If these conditions of job uncertainty and low demand sustain, the economy could enter a recessionary cycle. People might defer non-essential buys thus killing recovery
The impact of the pandemic on the economy has been acute and the Reserve Bank of India’s (RBI’s) Monetary Policy Committee (MPC), led by Governor Shaktikanta Das, recently said it was important to take into account the weak growth momentum. It pointed to the need for prioritising growth in view of the less- risky inflation outlook, while also ensuring that financial conditions remain benign when a recovery takes place, in order to sustain confidence.
The future: Though the MPC refrained from providing any forecast on the Gross Domestic Product (GDP) growth, members said they expect the economy to contract in the current fiscal year and noted that agriculture and allied activities have provided the only silver lining till now.
Chief Economic Advisor Krishnamurthy Subramanian also spoke about the downside risk to the economy and GDP contraction in the first quarter (Q1) of the Financial Year (FY) 21. He further said that this would lead to a fiscal deficit of over five per cent of the GDP in FY21. For FY20, the fiscal deficit came in at 4.6 per cent of the GDP, compared with the revised estimate of 3.8 per cent and the Budget estimate of 3.3 per cent. It had breached the 0.5 per cent escape clause, which the Fiscal Responsibility and Budget Management Act, 2003 (FRBM Act) allows.
A complex economy: Now, as India begins to open up after a prolonged lockdown, hotels, restaurants and other hospitality services and shopping malls have been permitted to open. The lockdown, however, will continue in containment zones till June 30. High-frequency data is already showing a pick-up in activity in the Indian economy and the easing of the lockdown is a clear positive. But actual recovery depends on the positive mindset of the people and their purchasing power. India’s growth story is basically a consumption-based one. India has a multi-layered economy with the rural-urban economy on one hand and the organised-unorganised one on the other. This makes the situation challenging for anyone to come up with one simple solution which would work. Hence, solutions should also be multi-layered and ones that can be woven into another solution best suit the need of the Indian economy.
The ground reality: Many people have lost their jobs due to the lockdown and many have experienced salary cuts. This might lead to a structural change in business because we might encounter a situation where consumers start spending on essential items only. Plus, even though malls have opened, it will be a while before people start thronging them because of the need for social distancing. In such a situation, the big gainers will be the e-commerce firms.
The guidelines for the much-hyped collateral-free and automatic loans, too, are yet to reach bank branches and MSMEs are literally struggling to get their share. In this situation, interest and capital subsidy to such loans could be provided by States, too. We have seen all support to businesses coming from the Central Government but nothing from States. When taxes are collected by States, it is disheartening to see them shying away from their responsibility to support regional businesses during a crisis. If these conditions of job uncertainty and low demand sustain, the economy could enter a recessionary cycle and people might end up deferring all non-essential expenditure, which would kill short to medium-term recovery.
The way forward: The Government should provide relief on interest, late fee and penalty on both Direct Taxes and Indirect Taxes. The Goods and Services Tax Council should waive any sort of late fee and penalty and make provisions for refunding the same. Waiver of interest for the moratorium period will also help the cash-starved middle class.
The Government should understand that recovery will not come in the short term and, therefore, to speed up the process, it should hike capital expenditure and announce some big projects.
Alternatively, when the Government can see that demand has collapsed and growth in FY21 is headed towards negative territory, then instead of infusing more liquidity by reducing repo rates, loans and so on, the Government should start taking fiscal measures. All the measures the Government has taken till date are mostly on the supply side and not the demand side.
Before the pandemic struck the world, India was facing an economic slowdown and last year, too, the actions taken by the Centre to remedy the situation were on the supply side, like reduction in corporate tax rates, hoping for some investments from positive cash flows and saving from tax outlays.
The Government should also concentrate and channelise its efforts in welcoming companies moving out of China as India still continues to enjoy the trust of foreign investors and its banking system remains healthy. But that might not be sufficient to make the proposal lucrative. The Government has announced the setting up of a high-level Empowered Group of Secretaries, to be chaired by the Cabinet Secretary and a Project Development Cell (PDC) in ministries/departments with a view to attracting investments to the country. This is the right way forward but work should be done at a faster pace.
To deal with the current economic crisis, India must find the right balance between leaning towards a high fiscal deficit and ensuring financial stability. In all likelihood, the Government would come up with a fresh round of stimulus package in the short to medium-term. Only time will tell how deeply negative the growth will be. The economic situation is bleak but there is a silver lining in every crisis. We just need to find ours.
(Writer: Abhishek Raja; Courtesy: The Pioneer)
Ladakh is forcing India to reduce dependencies. Rly, BSNL scrap projects despite asymmetric trade ties with China
The masks are off and the Wuhan spirit has all but evaporated. For China, at the receiving end of adverse world opinion in the pandemic era, doesn’t bother about good optics anymore. If the surprise medieval and almost bestial ambush by Chinese troops in Ladakh, risking the lives of their own men, and their stubborn refusal to restore status quo at Galwan Valley are any indication, then China is determined to push the salami-slicing of Indian territories on its terms, given the fluidic nature of the Line of Actual Control (LAC) on the ground, something it has steadfastly refused to codify for long. It shows that it will never renege on its border claims. And it has chosen India’s most vulnerable moment, when the pandemic is distressing our whole nation, to hold us down. Being the only nation that will ride out the pandemic without sliding to negative growth, with a high capacity war machinery and a desperate ambition to retain its supremacy in a post-pandemic world, it has allowed the escalation and may even prolong it within its affordable range. And Chinese President Xi Jinping, having lost the global perception of greatness by mishandling the Wuhan contagion, isn’t too concerned about another misstep at the moment, within controllable limits. So long as he can be a threatening big brother in the neighbourhood. He knows very well that despite India’s pro-US tilt of late, the Western superpower can hardly intervene on the ground except making grandiose statements and internationalising the context. Hong Kong is proof of such a propaganda war where rights protesters are facing the heat on the ground despite a global noise. So for all Western sympathies towards India post-pandemic, Xi wants to show that he can have the second biggest Asian power in his stranglehold and rob it of its comparative asset value. He can regain strategic edge along the Himalayan border that had been blunted by India’s rapid road-building and opening up of more Army conduits. China’s latest ingress means that it can monitor the road in the Galwan Valley that connects to Daulat Beg Oldi air base and keep a watch on Indian troops that are now favourably placed in many positions. China’s official English mouthpiece, The Global Times, warned that India could have to deal with multi-pronged border flashpoints from Pakistan and Nepal, too, if it stuck to its territorial claims.
But given the body bags that came back after the violent face-off, India has to stand up for its territorial integrity but do that smartly enough, graduating the incident to the highest level of diplomatic intervention. And encashing on the world’s favourable opinion towards it, the Government must publicise its reasonable rapprochement efforts globally to show why it is in the right and expose China’s naked territorial ambitions. Given the asymmetric nature of military and economic strengths between the two nations, India cannot afford an all-out conflagration at this juncture. Except for ground troop positions in the Himalayas, there is no parity in defence funding or resources. Economically, we are dependent on China for bulk supplies of pharmaceuticals, auto parts and electronics and while it may take long to build our manufacturing self-sufficiencies, fact is China, too, wouldn’t want to ignore our market potential. With a total trade of $85 billion, China is one of our largest trading partners. FDI from China was $1.8 billion between 2015 and 2019, some of them fuelling our start-up sector. Yet economic hitback could still be a deterrent. What began with the Government preventing opportunistic Chinese takeovers via FDIs in a pandemic-hit economy, continued with the Railways scrapping a dedicated freight corridor project with Chinese firms. The Department of Telecommunications has asked companies to consider reviewing future partnership with Huawei & ZTE. The state-run BSNL will no longer be using Chinese equipment for upgrading its 4G network. And while existing deals will continue and there’s no immediate danger of snapping economic relations that matter to both countries, future projects and 5G trial partnerships could be impacted. There would also be a progressive shrinkage of Chinese markets in India if the “boycott China” becomes an emotive surge among the masses, upset by the loss of soldiers at the front. Of course, going by China’s latest manoeuvres — increased patrolling in the Taiwan Straits, clampdown in Hong Kong — the latest offensive at LAC could be a short-term tactic to extract territorial concessions and tilting the balance of power in its favour while staying just beneath the escalation threshold. This will be Xi’s strategy, create a modern Warring States period where to his demoralised people, he can be a hero fighting the enemy.
(Courtesy: The Pioneer)
Just like Malaysia, India, too, must have its own forest certification to help promote wooden handicraft exports
In India, around 100 million artisans are involved in making handicrafts and they form the backbone of the non-farm economy in the hinterland, where mostly the tribal and rural poor live. Over the years, this sector has been the major source of livelihood for the landless poor. According to an estimate of the export-import council, the total export of handicraft during the financial year (FY) 2018-19 was to the tune of Rs 26,590 crore as compared to Rs 24,500 crore in 2016-17. Around 70 per cent of this is wood/forest-based. It is a sizeable amount and if proper institutional and other help is extended, this sector has the potential to act as an effective anti-poverty programme. The important clusters of wooden handicraft, according to a report of the World Wide Fund for Nature India, are based at Saharanpur and Nagina in Uttar Pradesh, Hoshiarpur and Amritsar in Punjab, Jaipur and Jodhpur in Rajasthan, Srinagar in Jammu and Kashmir, Jagdalpur and Behrampur in West Bengal, Channapatna and Chennai in Tamil Nadu, Bengaluru and Mysore in Karnataka and Ernakulum and Cochin in Kerala. There are many others artisans in small towns/villages producing handicraft and selling through middlemen. There is adequate availability of raw material and talent and the scope for scaling up the growth of the wooden/forest-based handicraft sector exists. However, due to trade barriers, poor policy and institutional back-up, the necessity of procuring a certificate of origin from sustainable forests/plantation sources, the sector has not grown. Forest certification has become a Gordian’s knot for artisans.
So what is this certification? On account of deforestation in tropical countries there was a hue and cry in the Western world, especially in the US and other European countries. Civil society activists and NGOs started pressurising their governments to stop importing timber and timber products unless the source of production was certified as having been obtained from sustainably-managed forests/plantations. Introduced in the 1990s, this rule entails that the certificate be validated by an independent agency with a complete chain of command confirmation, right from its origin to final manufacturing of the product and its export. The certification covers forest/plantation inventory, management practices, harvesting and environmental, economic and social impacts of such forests/plantation. Many countries have enacted laws and banned import of timber and wooden handicraft if the same is not accompanied by a “validation certificate.” The certification today covers 30 per cent of the world’s timber trade. This gave rise to the birth of some agencies like the Stewardship Council of Canada as a global body to help exporters certify their products.
Indian wooden handicraft artisans and exporters started facing hurdles, especially after 2000, though they kept exporting goods after payment of high fee. There is, therefore, an urgent need to have an independent autonomous body within the purview of the Centre to deal with the issue of forest certification. The Malaysian forest department, which was way behind India in the 60s, has attained a position of leadership in forestry issues in Asia as they created a National Forest Certification Council after 2000 and set-up standards and mechanisms to certify timber and wooden products.
The Indian forest working plans are based on the sustained yield concept, the bedrock of Sustainable Forest Management (SFM). India being a timber-deficient nation needs to import wood. We need not buckle under international pressure for institutionalising certification for domestic use of timber as most of the timber coming from Government forests is as per the working plan-based sustained yields concept. The Centre should not support any agency outside the Government to do certification for obvious reasons. However, as over 70 per cent of wood is coming from agro-forestry and other private lands, we would need to have a certification set up for timber grown outside recorded forests, mainly to overcome the trade barrier imposed by Western nations to help our handicraft export.
In fact, all over the world, the basic focus of certification is to overcome trade barriers. In 2003, the setting up of a National Forest Certification Agency under Section 3 of the Environmental Protection Act, 1986 was proposed, with zonal offices in the Ministry’s regional offices and a provision for accreditation of charter foresters and other experts. The then Minister, TR Baalu, approved it but then it got entangled in a bureaucratic web and never saw the light of day. The problem in this Ministry is unnecessary projection of foresters as anti-development before Ministers and the Prime Minister.
Senior officers should rid themselves of unnecessary fear and angularities for better governance. The late TN Seshan, who also worked as Environment Secretary, is remembered for making landmark reforms like setting up regional offices, setting up of The Indian Council of Forestry Research and Education and National/State Forest Academies and so on. He will be long admired for setting environment governance on the right trajectory. It is time for a national forest certification agency to be created under Section 3 of the Environment Protection Act, 1986 within the overall purview of the Environment, Forest and Climate Change Ministry with authority to conduct its business independently and focus on helping the exporter with minimum transaction cost.
(Writer: VK Bahuguna; Courtesy: The Pioneer)
City five-stars that have been converted to makeshift COVID-19 care centres fear stigma will hit future business. But we need them
Should Delhi, besieged as it is with the ever increasing numbers of Coronavirus patients and is running short of hospitals and beds to treat or resuscitate them, not requisition every public and institutional space to ramp up capacity? Only city hotels do not agree though the Government has attached the city’s five-star properties to nearby hospitals and act like their extension counter in times of the pandemic. So Hotel Crown Plaza in Okhla has been linked with the Batra Hospital and Research Centre, Hotel Surya in New Friends Colony with the Indraprastha Apollo hospital, Hotel Siddharth in Rajendra Place with Dr BL Kapur Memorial Hospital, Hotel Jivitesh in Pusa Road with the Sir Ganga Ram City Hospital and Hotel Sheraton in Saket with Max Smart Super Speciality Hospital. In fact, after appeals by the Federation of Hotel & Restaurant Association of India, a committee of Confederation of Indian Industries (CII) has written to the Delhi Government to revoke the order asking hotels to be converted to makeshift hospitals. Many industry representatives claim that hotels are neither designed nor equipped to deal with cases of this nature where ailing patients would need careful supervision in a sanitised environment. For example, the rooms do not have direct exhaust capacity, something that a specially designed and pooled facility would have. They argue that these plush properties are carpeted and, therefore, could not be sanitised as frequently as per protocol and could actually increase the risk of the disease spread. Besides, the staff are not experienced or trained in new SOPs and not necessarily want to deal with the pandemic in a frontline capacity. But what is actually worrying hoteliers is the social stigma attached to COVID-19 and its cascading effect on future bookings when the hotels do resume normal operations. No matter what the degree of sanitisation, disinfection and assurance of standards, hotels are worried that guests would not still want to check into what was once a COVID-19 facility simply because there would be an erosion of safety and confidence. And hotels rely on brand value and a carefully curated image of service for traction. It doesn’t matter if providing service and succour to the pandemic-hit is noble and conscientious; it just won’t up bookings or its ratings. The hospitality industry, which is estimated to be incurring a loss of almost Rs 5 lakh crore and job losses of around three crore, has already stepped up by offering quarantine facilities, hosting doctors and healthcare workers and providing food and basic services. But given the swamp in Delhi and the pressure on existing hospitals to provide care and a bed to the sick, there seems to be no other option but to make use of every bit of covered public space. Saving lives is more important and desperate times do call for desperate measures. Besides, although recent MHA guidelines have allowed hotels to go for a graded opening, most of them cannot operate given their geographical proximity to virus clusters. Also, these will be used for non-critical patients and those requiring basic oxygen support. Serious patients will anyway be moved to the adjoining hospital facility. So at least there will be a steady revenue stream in a bad year. With or without being a COVID facility, not many guests will anyway be knocking at the door. Repurposing may actually help some properties yet.
The Delhi Government has not done anything exceptional but followed templates of social responsibility. World over, nations have adopted a similar move to tackle a surge in the number of cases. While some turned into shelters for Coronavirus patients with mild symptoms, others converted them to safe houses to isolate those who may have been in contact with confirmed cases. For example, a four-star hotel in Madrid was transformed into a medical care facility to treat people with mild symptoms. Hoteliers voluntarily allowed regional authorities to use 40 hotels with 9,000 beds to treat patients. In the US, hotels in Chicago, big and small, were the first to clinch a deal with the Government as they started housing frontline medical workers and military personnel. Spaces were also provided to infected patients and those awaiting test results for quarantine. In Europe, the largest hospitality company, Accor, too, opened 40 of its branch hotels in France to provide shelter to those at the frontline, the nursing staff, doctors and the sick. In the end, no service is coming for free and if in the process, we can save lives and stem fatalities in unprecedented times, that testimomial, too, would hold good for posterity.
(Courtesy: The Pioneer)
Tech giants are getting away by not paying tax in the source country but the fact remains that their profits are coming from users located within the Indian territory. This anomaly needs to be addressed soon
On June 2, the Trump administration announced a probe into digital services taxes that have been either adopted or are under consideration by its trading partners viz, Austria, Brazil, the Czech Republic, the European Union (EU), India, Indonesia, Italy, Spain, Turkey and the UK. This refers to the so-called “Section 301 investigation” by the United States Trade Representative (USTR) to determine whether levies on electronic commerce discriminate against US technological giants like Apple, Google, Amazon and so on. The probe could lead to the US imposing tariffs on exports from these countries. The reaction of the US and the proposed retaliatory measures are triggered by genuine actions by the aforementioned countries (and many others) to salvage a grim situation, whereby they are losing billions of dollars in taxes due to the manipulative practices of multinational corporations (MNCs) in the digital space — most of them based in America.
While some countries (for instance, France and India) have taken measures to make the MNCs pay the taxes, structured efforts are being made under the aegis of the Organisation for Economic Cooperation and Development (OECD) to arrive at a so-called BEPS (base erosion profit shifting) framework agreement. Over 135 countries are participating in this project (85 have already signed the multilateral instrument on BEPS) that will form the basis for such taxation.
The OECD had released a draft on “taxing digital companies” on October 9, 2019. However, progress on this has been stymied by the Coronavirus crisis. The original deadline to complete the negotiations was this year, which now gets shifted to the next year. Meanwhile, it is important to unravel the modus operandi used by technological giants to dodge tax authorities in these countries and steps taken by India, a major source of income for them, to deal with it.
How does the Indian Government establish its jurisdiction to tax them on their operations in the country (a bone of contention between the MNC’s host country and India)? What could be the criteria to bring them under the tax net? How far can India go in building a consensus at the OECD around its stance?
By nature, operations of MNCs are transnational with entities located in several countries involving a high-level of interdependence and cross-border flows of goods and services between them, as also direct supplies to retailers and consumers. For firms such as Google, Facebook and Amazon among others doing business in digital mode, physical boundaries get blurred. They structure their investment arms through a maze of subsidiaries held outside India in low-tax jurisdictions such as Singapore, Mauritius, Ireland and among others.
These technology giants invoice Indian customers via these offshore entities despite having significant revenue, users or paying customers in the country even as their Indian entity is crafted more like a service company or commission agent to the parent company located abroad. This helps them in booking an overwhelming share of revenues in the parent company (registered in a tax haven) while a very small portion of service/commission revenue and income is reported in the entity registered in India.
The firms may be getting away by not paying tax in the source country (India in this case) but the fact remains that their profits are coming from users located within the Indian territory. Hence, it is none other than the Government of India (GOI), which has the right to tax these profits. The jurisdiction to tax lies with it. This position is also endorsed by the OECD under the BEPS framework agreement. It states: “Profits of MNCs should be available for taxation in the country where their customers are, irrespective of any physical presence in that market, and that a formula should be evolved for such taxation.”
Coming to the steps taken by India, in 2016, the Government had introduced the so-called “Google Tax” — also known as Equalisation Levy — with an intent to tax the Business to Business (B2B), e–commerce transactions/digital transactions. The tax is levied at six per cent on the payment made by a resident firm to foreign e-commerce companies for online advertisements on the latter’s platform.
While making a payment, the resident firm has to deduct tax from the consideration payable to say, Google, and deposit it to the department. For instance, if the consideration is Rs 10,00,000, then the former has to withhold six per cent or Rs 60,000 and pay the net amount of Rs 9,40,000 (the so-called equalisation amount) to the latter. The Google tax of Rs 60,000 is paid to the legislature. Through an amendment to the Finance Act, 2020, the scope of equalisation levy was extended to “all sales, gross receipts or turnover of non-residents not having a Permanent Establishment (PE is a fixed place of business normally located in the territory of the source country), who is providing the online sale of goods or provision of services or both to a person residing in India or a non-resident in specific circumstances, such as the sale of advertisement targetted to the Indian market or sale of data collected from the Indian market.” This levy is at two per cent on the sum received or receivable by an e-commerce operator and is payable directly to the Central Government on a quarterly basis.
Whereas the tax imposed in 2016 had very limited coverage (revenue from online advertisements), the two per cent levy introduced this year covers almost every good and service provided or facilitated by the internet giants.
But this approach is riddled with ad hocism and arbitrariness. There is no basis for having two widely divergent rates depending on the source of revenue viz, online advertisements versus all others. Besides, the “all others” category is open-ended and loosely-worded that leaves room for discretion.
What is even worse is that being a levy on the turnover/gross receipts (instead of profit which is the way it should be — as the intent is to tax the profits of MNCs), these are akin to indirect tax, which the technological giants conveniently recover from Indian users by correspondingly inflating their charges. They have been doing so in the case of six per cent levy on advertising revenue (in the above example, the resident firm is billed for Rs 10,60,000) and will do the same with respect to two per cent levy on goods and services imposed this year.
This defeats the purpose as instead of making the technological giants pay up, Indian firms end up paying more. Besides, the arbitrariness in this approach to taxation leaves the country open to criticism. What then is the way forward? How does GOI get these foreign firms to pay taxes on the earnings from their operations here?
In the normal course, for a foreign firm having a PE from where it conducts transactions — including sales made in India — and maintains accounts viz. receipts, expenditure, profit and so on for local operations, the tax department has a smooth sail. But technological giants don’t have a PE on Indian soil.
To overcome this hurdle, in 2018, a committee set up by the Central Board of Direct Taxes (CBDT) had mooted the concept of digital permanent establishment (DPE). The Income-Tax Act provides for levy of tax on the profit attributed to the Indian operations of such offshore enterprises in the country.
The committee proposed tax at the rate of 30-40 per cent, depending on the user base and revenues (only firms with a user base over 2,00,000 would be considered). As a follow up, in the Finance Act 2018, the Government proposed that “such offshore firms should be taxed in India if they have a market presence above a threshold to be defined in terms of their customer base and revenue.” But this needs an amendment to India’s tax treaties with all its trade and investment partners. The task will be greatly facilitated once the BEPS framework agreement is put in place. The Government should, therefore, work for early finalisation of the agreement.
It should vigorously pursue the DPE concept at the OECD and also get ready with a criteria for treating a foreign company as DPE. The criteria should give appropriate weight to three crucial parameters viz, the number of users, paying customers or annual revenue. The tax rate on such companies treated as DPE should be at par with the rate applicable to domestic companies.
(Writer: Uttam Gupta; Courtesy: The Pioneer)
Govt revenues have collapsed and won’t return to normal anytime soon but raising taxes would be unwarranted
The Goods and Services Tax (GST) regime introduced by the Narendra Modi Government has, despite its many flaws, made life a lot easier for consumers and producers, who now have to deal with one particular rate instead of multiple ones. However, in the aftermath of the Coronavirus-induced economic malaise, we might get to see another aspect of having one tax, the collections of which are managed by the Centre and further distributed to States. With the latter actively cribbing about not receiving their due compensation from the Centre, expect the coming GST Council meet to be a fiery one, particularly with the political scene heating up. With the extended deadline for filing returns and dismal collections because of the lockdowns, the Government has not released collection figures for April and May. However, States will have to be paid their compensation for the revenue loss due to GST implementation. It is almost certain that the guaranteed 14 per cent cover for any revenue loss annually, promised during the GST rollout, might not be paid either this fiscal, or actually any fiscal till 2022, thanks to the economic slowdown unless the Centre absorbs some of the loss. The States are clearly in a quandary as most of them are battling the worst of COVID-19 spirals amid a collapsing health infrastructure. It is to assuage some anxieties that the Centre last week released compensation worth `36,400 crore to States for three months up to February 2020. Besides dwindling cess collection in the compensation fund, the dependency of States on the promised GST compensation amid sharp fall in their own revenues due to the COVID-19 pandemic has further led to hardened positions.
Raising GST rates might seem like an easy way to generate funds but it might have the horrible effect of killing whatever little remains of consumer sentiment. Indeed, several industries have appealed to the powers that be that there should be a relaxation in taxes and not an increase in order to boost near-term consumer demand. The federal structure of the GST Council also makes it difficult for either the Centre or any State to act independently, yet the GST Council should resist the urge to increase taxes and should look at other avenues to raise money from the market, including the possibility of issuing bonds that even ordinary citizens could buy into. Some suggestions for payment of compensation cess from the Consolidated Fund of India or through market borrowings were, in fact, floated at the last GST Council session in March but a decision has been hanging fire since. In fact, the provision was made by then Finance Minister Arun Jaitley. He had assured that “compensation to States shall be paid for five years in full within the stipulated period of five years and, in case the amount in the GST Compensation Fund fell short of the compensation payable, the GST Council shall decide the mode of raising additional resources, including borrowing from the market which could be repaid by collection of cess in the sixth year or further subsequent years.” The Coronavirus has dealt a big blow to the economy but growth will resume. Predictions for the monsoons are positive and it is likely that the second half of the year will see a revival of demand. The GST Council has to resist any punitive short-term measures. It is difficult for the Government machinery to live with less but the solution to the hell the pandemic has wrought in India is not to squeeze the already suffering Indian consumer. Innovative solutions will have to be found on how to raise funds and even past decisions cast in stone might need revision. Depending on the mythical foreign investor to come and save the economy is not a substitute for a real plan.
(Courtesy: The Pioneer)
Business processes will change due to the pandemic and so should the way valuations of companies are done
Coronavirus cases are rising exponentially in India even as the country is in the midst of unlocking the economy. With the Government allowing almost all sectors to restart, companies are faced with the new challenge of valuing their businesses as a consequence of the pandemic. Nothing is the same now. The financial markets, the economy, real estate and almost all sectors have seen major turbulence and the uncertainty will not end anytime soon. According to the 2020, Brand Finance India 100 report, during the pandemic, the combined valuation of India’s top 100 brands dropped by $25 billion as compared to the start of this year. The uncertainty in future cash flows is now a hard reality. Organisations have to renew ways of measuring risks associated with the cash flow of their businesses as the categories of risk may have increased in the light of Covid-19.
The elements which are a part of the discount rates used in valuations, including the risk-free rate and unsystematic risks, may have changed, altering the way businesses approached valuations before the crisis. All business valuations are done on projections. However, in these unprecedented times, there is every chance that these projections might change. It has become difficult to quantify the short-term and long-term financial projections and the shape of economic recovery is also uncertain. It may be ‘V’ shaped, ‘U’ shaped or even ‘W’ shaped. Moreover, some industries may bounce back faster than the others. Even though governments across the world are providing economic stimulus, the fact remains that consumer demand may still be slow and may possibly see a paradigm shift in the long-term.
So, during these times, selecting a valuation model relevant to one’s own business is imperative. All three valuation methods — income, market and asset — are available to business managers and analysts. However, in the present situation, some methods may be more appropriate as compared to others. For example, of the two income-based approaches that are used to value a company, one may be more appropriate than the other now. The first method, the Capitalisation of Cash Flow (CCF) method is used by mature firms, which are relatively stable in their growth expectation and cash flows. Under this method, the valuator assumes a steady growth rate, picks a single income stream and predicts future income based on historical numbers.
On the other hand, the Discounted Cash Flow (DCF) method is more flexible and allows for more variations in the future cash flows based on varying growth rates, changes in the interest rates of debt repayments and any other factors that may change in future and could affect cash flows. Given this rising economic uncertainty and market disruption, DCF, with its flexibility to allow modelling of performance of future years of a business individually, with varying growth rates and cash flows till businesses stabilise, may be a more useful method. This method will not be devoid of challenges as valuators may still have to consider multiple scenario analysis to capture the growing uncertainty in the next 18 to 24 months.
Organisations can value their business using other methods as well. However, additional considerations need to be applied in doing so. For example, if a company was using the market approach of valuation earlier, it needs to make relevant adjustments in the financial parameters now. It may not just use an average of the previous three or five-year period, as it may not be applicable in these uncertain times. So usage of previous years’ financial metrics during these times needs more analysis and adjustments.
Cash flows and the ability of a business to continue its operations and generate cash flows are important for business valuation. In addition, cash balance and the rate at which money is being used by an organisation also determine its survival and ability to continue doing business. So any changes that help a firm to preserve capital and cash flows, now and in the near future, will help in the valuations as it can give a good idea of how long a company can survive in these turbulent times.
The longer-term prospects of any organisation are also important in assessing its value. However, every dark cloud has a silver lining and tough times help some companies to thrive or re-engineer themselves, like grocery and food delivery, manufacturers of PPE and digital businesses. These and similar other businesses by virtue for their relevance in these times, or because of timely reinvention, are actually booming during the outbreak. With world economies going through disruptions and maybe permanent changes in consumer behaviour, some companies would take advantage of the situation and do better than pre-pandemic times. Going forward, due to the unpredictability of the business environment and future cash flows, valuations cannot be done by just numbers. Stories of survival, tales of flexibility and the ability to either scale up or scale down at a short notice should be definitely part of valuations. Many things may not remain the same in the aftermath of the outbreak. Business processes will change and so should the way valuations of companies are done.
(Writer: Hima Bindu Kota; Courtesy: The Pioneer)
Venture capitalists are seeking stronger deal terms as the leverage has shifted back to investors during the pandemic
The countrywide lockdown has dealt a severe blow to the economy of the country. The consequent fall in stocks, which in turn has affected the private equity (PE) market, has resulted in conspicuous devaluation of companies. Start-ups are currently in a strong presence of leverage on the side of investors as the weakness in the market has led to a fall in fund-raising by 78.6 per cent as compared to last year. In such a scenario, it is smart to conserve energy otherwise expended in fund-raising to manage liquidity and the current cash flow. As monetisation of assets through exit activities will see a consequential hold before their prices recover and economic activity returns to normal, investors will want to protect their assets through insertion of restrictive covenants. Owing to the pandemic, venture capitalists are seeking stronger deal terms as the leverage has shifted back to investors.
For the purpose of hedging the risk that presents itself during this time, it is important that both the investors and the start-ups cooperate to maximise efficiency and solve the liquidity crisis that has hit the market currently. The contractual clauses so drafted depend upon the factual matrix of each start-up, made up of the bargaining power of either side. Often, it is a tussle between either side to include clauses that are more favourable either to the start-up or the investor. Such bargaining power resides in the potential of the assets that the start-up creates. There is an inverse relation between the strength of the company and the bargaining power of the investors to introduce such clauses that hedge the risk faced by the lender at the cost of the company. For those companies that are doing well amid the Coronavirus pandemic, these investor-friendly terms come up less. The strongest companies don’t see those tough provisions.
Such methods that hedge the risk by cannibalising the control of the start-up and inserting provisions that dilute the risk for the investor are detrimental to the relations between the two parties. Mostly, the survival of the firm shall be determined by various factors. Among them is the low burn rate through liquidity, adaptability and the basic strength of the start-up and its baseline health before the pandemic hit the world.
However, unique times require unique solutions and the same is reciprocated by legal measures so sought to reflect the mood of the start-ups and the venture capitalists. Conservative measures are on the rise across various industries to either protect the existing values/assets or to drive the economic activity up once the lockdown ends. Therefore, the conservative protective clauses that were prevalent during the dotcom phenomenon are rising again.
Full ratchet anti-dilution protection: This prevents the dilution of the shareholding of the investor in different scenarios. It is a form of protection against the dilutive events that the companies might face, as it completely protects the value for the investors by new stock issues at a price that is lower than the investor’s original investment. It changes and updates the price of conversion in order to maintain the investor at the same level of ownership stake in terms of the percentage owned.
Liquidation preferences: This gives one class of shareholders the right to be paid back first in the event of an exit. Though investors exiting during this time period will be exceptionally harmful but the fact remains that many firms will not survive this pandemic. Then in the case of exit by the investors such a provision would be an area of conflict, especially in this scenario.
Pay-to-play provisions: This enables a firm to penalise investors that don’t invest in later rounds. It is done to assure an investor that his/her firm isn’t the only investor in future rounds.
Pull-up provisions, discounts on bridge loans: Similar to the pay-to-play provisions, these are designed to provide a strong incentive for existing investors to participate in future financing. Heightened rewards are only affirmative of the unequal bargaining power of the investor against the start-up.
Blocking rights on exits: This gives investors more control of a company so that they can block an acquisition of a firm. This can be used if an investor thinks his/her firm isn’t making enough money in an exit.
At this stage of the Coronavirus pandemic and its resultant impact on the economy of the country, it is imperative for the investors and the firms to amicably cooperate in order to effectively guide the firm out of troubled waters. The devastating effect that the pandemic has had on the bottomlines of firms, especially start-ups is not something that can be wished away overnight.
It will take a concerted effort, on the side of the investors, the start-ups and all stakeholders to steer companies out of the current storm. More measures aimed at reinforcing the moral fabric of the company by providing the right treatment to the employees should be adopted and the firm should not be seen as a lamb being fattened up only to be slaughtered at the apt time.
(Writer: Sonam Chandwani; Courtesy: The Pioneer)
The only way to come out of the looming economic crisis is to have large-scale direct cash transfer at least for the next six months to boost demand. This in turn will generate jobs and increase consumption levels to bring the country out of the trough it is in now
India is facing a humanitarian and economic crisis of epic proportions. As a result of the extended lockdown, millions of hungry and penniless migrant labourers are stranded in cities, desperately waiting for a seat on a bus or a train to take them home. Fed up of the endless wait, the “atma nirbhar (self-reliant)” among them decided to take matters into their own hands and began walking back to their hometowns and villages, hundreds of kilometres away.
These workers, who form the backbone of the informal economy of the country, are generally employed in Micro, Small and Medium Enterprises (MSMEs), restaurants, retail shops, construction sites and other enterprises which shut their doors during the lockdown or are at the brink of closure, due to it. What a lockdown of over nine weeks would do to the economy of the country and consequently, the lives of daily-wagers is not beyond the scope of the imagination of those who are in touch with reality.
The so-called Rs 20 lakh crore economic package was an exercise in futility, which did not offer anything to the struggling migrant workers. Instead, the Government announced measures to make it easier for Indians to travel to space. Perhaps, the Government got it wrong. People want to travel to their States, not space. Most analysts, rating agencies and banks have placed the size of the fiscal stimulus announced by Finance Minister Nirmala Sitharaman between 0.7 to 1.3 per cent of the Gross Domestic Product (GDP) and not 10 per cent as claimed by the Government. According to the Government’s own admission, a Rs 8.01 lakh crore liquidity infusion by the Central bank forms a part of this Rs 20 lakh crore stimulus.
The outcome of the Reserve Bank of India’s (RBI’s) Monetary Policy Committee (MPC) meeting, which decided to cut the repo and reverse repo rate further by 40 basis points (bps) to four per cent and 3.35 per cent respectively, came as no surprise. The consecutive rate cuts by the RBI are aimed at injecting more liquidity into the market. However, the industry and retail borrowers are not going to benefit from this rate reduction as there is no demand for credit. And for banks, liquidity is not an issue right now but risk aversion is. This risk aversion among banks is creating a hurdle in increasing credit flow and ensuring the transmission of rate cuts to the industry and retail borrowers. But these rate cuts will affect the middle and lower-income classes the most, with an expected fall in interest rates on their savings (Fixed Deposits) by around 0.5 per cent in the days to come.
However, banks alone cannot be blamed for turning cautious on lending. The economy is passing through uncertain times and banks are trying to prevent non-performing assets (NPAs). The primary issue is the absence of demand for liquidity and to generate this demand, capacity utilisation, which was 68.6 per cent (October-December 2019), has to be increased. Here comes the immediate need for additional Direct Cash Transfer of Rs 7,500 to each Jan Dhan, PM-Kisan and pensioner’s account. This transfer will generate demand in the rural and semi-urban sector, which in turn would force India Inc. to use the remaining 31.4 per cent capacity or go for capacity enhancement which may require liquidity support from banks. Just increasing liquidity in its current form by the RBI is not going to translate into higher credit offtake.
Another major announcement by the RBI was the extension of the moratorium on loan repayment by another three months. The RBI also announced the conversion of moratorium interest payment into a term loan, payable in the course of the Financial Year (FY) 2021. These measures could bring relief to borrowers but not for banks, as they will see more pressure on their balance sheets. The Government should ensure that in the endeavour to become atma nirbhar it does not end up making our banks and Non-Banking Financial Companies (NBFCs) “parmatma nirbhar (dependent on God).” In the last few years, we have already seen some examples of this in the likes of PMC Bank, Yes Bank and so on.
Another challenge for the country is the consistent increase in the food inflation rate. The unplanned lockdown resulted in major supply chain disruptions, which in turn increased the food inflation rate to 8.6 per cent in April. If proper planning regarding supply chains is not done before reopening the economy, food inflation will skyrocket. If food inflation does not decrease, we will have an economy with a high inflation rate and negative GDP growth.
Although the RBI has not provided any concrete number for the projected GDP for FY21, it predicted a negative growth rate. Already a few national and international rating agencies have forecast a negative GDP growth rate (minus five per cent), which can also have huge fiscal implications for India.
The only way to come out of this difficulty is to have large-scale direct cash transfer at least for the next six months to boost demand. This in turn, will generate jobs and increase consumption levels. Thereafter, our demographic advantage will accelerate the economic wheel of the country.
(Writer: Gourav Vallabh; Courtesy: The Pioneer)
The Centre should come out with a huge package of about ten per cent of the GDP which might help revive the economy hit by COVID-19
Though India is slowly opening up its economy after a prolonged lockdown, the correction in the downward slide is unpredictable. Therefore, it is important to be conservatively positive about the economy and analyse the situation at a more granular level for making timely public policy interventions. Economists and financial experts worldwide believe that printing money as part of quantitative easing will generate consumer demand, kickstart new projects, support businesses and the workforce. The US, Europe, Japan, Turkey and Indonesia are printing money and implementing measures to bring their economies back to normal. The printing of money as a fiscal measure works as per the Keynesian notion, where you enhance spending and consumption, which in turn increase the income equal to multiplier times. Every economy has its own value of multiplier, which increases the income equal to multiplier times of consumption. It is vital to grasp the functioning of multiplier to understand and propose the printing of notes.
The concept of the multiplier was first formally introduced into economic theory by RF Kahn in 1931and then was taken up by Keynes (1936). The Keynes-Kahn multiplier says that if the government expenditure (G) goes up by one unit, it translates to more than one unit increase in aggregate demand. The initial round of spending stimulates further rounds of spending such that ultimately the effect on output is multiplier times the original increase in spending. For an initial increase in government expenditure DG and marginal propensity to consume (MPC), change in output DY is K times DG, where K is the fiscal multiplier and equals, K = 1/(1-MPC), under the assumption of closed economy. The value of fiscal multiplier is the accumulated effect on output through various rounds of spending. One person’s consumption is the other person’s income.
Suppose the government spends Rs 1 lakh crore through printing of notes and the MPC of the economy is 0.75, the value of the multiplier will be four. It means for Rs 1 lakh crore of spending, income will increase to Rs 4 lakh crore if other assumptions are fulfilled. Moreover, it doesn’t stop here only and the super multiplier will also work. In a situation where investment is determined by the growth of income itself, we have the operation of what Lange (1943) had called the “compound multiplier” and Hicks (1950) had called the “super multiplier.” Conceptually there is a difference between the multiplier and the super multiplier that subsumes the effect of increased spending on investment via the accelerator (A). However, when we talk about the empirical estimation of the aggregate effect of changes in fiscal variables on the aggregate level of activity, we usually consider the combined concept of super-multiplier as the fiscal multiplier. It can further multiply the income and employment manifold depending upon the capital-output ratio in the Indian economy. Suppose the value of acceleration is again three, this will increase the income many times as the value of A which is A= I/Y, and K=DY/DI and so on. The investors can also be induced with the increase in aggregate demand. The Indian Government’s revenue will also rise with the increase in income and employment.
The fiscal multiplier will work inversely if spending is reduced, which is happening right now in the Indian economy due to the huge job losses and even salary reductions. It will negatively affect the economy, which is already in turmoil. So, the Government should not use the measures which can reduce consumer spending.
Critics will say that prices will rise with the printing of notes. Well, the economy is in huge deflation and there is a scope of the economy hotting up to some extent. Moreover, interest rates are going down to reduce the cost of production. In short, the multiplier effect will be larger when some conditions are fulfilled: The propensity to spend extra income on domestic goods and services is high, the marginal rate of tax on extra income is low, consumer confidence is high and businesses have the capacity to expand production to meet demand. The leakages in the form of imports are already low, which makes multiplier more effective.
Quantitative easing will help generate “helicopter money” to empower the public with money to buy things and boost the economy. Obama did it for the US economy during the 2008 crisis. This concept can be re-invented into a “Drone Drop Money” (DDM) for us. This money should directly go to the individual. The difference between DDM and “helicopter money” is that due to COVID-19, you cannot opt for spending in public works to a major extent. It is the best time to go for printing of money and much-needed, too. There should be a reduction in direct and indirect taxes to boost consumption further, which will increase the tax revenue as per the Laffer Curve. In the current crisis, everyone needs support. Vulnerable people need cash transfers. Large companies need support on liquidity. Small companies may require protection from bankruptcy. Those nations which take timely measures will fare better in reviving the economy. The Centre should come out with a huge package of about ten per cent of the GDP immediately, which might help revive the economy. It could be a V-shaped revival as soon as the lockdown ends.
(Writer: Pradeep S Chauhan; Courtesy: The Pioneer)
With a vast range of options for funding available today, the selection of a suitable source is quite tricky for founders. With a detailed, compelling pitch, they can ride the tide
In India, start-ups are growing at an astounding rate with a record fund raising of $3.9 billion for the first six months of 2019. Last year, they clocked more than 100 per cent growth with funding doubling from $2 billion to $4.2 billion, from 2017 to 2018, according to NASSCOM. The country is on its way to becoming a startup hub with more than 1,200 new businesses coming into existence in 2018, including eight unicorns, thus taking the total number to 7,200 start-ups last year. When compared to the first six months, investments this year across 292 deals saw a 44.4 per cent jump from the $2.7 billion received by domestic start-ups in the first half of 2018, according to Venture Intelligence.
Private funding through private markets like equity, venture capital and angel investing, is the reason for this phenomenal growth of start-ups in India. In the past, private firms often went public when their need for capital exceeded what investors could provide. However, in the last decade, firms have found a good alternative in private markets. This because of two reasons. First, drawn by the potential of high returns, more investors have entered the space, thus creating an influx of available capital. This has in turn altered the trajectory of private companies because they are no longer forced to raise capital on public markets. Second, as more investors pour money into private markets, it has now become easier for new private companies to get funding needed for growth. As a result, there has been a sharp influx in the number of Venture capital (VC)-backed startups and PE-backed companies in recent years. In other words, as more money flows into this space and as more firms stay within, private markets will continue to grow in value and opportunity.
Even though the private funding market is booming, it is not easy for start-ups to raise funds. They require several things — capital, strategic assistance and introduction to potential customers, partners and employees among other things. Entrepreneurs will be better prepared to obtain funding if among other things, they understand the basic difference between distinctive type of private funding available. VC is the finance that investors provide to start-up companies and small businesses. These are believed to have long-term growth potential and can be provided at different stages of the companies evolution. VC generally comes from well-off investors, investment banks and any other financial institutions. However, it does not always take a monetary form; it can also be provided in the form of technical or managerial expertise. It is basically a subset of Private Equity (PE), which focusses on emerging firms seeking substantial funds for the first time. PE tends to fund larger and more established firms that seek an equity infusion or a chance for company founders to transfer some of their ownership stakes. Apart from the stage of investment, PE firms make investments in a few companies only and provide funds to matured firms that have a good record while VC firms make their investments in a large number of small companies, who may not necessarily have the desired track record.
Third, PE investment can be made in any industry as opposed to VC in which investment is made in high growth potential industries like energy conservation, biomedical, quality upgradation, information technology and so on. Fourth, the risk profile in VC is comparatively higher than PE. Lastly, the use of funds is different in both cases. In PE, funds are utilised in financial or operational restructuring of the vendee company. On the other hand, VC funds are utilised in streamlining business operations by way of developing and launching new products or services.
While the roots of PE can be traced back to the 19th century, the birth place of VC was in the US. It developed as an industry only after the Second World War. Georges Doriot, Harvard Business School professor, is generally considered to be the “Father of VC”, who raised $3.5 million fund to invest in firms that commercialised technologies developed during WWII. ARDC’s first investment was in a company that had ambitions to use X-ray technology for cancer treatment. The $200,000 that Doriot invested turned into $1.8 million when the firm went public in 1955. In a VC deal, large ownership chunks of a firm are created and sold to a few investors through independent partnerships that are established by VC firms. Sometimes these partnerships consist of a pool of several similar enterprises.
Another important way of raising funds, particularly for small business and companies in emerging industries, is through angel investors, which is typically a diverse group of individuals, who have amassed their wealth through a variety of sources. However, they tend to be entrepreneurs themselves or executives recently retired from the business empires built by them. Self-made investors providing VC typically share several key characteristics. The majority look to invest in companies that are well-managed, have a fully-developed business plan and are poised for substantial growth. These investors are also likely to offer to fund ventures that are involved in the same or similar industries or business sectors with which they are familiar. If they haven’t actually worked in that field, they might have had academic training in it. Another common occurrence among angel investors is co-investing where one angel investor funds a venture alongside a trusted friend or associate, often another angel investor.
Although angel investors and venture capitalists have a number of similarities like catering to innovative start-up businesses, there are also a number of differences between them. First, an angel investor works alone. Venture capitalists are part of a company. Angels are rich, often influential individuals, who choose to invest in high-potential companies in exchange for an equity stake. Given that they are investing their own money and there is always an inherent risk, it’s highly unlikely that an angel will invest in a business owner who isn’t willing to give away a part of their company. Venture capital firms, on the other hand, comprise a group of professional investors. Their capital comes from individuals, corporations, pension funds and foundations. These investors are known as limited partners. General partners, on the other hand, are those, who work closely with founders or entrepreneurs; they are responsible for managing the fund and ensuring that the company is developing in a healthy way.
Second, they invest different amounts. While angel investing is relatively limited in its financial capacity, this mode of investing can’t always finance the full capital requirements of a business. Venture capitalists, on the other hand, can raise large amounts of fund.
Third, they have different responsibilities and motivations. Angel investors are primarily there to offer financial support. While they might provide advice if asked for or introduce to important contacts, they are not obliged to do so. Their level of involvement depends on the wishes of the company and the angel’s own inclinations. A venture capitalist looks for a strong product or service that holds strong competitive advantage, a talented management team and a wide potential market. Once venture capitalists are convinced and have invested, it is then their role to help build successful companies, which is where they add real value. Among other areas, a venture capitalist will help establish a strategy and recruit senior management. He/she will be on hand to advise and act as a sounding board for CEOs. This is all with the aim of helping a company make more money and become more successful.
Fourth, angel investors only park funds in early-stage companies. They specialise in early-stage businesses, funding the late-stage technical development and early market entry. The funds an angel investor provides can make all the difference when it comes to getting a company up and running. Venture capitalists, on the other hand, invest in early-stage companies and more developed firms, depending on the focus of the venture capital firm. If a start-up shows compelling promise and a lot of growth potential, a venture capitalist will be keen to invest.
A venture capitalist will also be eager to invest in a business with a proven track record that can demonstrate it has what it takes to succeed. The venture capitalist then offers funding to allow for rapid development and growth. Lastly, they differ in due diligence. Venture capitalists focus more on due diligence. These are some of the differences between PE, venture capital and angel investors and the decision of which to approach is personal. To improve the odds of securing investment and appealing to an investor, a start-up company should take the time and consideration to create a detailed, compelling pitch. With sufficient luck, it can end up with the financial and entrepreneurial support to skyrocket its business.
(The writer is Assistant Professor at Amity University)
Writer: Hima kota
Courtesy: Pioneer
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