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Podcast: How Slow Is The Indian Economy? (Episode-8)


‘Under normal circumstances, merging PSUs would have been impossible, had the government tried it 5 years ago, there would been riot on the street, today there is not even a murmur. They were able to do that because the slowdown is obvious!’- Deepak Shenoy

Host Deepak Shenoy (CEO) and Aditya Jaiswal (Analyst) discuss about the economic slowdown witnessed in the Indian economy.

The Podcast was divided into three broad sections:

a) Macro indicators (20 mins)

b) Recent federal regulations (8 minutes)

c) Few sectors which are currently facing a slowdown (30 mins)

Here’s the podcast: (See more episodes at The Capitalmind Podcast.)

Below is an excerpt of the podcast with time stamps of important sections, followed by a verbatim transcript.

1) Macro-indicators

1:40-  GDP growth:

We have had 5 consecutive quarters of decelerating GDP numbers, right from 8.2% in Q1 18 to 5% in Q1 19, this was the slowest growth in 25 quarters. How bad the situation is and is the worst behind us? Or should we expect a couple of more tepid quarters?

3:20- Inflation:

Inflation has been under control, it has been consistently falling for 6 straight months since Jan 2019, when inflation is under control, why is the GDP falling? Does this reflect weakening demand ultimately cooling off growth? Weakening of demand is concerning because we recently heard two big biscuit manufacturers going on record to say that people are not buying even 5-rupee packet biscuits.

8:07- Unemployment:

Unemployment in FY18 stood at 6.1%, a 45 year high, now with big manufacturing units announcing massive job cuts, auto alone has seen 2.3 lakh people losing jobs, where do you see unemployment situation going in the near term?

11:02- Private consumption:

Private consumption which constitutes about 58-59% of the GDP has been slowing down. Urban wage growth has stagnated, white collar wages have been slowing and rural consumption has also fallen on back of collapse on food prices and job cuts by manufacturing units, where do you see this going?

15:00- Investments:

We looked at the GDP growth, inflation, unemployment and consumption, let’s talk about investments. The gross capital formation has fallen from 34% in 2011 to 29% in 2018. Do you believe that we are stuck in a low growth cycle? (Falling wages- falling savings-falling investments – low GDP growth)

2) Recent federal regulations

20:30- Impact of GST and Demonetization on the economy

About 30% of the Indian economy is completely informal and employs a chunk of the population. In 2014-15, late Arun Jaitley had made a statement, the informal sector doesn’t want to operate in shadows, neither they are corrupt, rather it was a failure on the part of the federal governments that even after six decades of independence, we couldn’t integrate them with the formal economy”

In the pursuit of this integration, the government went ahead with the vision of cashless economy, demonetization and GST. Do you believe that demonetization and GST have actually hit the informal sector really hard? Do you think, somewhere, it turned out to be a shock therapy for the unorganized sector?

3) Sectors

28:18- Real Estate

Residential real estate which was mostly fueled by black money is really not moving except the affordable housing part. Now that black money is hiding in may be gold! How will that come back into the economy? Where do you see the sector going?

33:09- Automobiles

Now, we all know that there is a crisis in the Indian auto industry,  all big manufacturers are reporting double digit falls in volumes. TVS chairman made a big statement, that this slowdown is the worst in 3 decades and spread across sectors. Auto stocks recently witnessed buying interest in the anticipation of a GST cut, do you believe that a GST cut can change the fortunes of the sector?

41:28- Automobile replacement cycle

A lot of existing car owners have started using Ola/Uber/Quick ride and this has led to postponement new car purchase, where do you see the replacement cycle going forward?

45:23- FMCG

Parle-G and Britannia went on record to say that people are not buying even INR5 rupee packet biscuits. But FMCG stocks still command relatively high premium, why is that? Do you see optimism in investors, that among autos, infra, discretionary, real estate, financials, FMCG will be resilient.

50:50- Final thoughts!


Deepak: Hi, this is Deepak Shenoy from Capital Mind. Welcome to the Capital Mind Podcast. We have for you an interesting show today because it’s a show about the slowdown. We’ve talked about it, we’ve heard about it, let’s go through some of the details. My colleague Aditya Jaiswal and me will go through some of the elements that have triggered, or caused, or have been deemed to cause but not necessarily have caused jitters in the economy in India.

Firstly, welcome Aditya to the show. Glad to have you here for the second time.

Aditya: Thanks a lot Deepak. Thanks a lot. It’s a pleasure being here speaking with you and I would like to take this opportunity to our listeners as well because we recently touched 10,000 units downloads mark, which is remarkable.

Deepak: Cool. 10,000 people, that’s awesome. We look forward to 100,000 mark next.

Aditya: Absolutely.

Deepak: Please listen in, chime in, and tell us your views and let’s get on with the show. What do we have here, Aditya?

Aditya: Deepak, I have a lot of questions, but we’ll go systematically. Let’s first start with some of the macro indicators. Let’s first start with the GDP growth.

We had 8.2% GDP growth in Q1 2018. And now in Q1 2019 the number has decelerated to 5%. This was the slowest growth in like past 25 quarters. I just wanted to know how bad the situation is, and do you feel the worst is already behind us or should we expect a couple of more tepid quarters?

Deepak: You know, Aditya, the worst is almost never behind you when you think it is behind you. It’s only behind you when it is actually behind you, which means the numbers show a change. I don’t expect growth to start jumping around and going at 7%, 6% in a few quarters. But there has to be some change.

Now, one of the things is that we have a slowdown in terms of GDP numbers. Some of that slowdown comes as an aspect of higher perhaps imports of gold, which has been going up recently. There are other structural aspects like manufacturing is very weak, but I don’t expect that revival to happen all of a sudden. It never almost happens all of a sudden. Slowly policy start to take center stage over some time. And only after some time when the rot has caved in, in the sense things have started to be rebuilt is when things move.

I don’t think we see a great numbers in the next few quarters. We should look at this as it’s going to take us a year or two to start showing great numbers again. It’s not a bottom because everybody’s thinking this is the bottom. It’s going to be a bottom when nobody’s talking about.

Aditya: Let’s talk about inflation. Inflation has been under control and it has been falling since the past six months straight from January 2019. When inflation is under control, that’s the best time like… if there’s a situation when inflation is under control, and we have decent growth, that is the ideal situation for the economy.

But right now what we are facing is inflation is under control. Despite being that, the GDP has been falling. So does this reflect a weakening demand which is ultimately cooling of growth? Now, weakening of demand is concerning because we recently heard two biscuit manufacturers going on record to say that people are not even buying five rupee biscuit packets.

Deepak: That’s, I think, a negotiation tactic. To be honest, nobody will stop buying biscuits just because there is a bit of a slowdown. I think people will stop buying expensive biscuits, but the five rupee pack may be moving to the 10 rupee pack and maybe SKU differences will be in place, but largely I feel that is a ploy for the biscuit manufacturer to change GST, which means reduce the GST on organized manufacturers of biscuits when it is already low for unorganized manufacturers.

However, there is a problem in the sense inflation has dropped. We won’t see or we haven’t seen great amounts of growth, but the problem is also that because inflation has fallen, incomes have corrected substantially. When inflation falls, I’m talking about core inflation, I’m not talking about inflation from just the headline inflation numbers, which have fallen earlier as well. But core inflation, which means inflation of certain other things; rents, for instance, or demand of say, health care services, or some of the other services where we’ve had… It’s like, I’ve spoken about this before, when the onion price increases, you think it’ll come down, but when the menu price of a restaurant increases, it doesn’t come down very easily, right?

So when you have a six or 7% on the core inflation from the restaurant menu front, and the headline inflation is very low, that means the inflation of secondary levels continues to be high. It’s the primary inflation that’s down which means fuel inflation, food inflation, and so on, their prices tend to fluctuate. But if you look at secondary inflation over the last six or eight months, maybe over the last maybe a year, you’ve seen that also coming down. And that’s coming down to a point where it’s about 4%.

This is actually good, but in the process, it reduces income, it dampens demand. And that results in some kind of GDP impact where people clamp down and say, “Listen, I won’t buy because prices are coming down, and I only buy the essentials,” or, “My job is at stake.” And this is a point of result naturally of an attempt to control inflation. Remember, our interest rates have been way too high.

When interest rates are way too high, there is no need to create business, right? So there’s no need for anybody to actually run a business compared to just keeping your money in the bank or buying something that’s fixed income and earning a phenomenal return on effort. Because inflation is so low that you could build another podcast on the cost of capital in India. It actually makes no sense for someone to run a business trying to earn a 12% return on equity when all you can get in inflation itself is a 4% increase, with the cost of raising debt by paying high interest rates. Eats up all the gains that you have and clamps your margins down.

I don’t think the recoveries will happen purely with inflation coming back up. It will take a time for the cycle to create lower interest rates in the system, create interest rates so low that they’re as low or lower than inflation, and therefore create an impetus for the growth to come in from new investments.

Inflation is down. It is supposed to be down in the US also in 1981, or ’79 to ’81 when Volker introduced two twin recessions. He actually brought GDP growth down to control inflation. He brought it down so badly that interest rates were increased to 16% in order to bring inflation down. That actually created a massive lack of demand, deflation over some time just to be able to control inflationary growth.

We’re in the same part of that cycle. Whether it’s a cycle or it’s structure we’ll know only in time, but we’re not extreme crisis situation. 5% is still okay, but it could go lower from here and that’s the fear.

Aditya: If you look at the unemployment numbers, in FI 18, the unemployment rates stood at 6.1%. Now, this is a 45 year high, like this is really serious. And now with big manufacturing units announcing massive job cuts, and auto alone has seen like 2.3 lakh job cuts. Where do you see the unemployment situation going in the near term?

Deepak: Unemployment records have had to change over the last few years. As a person employed as a gig economy person considered employed, the answer to NSA survey question would be, yes, you have to consider somebody earning any kind of money through even temporary employment or a consultancy to be employed.

But many times if you ask people who work for Swiggy or an Uber, they don’t actually consider themselves employed, employed. They actually consider themselves as they are self employed. They actually don’t have a job, but they’re doing this as a personal business.

One part of it would be data collection to find out how the gig economy has probably impacted data connection on the job front, but there is definitely a job losses. We’ve seen job losses in a number of sectors where there is a slowdown and I think this is a significant problem, but it is an impact of cut in various things. Some of it is regulatory, for instance, the auto sector has had regulatory challenges. They’ve had to increase their costs because of regulatory challenges. They are coming up with BS VI in six months and they’re going to have to sell those BS VI models only after April 2020.

Obviously, demand is not going to come out shooting through the roof. There is a big impending change in models. They also had to increase costs so they were to include five years of insurance for cars, three years for bikes, or the other way round, I don’t know which one. But the idea here is that the cost of the same asset that was required is not going up because the cost of raw material is going up or my margins are going up. It’s because the cost of regulation is increasing the cost of what I have to produce. And that is causing me lower sales, and that’s causing me to lay off contract labor, and that’s causing job losses down the ecosystem.

A lot of this part of this ecosystem will only reset when people adjust themselves to the higher prices. Crazily enough, this is happening in a low inflation environment. You’re actually seeing we have low inflation, but high inflation in certain items where large amount of industry was concentrated, which is therefore cause job losses.

It’s like my income is not growing because inflation is low, but my expense is grown because the government is introducing a regulation that adds a lot more expense to me. It’s a tough situation but it has to be managed in an interesting way from here going forward.

Aditya: If we look at the private consumption, it constitutes about 58 to 59% of the GDP. It has been slowing down. Urban wage growth has stagnated, white collar wages have stagnated, and rural consumption has also fallen back on the collapse of food prices and job cuts by manufacturing units. Where do you see this going?

Deepak: Aditya, I think the problem with private consumption has been that we’ve always felt or we’ve always not considered private consumption to be a good thing. We apply a 28% GST on motorbikes, why are motorbikes considered luxury items? I don’t understand. The part of private consumption there, but it actually sometimes elements of investment as well.

In the rural sector, you’re not going to be able to transport goods only by tractors. Tractors are slow, inefficient beast. You’re going to have a lot more transport even of goods coming in through regular transport and some of that is going to be bikes, and some of that is going to be cars and trucks. That is actually some part of it is capital investment as well. It’s not just consumption, but it’s recorded as consumption.

The part is durables, imports. We’ve actually clamped down on a huge amount of import from China’s. China’s imports are actually fallen off a cliff. Now India doesn’t have some of those industries, which China has or has thrived over the years. Toys for instance. A large amount of toys are manufactured in China. We added a 10% of 15% duty on those toys, so they become more expensive to import from India. The demand has dropped, and there is no correspondingly priced toy manufacturer in India that is benefiting because all the toy manufacturers went out of business, because for years and years, Chinese toys were allowed to be imported for a very low cost. And they have driven the Indian manufacturer out of business.

The demand for toys perhaps is no longer available because all the goods are available. Let’s say imports from China are at a higher price, which nobody wants to pay. A lower price, guys, could have existed in India, because they used to, but they’ve been driven out by the policies of the past where imports were made free and they were importing toys even below cost. So, to a certain extent, you have a period in which consumption has to be low because the supply is less and the demand is less. The only supply is at a price that’s higher, then you can make a corresponding system in India.

While some part of this is structural, in the sense you’re going to have to revive that manufacturing in India in order to make up for this lack of Chinese imports, and at the same time, give some assurance that, boss, we will always have some kind of duty on these Chinese imports so that I will not let your industry die. But some part of it is cyclical as well, because you just have to let this ride and people to realize that, listen, I don’t need a monopoly set or something like that made only in China. Why don’t we build in house a new manufacturer? Build that, and actually monopoly is the wrong idea because some part of it is manufactured in India, but there are lots of other toys where we should only import from China, and some parts of that I think we’ll have to start getting being made here.

Some part of this private consumption beast is cyclical, some part of it is structural, but I think India is a land that consumes. We may hunker down and see for a couple of quarters, but in the end, we will spend. We don’t overspend. India is not a luxury product overspending country. It spends on the basics. I might cut down on watching a movie in a theater for a few months, but in the end it’s going to happen that the prices there will also come down and my income levels will also readjust so that I can go back to watching those. I don’t think that part will stay long for too long. I don’t think India is an overspending country, so we’re not going to shut this down for too long.

Aditya: We looked at the growth, inflation, unemployment, consumption. Let’s talk about the investment data. The gross capital formation has fallen from 34% in 2011 to 29% in 2018. When you look at these numbers, do you believe that India is currently stuck in a low growth cycle? For example, wages are stagnant, so savings are falling.

Savings are falling and investments are also stagnant, and because of that, the overall GDP growth is falling. Do you look at it as a low growth cycle?

Deepak: This is an interesting point because I think the problem really is in the words. We talk of savings, but do we understand what is in those savings parameters? Are we thinking in detail and said, okay, let’s look at what the government calls our savings. Is also savings or fixed deposits minus your loans. You’ve taken some personal loans and the loans that are behind it, and the real estate that you own. That is what is called a household saving, right?

45% of the total saving of this country was in household owned real estate.

Aditya: Amazing.

Deepak: This is insanity. We should not be saving all half of our money in household real estate. That is just totally dumb instrument to save things in. Gladly, now that number is spilled 33%. It’s still quite a bit, but it’s down from 45% to 33% as of Jan 2018 or well, March 2018. I think that’s the number we have so far. And probably it’s even lesser right now.

I’m very happy that’s happening because that also means that the savings are more constitute of two things, which I think deserve to be higher. First, financial savings by the individuals in India. That has gone up to an extent that’s nearly 2x in six years or more than 2x in six years. And although our indebtedness has also gone up, our gross financial savings is also gone up considerably, which means the households are saving in financial instruments.

There’s also massive increase in corporate savings because corporates have deleveraged themselves, reducing their debt, and therefore their savings has come up quite substantially. We’ll show this or demonstrate this in charts, but what is important is that this number actually tells us that the savings number coming down is just… If it’s down from say 35% to say 28%, all of that drop is contributed by a lack of interest in buying real estate, which is fantastic. We should be reducing our focus on real estate. We should be at 20% of our savings is real estate, 80% in financial savings, so that 80% can be used.

Now go back to investment. Savings results in investments, how much of are gross financial investment? That’s called gross capital formation. How much of that gross capital formation is controlled by different sectors? The whole of the manufacturing sector added up corresponds today to only 17% of our gross financial sales. Okay?

Coming up next is trade business. Trade and transport constitute about 10% and 9% of this, of our gross financial savings. Everything else is really small in nature. Agricultural 7%. But guess what’s the highest number even there? Real estate.

Aditya: It should be, yes.

Deepak: You’re sitting with 22% as of last year, and it was 25% as of 2011. 25%, one fourth of our gross savings are sitting into going more into more unproductive assets. First of all, we have 50% of our gross savings in, we usually have 50%, now it’s about 33% of our gross savings go into real estate, and then we’re investing more money into real estate, which is 25% of the total investments in the country, gross capital formation of the country.

This is bad. And if it’s coming down from 25% or 22%, it’s a good thing. Gross financial savings have actually gone, or gross capital formation has actually gone up from 32 lakh crores in 2011 to 2018, is about 50 lakh crores. And now it should be a little bit higher though it’s not grown so much, 4 or 5%, so maybe 55 to 56 lakh crores.

We need that to increase. 55 lakh crores is just about one fourth of GDP, we need that to be a little bit higher than that. But given that as well, I don’t think we should be focusing on trying to do the same old mistakes, which is put money back into real estate. Instead, we should actually be encouraging people to build industries, create capital. We don’t do that, and I’ll come to that in a different thing, that we should really be encouraging creating of companies, even if companies are coming to India to only build their products and sell it to the Indian population. We should encourage that, sell it abroad. We should encourage that. This is what is the core of investments, not real estate.

Real estate is the dumbest investment that you can make. People have made money, I’m sorry, but if it hurts a lot of people who’ve made a lot of money using real estate, but I don’t think this is the future. Agriculture was not the future of this country. It was a huge part of our GDP at some point in time, luckily, we recognized that and urbanized. We need to get out of the mentality that real estate is in any way important and move away from that as well.

Aditya: Let’s move on to few policy decisions taken by the federal government in the recent past. We know that about 30% of the Indian economy is completely informal, and 50 to 60% is quasi informal, and it employs a chunk of the population. So if I remember correctly, in 2015, or ’16, late Arun Jaitley had made a statement and it was a great statement.

Basically, what he said was that the informal sector doesn’t want to operate in shadows, neither it is corrupt. Rather, it was the failure of the successive federal governments that we fail to embrace them even after 60, 65 years of independence. And in this pursuit, I believe the government went ahead with demonetization, cashless economy, GST and all that stuff. Do you believe that we went a bit harsh, and the very policies that were meant to embrace the informal sector actually hit them really hard. And because of that, the economy is that current situation?

I’ll give you an example. Under the current GST, selling without an invoice is a criminal offense and GST compliance cost is also high. Do you believe that we are giving the informal sector a shock therapy and these are the results of that, the slowdown?

Deepak: I don’t know whether the slowdown is directly connected. I don’t know because I don’t know whether the linkages are appropriately linked. But anecdotally, definitely, the slow downs actually started for the informal sector since demonetization.

If you think about how complicated it has been for the small vendor or other small businessmen, and also let’s say there’s a guy who pushes carts and sells his goods on the cart. Is he going to give an invoice to his customers? He’s not going to give an invoice. We say, oh, what? He’s not criminal because he’s too small, but your law makes him a criminal.

Aditya: Exactly.

Deepak: And that’s, if you really wanted and you hated hawkers, you will go behind them using this very law that you created that criminalized people for doing something that should not have ever been criminal in the first place.

The second thing, the demonetization law is the dumbest thing that I think could have existed. I remember even then I was initially thinking that it will result in a good thing, but my views on the monetization is a disaster. It was never supposed to be good, I even called it that there would be a slowdown of some sort because things will hit hard. What happened really was people put their money into banks, that money came into the formal economy, that formal economy money went into stock markets and assets. It didn’t go into real estate, luckily, but inflated prices, a lot of things. But now that’s coming back home to when the steroids of the formal economy has gone away.

The informal economy, which is really there to support it when the formal economy went down is simply not there. You don’t care anymore. So, yes, you’ve created bank accounts. That was the only good thing that happened because of this whole process, that people created their own bank account. But beyond that, the return of cash has happened, people have gotten back to just as much cash, we have printed just as much cash as was there before.

But here’s the thing about GST. GST actually impacts things because we made rules that said that, “You can’t do this at all.” The government said, “Well, we know what? Everybody does it this way or nothing else.” And that actually has consequences, and we’re seeing that consequence today. The collateral damage is for all of the small businesses, they will emerge victorious because of two things; first that they are smart. They will figure out a way to get around this, nobody lets this go. They will be non compliant. And let them be non compliant, but the government will also have to turn a blind eye to a lot of non compliance in order for things to move ahead. Because already they had to scrap the reverse charge mechanism.

The reverse charge mechanism was a way that every deal in this country made by end company would see GST, which means if you’re a person who’s doing a consultancy for a business and you only did one lakh rupee consultancy, then the company would pay GST on your behalf because you’re not GST registered. That reverse charge mechanism is no longer there or has been suspended for a while, and that would have resulted in so much more expense being borne by everybody involved that it would be a nightmare for compliance for a number of factors and would have led to literally the whole of the corporate world saying, “If you don’t have a GST number, I won’t work with you.”

The bad part is they still have 50% of the corporate world thinking that if you don’t have a GST number, I won’t work with you. But at least there’s a 50% set of people who will say, “I will work with the informal sector even if they don’t have a GST number. All these small, small rules, we have to change. We have to go out there proactively change them. We will lose revenue for a while, but I think we will create a need for better compliance.

And even now, people haven’t seen how much of a benefit GST can give us. It’s only now that the likes of Hindustan Unilever or some of the others were who have seen a massive margin expansion because they haven’t cut the prices of their product. Instead, they have reaped the benefits of GST, have now started to realize that, “Oh listen, we can cut prices, our old margins, which are very good margins, and still attract people.” You will see prices cut now and hopefully that will stoke up demand as well.

Aditya: Deepak, when you interact with people operating in the informal sector, some of them say that the license Raj has been replaced with tax Raj. It’s very difficult for them to understand so many tax labs and people come up with questions such as why is Parle G taxed at 18% and gold is taxed at 3%?

Who is going to address those questions? And do you believe that the rates should further be rationalized? There are too many rates under the GST?

Deepak: Yeah, I mean, there are of course, but some parts of it, you can’t avoid the 3%, 2%, 5% kind of thing. But 28% at the high end for a lot of stuff that is actually basic is not acceptable. You can’t have, for instance, bikes at the same rate as extremely expensive cars. We can’t have a lot of items in the 28% sector. They had paints in the 28% sector, they got that down to 18%.

I think India will actually do better if we were to bring a lot of things down to the 18 to 20 percent range. Actually taxed rich farmers. Find guys who are earning more than one crore rupees from farming, a lot of listed companies also do it. They don’t pay any tax. Why? I mean, it’s just nonsense that they shouldn’t. If you earn more than one crore rupees, then you have no business to hide under this state subject law, you should actually change things and you can, you have the majority, you can change things to tax farmers, tax rich farmers, not farmers that are small, one crore above.

You don’t build an entire economy by taxing only one set of people and not taxing another. It’s a little unfair to reduce the rates of tax on stuff everybody uses and tax everybody. That has to be the fairest part of the game. You’ll actually do well if you reduce the number of tax rates, reduce the number of direct tax rates as well. Today you have 42.74 39, 35, 33, twenty-something and 11 something. These are the number of tax labs you have in the direct tax regime depending on how much income you make.

And then you have capital gains tax, some exemption, this that, that this. Just take out all the exemptions, put everything at 20%, I think life will be a lot simpler. That’s too much to ask, politically, it’s not quite as palatable.

Aditya: Let’s come to a few sectors. Let’s start with the real estate. See residential real estate, which was mostly fueled by black money is really not moving except the affordable housing part. Now that the black money is hiding in maybe gold, how will that money come back into the real estate? Where do you see the sector going ahead, because there’s a vacuum right now?

Deepak: Problem really is that I think we shouldn’t have too much emphasis on real estate, for one. Second, I feel all the emphasis should only be given to affordable housing. That means houses of 500 square feet, give only them any potential tax advantage or benefit. In Bombay, make that 200 square foot because 500 square foot is a luxury apartment.

I mean, everywhere else it will be 500 square feet or less and it should be, listen, will give you some kind of tax code or some kind of beneficial service. Think of the number of benefits real estate has today. So, you buy a house, the principle is tax exempt under etc. The interest is tax exempt up to two and a half lakh rupees or something like that.

Your loan for the housing loan is given to you at a cheaper rate than say buying a car. Why? Because the bank gets a lower risk wait on that loan, because it’s considered part of a, the priority sector, and b, it is given a lower risk rate by the RBI itself saying less than 75 lakh rupee loans will be charged a lower risk rate. So, versus a personal loan, versus a credit card loan, versus a loan for even setting up a business is considered to be lower grade than a housing loan. Because you have an asset, you think you have an asset, you can’t really sell it if there’s a crisis.

The last part is that you know that housing is only place where if you sell a house, you can buy another house and the capital gains tax is not payable. If you sell a car, oh, sorry, not a car. But if you sell an investment, like a share of a company, you can’t reinvest into other shares and say, “Listen, I won’t pay any tax.” That’s not allowed. Only in real estate do you have this.

The worst part is this, I can sell shares that I own, and then invest that proceeds into a real estate house and not pay tax. What kind of crazy thing that we have to say that, “Listen, I can go and create a new business and I won’t get a tax advantage. But I can actually…” I mean, of course, at least recent laws have allowed people to invest in companies and those companies if they own 25% of that business, then they will get a tax advantage on having invested that much money into the business.

But that is still fraught with some errors. And it’s a good thing though I think they should encourage people to do more of that. But why give this benefit to only real estate? I mean, why allow people to say that, if I sell shares of a company even sell gold, if I sell land, if I sell a commercial building, also, any capital gains can be reinvested into a residential house and a war tax completely avoided? You’re just fueling more black money, more this thing. But to keep the pressure a little bit less, I think we should encourage small and real estate, we should encourage rural real estate.

We should encourage real estate development in places where the fact that people will start looking at better houses will make those micro economies also better. A lot of villages, a lot of places where just improving the facilities around and helping or pushing that real estate infrastructure in that place, will actually create more ownership within people that will improve the area, creating zoning for commercial and residential real estate and then offering higher FSI, which is the number of floors you can build on the same area of land for multiple areas.

We need to grow higher in a lot of our cities because we’re too congested. We should encourage people to build higher where they can so that… But, I mean, don’t expect tax benefits for expensive houses. Build high but small houses, it’s perfectly fine. I think we should encourage that, rather than trying to encourage real state as a whole. Just don’t, you already given it to me incentives. If it has to die or slow down and we’ll have to wait a little bit until other industries pick up, it might be the only thing that we can do properly.

I know I feel a lot for construction labor who will hurt a lot because of this, but I think really that we need to have a comprehensive plan too because this whole dependence on real estate is a bad thing.

Aditya: Deepak, let’s talk about the most toxic sector right now, which is autos. We all know that there is a sort of crisis in the sector where all the big manufacturers are reporting double digit falling volumes. TVS Chairman recently made a statement that this slowdown is the worst that he has seen in the past three decades. The sector is demanding a GST cut.

Do you believe that a GST cut can bring substantial, like it can change the fortunes of the sector right now? Because I personally believe that is not going to make a big impact. What are your thoughts on this?

Deepak: I think you know, first of all, the sector is looking for a lot of changes. They’re saying GST cut karo and life will be good. They are saying that we should be allowed to do X, don’t do EV so fast. A lot of these things are according to me, cyclical, temporary, and they will be acceptable.

You’ve increased the cost of a car to how much? 1986 when I came in for an entry level car, it was two and a half lakhs or two lakhs approximately. Today, 23 years later, we are still looking at an entry level car costing maybe three lakhs, three and a half like a similar car. I’m not talking about anything else. So at the entry level the price of a car has not increased so much that people can’t afford it because if a person in 1986 could afford it, then a person in 2019 can definitely afford it.

Aditya: And the car in 1996 did not have so much features. Now, even the entry level cars have really, really good interiors and features, safety features.

Deepak: We had to pay for power steering separately and not for separately but you had to pay more for power steering. My first car didn’t even have power steering and it had only power windows in the front. Those cars still exists but we have cars now with a lot more safety features.

Same thing with bikes. When I bought my first bike, it was 135 CC bike. I wish I hadn’t sold it, but that was available at about 44 or 45,000 rupees. A similar bike today would still be 55 or 60,000 rupees, so you’re talking over 40% inflation over 24 years or 23 years. That’s 2% inflation per year.

This is a time when steel prices have gone up. Prices of labor have gone up, real estate prices have gone up, so my factory cost has gone up. Yet they have managed to increase efficiencies to the point that the bike is managing to cost the same or are roughly a 2% inflation and they are making record profits. Even today, they’re making profits, they’re not making losses. They’re making less profits than they were earlier, but they’re definitely making profit.

I don’t think auto is in a situation where they cannot recover from. Remember, most of the automakers have no debt. There is no debt in Maruti. Maruti has a significant amount of cash 20,000 crore plus so does Bajaj. Hero motor car has 5000 crore plus cash. There’s no debt in these companies. They’ve built their businesses over time, taking the profits, eliminated debt costs, continue to make relevant cars for India and bikes for India. But at the same time, I think there’s been a lack of innovation of any sort.

Well, for the most part, the kind of innovation we see is we take a foreign one, raise the chassis a little bit higher. Other than that, there’s not so much of the innovation front. For instance, you might find the most innovations come from Google, which is created maps where you can talk in kannada.

You see that the car manufacturers on their own never created Hindi or Canada or any other kind of interface for the cars in build. Much of that has come in, I mean, they’re not adopted or adapted to that kind of thought process. They fostered a lot of the Uber and Ola movements, but they haven’t really been able to make that into a substantially larger piece of the pie. A car manufacturer might have said, “Listen, if your Uber and Ola, I will actually set up special kind of care for you guys.” Uber and Ola are to set it up themselves, but the innovation hasn’t come from the car industry. It’s come from other places.

I don’t think it’s a time for them to complain that life is in doldrums. They’re still making profits, other than Tata Motors, which I don’t think will make a profit even if the industry was in fantastic shape. Other than that, we have actually got none of the profit or none of the large automakers making losses. I believe that this is still a good time for them to rethink, build more efficiencies, and come to India as the cyclical turn.

Look at it in another way, there are only so many things you can do in the rural areas. You don’t have public transportation, semi urban areas. You’re not going to get public transportation, and you will drive around only in a tractor. More people are being born there, they’re coming up, they’re going to want transportation of some sort. It’s not all secondhand vehicles that they will come there. At some point they will buy bikes as well. They will buy bikes for transportation, for their businesses, for their own selves as well.

This is not while they have stopped buying or reduce their buying for the last one year. It just means they’ve postponed their purchases to a time when maybe they will save a little more money and then come to the market and buy. We’re seeing the first signs of life in the Twitter market, first tiny signs of life. The first month on month increase in a long time. But if this sustains then the recovery would have actually happened and it’s called a cycle.

The structural problem is they’re still not being as relevant to the Indian industry going forward as they were in the past. They need the little bits of innovation, they need a little more thinking on that process to be able to compete better in the longer term. But this particular time may still be a cyclical change. And things are bad, things are very, very bad, but I don’t think that this is a time when all of them are going to die.

Aditya: Deepak, so many questions still remains. Recently, we saw a lot of buying interest in the auto stocks because on the anticipation that they will receive a GST card. What do you have for those investors who suddenly showed some buying interest in auto stocks in the anticipation? Say on Monday, the government announces some sort of GST cut on autos, do you think in the near term that is going to change the fortunes for the sector?

Deepak: GST cut will only help new cars are being built. Look at the downstream impact. There’s the fact that I will sell a car at 18% but I already have a car in my inventory on which the input items are already bought at 28%. My margins will actually go down because the net GST, I will still have to pay, right? So I won’t make instant profits.

Assume going forward also. If I introduce a GST or cars, I’m I reducing it on auto components as well? Which means the compressor, the engine, the piston, the valve, the exhaust pipe, the body. Am I going to say 28% goes down for all of them? In that case, everybody who makes doors of sheet metal of sorts may say, “Listen, I also want a 28% GST.

It will be a cascading impact on how much that GST cut will apply to how many downstream components. Can you also say that they will make it only for cars? And the person making wires which go on bikes is not very dissimilar for wires are go on cars. So, you don’t only cut it for bikes and then increase it for car. It’s an ecosystem problem as well. I think we’ll have to address that meaningfully. It would be better for all of it to be brought down to 18%, but I think we’ll go piecemeal. While people are excited about this, I don’t think we’re going to see this euphoria last too long. The only thing that will change things is actual sales changing.

If that doesn’t happen by the end of the year, these talks are going to get more and more disappointments.

Aditya: Let us talk about something more structural in the auto industry. Where do you see the replacement cycle? I interact with a lot of people in Bangalore, and I have met people who have been owning cars say seven, eight years, and now when I talk to them, they’re like, “I don’t want to buy a new car. Because anyways, I use a quick ride or Ola or Uber. People are pushing replacement. Do you see a replacement cycle getting elongated, because that is going to eventually hurt industry?

Deepak: There isn’t a reason why people say, in New York should buy a car. It’s actually very negative because New York is not going to see increasing car sales, simply because there are already too many cars and parking costs a whole lot of money. But New York is not seeing a decline in car buying. What’s happening really is people who replace their cars with new cars end up selling, they buy their car somewhere else. The cars are then transported to other parts of the US.

India for instance, you won’t remember seeing a Maruti Zen on the road for a long time in Bangalore, because Maruti Zens things are not sold in Bangalore, Maruti Zens are transported and sold to people in Chikmanglur, or towards or halfway to Mysore. So when you travel down that road, you’re going to see a lot more selling cars over there. Car ownership in cities may not go up tremendously. I don’t believe it will. And I don’t think that’s the future. I just think that the future will be because there are a million… Well, there are probably more than probably a billion people that live outside of the cities that need transportation. And we sell three lakh cars a month, maybe four lakh cars a month.

That’s on the order of magnitude lesser than whatever China does or whatever US does. In fact, four lakh cars a month is what a small country like France does, and France has six crore people. We have 130 crore people and we sell four lakh cars a month. A place like France, which is developed, well, there should be no reason for people to change cars, because they’ve got cars that work for centuries. A car, you can actually buy a 1965 car it’ll still work. But they also buy more than four lakh cars a month.

This is actually strange, because if you have… They buy a significant crore, I don’t know how many. I think it’s pretty close to India’s cars, but they have a population that’s substantially lesser than India. Yes, they do have higher per capita income. But tell me, don’t we have at least six crore people in India? Having France’s per capita income, I think we would probably two or three crore at least. And yet we don’t buy our cars, which cost a fraction of what perhaps… Our entry level cars are very cheap, so two and a half lakhs, you will not find something at that price range. And that is literally 5000 euros. I don’t think you’ll find a car worth 5000 euros that’s new in France, because France also has very high taxation.

Even then, we have a much lower… I don’t think this is the end of that cycle. I think this will come back. There will be a demand recovery of some sort, but it will need a little bit of rationalization of taxes in some way. Even fewer taxes are quite high. Until we pass through the cycle, live through the pain and perhaps encourage people to create industries and maybe help revive the commercial local market, help create more incomes that will allow them to then go out there and buy bikes and cars, that is when we are going to see a recovery in the car market. It won’t necessarily be just be GST.

Aditya: Deepak, let’s come to FMCG. As I mentioned, we have had Parle G and Britannia going on record and saying that even five rupee biscuits people are not buying, but still these stocks command relatively high premium. Maybe the investors are relying on these stocks hoping on the consumption story. What do you have for them? Why do these stocks still come on high premium, and what are your thoughts on this?

Deepak: Let me tell you an interesting story. You don’t have growth in these companies. These companies grow at 10%, it’s a great thing, 12% maybe 15%. Margins are increasing now because they haven’t really passed on all the benefits of the GST that they received. I’ll give an example of how crazy it is. You said you had a five rupee item earlier, then you had a 10% GST on it, sorry 10% excise duty on it, so you had 12% excise duty 12% VAT earlier.

What would happen was that your inputs would have already paid your 12% duty and then added 12% VAT on top of it, and then price something at rupees five. Now, what’s happening is that you get a GST offset on a lot of things. So you charge five rupees, you charge a 20 or 18% GST on that discount. And then you go in, and you have all your inputs on which you also paid 18% GST.

You can offset off the 18% against the 18% in the front and if you look at it mathematically, you started with something that’s five rupees out of which let us say four rupees 20% was the price of whatever I had my whole input costs and 80% was GST. My price is for rupees 20% not because all my input costs are for rupees 20%. It’s actually because four rupees 20% is just the cost, I should not count the GST part of things, of my inputs. But because when people make accounts they say, you know what? I paid one lakh rent plus 18% GST, so my rent cost is one lakh 18,000 rupees.

I will put that into my biscuit cost, and I will add the biscuit cost and come to four rupees 20%. In the input side I’ve added my costs input GST as my input costs, which is what I used to do because excise was not offset able against VAT, so excise was a cost. Here, input GST is not a cost. Input GST is kept separate, then your cost will be three rupees 60%. You’re selling at four rupees, I mean, five rupees. Your input costs without GST at three rupees 60%. You pay 80% GST to the government because both input GST plus output GST, you have to offset it out. You’re now going to make substantially higher margin then used to make earlier. Where earlier you used to make 10% per biscuit, now you’re making 40 or 50% per biscuit packet.

What’s the solution? Bring the price down to four rupees 50 paisa? No. Because at four rupees and fifty paisa you’ve created the problem of change. Nobody has 50 paisa. No, everybody hates you. What do you, a new stuff more biscuits. You say 18% more yaar, I’ll give you 18% zyada biscuit.

Aditya: Exactly, exactly. That is now happening.

Deepak: So you will get 18% more biscuits, but I don’t want 18% more biscuits. It will give me 18% more uska krunga kya? I was okay with that until now, so now I need you to reduce the price to four rupees. You are unwilling to do that because you like the price point of five rupees. But actually you need to do that to shake up demand.

A lot of these FMCG companies have patched stuff inconvenient pricing points, dough, for instance, or soaps, 38 rupees, 48 rupees, 68 rupees, something like that. Now, they have to bring the price down to 58. They don’t want to do it. They go, “If I bring them from 68 to 58, then everybody will, all my Saaman will not sell, because I’ve already got so much maal into the market at 68 rupees. They will return all of that to me.” Which is a cost, yes, but you have to bite that bullet. Because if you don’t bite it, then people will not sell.

Now, you see that a few of the companies are actually doing this. PNG started to do this, HUL do some of this. I believe it will come to the other FMCG companies as well, unofficially. I mean, officially, of course, doing this is illegal because you cannot not pass on the benefits of GST to end consumers. But the government has actually long gone and dinged a whole lot of people because everybody would have done this. But slowly as they reduced prices is where demand is going to come back. Until that time, their margins have been high, because people have been buying the stuff.

People have slowed down buying some of this stuff, not biscuits, I don’t believe the big story on biscuits. But I do believe that in many other FMCG items, they will be a slowdown of demand now because people are hunkering up and cutting this thing. There will be a rude shock for investors when their margins appear to go down, because they expected that these higher margins would last, and their margins will not, because competition and demand are very, very important factors here. When they go back to the previous margins, will the prices correct? Well, I certainly hope to see that they are available at more reasonable prices. But I do believe some of the shocks will be rolled in the next few years.

Aditya: Deepak, I was reading your article, Don’t Waste A Slowdown. It was a very interesting article and you ultimately, the conclusion was that this slowdown will pave the way for good times. The most important thing that was concerning you was the 0.6% growth in manufacturing. I would like to know your thoughts on that, and we will end the podcast with your thoughts.

Deepak: The problem with slowdowns is that we don’t really… we tend to panic more than anything else. But slow downs are actually what cause the economy to change, to grow. We’ve got a problem with the economy, those problems are partly cyclical, partly structure. We’ve got to change the structure. The items that are cyclical will also be impacted by structural changes.

Car sales are down because of a structural problem. Let’s say, today, a lot of our companies are unsafe in terms of chemical production. We produce chemicals, we throw affluence into the seas, we pollute the air, but we said that, “Oh, it’s okay. You know what? They’re giving employment.” Tomorrow we create pollution laws, there will be a slowdown in the chemical industry because they will… Some of them will shut down because they cannot sell their goods at a price when they are to incorporate the cost of combating pollution. If you did that, would it be a bad thing? That’s not necessarily bad.

What we’ve done is we have not wasted a slowdown. We’ve actually created a better set of processes. India did that, which is why China are suffering now in the chemical area because only now they realize that they shouldn’t be polluting stuff. India’s pollution laws have been ahead of the game a little bit, so we now reap the benefit that we don’t have as much pollution. We do have polluted industry and a lot of it has resulted in, I think, the top seven of India’s, of the world cities, polluted cities are in India.

Aditya: Are in India. Exactly.

Deepak: We do have a lot of that pollution. Whenever we choose, we’re to get rid of that pollution. We did that in Delhi by saying no petrol and CNG, no petrol and diesel taxis.

You know what, that has all been reversed because Uber and Ola have come. They are petrol and diesel. They don’t come under the court framework, but tomorrow if somebody takes you to court and say, “Listen, all public transport needs to be CNG. We need to put a line over under CNG.” All the startups, and Twitter, and everybody will start exploding saying, “Slow down, slow down, you’re killing all the Uber people, you’re killing…” But the point is the law was created to reduce pollution.

If you brought back pollution Delhi by overriding this law of taxis by calling Uber a taxi, which has got a national permit, and therefore they should have CNG and they should have petrol and diesel. The court will look at you and say, “I don’t care. You’re in Delhi, please operate only with CNG. I don’t care if you have a national permit, or whatever. But if you are an aggregator, a cab aggregator. You’re a cab aggregator in any city, should only allow petrol and diesel cars.”

This will cause a slowdown, but it’s a good causing of a slowdown because that is what will drive people to put more CNG in those vehicles, change them. For that time, there will be a slow down, but they will come back. Economy as a whole is going through these kind of changes as well. Some part of it is because people weren’t renewing insurance. Supreme Court said you have to buy insurance with a car for three years or five years at a time. This is to combat the fact that people don’t do it.

The road department has increased the fines of people. People are complaining, “I’m going to pay 10,000 rupees for a car, that is a bike that is only worth 15,000 rupees.” Well then, don’t violate traffic laws.

This idea of not wasting a slowdown is basically to say, “Make changes that will improve the structure of the economy.” Last time we did that we had a crisis in 1992. And those 1992 laws, pre 1992 laws restricted how much items you could produce from one factory. They licensed every single piece in India, which was if you want to do 100 scooters, you have to buy a license 100 scooter. It was not based on demand and supply, it was based on licensing. And that, I think has to change. We’ve actually gone back to a large extent to license Raj. For instance, today they’re saying, “Oh, if you want to set up a News outlet, you have to have a license. If you want to this, you have to have a license. You want to you want to create a website that gets money from abroad, file this kind of license with RBA for this kind of this for this.”

We still have a lot of licenses we haven’t disbanded that part of what they did in 1992 was disband the basic element of saying, “We will license everything. We will license only a few things.” That structural change was not required. I mean, certain parts of it were in the sense that the foreign funding came to us with a condition that they had to allow foreign investment inside India. They didn’t have to disband license Raj. They could have still gotten foreign investment in without doing it, but they chose to expand the scope of it and change.

That kind of reform is missing. And I think we should talk more about it perhaps in another podcast, is about how we can address individual items that change or hurt certain things. Why we should discourage gold imports, and the ways we can do so, why we should encourage more of private company creation, private entrepreneurs, why we should focus not on large scale job creation but on small scale job creation, and why we should not focus on the savings rate per se, but the components of the savings and the components of the investment policy that we have, our investment rate that we have, and therefore improve those.

But don’t waste this further. It gives you the opportunity to tell people that the naysayers are going to always be against you in good times, whatever you do. So tomorrow, if you introduce an agricultural tax on farmers, there will be hundreds of people who will protest even people who are not farmers, saying, “Oh, this government is protesting farmers.” But if you do it and things are looking so bad that the only alternative is, “Listen, guys, if you want a GST cut, I have to tax farmers.” Then everybody who’s got the GST cut will be like, “Okay, fine, fine, you know what, tax farmers. I don’t care. It will reduce my income tax from 40% to 30%. Okay, fine can tax farmers.”

This happens at a time when people are with their backside to the wall and people are clamoring for the government to do things. They can get more of these cut or reforms done without as much protest as earlier, and people will actually like it because it will fuel good things.

When I say tax farmers is not necessarily a good thing, but reducing tax on everybody else is a good thing. Agriculture is a very small part of our economy, but there are lots of rich farmers. And those farmers if they paid some tax, it could actually reduce the amount of tax collected from some of the other set of people in the economy. But that was just one kind, there’s so many others. For instance, you could streamline a lot of systems, remove… The government has done part of this by saying, “We’ll merge the banks together.” What unpalatable job losses, right? Some of them have to lose jobs. So all of the banks are creating a voluntary retirement system, saying if you’re within a few years of retirement, if you have more than five years to retirement, take a package, walk away.

This kind of VRS kind of scheme will also help in the… Normal circumstances doing this would have been impossible. Try to merge these banks five years ago, you would have got absolute riot on the streets. Today, not a murmur. You were able to do that because the slowdown was obvious, the impact was evident. And the reason you’ve been able to do it now is the same reason you will be able to do more good reforms in the coming days. You can also do bad, that’s a point we have to be careful about, but good is always acceptable. And I think we should do more of that and not waste the slow down.

Aditya: That was amazing, Deepak. It was a great podcast. Thanks a lot for your time. Looking forward to the next podcast with you.

Deepak: Lovely, and thanks all for hearing. I hope you all enjoyed it. Please let us know your comments. I’m Deepakshenoy on Twitter. Aditya is AstuteAditya on Twitter. You can Ping us, we are at capitalmind_in. Would love to hear your thoughts and do remember none of this is investment advice, we’re just giving you a going about the economy. And yes, it’s an AC room but the AC has temporarily been switched off.

We may be armchair warriors, but hey, sometimes you need people sitting in arm chairs also because otherwise nobody else has time for podcast.

Aditya: Thanks a lot, Deepak. Thanks a lot.


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