
railways, road, air & water, communication, banking and insurance). GDP is, then, calculated by
adding indirect tax revenue (minus subsidy) to GVA. Tax revenue used for GDP compilation
includes non-GST revenue and GST revenue based on GSTR filings. The figures are, then,
deflated by appropriate price indices (which is different for each group) to remove the impact of
inflation, and arrive at GDP/GVA at constant prices.

The current series takes year 2011-12 as the base year.

For the current quarter, the public administration segment has recorded the maximum growth
(10.9%). The segment is largely driven by government expenditure; and provides a cushion in
cases when other segments are not doing well. It has recorded an average growth of 11.1% over
the past eight quarters since demonetization, as against just 7.9% in the earlier period; providing
some support to the economy. Growth of the manufacturing sector has come down sharply (from
13.5% in Q1 to 7.4% now). The slowdown is, probably, due to sharp rise in crude prices. Yet,
the rate is reasonable for the sector, which is trying to stabilize itself.
Another way to calculate GDP is expenditure-side analysis. GDP is classified into three groups:
Private Final Consumption Expenditure (PFCE, share 54.5%), Government Final Consumption
Expenditure (GFCE, 12.4%) and Gross Fixed Capital Formation (GFCF, 32.3%). The last refers
to the money spent on investment.

While PFCE has increased by 7%, the other two have risen by over 12%. As India has been
largely witnessing "consumption" driven growth, lower PFCE is actually good for a country like
ours. It will help channelize resources into building physical and social productive capacity of
the economy, through higher GFCF and GFCE.

The share of GFCF in total GDP has risen to 32.3% for the quarter after hitting a low of 30.3% in
FY'16, which is good but not yet sufficient (the share had reached about 37% during 2006-08). It
may be noted that the secret of growth of the Chinese economy is GFCF, which has been almost
50% for several years.

A word on agriculture and mining, the two primary sectors. The share of agriculture has been
declining steadily, reaching a level of 10.2% in Q2 (from 17.2% in FY'12). Even though the
average growth rate has moved up to 4.6% over the last eight quarters (from 1.2% in the
previous year), it is still not sufficient.

The condition of core farming is even worse, as most of this growth has come from livestock,
forestry & fisheries, which account for over half of the segment's contribution. The farming
sector needs a breakthrough, may be through massive investment in irrigation, mechanization,
etc., which will bring about a quantum leap in productivity, like in the earlier 'Green Revolution'.

The mining sector also offers some insights, although its share is very low (just 3%). It has
recorded growth of as high as 20.7%, in terms of current prices, whereas it shows a decline (-
2.4%) after using price deflator. The reason being sharp rise in crude prices, which artificially
inflates the value produced by the segment. This is reversed, when the production is compared
on constant price basis.

NPAs, Provisioning, and the Rest

IDBI Bank continues to remain in deep NPA mess, as per the financial results for the quarter
ended Sept'18. With provisions of about INR 10,000 crore towards NPA during the first half of
this financial year, its total provisions have gone up to INR 33,000 crore - covering about 68% of
expected loss (Provision Coverage Ratio). Yet, the banks' core operations have sufficient
strength; and acquisition of majority stake by LIC should give it the financial resources
necessary to tide over this crisis.

Here is a brief discourse on its NPAs and other financials.

IDBI Bank is among the large public sector banks of India, with a total balance sheet size of INR
3.26 lakh crore at the end of the quarter ended Sept'18. The balance sheet has shrunk over the last
six months - from INR 3.5 lakh crore after being put under PCA (Prompt Corrective Action)
watch by the RBI. While the bank was among the efficient entities, the skeletons began to tumble
with the imposition of stricter norms for recognition of NPAs by the RBI in 2015-16. NPA
discourse centers on the amount of loan given, total amount of loan under default, amount of
money set aside by the bank to compensate for this loss, and any amount from this loan portfolio
which comes back to the bank (the last is important as a number of loan portfolios starts paying
up if the economic conditions improve).

Of the total capital available with the bank, gross advances (or loans given) stand at INR 1.91
lakh crore in Sept'18 (rest of the money is invested in government securities or parked with the
RBI). Out of this amount, as much as INR 61,000 crore have turned NPA, implying a gross NPA
to advance ratio of as high as 31.8%.

This is an abnormally high figure; with any ratio above 10% being a cause of alarm. However,
this does mean that there is no chance of this money coming back. If the borrower settles past
dues, and starts paying regularly, the loan account becomes regular again. The defaults are
further classified based on the period for which the money has been outstanding. Against these
bad debts, banks have to make provisions, depending upon the period for which the loan has
been unpaid. Provisioning is made from the bank's operating profit; and if the profits are not
sufficient, by reducing its equity capital. Sharp reduction in its equity capital, despite fund
infusion by the government, is the reason the government finally decided to ask LIC to acquire
the bank.

IDBI has made provision of about INR 10,000 crore in the first half of FY'19, INR 17,500 crore
in FY'18 and INR 11,000 crore in FY'17 towards NPAs. The sharp escalation in the level of its
bad debt is evident from the fact that more than 80% of its provisioning has been done in the last
2.5 years alone. Gross NPA during this period went up from INR 25,000 crore (FY'16) to INR
45,000 crore (FY'17); and stands at about INR 61,000 crore (Sept'18).

However, not all loan groups are defaulting on their loan obligations. The biggest culprit is the
large-scale industries sector, whose bad debts stand at INR 47,000 crore against total advances of
INR 89,000 crore. This translates to an NPA ratio of as high as 53%. Corporate advance for the
banks is also high (at 55% of total advances) - lot higher than the banking sector average of
about 45%. Indiscriminate lending to the corporate sector, which has turned into NPA, goes
against the prudential norms; and have invited charges of mala fide lending practices.

While the high level of NPA remains a huge concern, there are some signs that things might be
improving. First, fresh slippage has come down from 11.7% in March'18 to 2.7% now. Slippage
refers to loan account that defaulted on their obligation during that specific period. Second, the
bank's recovery from defaulting accounts and loan accounts, which have started paying back, has
increased from just about INR 8,000 crore in FY'17 to INR 15,000 crore in FY'18 (gross NPA
figures are net of this amount). With increased recovery and improving economic conditions, the
recovery rate might increase further going forward.

While the NPAs remain, the crisis has led the bank tighten its belt in other areas. Its cost of funds
has come down substantially (from 6.5% to 5.6% in FY'18) with increase in savings deposits. It
has also managed to reduce its operating expenses, which, together with lower cost of funds,
helped increase its operating profit to INR 7,900 crore in FY'18 (an increase of as much as 70%
over the previous year). However, operational gains seem to have dissipated during H1'FY19 due
to lending restriction, which reduces the income while the costs remain largely fixed. Funds
infusion by LIC and resumption of normal operations should help it come back to health.
India Business Analysis