Risk and reward

Opinion

Risk and reward

It was impressive to read about the 89 year old American billionaire Kirk Kerkorian offering to buy an ailing Chrysler Corporation for 4.5 billion dollars on April 5th, 2007. Kerkorian, the Brioni-suit-wearing Beverly-Hills-living investor has a present net worth of around US $ 15 billion. But just months away from his 90th birthday, he is unfazed about risking a neat 30 per cent of his fortune on yet another new venture. If he succeeds in buying Chrysler, Kerkorian will have to turn around the ailing marque in a highly competitive global automobile market. It will take even more of his money, a good deal of his genius and not a little of his time to pull off the feat. But then, this is the action of a habitual risk taker, an immigrant son from Armenia who thought it fit to drop out of the eighth standard to become an amateur boxer under the moniker “Rifle Right Kerkorian”.

Contrast the kind of brass and “Rifle Rightism” that led Kerkorian on to make a success of Las Vegas property development, stewardship of Metro Goldwyn Mayer (MGM), significant holdings in General Motors (GM) and so on with the traditionally risk averse ways of the Indian middle class. But lately, at least on one side of the fence, when it comes to taking on debt, as in home, car, personal loans and credit card spending, many in the urban Indian middle class may have already changed beyond recognition. Gone are the “neither a borrower nor a lender be” prescriptions of the past.

While this is a bold departure for the fastest growing section of India’s population, the tricky part might lie in how to fund all this easy credit. The middle class, hard-wired for generations to favour caution and prudence in matters financial may have at last splashed out on a consumer spending spree but still has little or nothing to hold off the consequent financial pressures except the income from their salaries. It is true that salaries have risen considerably and so have the total quantum of household savings - but most of the surplus still nestles in low yield bank deposits that have little hope of funding the sharp expansion in aspirations and lifestyles. But even in the face of countless rags-to-riches stories and rich-get-richer truisms all around, the middle class remains fixated on limiting risk even as it has succumbed to the blandishments of an upwardly mobile lifestyle. The result is a feeling of increased financial pressure that only seems to grow day by day.

The government, on its part, has anticipated this phenomenon by default, interested as it is to attract the funds to propel the robust growth of India’s economy. It realises the benefits of substantial household savings pouring into the stock market to participate in and partly fuel the expansions of business and industry on a risk-taking basis. Over the years, successive governments from both sides of the parliamentary aisle have gradually introduced a very attractive tax regime to encourage this process. For those resident individuals who are prepared to take a calculated risk by investing in listed equity, the income tax rate on any short term capital gains (meaning up to one year from date of investment), they make, is a flat 10 per cent. Otherwise, the same people are well used to paying up to and over 30 percent against their salaries and other income. Further, there is no ceiling on the amount of profit they are able to earn from stock market traded equity under these self-same terms. This then, is the sweetest spot in the provisions applicable to personal income tax at present. It gets even better. Beyond the first year of holding a listed equity investment, profits made against the holding are completely tax free.

The catch, of course, is the risk involved, but it must be said the choices otherwise are both low yielding and limited. Indeed the “fixed interest” investment universe has changed drastically. Even as the government is fighting inflation via higher interest rates at present, persistently high GDP growth and low inflation remains the economic forecast for the medium to long term. So, the middle class, so quickly habituated to the palatable phenomenon of low cost home, car and personal loans in a modest inflation environment- must now accept the flipside of this scenario too. Gone, most likely for good, are the“safe” but high yield bank fixed deposits and all similar instruments ranging from public provident funds to national savings certificates to tax free bonds and even the riskier company and non-banking finance company (NBFC) fixed deposits. Not only will the returns from these options rarely see double digits again, but inflation indexed, even at less than 5 per cent, they barely break even. And this is before income from such investments is subjected to the full whack tax treatment in line with one’s tax slab. Even higher threshold slabs for income tax applicable to senior citizens and women and an extra percentage point or so on senior citizen fixed deposits hardly make any difference.

Contrast this bleak scenario with average stock market equity returns in the 40 per cent plus region over the last few years and a consistent long term average of some 15 per cent and the way ahead seems crystal clear. Kerkorians one and all we may never become, whether at nine or ninety, but at a minimum, a shift in gear at the income end of things is definitely called for. Going back to neither-a-borrower-nor-a-lender-be times may not be a viable option anymore.

Besides, the foreigners and the rich have gone forward an additional step and shown a marked preference for private equity. Investing, as they often do, in well chosen private unlisted companies, they confidently look forward to profits running into hundreds of percentage points when the companies finally go public. We can, as a mass, take our cues from this pointer as well - if we have the requisite risk appetite. But, at a minimum, the days of rewards without appreciable risk may be truly over and the sooner the middle class accepts this, the better.

( 1,033 words)

Tuesday 17th April, 2007
By Gautam Mukherjee

Also published in The Pioneer on Thursday 26th April 2007, Edit page.