New Cost Inflation Index – know about it

One of the important aspects in personal finance is to keep track of the regulatory and policy changes in order to see if they affect you in any manner. While a lot of these changes are announced in the budget speech of the Finance minister, several of these can and do happen throughout the year. One such thing which many of us have missed is the new Cost Inflation Index ( CII ) with the new base year ( FY 2001-2002 ). Let us see what the changes are and what does this mean to you.

For those who are interested in the CBDT notification of the new CII read here. In simple terms the base year for the earlier CII was 1981 and the base was taken as 100. Every year the government announced the CII for that FY. In the year 2016-2017, the index was at 1125. In real terms it meant that if you had acquired an asset for 100 Rs in 1981 and was selling it in 2016, then you could take the cost of the asset to be 1125 Rs and look at your capital gains accordingly. Let me give a real life example to make this clear.

  • Assume you bought a 3BHK flat in Kolkata for 18 lacs in 2001.
  • You wanted to sell it in 2016 for 1 crore.
  • CII in 2001 was 426 and in 2016 was 1125.
  • The indexed purchase cost to be taken in 2016 will be 1125/426 x 18 lacs or 47.53 lacs. The capital gain will therefore be 53.47 crores.
  • You can use the capital gain in buying another property or invest it in Capital gains bonds to avoid taxation.
  • In case you do not do the above you will be charged at 20 % tax on the capital gain.

What are the changes then? As I said before, the new base year is 2001-2002 and the base is taken to be 100 for that year. The CII for subsequent years have now been recalculated and for the current FY 2017-2018 it is 272. Any asset sale being done in this year will be governed by the new Index for the purpose of capital gains determination and taxation.

Let us take the previous example now and assume that you sell the flat in 2017, instead of 2016. The indexed purchase price now will be 272/100 x 18 lacs or 48.96 lacs. For an apple to apple comparison if we took the 2016 CII of 264 then the indexed purchase price will be 2.64 x 18 lacs or 47.52 lacs. This is virtually the same as with the old CII.

How will the impact be on the Long term Capital Gains calculation of Debt funds or Bonds etc? I will cover this in the next post.

Educational costs & inflation – A personal perspective

May is that time of the year when all parents of college going children have to figure out ways and means of arranging the fees for the upcoming semester, term or year in college, as the case may be. I have been in this situation for 5 years now and am likely to be in it for a few years more, given that I have two children.

Let me give a brief background for new readers here. My daughter Rinki has graduated from BITS Pilani, Hyderabad campus with BE in ENI. After her graduation in 2016, she has joined XLRI for their BM program and has now completed her first year there. My son Ronju is doing a 5 year dual degree course from BITS Pilani, Goa campus in Msc Maths and BE Computer Science. He will graduate in 2019 from there. If you are interested in knowing more about the overall costs and how I arranged for the funds etc, you can read up several posts available in the blog under “Education” category.

In this post I particularly wanted to discuss about the overall costs of a college degree in BITS and the inflationary nature within the course. Unlike some colleges, which give you a total figure for the 4 or 5 year course when you join, BITS only talks of the first year costs and then increases it every year. They have been transparent to say that the fees can increase by up to 15 % a year and, more often than not, it actually increases by that much. Let me take the component of the Tuition fee and see how it increased during the time Rinki was in college :-

  • In her first year 2012-2013, Tuition fee was 70000 per semester or 1.4 lacs in the year.
  • In 2013-2014, it was 78000 per semester or 1.56 lacs for the year.
  • In 2014-2015, it was 89000 per semester or 1.78 lacs for the year.
  • In 2015-2016, it was 101000 per semester or 2.02 lacs for the year.

Now apart from these there were Admission fees, hostel fees, mess fees, personal expenses, travel, practice school fees etc. From my notes I can see that the total expenses for her college degree was approximately 12 lacs.

At XLRI the overall costs are in the range of 24 lacs and you can add another 2 lacs or so for travel etc. Therefore her total Education costs in college is about 38 lacs.

For my son Ronju the last 2 years of Rinki will be common. Beyond this the fees for the other 3 years are as follows:-

  • in 2016-2017, it was 1.13 lacs per semester or 2.26 lacs for the year.
  • In 2017-2018, it is 1.30 lacs per semester or 2.60 lacs for the year.
  • in 2018-2019 it will be 1.5 lacs per semester or 3 lacs for the year.

Therefore for Ronju’s graduation the overall costs will be in the range of 20 lacs or so. I have not thought about his PG yet, as he is not sure whether he wants to do one. However if it is from a good B school, it will be in the range of 28-30 lacs. Assuming this to be the case, his total costs of college education will be in the range of 50 lacs or so.

From the above data you will be getting a pretty good picture of the educational inflation too. In 5 years the tuition fees has increased from 1.4 lacs to 3 lacs. The other costs have also increased and as you can see, a 4 year course for BITS starting today will easily cost more than 22 lacs or so, all things considered. Just the Tuition fees will be 13 lacs or so.

How will this look if your child is starting college after 15 years? Well, at an inflation of 15 % the tuition fees alone will be 1.8 crores. I know this sounds fantastic, but remember just 10 years back the Tuition fees of BITS was 50000 a year and it has gone up more than 5 times.

I am happy to spend this amount on giving a good education to my children as it is going to be a huge competitive differentiating aspect. However, I was able to do so as I prepared for the same in terms of my planning. Even then the inflation was surprisingly high and I had to rejig some of my plans.

You need to work on your plans right now and put them in place.

A layman’s guide to capital gains and indexation

It has recently come to my notice that capital gains and indexation are two aspects of personal finance that many investors do not have a clear idea about. I was speaking to one of my friends the other day and he told me that he leaves such things for his CA to worry about. While, you can obviously take help of a CA to decide on how to deal with your taxes, it is important for every investor to understand these, especially in the context of debt instruments.

Let me start with capital gains first. We buy assets, physical or financial at a given price. For example the apartment that I bought in Chennai, cost me about 35 lacs in 2003. You may be doing a monthly SIP of 10,000 Rs in one MF scheme regularly. When we sell the asset at a later date at a higher price, the gain made out of such a transaction is termed as the Capital gain. In other words, Capital gain is the difference between the sale price and the acquisition price. Of course, if you are selling your asset at a lower price then there would be a capital loss. This is normally relevant for depreciating assets such as a car, which will fetch a lower value normally when you sell it after a few years.

Capital gains are part of our income and hence they need to be taxed. For the purpose of taxation these are classified as Short term or Long term. Depending on the asset, if you sell it within a defined time period the Capital gain is categorized as short term. Anything beyond this period will be treated as Long term capital gains. This distinction is very important from a taxation perspective. For example in the asset class equity, if the sale of the asset is within one year of acquiring it then it will fall under STCG. This will then be taxed at a rate of 15 %. So if I buy 500 shares of TCS at 2000 Rs and sell them within 6 months at 3000 Rs, my STCG will be 5 lacs and I will need to pay a tax of 75000 Rs in the year of sale. 

Now for equities the Long term capital gain is applicable after one year and LTCG is currently not taxed. So in the same example as above if my holding period of the 500 TCS shares was more than one year, my LTCG will be 5 lacs but I will not be paying any taxes on it. This is true for any equity based asset such as Equity MF or a Balanced MF where the equity holding is more than 65 %.

It would be nice if LTCG for other assets were like equity but it is unfortunately not so. For Real estate and Debt instruments the LTCG applies only after 3 years. So if you invest in a debt MF today and redeem it in less than 3 years, the gain you make will be STCG and get added to your income. Also, unlike Equity the LTCG is not exempt from tax. However, recognizing the fact that inflation will have an impact on dampening the gain, a concept of indexation is used to calculate LTCG. The way this works is explained below:-

  • Cost Inflation Index of the year 1981-1982 is taken as 100. Based on inflation from that point the index is revised every year. The current index for 2015-16 is announced at 1081.
  • What this really means is an asset bought in 1981 needs to be indexed at around 10.81 times, in order to counter the effect of inflation, the asset cost in 1981 needs to be multiplied by 10.81 to get a fair value of cost in 2015.
  • The LTCG can now be calculated with this indexed acquisition cost figure.
  • For example I purchased my flat in Chennai for 35 lacs in 2003-2004 when the Cost Inflation Index was 463. If I want to sell it in 2015, when the Cost Inflation Index is 1081, the indexed purchase cost will need to be calculated by using the formula 1081/463 x 35 lacs. So the indexed cost will come out to be 81.7 lacs.
  • So if I sell my flat for 1 crore today, the LTCG will be 18.3 lacs.
  • This then will be taxed at 20 % in the relevant year of sale.

How does indexation help in debt investments and how are things changing on that front? I will try to address this in the next post.

The changing landscape of debt investments

While all the noise and excitement is normally about the stock markets, I think it will be fair to say that most investors in India historically have always depended on debt for their short and long term investments. Whether you look at the number of investors or at the financial assets invested, this conclusion is an inescapable one. Even for investors focused on equity, the almost automatic investments in FD, RD, PPF / NSC and of course PF is a reality. This is also a good thing as I am a staunch believer in having a solid bedrock of debt investments for giving stability to any portfolio.

In the present investment climate of India, the significant changes that are happening to the debt instruments and their potential returns have almost gone unnoticed. It is important to understand the changes to the landscape and more importantly, what will be the impact on the investors who are investing primarily in debt instruments. Before we look at the various classes of instruments, we need to understand the main reasons for the changing scenario.

As most of us know, returns from debt instruments have always been closely linked to the prevailing inflation rates in the country. Obviously, if the inflation is high the returns from such instruments also needed to be high, in order to remain attractive for people to invest in them. While inflation figures and interest rates have fluctuated over the last few decades, in general they have remained high. I remember the PPF rates used to be 12 % when I started investing in it more than 20 years back and went down to 8 % at it’s lowest point. Interestingly our financial institutions are quicker in lowering rates when needed and quite sluggish in raising it when the inflation gets higher.

Now all high inflation economies will get control over inflation as time goes by. Developed nations have lower inflation and going forward it is quite possible that we will be looking at inflation rates lower than 5 % before long. As the RBI Governor has signaled, it is going to work in closer coordination with the government on the policy rates. This essentially means the returns from debt instruments are going to change. What is more, with inflation being tamed, the changes in the returns may well be more permanent in nature than what we have seen earlier.

Bank FD s are always the first product to have the rates revised and this has already happened. Most banks are offering rates lower than 7.5 % now and even for senior citizens the highest rates available is 8.4 %. My parents have some FD s started a year back and they were getting 9.5 % in those. It is quite possible that over the next year, as policy rates go even lower with inflation declining, the FD rates will drop to below 7 %. This will be quite significant as I cannot remember the last time when these rates were below 7 %.

The other important impact will of course, be on the rates of the small savings schemes such as PPF , POMIS etc. The RBI has recommended that returns from such schemes be aligned to the bank interest rates. While this will be politically a tough thing to carry out immediately, over a period of time this conclusion is an inevitable one. The PF rates again will quite possibly be revised downwards, though even here it will be a difficult decision to implement.

What about debt mutual funds? Well here, the returns impact will depend on the type of funds we are talking about. Liquid funds and MIP etc will have lower returns. Investing in FMP seems to have very little point now. Gilt funds and other debt funds will have higher returns in a declining interest rate cycle and they can be invested in. However, with lower inflation we will also have a dampening effect on the Cost Inflation Index. This will essentially mean that the effective taxation on the capital gains will be more when you redeem your debt funds. This is too complex to explain in the context of this post, I hope to write a post on this later in the week.

The above would have shown you that there aren’t a whole lot of options as far as decent returns from debt instruments are  concerned. What should be the debt strategy then? Let me write about this in my next post.

How I plan to invest in current rate regime

Things can really change first in the investment world and unless we are monitoring our investments for these changes we can well be caught unawares. This happened to me recently and had led me to look at some changes in the way I operate with my investments. As part of my emergency fund, I had a small investment in a Liquid fund now for over 3 years. In the beginning the IRR used to be around 10 % and it came down to something like 9 % in 2015 first half. This week when I looked at it, post the rate cuts, I saw that the IRR was only 7.85 %. I have of course, redeemed the fund now.

Fortunately, the price paid for my negligent attitude was not high in this case and it was a good lesson learnt. It also set me thinking as to what will be the effect of the interest rate changes on my investments and whether there is a need to revisit some of my investment decisions made earlier. One thing is clear – we are not looking at a just one-off rate cut here, there is every possibility that we are in the beginning of a low inflation, low interest rate cycle. This will definitely have an impact on my own situation in terms of my current passive income, my current investments and my future needs.

Let us see how each of these are likely to be affected:-

  1. My passive income is made up of interest from tax free bonds, rental income, capital gains from debt funds (mostly FMP) and dividends from stocks/MF.
  2. Out of these the capital gains from debt funds can get affected positively for debt funds with maturity periods of more than 3 years as interest rates decline. The others including FMP will really be immune to the rate changes.
  3. If I take my retirement to be 8 years away, it is likely that the level of inflation will reduce and this will hopefully mean that I need a lower corpus to retire with. However, my policy has always been to assume a zero rate of real returns in the post retirement period. With this conservative approach in place, the retirement corpus I look at is pretty much the same for all levels of inflation.
  4. As far as my investments go, there will be serious implications there, mainly in the following areas:-
    1. The PPF rates will decline significantly to 8 % or less and this will impact my corpus to an extent.
    2. I have some investments in debt funds, other than the FMP variety. These will have lower returns for the Liquid and short term funds and a slightly higher return for the longer term funds.
    3. The FMP returns will be largely unchanged for the ones which I will redeem at maturity. For the few which I need to roll over because of tax purposes, the returns will definitely get lower.
    4. Equity performance should generally improve over this year and the next few years.

Based on the above, the following are the actions I will take on my investments:-

  • Keep my investments in PPF going on, even at lower rates this is going to be one of the better instruments.
  • Redeem all Liquid and short term debt funds, returns from these will get progressively worse with time.
  • Not invest in any future FMP as it does not make sense any longer. Any redemption from existing FMP, I plan to put the capital amount in longer term debt funds and/or Arbitrage funds.
  • As I said before, for MF investments I will stop my standard SIP and look at targeted one-time investments, which will largely be done in an overall manner.
  • As money becomes available from debt redemption, I plan to keep investing more in equity over a period of time.
  • In the above scenario, while the overall returns on my portfolio can get lower, my cash availability will be high. I am therefore looking at going on a vacation to South Africa next year and hopefully pay for my daughter’s MBA from my own resources, should she be getting into a good institute.

I suggest you do this exercise for yourself and see how your investments are likely to get affected and therefore, what investment decisions and actions you need to take. Remember, this can very well be the beginning of a different cycle in our economy and business. Changes are absolutely required, only question is what and how.

In the next post, I will write on the outlook of medium and longer term inflation and how it can affect each one of us.