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Investing in India - Straight from the Hip by J Mulraj
Overcoming economic ennui A  A  A

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28 JUNE 2014

The UPA went into slumber, and with it, the economy, after various corruption scandals broke out, and, as a result, both the polity and the bureaucracy were loath to take decisions that could be questioned at a later date. The political agenda of the UPA was filled with enactments on welfare that contain clauses which further impede development. The economy stagnated, and investors, both domestic and foreign, were enervated by economic ennui.

The Modi Government has to overcome this. But there cannot be a quick fix solutions. When it tried to correct past neglect in raising passenger and freight rates significantly, there were public protests. A responsible Government has to heed such protests. The hike was moderated. A similar situation will be faced when it tries to start hiking rates of kerosene and LPG; if the hikes are too sharp, it would lead to protests. Overcoming ennui is not easy, especially if the neglect to govern effectively has been over several years, as in the case of UPA.

The Modi Government, to be sure, has been taking steps to chop the economic deadwood. For example, environment Minister Javalgekar has made the process of obtaining environmental clearance transparent, which is very welcome. Transparency reduces corruption.

Modi has also galvanised the bureaucracy into action, assuring them that they would be protected by him for honest mistakes. This, too, is very welcome.

The coming Union Budget, to be presented on July 10, will be the first major policy announcement of the new Government. Arun Jaitley has a mountainload of work to do, and a lot of past mistakes to clear. Some of the Budget proposals would be welcome and others not, but are the cleansing of past sins. The market would react in different ways to the proposals, and there would be a lot of volatility on Budget day.

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For example, the Government has already announced its distaste for 'tax terrorism'. This indicates that it will not make retrospective amendments to tax laws, and will also, probably, be more reasonable in creating the types of disputes that are preventing, say, Eisai Pharma, Mitsubishi, Honda etc, of Japan, from investing more. Eisai Pharma invested $ 50 m. in an SEZ on the assurance that profits would be free of all taxes, was asked to pay a MAT (minimum alternative tax, calculated on book profits) nonetheless. In the case of Vodafone, the former Additional Solicitor General has moved the Supreme Court, insisting that it restrain Vodafone from going ahead with international arbitration.

Given India's huge population (= huge market) and the size of its domestic economy, there is a lot of foreign direct investment waiting, and willing, to come to India. But they need the assurance of a stable tax policy regime. So if, in the Budget, the FM announces an end to retrospective amendments, and a more reasonable approach to disputes, especially over transfer pricing issues, by the IT Department, it could pave the way for more FDI, which the Government needs, to create jobs.

Clearing years of cobwebs built by a sleeping Government won't be easy, as the Government found out in the matter of gas pricing. It is indisputable that India needs to look for more energy resources. The hunt for oil and gas, is a very expensive proposition, which only a few global companies can afford. This is especially true for deep sea oil and gas exploration, in which the daily hire of a rig can be $ 500,000. There is no guarantee that oil/gas will be found to recover spending of a half million bucks a day. The price has to be attractive for operators to bid for oil blocks. But a higher price affects the cost of the electricity or fertiliser produced, using it. So the Government tries to balance the interests of the explorer with that of the consumer. The UPA Government, using the formula worked out by Dr. Rangarajan, (a renowned economist but not an expert on oil) arrived at a rate of $ 8.4/b. The application of this higher price was to be effective earlier, but was postponed due to the elections. It is further postponed, as a result of which stocks like ONGC and RIL fell, impacting the index.

One wonders why India has not moved faster to look for tight gas formations of oil and gas, like in shale rock, using the new technology of hydraulic fracking. The USA has moved the fastest in this, and has produced plenty of oil/gas, and is starting to export some of it. China is believed to have discovered even greater reserves. Why is India lagging behind? Is it because of the time consumed in announcing a price for gas or because India does not have much of tight oil?

Or is it because the rights to oil/gas, or any resources, found under private land, actually belongs to the State, and not to the land owner, as is the case in the US. Companies looking for tight oil/gas are paying a fee to the owners of land for the right to drill for it. Initially, many of the owners were overjoyed at this sudden, unexpected, bounty, until they found that their water was being badly contaminated, and had turned undrinkable and unusuable, due to the chemicals used in the fracking process. The shale industry had managed to obtain exemptions from the applicability of legislations like the Clean Water Act, and are not required to disclose what chemicals they use.

Whatever it is, the Modi Government needs to move forward on gas pricing and speedily take a decision, as outlined in this Business Standard editorial.

An increase in gas prices would translate into an increase in cost of power and of fertiliser, the users of gas, because the Government cannot continue the bloated subsidy bills on these. However, as power minister Piyush Goyal has very rightly pointed out, the increase need not necessarily have to be high. We do not need to accept the 'cost' presented by generating companies as gospel truth. Different states have performed differently. As he points out, Gujarat has succeeded in providing 24X7 power, at reasonable cost (it has had the lowest increases in tariffs across India); yet its power utility makes a decent profit.

In order to increase supply of much needed gas, India is seeking to ask Russia and China to extend the gas pipeline through which the former would supply gas to the latter. The price at which the 30 year deal between the two was concluded is unknown, but stated to be between $ 9-11. By the time it reaches India it would be higher. So a lower price for domestically discovered gas should be acceptable.

Other than provide stable and regular electricity, Modi has also succeeded in tackling the water crisis (see this video. This has had several benefits to the state. Availibility of water has permitted industry to go, and provide local jobs. It has had a massive social and health impact, as women do not need to physically search for water, over long distances. Groundwater levels have risen. If Modi can replicate this all over India, it would be a huge gain for the country.

Steps like providing single window clearances for large projects in steel, coal and power would also be welcomed by industry and by the stock market.

India's infrastructure, in roads, power plants, airports, ports, hospitals, colleges, etc.,needs large investments. The Government is planning issuing more tax-free bonds to fund it. This would be an expensive way to fund infra. Perhaps the Budget may introduce a voluntary disclosure scheme, as a carrot to bring back funds parked in offshore centres. Yes, this poses, as always, a moral hazard. But it also provides a method, easier on the fisc, of investing in infra. It is believed that account holders are more willing to surrender the funds in the bank accounts, than to face action (perhaps jail terms) by bringing it back. So, if given the option of bringing the funds back, no questions asked, at a cost of, say, 50% (or whatever the Government feels would work), it would help fund some of the infra needs.

A carrot needs a concomitant stick. The stick would be in an announcement that investment through P-notes (participatory notes) can be made only if the identity of the holders of the P Notes is declared to the Government. As this editorial suggests, a crack down on P notes, would be necessary.

Such a crackdown would be good in the long term, as it would reduce the market dependence on hot money, which flees at the first sighting of the canary in the mine. In the short term, however, an announcement that P Notes would be permitted only on disclosure of identity, would lead to a sharp fall. It is suspected that a good chunk of the P Note money coming in as FII investment, is actually Indian money on a round trip. It gets the further advantage of being tax free if routed through centres like Mauritius. Its possible that Jaitley would crack down on P Notes.

On the flip side, another announcement would be extremely bullish for the market. This is the proposal to allow Pension, Gratuity and Provident funds to invest upto 30% of their corpus in equity and upto 40% in debt mutual funds. Should this be announced, the market may well go through the roof.

The Budget exercise is shrouded in secrecy, and those working to prepare it are sequestered to such an extent that nobody, not even Luis Suarez, can get a bite of it!

Hence the market was flat last week. The BSE-Sensex ended the week at 25,099, up 5 and the NSE-Nifty gained 2 to close at 7,508.

The factors to watch out for, other than the Union Budget on July 10, would be the progress of the monsoon, which is weak and the progress of ISIS in Iraq. The Iraqi army and institutions were destroyed during the occupancy by the US. Evidence of this is the manner in which ISIS, with an estimated 2000 men, could manage to get the Iraqi army, with 100,000 men, on the run, leaving behind military equipment. ISIS gets its funds from gold lying in vaults of towns like Mosul captured by it. So it gets its money and its equipment, and also gets recruits from the towns it captures. ISIS is now at the gates of Baghdad. A capture of Baghdad, or an encirclement of it to cut off the oil supply pipeline running south of it, would disrupt oil supplies sufficiently to cause a rise of $ 10-15 in crude prices, which would negatively impact global markets.

Another factor of concern is that US Q1 GDP fell at an a rate of 2.9%, worse than the worst estimates. Its consumers are not buying, and that's because unemployment is rising as technology takes over jobs. This is because machine productivity is rising faster. Forget Google cars; think about driverless trucks. These 40 tonne, 18 wheeler trucks, without drivers, were tested for fuel efficiency in a convoy of 4 trucks. The technology permits them to be driven much closer apart than human drivers can; leading to a 7% saving in fuel costs. If successful, trucker jobs (estimated 5 million) would go.

Technology is fascinating, but can be very disruptive, for existing industries, for jobs and for investors who have invested in them. In Tel Aviv they are building sky cars, much like a sci-fi movie, which travel on elevated, magnetic tracks. Users can call for them on demand. India can plan for these in the new cities being built.

In America, cars are unused 95% of the time. Even when they are used, there is usually one passenger in a vehicle built for 5. Most of the energy in the oil is used to drive the vehicle which would be 20 times heavier than the single passenger in it. So the structure of the industry is crying for change in an era where oil is expensive and depleting. The sky cars, or the driverless google cars, would be a way forward. This would mean that existing manufacturers would have to develop such products. Demand for private ownership of cars would also go down if services like shared cabs (Uber) become popular.

Just as it has assured bureaucrats of its protection, the Modi Government must assure duped investors of protection from fraudsters and crack down with harsh punishment on those who commit fraud. In the NSEL case, the Monitoring and Action Committee set up by FMC has ordered the defaulters to deposit their title deeds with the court, to enable sale of the assets purchased via the fraud.

Why does it take so long? There is, after all, no dispute. The borrowers have accepted they have received the money. There is no contention. They have to return the money, together with interest for the delay. Unless investors are protected, and feel safe, all of Modi and Jaitley's plans to grow the economy would come a cropper.

There will be increased volatility on Budget day. Whether the market reacts more negatively to the expected changes in P Note investing, or more positively to the expected increase in flows from PFs, pension and insurance companies, is to be seen. Perhaps there could be a dip before the next rally. Buy on a dip.

I thank Equitymaster for the opportunity to post my columns, and my readers for their unstinting support over the years.

J Mulraj is a stock market columnist and observer of long standing. His weekly column on stock markets has run for over 27 years. An MBA from IIM Calcutta, he has been a member of the BSE. He is Conference Head - India, for Euromoney. A keen observer of events and trends, he writes in a lucid yet readable style and takes up issues on behalf of the individual investor. Nothing pleases him more than a reader who confesses having no interest in stock markets yet being a reader of his columns. His other interests include reading, both fiction and non-fiction, bridge, snooker and chess.

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6 Responses to "Overcoming economic ennui"
Krishna Moorthy
Jul 22, 2014
Mulrajji, What a Pleasure it was ? Your wonderful articles have spread knowledge across a spectrum of people. Microscopic knowledge combined with a macro outlook with a little bit of aggression - I believe - contributed to the magnificent articles.

Any how I won't be missing ur articles as iam a subscriber of Mint.
Thanks to the Equity Master for providing a platform with wonderful articles.
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Parag
Jun 30, 2014
Dear Sir,
You have shared so much of knowledge with us for so many years. We sincerely thank you for this.

Thanks,
Parag
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yrsharma
Jun 30, 2014
Since long, I have got into habit of eagerly waiting for this weekly column and is part of my life now. Its short and very relevant, and shares great insight of whats happening around from economic perspective. Thanks Jawahir for these insights, and I would miss your post very much. Like 
viren thakkar
Jun 30, 2014
Dear Jawahir Sir,

It is like i am losing a family member in the world of finance. I have been following your posts since you wrote in The Times Of India. Then suddenly you vanished without a trace. i did manage to find you on Straight from the Hip post. But now what. i will have to search for you all over again. But i am hopeful, i will find your columns. You are "GOD of small investors"
Like (1)
chandra shekhar sood
Jun 29, 2014
It has been great reading the honest and straight forward comments of Jawahar. Yes, there have been times when being a professor of political science I have found it difficult to agree with some of his political views; but, there has hardly been any skepticism about his economic views. India would surely be a much better country to live in if more, and many more, might muster the courage like Jawahar to call a spade a spade and face the truth squarely. Like (1)
N.M.R.Shreedhar
Jun 28, 2014
As always, very concise and well articulated-- sorry to hear that Mr.Mulraj will no longer be writing for Equitymaster--I am sure, sir, many readers will miss your incisive and thoughtful views on the economic scenario in the country--hope you will return soon !! regds Like (1)
  
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