Types of Enterprises in India: Company

This post is a continuation of my previous post in which I talked about Sole Proprietorships, Partnerships and Limited Liability Partnerships – the main types of Enterprises in India. The only significant type left is the Company, which I will discuss in this post. 

But before any of that, this (straight from my Facebook page). 

Spock speaks to future Spock

I figured it was a waste being my mother’s (T – 25 years) doppelganger, if I couldn’t use it for comic effect. 

What is a Company? 

A Company is defined in section 3 of the Companies Act, 1956 as a Company formed and registered under this act or any other previous company laws. A company usually raises the capital it needs for its operations through the issue of “shares”. The amount thus raised is called “Share Capital”. The persons who buy these shares are called “Shareholders” of the Company. They are the owners of the Company. 

A Company has the following characteristics:

• Legal Identity separate from that of the owners: A Company has a legal identity separate from its owners/ shareholders. It can sue/ be sued in its own name, pays its own taxes, has its own seal etc. 

• Limited liability of owners: As per the Companies Act, 1956 there are different types of companies. A Company may be a “Company limited by shares” or a “Company limited by guarantee” (we’ll explain what these mean later). In the case of a Company limited by shares, the liability of the shareholders is limited to the face value of the shares subscribed by them. In a Company limited by guarantee, the liability of owners is limited to such amount as they may undertake to contribute to the assets of the company in the event of its being wound up.

• Perpetual Succession: The Company continues to exist despite the death/ bankruptcy/ exit of owners/shareholders. It ceases to exist only when dissolved as per the Companies Act. 

• Compulsory to register Company with ROC (Registrar of Companies) 

Types of Companies in India

Per the Companies Act, 2013 (revised version of Companies Act, 1956), the following types of Companies can be registered in India (see section below, after reading the following note):

Note: “Company limited by Shares” is the predominant type of Company in India (this is what most people mean when they use the term “company”). Over 99% of all new companies registered under the Companies Act in 2013-14 were Companies limited by shares (see charts below). That said, I’ve talked about the other types of Companies allowed under the act as well, so that you - my reader - get some perspective on what’s out there. 

Companies Registered under the Companies Act, 1956, in 2013-14 (total number and as % of total): Click on charts to enlarge. 

       

Source: 58th Annual Report On the Working & Administration of the Companies Act, 1956 for year ended March 31, 2014, Ministry of Company Affairs.

1. Company limited by Shares: 

(The most common type of Company; 99% of all new companies registered in ’13-14 were of this type)

A Company limited by shares has a Share capital and the liability of each shareholder is limited to the extent of the face value of shares subscribed by him. Let’s explain this with an example. Let’s assume that the face value of a share in a company is Rs. 100, and shareholder “A” has subscribed to 10 shares of the company and paid Rs. 50/share. During the life of the company or in case of winding up, “A” can be held liable (asked to pay up) for the remaining Rs. 50/ share * 10 = Rs. 500, and not more. A company limited by shares may be a public company or a private company (we’ll discuss this later in the post). 

2. Company Limited by Guarantee: 

(Mostly Non-profit companies focused on social, cultural, religious or other work usually use this structure; only ~0.5% of companies registered in ’13-14 were of this type)

The liability of each member is limited to the amount he undertakes to contribute in the event of the company’s liquidation/ winding down in order to meet the liabilities of the company. Such a company may or may not have Share Capital. If it has share capital, it can be a public or private company. 

3. Unlimited Company: 

(Very rare; only 0.01% of companies registered in ’13-14 were of this type)

An Unlimited Company does not have any limit on the liability of its members. It may or may not have Share Capital. If it has share capital, it can be a public company or a private company. Unlimited companies are very rare. 

4. One Person Company: 

(Very new concept; introduced in the Companies Act, 2013) 

The concept of a One Person Company (OPC) was introduced in India with the Companies Act, 2013. Such a company has only 1 shareholder. Only a natural person, who is a citizen and resident of India, can form an OPC.

Why a One Person Company when you can have a Sole Proprietorship?

Unlike a Sole Proprietorship (read my previous post titled “Types of Enterprises in India: Sole Proprietorship, Partnership, Limited Liability Partnership” for details), an OPC has a separate legal identity from its owner/shareholder and the owner has limited liability (this is attractive for entrepreneurs who are just starting out). Since an OPC has a much higher compliance and disclosure requirement (under the Companies Act, 2013) vs. a Sole Proprietorship (minimal compliance), lenders feel more comfortable lending to an OPC vs. a Proprietorship. Also, it is easier for an OPC to convert itself into a Private Limited Company and attract venture capital and other investors. This transition is much harder for a Sole Proprietorship. 

The biggest drawback of an OPC vs. a Sole Proprietorship is that an OPC is taxed at a 30% base rate (MAT and dividend distribution tax is applicable as well) whereas the income of a Sole Proprietorship is taxed based on the tax slab in which the proprietor’s income falls. 

Private Company vs. Public Company

If a company has Share Capital, it can be a Public company or a Private company. We know from the section above, that a Company limited by guarantee and an Unlimited Company could both have share capital. However, these companies aren’t very common, so when we talk of Public companies and Private companies, we usually mean Public and Private companies limited by shares. 

Note: 96% of all new companies registered in 2013-14 were Private Companies limited by shares; 3% of all were Public Companies limited by shares (see charts above). 

Private Company (also called Private limited Company)

Per the Companies Act, 2013, a Private Company has the following characteristics:

• Has a minimum paid-up share capital of Rs 1 lakh.
• Minimum number of members (shareholders) is 2, and maximum is 200.
• Restricts the right to transfer its shares. If a shareholder wants to transfer his shares, he usually has to offer them to other existing shareholders first. The consent of other shareholders is required before selling shares. 
• Prohibits any invitation to the public to subscribe to securities of the Company. This obviously implies that private companies cannot be listed on stock exchanges and cannot raise funds in an IPO. 
• Has a Board of Directors – a minimum of 2 directors; maximum of 15. 

Public Company (also called Public limited Company)
Per the Companies Act, 2013, a Public Company has the following characteristics:

• Has a minimum paid-up share capital of Rs 5 lakh. 
• Minimum number of members (shareholders) is 7; no upper limit. 
• Shares are freely transferable. 
• Invites the public to subscribe to any securities of the Company (shares/debentures etc.) 
• Has a Board of Directors – a minimum of 3 directors; maximum of 15.

Between Public and Private companies, private companies are relatively smaller and are often owned by families. The restrictions on transfer of shares allows the family/a few shareholders to maintain control of the company. Also the compliance burden (with the Companies Act, 2013) and public disclosures mandated are lower for Private companies vs. Public companies. 

The downside however, is that Private companies find it harder to raise funds vis-à-vis Public companies, that can raise funds through from the public through public offerings. Lenders/ banks also feel more comfortable lending to Public companies because of the higher level of compliance/scrutiny that they are subjected to, more professional management, larger size, better access to capital/ expertise etc. 

Let’s take an example to underscore the different types of structures used by enterprises as they grow. Tribhovandas Bhimji Zaveri Ltd (TBZ), one of the top jewellers in India, was established by Tribhovandas Bhimji Zaveri in 1864. Business was carried out in Partnership between Tribhovandas Bhimji Zaveri and other members. The first partnership deed was executed in 1949. The partners changed through the years, and the partnership deed was altered to reflect these changes. The firm grew, opened new showrooms and hired professionals to manage the retail business. In 2007, the enterprise was incorporate as a Private Limited Company. It continued to grow and add additional stores. In December 2010, the company was converted into a public limited company - Tribhovandas Bhimji Zaveri Ltd. The company did its IPO (raise 200 crores) in April 2012, and started trading in May 2012 on the Bombay Stock Exchange (BSE) and National Stock Exchange (NSE) under the ticker TBZ. 

Enough about Companies now. This post gives you all you’ll need to grasp company data as you encounter it in future posts. 

Sayonara. 

Types of Enterprises in India: Sole Proprietorship, Partnership, Limited Liability Partnership

In this post I’m going to talk about the different types of enterprises in India, and also about the difference between an “enterprise” and an “establishment”. These concepts are necessary for grasping the data collected in the Economic Census and various NSS surveys (we’ll talk about these in future posts), which is then used to make NAS estimates. 

Enterprise Vs. Establishment

What is an Enterprise? 

An institutional unit in its capacity as a producer of goods and services is known as an enterprise. An enterprise is an economic transactor with autonomy in respect of financial and investment decision-making, as well as authority and responsibility for allocating resources for production of goods and services. It may be engaged in one or more economic activities at one or more locations. An enterprise may be a sole legal unit. (from the 5th Economic Census)

What is an Establishment?

The establishment is defined as an enterprise or part of an enterprise that is situated in a single location in which one or predominantly one kind of economic activity is carried out. It is an economic unit under a single legal entity. (from the 5th Economic Census)

Examples please!

Let’s use examples to better understand the difference between an enterprise and an establishment. The State Bank of India (with all its branches spread all over the country) for example, is a single enterprise unit. Its individual branches are establishments. The “Big Chill Cafe” chain of restaurants is an enterprise. The Big Chill Café at Khan Market is an establishment. The small mom and pop store in your neighbourhood (the only one that the owners have) is an establishment as well as an enterprise. Most small businesses in India have just one location, so the establishment = the enterprise in their case. The distinction between establishment and enterprise becomes important for larger, multi-location, multi-activity businesses. 

Why the distinction matters

The reason that this distinction is important to us is because when the Economic Census is conducted in India, it counts establishments. When NSS surveys are conducted, they usually sample enterprises. Sometimes these terms are used interchangeably, and sometimes they’re not. We’ll talk more about this later, but for now, suffice it to say, one must be aware of the distinction. 

Different types of Enterprises in India

1. Sole proprietorship

“Sole Proprietorship” is an enterprise that is owned by a single person and is not registered as a Corporation, Partnership or Limited Liability Partnership (LLP) (Partnerships and LLPs have at least 2 owners). There is no legal distinction between the owner (proprietor) and the business in the case of a Sole Proprietorship. The owner receives all business profits and has “unlimited liability” for all business debts, claims, losses etc. This means that his personal assets can be attached to meet business claims. 

Easiest type of Enterprise to start in India

A Sole Proprietorship is the easiest type of enterprise to start in India. The PAN (Permanent Account Number) of the owner serves as the PAN for the Sole Proprietorship; no separate PAN is needed. No “blanket” registration with the government is needed, so to speak, the way it is for a Company for instance (needs to be registered under the Companies Act, 2013). Registrations with the government are done only on a requirement basis. For example, if a proprietor is involved in selling goods and VAT is applicable on the sale of those goods, he has to obtain a VAT registration. This has to be done by all type of businesses in India that sells goods. Similarly, if the proprietor is involved in selling a service and service tax is applicable (independent lawyers don’t have to pay service tax for instance), then registration with the service tax department is needed. 

When is Sole Proprietorship a good structure for an Enterprise?
Sole proprietorship is a good form of enterprise when the associated business is small. It is the easiest to start, has the lowest compliance and capital requirements and the owner has full control.

Examples please!

Examples of Sole Proprietorships include: 1) a lawyer, accountant, financial consultant, wedding planner, photographer, plumber etc. who works alone and owns his own service business 2) any of the above who is the sole owner of his service business and employs others as well 3) The sole owner of a small manufacturing business that provides employment to others as well. 

Disadvantages of a Sole Proprietorship

A Sole Proprietorship’s key disadvantage is its small business size. Due to this reason, 1) it is hard for a proprietor to access capital (banks are more cautious to lend), talent and expertise 2) a proprietorship is more risky/less stable that a larger, better-funded enterprise 3) the business is hard to scale/grow. 

2. Partnership

Under the Indian Partnership Act, 1932, a "Partnership” is defined “an agreement between two or more persons who have agreed to share profits of the business carried on by all or any one of them acting upon all." Here are some of the key characteristics of a Partnership enterprise (as laid down by the Indian Partnership Act, 1932 that governs all Partnerships in India). 

• Needs at least 2 members: At least two members (or Partners) are needed to start a Partnership enterprise. For a partnership enterprise involved in the banking business, the number of members should not be >10; for other businesses, the number of members cannot be >20. 

•  Requires a Partnership Agreement, written or oral: A written Partnership Agreement, also called “Partnership Deed”, is preferable so that any disputes arising between partners may be more easily resolved in the future. A Partnership Deed usually includes names of partners of the firm along with their addresses, capital contributions of partners, profit sharing ratios for each partner, duties and rights of partners, salaries/ commissions to be paid to partners, duration of partnership, procedures to be employed while addressing disputes between partners etc. 

• Unlimited liability of partners: This means that partners are personally liable to meet claims made on the Partnership. Their personal assets can be attached to meet such claims/liabilities. 

• Profit sharing: Profits of a Partnership are shared between partners based on the rules laid down in the Partnership Agreement. In case there is no formal agreement on profit sharing, the profits are usually shared equally amongst partners. 

• Not compulsory to register Partnership: It is not compulsory to register your Partnership enterprise under the Indian Partnership Act, 1932. That said, it is recommended to register anyway because in the absence of registration, a Partnership enterprise cannot take a 3rd party to court for breach of any contract. Also partners cannot sue each other or the Partnership enterprise for breach of contract. 

Note: A partnership firm has its own PAN number, even though the partners have unlimited liability. 

When is Partnership a good structure for an Enterprise?

I mentioned the key disadvantages of a sole proprietorship above – limited access to funds and talent, more risk/ less stability, hard to grow the business etc. A Partnership structure helps overcome some of these disadvantages. 1) Due to the larger number of owners/ partners (2-20), the access to capital is higher. Not only do the partners contribute capital themselves, banks are more willing to lend. 2) The partners bring with them their own expertise and years of experience, which helps in better management of the enterprise. 3) It is less risky than a sole proprietorship, since the risks/ losses are shared, just as are the profits. 4) While there is a partnership deed (in most cases) that lays down rules for the functioning of a partnership, it is still a fairly flexible form of enterprise (much more than a corporation). Decisions can be taken rather quickly if the partners agree. 5) It is easy to form; registration is not compulsory. 

An important point to remember is that Partnerships are ideal for a business with a high-small (my word invention) to medium type of capital requirement. If the capital needed is small, a Sole Proprietorship would be ideal – why would the proprietor want to share profits with a partner? If the capital requirement is large, a Corporation would be preferred since it would have greater access to funds given its ability to sell stock, as opposed to a Partnership which cannot do so (would have to bank on loans, turn to partners).

Businesses where certain types of expertise are required are also well suited for the partnership structure, law firms being the poster-child in this regard. A majority of law firms are operated as partnerships as opposed to corporations. 

Examples please!

Examples of Partnerships include: a small store owned and run by 2 partners, a manufacturing partnership business owned by 2 or more partners, a law business that is a partnership between 10 lawyers, a financial consultancy firm which is a partnership between 2 former employees of a big bank etc. (just off the top of my head). 

Disadvantages of a Partnership

These include 1) disputes between partners which can hold back growth/expansion 2) unlimited liability of partners 2) uncertainty about life of the partnership in case of death / exit of partner(s).

3. Limited Liability Partnership (LLP)

The Limited Liability Partnership (LLP) was introduced in India only after The Limited Liability Partnership Act, 2008 came into effect in 2009. 

Need for LLP structure?

A Partnership in India cannot have more than 20 members and all members have unlimited liability for the Partnership’s debts and losses. 

This means that even if new members with capital and expertise are available, Partnerships that have 20 members already, cannot bring them on. Also, the existing partners are always cautious about expansion/ growth, since they are personally liable incase of any missteps. There is an increasing trend of litigation in India citing negligence by professionals. Such suits are especially challenging for partners (in professional Partnerships) since their personal assets can be attached. Together, these factors severely limit the growth of Partnership enterprises in India. 

With the LLP, these deterrents are addressed. The LLP is a hybrid structure that combines the limited liability benefit of a Company with the flexibility of internal organization of a Partnership (i.e. flexibility to draft mutually acceptable rules of operation in Partnership agreement). 

Key Characteristics of an LLP

• Legal entity separate from Partners; Perpetual Succession: An LLP is a body corporate formed and incorporated under the Limited Liability Partnership Act, 2008 and a legal entity separate from its partners. Remember, a Partnership does not have a legal entity separate from its partners. Also, unlike a Partnership, an LLC has “Perpetual Succession” which means that any change in Partners (death, exit, retirement) will not affect the existence, rights or liabilities of the LLP. 

• Limited liability of Partners: The liability of the partners in an LLC is limited to their agreed contribution in the LLP. No partner would be liable on account of the independent or unauthorized actions of other partners or their misconduct. However, the liabilities of the LLP and its partners who are found to have acted with intent to defraud creditors or for any fraudulent purpose shall be unlimited for all or any of the debts or other liabilities of the LLP. 

• Minimum 2 partners; at least 2 individuals as “Designated partners”; no upper limit on total number of partners: An LLP should have at least two partners (can be individuals or body corporates) and at least two individuals as “Designated Partners”, of whom at least one should be resident in India. Designated partners are responsible for compliance with the provisions of the LLP Act, 2008. There is no upper limit on total number of partners. 

• An LLP Agreement is recommended, but not mandatory: The drafting of an LLP Agreement defining the rights and duties of the Partners is recommended, but not compulsory. In the absence of such an agreement, the rights & duties as prescribed under Schedule I of the LLP Act, 2008 will be applicable. 

• Compulsory to register LLP with ROC (Registrar of Companies)

When is LLP a good structure for an Enterprise?

The LLP structure is available to all manufacturing, service/professional and trading enterprises that fulfill the requirements of the LLP Act, 2008. Small and Medium Size Enterprises (SMEs) can especially benefit from the LLP structure. Most SMEs in India are Sole Proprietorships (close to 95%), only ~2% are Partnerships. With the LLP structure, SMEs can get better access to credit (no limit on partners, banks also more willing to lend) as compared to the Sole Proprietorship and Partnership structures, while also maintaining relatively high flexibility and low compliance cost (vs. a Corporate structure). 

LLP is also a good structure for professional firms of lawyers, Chartered Accountants, financial consultants etc. It also provides an alternative structure for entrepreneurs looking for flexible / low compliance structures. 

OK.... the blog police called again! This post is much longer than I intended. That said, I daresay it provides a good comparative view of different enterprise structures in India. I still have to cover the “Company” which I will take up in my next post.

India's GDP Composition (by Expenditure) vs. the Rest of the World

In my last post Going through Indian Macroeconomic Aggregates from the New Series (2011-12): Production Approach, I looked at key macroeconomic aggregates of the New Series of National Accounts (base year 2011-12) related to the “Production” or “Value Added” approach of GDP estimation. In this post, I will talk about the macro aggregates (of the New Series) thrown up by the “Expenditure” approach to GDP estimation. More specifically, I will compare India’s GDP composition (by expenditure) with that of the rest of the world (ROW).

Before I go any further, here is the equation based on which GDP is estimated by the Expenditure approach.

GDP = Private Final Consumption Expenditure (PFCE) + Government Final Consumption Expenditure (GFCE) + Gross Capital Formation (GCF) + Exports - Imports.

For those who’re not familiar with this identity or those who’d like a little Econ 101 refresher:

In the Expenditure approach, GDP is estimated as the sum of expenditures on final goods and services produced in the domestic territory of a country. Final goods/services are acquired for final (as opposed to intermediate) consumption or investment. The broad final expenditure categories for an economy are 1) PFCE or final consumption expenditure by households and Nonprofit institutions serving households (NPISHs), 2) GFCE or the value of goods/services produced by the general government for own use, 3) GCF or investment expenditure, and 4) Net Exports (Exports - Imports). 

The first three categories are intuitive enough, but why are Net Exports included while estimating GDP, you ask? This is because in order to estimate GDP correctly through the Expenditure approach, we have to account for that part of domestic product that is bought by foreigners (i.e. add exports) and also for the domestic expenditure made on buying imports, which are not part of GDP (i.e. subtract imports). 

With that introduction, I’m going to reproduce the first table from the release titled “New Series Estimates of National Income, Consumption Expenditure, Saving and Capital Formation (Base year 2011-12)” published on 30th Jan 2015, in which MOSPI debuted the New Series of National Accounts.

Table 1: India’s Key Aggregates of National Accounts at Current Prices


I’m going to focus on the second box (with the head “Final Expenditures”).

PRIVATE FINAL CONSUMPTION EXPENDITURE (PFCE)

1. India’s Private Final Consumption Expenditure was ~60%1 of GDP in 2013-14 (see Table 1). This means that 60% of the expenditure on final goods and services in India in 2013-14 was undertaken by households, underscoring the importance of private consumption for our economy. 

How does this compare with other nations? See the chart below based on data provided by the World Bank. There are some interesting results here. 

Chart 1: Private Final Consumption Expenditure (PFCE) as a % of GDP. Even though this chart is titled Household Final Consumption Expenditure (% of GDP) by the World Bank, it represents PFCE since these figures includes the final consumption expenditure of NPISHs.

Source: World Bank (http://data.worldbank.org/indicator/NE.CON.PETC.ZS)

2. PFCE (as a % of GDP) for the US and for Sub-Saharan Africa is almost the same. (?) 

USA’s PFCE as % of GDP was 68% in 2013, almost the same as Sub-Saharan Africa’s 67%. This appears strange at first glance, given that the US and Sub-Saharan Africa are at completely different stages of economic development. Sub-Saharan Africa is a poor, under-developed geography that is starved of capital formation/investment expenditure. This explains it’s high PCFE (as a % of GDP). With weak investment expenditure, consumption expenditure dominates. 

The US on the other hand is arguable the most developed economy in the world. That said, given its mature stage of economic development, US GDP growth is quite modest compared to that of India or China. For context, US GDP (at constant 2010 prices) grew at an average 1.6%2 y-y over the 10-year period from 2004-13, while Indian GDP grew at close to 8%2 y-y during the same period. 

Now, consumption is important no doubt, but it is Capital formation or investment (in the form of factories, buildings, machinery, stocks etc.) i.e. what you save/invest today, that drives future growth. (I’m going to do a separate post on this subject). 

USA’s sub 2% y-y growth rate does not require a high rate of gross capital formation (GCF) (as a % of GDP). Also, various factors including stagnant wages, credit-driven consumption, inadequate social security etc. have all led to a systemically low rate of domestic household saving along with high consumption. The end result is that private consumption (PFCE) is an especially high % of US GDP (68%) as seen in the chart above, while GCF for the US is not particularly high (when compared with other nations).

Bottom-line: Due to very different reasons, USA’s and Sub-Saharan Africa’s PFCE (as a % of GDP) is almost the same.

3. China’s PFCE in 2013 was 36%, much lower than the US’s 68%, EU’s 57%, India’s 60%1 and Russia’s 54%. 

Here’s why. China’s wealth is very unequally divided. The vast majority of its population (working class) has very low disposable income. Most of the wealth belongs to the top few % of the population, who tend to invest locally in property/stock market and in assets abroad. Their spending does not create the kind of virtuous domestic spending cycle that begets more spending by putting money in the hands of other domestic spenders. 

Also, increasing domestic consumption and/or alleviating income inequality have not been a priority for the government (at least so far). The government has focused mainly on investment and manufacturing for international markets. Despite the recent slowdown, China is still the “factory of the world”. 

Given these factors, PFCE for China is quite low compared to other nations. 

4. With all that context, India’s PCFE of ~60%1  (close to the world average) is a good, balanced place to be. While there are a lot of dynamics that that feed into such a metric, at the outset, avoiding the extremes of the US and China is prudent.

GOVERNMENT FINAL CONSUMPTION EXPENDITURE (GFCE) 

A little background is needed here before we delve into the numbers. 

Government final consumption expenditure (GFCE) represents expenditure by the government on goods and services that are used for the direct satisfaction of individual needs (individual consumption) or collective needs of members of the community (collective consumption). 

More specifically, GFCE = the value of the goods/services produced by the government - own-account capital formation - sales + government purchases of goods/services produced by market producers that are supplied to households as social transfers in kind. 

“Social transfers in kind” correspond to individual goods and services supplied to households as transfers (without any payment/quid pro quo in return) by the government or NPISHs, whether the said goods and services were purchased on the market, or whether they were produced (non-market production) by the government or NPISH. They include: 1) social benefits which involve goods and services supplied directly by the general government (e.g. housing), 2) social benefits that beneficiary households buy themselves and then have reimbursed (e.g. healthcare) and, 3) transfers of individual non-market goods and services produced by general government, particularly education and health. 

1. Social transfers in kind are especially important in European “Welfare” type states where the government plays a big role in providing consumption goods/services to its population. Examples include Denmark, Sweden, Finland, Belgium, Norway, Netherlands, France, Germany, Greece (poster child for welfare state ruin) and Luxembourg. 

In these nations, GFCE is a high % of GDP. For context, for the EU (which includes all the welfare states listed above), GFCE was 21% of GDP in 2013. At 26%, Denmark had the highest GFCE (% of GDP) amongst these states in 2013.

Chart 2: India’s GFCE (as a % of sales) in 2013 was 11% vs. EU’s 21%, USA’s 15%, China’s 14% and a world average of 17%. 

Source: World Bank (http://data.worldbank.org/indicator/NE.CON.GOVT.ZS)      * Sub-Saharan Africa includes IDA & IBRD countries.

2. At 11%, India’s GFCE as a % of GDP is the lowest in the chart above, much below the world average of 17% for 2013. The reason for India’s low government expenditure (as a proportion of GDP) has been the government’s inability to raise taxes/revenue and finance government expenditure from sources other than debt. As a result, curtailing Fiscal Deficit, which the current government has done well (FD = 3.9% of GDP for 2015-16) has meant mainly cutting government expenditure, rather than raising revenue. 

This is the subject of much debate right now. Many believe that it’s OK for the Fiscal Deficit to be higher, as long as the government spends on infrastructure and other areas that will help accelerate GDP growth in the future. 

In any case, till the government can find means of raising tax revenues (tax payers accounted for just 1% of our population in 2013) and checking income tax evasion (which is quite rampant), government expenditure as a % of GDP is unlikely to rise significantly. Note: the Goods and Services Tax (GST) is a very constructive step in this direction. We’ll discuss why in a separate post. 

GROSS CAPITAL FORMATION (GCF) 

While how Gross Capital Formation is calculated in India is a complex subject (I hope to take it up in a future post), here's what is included:

GCF = Gross Fixed Capital Formation (GFCF) + Changes in Stock (CIS) + Change in Valuables where: 

GFCF = Acquisitions less disposal of new or existing tangible fixed assets (1. dwellings, 2. buildings and structures, 3. machinery and equipment, and 4. Cultivated biological resources, which include trees, livestock etc. that can be used repeated to produce products) + Acquisitions less disposal of new or existing intangible fixed assets (1. software, 2. mineral exploration costs, 3. entertainment, literary or artistic originals, 4. Other intangible fixed assets) + major improvements to tangible, non-produced assets including land and sub-soil assets (mineral deposits) + costs associated with transfer of ownership of non-produced assets.

CIS = changes in inventories of finished goods, work-in-progress goods and materials 

Change in Valuables = net acquisitions of precious metals/stones, paintings, sculptures etc.

1. Since GCF is crucial for future economic growth, high GCF (as a % of GDP) is desirable for all nations that want to grow at a high-single-digit or double-digit pace. This is mirrored in the chart below, where China and India, the fastest growing economies in this group, have the highest GCF (as a % of GDP) ratios.

Chart 3: India’s GCF (as a % of GDP) was 37%* in 2012-13 while China’s was 49% for 2012. The mature, slower - growth economies of the US and EU had GCF (as a % of GDP) of 18-19% in 2012.

Source:www.datamarket.com (link here)  *the World Bank estimates India's GCF at 35% of GDP for 2012. I've used 37%, the ratio derived from the New Series of National Accounts (at current prices) (Table 1). 

NET EXPORTS

Finally, the chart below shows India’s Net Exports or External Balance of Goods & Services (as a % of GDP) vs. the ROW. As you can see, our Net exports (as a % of GDP) improved sharply to -3% of GDP in 2013-14, from -6.7% of GDP in 2012-13 mainly due to a fall in the imports of gold and capital goods. 

Chart 4: External Balance of Goods & Services (as a % of GDP) 

Source: World Bank (http://data.worldbank.org/indicator/NE.RSB.GNFS.ZS)

Ok, that's a lot of charts for one post. Ciao for now.

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1 The World Bank estimates India's PFCE at 58% of GDP for 2013. I've used 60% (for PCFE as a % of GDP in 2013-14) based on estimates from the New Series of National Accounts (at current prices) shown in Table 1.  

2 1.7% is a simple average of USA's annual GDP growth rates (at constant 2010 US dollars) from 2004 - 2013 (based on World Bank data). To estimate India's average growth rate for the same period, I've used annual GDP (at market price) growth rates at constant 2004-05 prices, from the old series of National Accounts for the years 2004-2010. For the years 2011-2013, I've used GDP growth rates (at constant 2011-12 prices) from the new series. The simple average of these annual growth rates (2004-13) is 7.8%. 

Going through Indian Macroeconomic Aggregates from the New Series (2011-12): Production Approach

In my post New Series of National Accounts: The Dork Awakens, I talked about how the new series of National Accounts (with base year 2011-12) released in Jan 2015, was different from the previous series (with base year 2004-05) released in Jan 2010. Take a quick read if you havn’t already. 

In this post, I am going to present the first table from the release titled “New Series Estimates of National Income, Consumption Expenditure, Saving and Capital Formation (Base year 2011-12)” published on 30th Jan 2015, in which the Ministry of Statistics and Programme Implementation (MOSPI) debuted the New Series of National Accounts. 

From this table, we’re going to extract key figures and ratios, so as to get a robust feel for numerical magnitudes and inter-relationships between key Indian macro-economic aggregates. For instance, henceforth, if you come across India’s GDP in the paper, you’ll know that roughly xx% of it  comprises of net Product taxes, xx% of depreciation, xx% of capital formation etc. etc. We’re also going to compare some of these key ratios with those of other developing and developed nations, in order to understand how India stacks up vs. global competition. 

I’m going to conduct this exercise over a series of posts. 

With that introduction, I am pleased to present..........table 1. [Applause please]

Table 1: Key Aggregates of National Accounts at Current Prices


Source: MOSPI Press release 

In today's write-up, I’m going to go through the first box of the table, which deals with GDP measured through the “Production” or “Value added” approach. 

The key formulae to remember here are: 

GVA at Factor cost (earlier called GDP at Factor cost) = Compensation of Employees + Operating Surplus/ Mixed income + Consumption of Fixed Capital (CFC) 

GVA at Basic prices = GVA at Factor Cost + Production taxes - Production subsidies 

GDP = GVA at Basic prices + Product taxes - Product subsidies 

NDP = GDP - CFC                                                                     (Note: GVA stands for Gross Value Added)

Remember from my post New Series of National Accounts: The Dork Awakens that "GDP" now refers to “GDP at Purchaser’s prices” or what we earlier called "GDP at Market prices”, unlike in the previous series where it referred to “GDP at Factor cost”. In-line with SNA 2008 recommendations, GDP at Factor cost has now been relegated to the background and will no longer be discussed in press releases. That said, I’ve added the GDP at Factor cost figures in Table 1 in order to get an idea of the magnitude of production taxes and production subsidies in the India economy. Let’s do that next. 

1. You’ll notice from the chart above, that GDP at Factor cost is actually higher (even though slightly so) than GDP at Basic prices for all 3 years, which is counter-intuitive. The reason for this slightly surprising result is that Production subsidies (doled out by the government), which include losses of government departmental enterprises, input subsidies to farmers, subsidies to village and small industries, administrative subsidies to corporations or cooperatives etc. are higher than the Production taxes received by the government. Net production taxes were around - Rs. 10,000 Crore (-0.1% of GDP) for 2013-14.

Bottom-line, Net Production taxes are usually around a measly -0.1% of GDP. They're insignificant. 

To understand the difference between Production taxes/subsidies and Product taxes/subsidies, read my post Say VAT? ..... And Other Concepts. 

2. Let’s now move to Product taxes and subsidies (these are paid per unit of product/service) which are a significant % of GDP. Product taxes - Product subsidies or Net Product taxes are usually = 7-8% of GDP. Hence, GDP at Basic prices is usually ~92-93% of GDP. This is the case not only for the new series estimates shown above, but also for estimates from the old series for the period 2000-2010. 

3. Consumption of fixed capital is usually ~10% of GDP (in the new series as well as the old series (2000-2010). This implies that Net Domestic Product or NDP is ~90% of GDP.

4. Now, let’s take in/absorb the most important macroeconomic aggregate: the GDP. India’s GDP for 2013-14 (at current prices) was Rs. 1.13 Crore Crore or Rs. 113.5 Trillion. Note: the repeated Crore is not a typo. 

What proportion was this of the world’s GDP? 

Per World Bank data, the GDP of the world in 2013 in current US dollars (i.e. based on the average purchasing power of the US dollar in 2013) was US$ 76.431 Trillion. India’s 2013-14 GDP in current US dollars was US$ 1.863 Trillion1. 

This implies that India’s GDP in 2013-14 was 2.4% of world GDP. 

Let’s put this in context by adding some international flavour, shall we?

Table 2: The EU comprised 24%, the US 22% and China 12% of world GDP in 2013. India’s GDP was 11% of US GDP and 20% of China’s GDP in 2013.

Source: World Bank (http://data.worldbank.org/indicator/NY.GDP.MKTP.CD)

Also note, India has been growing at a much faster pace than the world on average over the last 10-15 years. In 2000, Indian GPD was just 1.4% of world GDP. 

5. Now that we have a good idea of how Indian GDP stacks up internationally, let’s look at our Bank Deposits to GDP ratio. Since I’ve already done a few posts on bank deposit composition/Repo rate cut transmission etc., this is a good next step. 

Why is the Bank Deposits/GDP ratio important? 

It's important because it gives us a measure of the quantum of funds/savings that the banking system is able to mobilize from households and corporations. A higher Deposit to GDP ratio is better for the country, as it allows for greater financial intermediation (i.e. allows banks to mobilize funds from lenders and make them available to worthy borrowers), which is critical for accelerating economic growth. 

Per my calculations, India’s Bank Deposit to GDP ratio for 2013-14 was 66%2. See my note at the end of the post explaining why my calculation is different from the IMF's in the chart below (the   IMF estimates that India’s 2013 Bank Deposit to GDP ratio was 63.4%). 

How does India compare with the rest of the world on this metric? 

Chart 1: Bank Deposits to GDP Ratio (deflated by CPI)
Source: www.datamarket.com (link)

In 2013, the Bank Deposits to GDP ratio for USA was 80%, 78% for the Euro area, 45% for China and 46% for Russia.

As can been seen from the chart above, India has done well in its endeavour to improve this metric. Even though some developed nations have Bank Deposits to GDP ratios of >100%, India’s Bank Deposits to GDP ratio has grown over the decades to a respectable 66% in 2013. 

This has been driven by a significant shift in the composition of household financial savings towards bank deposits since the mid-90s (this is mirrored in the chart above). Over 50% of household gross savings are in bank deposits today. 

I’m going to go through the other sections of the Table 1 in subsequent posts.

********************************************************************************

1 This is based on an average USD-INR exchange rate of 60.9 for 2013 (data point provided by the IRS - here). 

2 Per IMF data (this is what www.datamarket.com uses), India’s Bank Deposit to GDP ratio for 2013 was 63.4%. This is different from my calculation of 66% because: a) the IMF's ratio is calculated after deflating data using CPI inflation, b) it's Deposits and GDP data may be different from the updated figures I’ve used. By clicking on the source link for Chart 1, you can view the notes on the methodology employed by the IMF.

What are Advance Estimates, Provisional Estimates and Revised Estimates?

As a follow-up to my previous post, New Series of National Accounts: The Dork Awakens, I think it’s a good idea to do a quick post on the nomenclature and release dates of annual GDP estimates (for the same year) and related macro-economic aggregates. 

Why? Because there is nothing more annoying on this planet than GDP estimates for the same year that don’t tally. OK, so maybe a guy stealing your parking spot is more annoying, but this is a very, very, very close second.

Let me elaborate. The GDP Estimate for 2014-15 for instance, could have 5 different values depending on when you looked/look up this estimate. In Feb 2015, the Advance Estimate for 2014-15 GDP was released; at the end of May 2015, you got the Provisional Estimate; in Jan 2016, you got the First Revised Estimate; in Jan 2017, the Second Revised Estimate will be released; and finally, in Jan 2018, you'll get the Third Revised Estimate for 2014-15 GDP. Phew! *wipes her brow. 

Why so many revisions? Because it takes time for government agencies to access finalised data required in the compilation of GDP and other macro-economic estimates. See the table below for details (click on table to enlarge). 

Nomenclature and Release Dates for Annual GDP Estimates released at various points of time for a given year:

Source: Ministry of Statistics and Programme Implementation (MOSPI) press releases (http://mospi.nic.in/Mospi_New/site/inner.aspx?status=3&menu_id=82)

Notes:

1 The Index of Industrial Production is released on the 10th of every month with a lag of 40 days. For instance, the IIP for Dec 2015 was released on the 10th of Feb, 2016. On the 7th of Feb of each year, when Advance Estimates for GDP and other macro aggregates are released, only 8 months of IIP data is available for that FY (Apr - Nov).

2  Nomenclature and Release Dates for Annual Crop Production Estimates released at various points of time for a given year:

Source: Ministry of Agriculture press releases (http://pib.nic.in/newsite/PrintRelease.aspx?relid=126120)

This quick read will hopefully save you a lot of future pain!

Ciao.

How the New Series of National Accounts (2011-12) differs from the Old Series

I couldn’t help but get caught up in Star Wars hysteria the last few weeks. (For those of you living under a rock, “Star Wars: The Force Awakens” opened on Dec 25th). Star War references were everywhere – on TV, online, and even at home.

Since you’ve probably endured far too many Star War jokes already................I’m gonna present you with some more. 

Q. Who tries too hard to be a Jedi? 

A. Obi-Wannabe 

Q. What do you call Harrison Ford when he smokes up? 

A. Han So-high

Q. What do you call the website that Chewbacca started that reveals Empire secrets? 

A. Wookieleaks

OK then. Back to business. Let's move on to how the new series of National Accounts, released by the CSO (Central Statistical Office) in Jan 2015, differs from the previous series.

What is a National Accounts Series? 

A National Accounts series refers to estimates of macro-economic aggregates (such as GDP, Gross National Income, Savings etc.) made by the CSO for current and previous years based on a common methodology and pre-determined sources of data. When a new series is released, not only does the base year change (this is the year whose prices are used to make estimates for other years at constant prices), revisions in the methodology of compilation of estimates, adoption of latest classification systems and inclusion of new data sources is also done. As a result, not only do estimates at constant prices change (have to because of new base year) in the new series, estimates at current prices change as well given the changes in methodology and sources of data. 

New National Accounts series (2011-12 base year) vs. prior series (2004-05 base year) 

The new Indian National Accounts series released in early 2015 uses 2011-12 as it base year instead of 2004-05, which was the base year for the previous series. Besides this obvious change, there are other significant changes that one must be aware of:

• GDP at Factor Cost (the key GDP measure used by the CSO so far) will no longer be discussed in government press releases. 

I’ve covered in detail the concepts of Factor cost, Basic price and Purchaser’s price in my previous post “Say VAT? ....And Other Concepts”. Up until now (before the 2011-12 series was introduced), GDP at Factor cost was the key GDP measure used by the CSO. Infact, whenever the term “GDP” or “GDP growth” was used by official government sources, it referred to GDP at Factor cost (usually at constant prices). 

With the release of the new series however, in-line with SNA 2008 recommendations, GDP at Factor cost1 has been relegated to the background and will no longer be discussed in press releases. 

The reason the SNA takes this approach is because there this no observable set of prices, such that GVA2 at Factor cost can be obtained directly by multiplying this set of prices by quantities of output. By definition, taxes or subsidies on production cannot be eliminated from output prices the way product taxes and subsidies can. Thus, the SNA considers GVA at Factor cost not strictly a measure of value added, but rather a measure of income. 

1 GDP at Factor cost referred to as GVA at Factor cost in SNA 2008. 
2 GVA = Gross Value Added 

• “GDP” will now mean GDP at Market prices. 

From now on, “GDP” will mean GDP at Market prices (unless otherwise stated). This is in-line with SNA practice, even though technically the SNA recommends using the term GDP at Purchaser’s price instead of GDP at Market prices. 

Refer to my previous post “Say VAT? ....And Other Concepts” to understand meaning of GDP at Purchaser’s prices.

• Industry-wise estimates will be presented as GVA at Basic prices (instead of at Factor cost). 

Industry-wise estimates will now be presented as GVA at Basic prices, instead of at Factor cost (SNA recommendation again). If GVA at Factor cost is needed, it can be derived from GVA at Basic prices by subtracting taxes on production and adding subsidies on production. 

The reason GVA at Basic prices is preferred is because unlike the situation with factor cost, basic prices can be observed directly and recorded.

• Classification of indirect taxes and subsides into: production taxes and subsidies, and product taxes and subsidies. 

This has been done for the first time. Without this, the calculation of GVA at Basic prices would not have been possible. See my previous post “Say VAT? ....And Other Concepts” for discussion on product vs. production taxes/subsidies.

• Changes in sources and methodology for calculating value added in the manufacturing and services sectors. 

1. Comprehensive coverage of the Corporate Sector (enterprises registered under the Companies Act, 1956) both in manufacturing and services with the incorporation of the annual accounts of companies filed with the Ministry of Corporate Affairs (MCA) under MCA21, their e-governance initiative. 

What is MCA21? 

(I’ve simplified and pasted below sections from the document “MCA21: Improvements in Private Corporate Sector data”– written by Dr. Sunita Chitkara, MCA) 

Under the provisions of the Companies Act, 1956, registered companies are required to file certain documents (Annual reports, Balance sheets etc.) with the offices of various Registrars of Companies (RoCs) (part of the MCA). Thus, the responsibility for collection, compilation and dissemination of basic statistics on the Indian Corporate Sector lies with the MCA. 

MCA21 is an e-governance programme initiated by MCA, aiming to provide easy and secure access to MCA services in anywhere – anytime mode. Prior to the implementation of the MCA21, all transactions, including statutory filings by companies, were conducted in the manual mode using physical paper form. With the launch of MCA21 in late 2006, these forms have been re-engineered and converted into electronic forms (e-forms). Rather than compelling the business community to physically travel to MCA offices, MCA services are now available to them via the Internet at the place of their choice (homes/office). Thus, MCA21 has really helped the business community in meeting their statutory obligations. 

In the previous National Accounts series (2004-05 base year), ASI (Annual Survey of Industries) data was used to gather information on the “organized” manufacturing sector. In the new series, the MCA21 database has been used to supplement the data available from the ASI. 

Similarly the “corporate” services sector has also been covered more comprehensively in the new series given the incorporation of data on service companies from the MCA21 database.

2. Incorporation of the results of recent NSS Surveys –i) Unincorporated Enterprise Survey (2010-11), and ii) Employment-Unemployment Survey (2011-12), along with the adoption of “Effective Labour Input Method” for unincorporated manufacturing and services enterprises. 

The National Sample Survey Office (NSSO) which falls under the Ministry of Statistics and Programme Implementation (MOSPI), conducts surveys on unorganized/ unincorporated enterprises in various sectors of the economy, in order to enable the estimation of (amongst many other parameters) value added in these sectors. 

In 2010-11, the NSSO conducted a survey on all unincorporated (not registered under the Companies Act, 1956) non-agricultural enterprises in the country (excluding those in construction). The total number of such enterprises in the country was estimated at 5.77 crore. The survey estimated (using sampling techniques) various parameters included Gross Value Added (GVA) per worker for manufacturing, trade and other sectors. These recent estimates have been incorporated in the new NAS series, replacing estimates made in dated surveys. 

What is “Effective Labour Input Method”? 

In order to estimate the GVA originating in the unorganized portion of a sector, lets assume the manufacturing sector, the CSO estimates the GVA per worker (from NSS surveys) in the unorganized segment of the manufacturing sector for a benchmark year (generally the year in which the NSS survey is conducted), and then multiplies it with the estimated number of workers in the unorganized manufacturing sector. This is called the “Labour Input Method”. 

With the new series, the CSO has refined this methodology and started using the “Effective Labour Input Method” for estimating GVA in the unincorporated manufacturing & service sectors. This method gives different weights to different categories of workers unlike the previous method, which assumed equal value addition per worker.

• Better coverage of government activities due to improved coverage of local bodies in both rural and urban areas. 

While there are other more specific changes in the new National Accounts series, I have covered the most significant ones. 

Also, the blog police just called..... I have exceeded the word limit. I'm also being fined for "Bad Star War jokes" - I've been assured that really is a bonafide fine category.

Ciao.