Will the govt.'s populist thrust hurt the economy?

Oct 4, 2011

In this issue:
» Investors are punishing banks
» Hiring in developed world falls
» Euro was destined to fail
» PSU banks to improve pay scales
» ...and more!
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When the UPA government came into power, its main thrust was to improve conditions for the farmers and the poor of the country. Officially, the focus was on inclusive growth and correcting historical wrongs to the disadvantaged. So far the government has failed to actively bring in reforms both in the social sector as well as in the economy. If a wobbly coalition thwarted its attempts to get going in the first tenure, corruption scandals and high inflation have tied its hands behind its back in the second tenure.

At present, economic ills are plenty. Inflation is high, so are government borrowings and the overall deficit. Corruption keeps mounting and nothing much appears to have been done on the oil subsidy front. There is an increasing possibility of GDP slowing down as high interest rates continue to bite. As a result, most of the current government policies seem reactive rather than proactive as many are proposed as and when problems arise.

For starters, it has sought to cut down expenditure in order to bring the deficit down. But most of the cuts are taking place on the capital outflows front rather than on unproductive expenditure (subsidies being one of them). This is bound to have long term repercussions because when government fails to spend on infrastructure, the slowdown can only accelerate as business incomes wither.

The other problem is the commitment of the government to come to the rescue of the disadvantaged. There is nothing wrong with this per se, but the methods employed by the government could come at the cost of economic pressures for the country. The Mines and Minerals (Development and Regulation) Act and the compulsory sharing of 26% of profits with tribals and others displaced by new mines could push up the prices of coal, aluminium, cement and steel and ultimately power and infrastructure. Same could be the case with the Land Acquisition Bill which will push up infrastructure costs again. And the Food Security Bill where higher minimum support prices will only fuel inflation.

Because so many scams and scandals have tainted the image of the government, one wonders whether its policies are aimed at seriously improving the standard of living of the poor in the country or merely to save face and garner votes. Luckily, for India, a lot of strong growth in the past has come in spite of the government. But more initiative on the part of the latter to introduce some long term reforms will go a long way in taking India's economic growth to the next level.

Do you think that the government's populist policies will put further pressure on the Indian economy? Share with us or post your comments on our Facebook page

 Chart of the day
Today's chart of the day shows that effective tax rates (including both income tax and contribution to employee social security) for India is among the highest. This holds true even if you take into account only the income tax component. Interestingly, what makes the overall tax rates high for the developed countries is the higher proportion of contribution that is made towards employee social security. Excluding those, the income tax rates by themselves are on the lower side.

*May 2011
Data Source: The Economist

There seem to be only three ways in which a nation can pay off its debts. Repay, print or default. The first two seems almost out of the equation for several countries like the fabled PIIGS (Portugal, Italy, Ireland, Greece, and Spain) in the Eurozone. Thus, default seems to be the only viable option before them. In view of the increasing possibility of such an event, investors seem to be taking global financial institutions like BNP Paribas, Societe Generale and Unicredit completely to the cleaners. This is because in case of a default, the capitalization of these banks will suffer enormously. What more, even institutions on the other side of the Atlantic have started facing the investor fury. Take Morgan Stanley for example. The banking giant, one of the few remaining independent investment banks, has seen its share price drop as much as 50% in the last one year. The fall is mainly on account of a large exposure to bonds of troubled Euro nations. Executives at Morgan Stanley however continue to insist that the fundamentals of the bank remain as sound as ever. It should be noted that similar optimism was shown by top executives at Lehman Brothers right until the time the bank went bankrupt. Thus, it is only correct that investors are acting twice shy despite being bitten once.

The global crisis is something everyone is talking about. The bleak picture painted for the developed countries is not much of a surprise to anyone. A direct result of this crisis has been the visible change in the employment patterns in the world. As per a report of the International Labour Organisation, the companies in the developed world are rolling back their hiring intentions. The big reason for this is the fear that things are just going to get worse than what they are currently. The governments of these countries are trying very hard to save themselves from another, deeper recession. But unfortunately most of the measures adopted by them to boost the economies have not helped as these were bailouts to help save the sinking ships. Very little was spent on activities that directly help in generating employment opportunities.

At the same time, the employment opportunities in the developing nations have continued to rise. This is even more prominent in the manufacturing sector. So while the developed world is right in cribbing that the developing countries have 'stolen' their jobs, the truth is that they should actually blame their own governments for this. Had the governments focused more on the healthy and performing sectors rather than saving the dead and sinking ones maybe things would have been different.

There has been a growing buzz about the impending collapse of the Euro. You must note here that until last year, the collapse of the Euro was unthinkable. Let's understand the reasons why the Euro was destined to fail. The Euro is a case of a monetary union through the use of a single currency. But to ensure that it works well, member nations have to adhere to strict discipline as far as fiscal deficit, inflation, government debt, current account deficit and such other factors are concerned. The concept seemed to work well for a while. It was only last year that it was found out that Greece had fudged accounts and understated numbers to be able to join the Eurozone. But by then Greece was on the brink of default.

Now, there is a striking difference that sets the Euro apart from the US dollar. While the US central bank can print unlimited amount of dollars to pay up its liabilities, Eurozone members cannot do the same. The Euro is controlled by the European Central Bank (ECB). The other important fact is that about 30-60% of ailing nations had their debts held by other Euro members. So allowing these economies to default meant a major loss to the lending countries. No wonder the entire Eurozone got affected by the debt contagion. In retrospect, it is clear that the idea of a common currency among nations with diverse economic and political pressures was not really a smart thing to do. When and how the Euro dies and what consequences it will have on the globe is sometime to watch out for.

Public sector banks are the true stalwarts of banking in India. 27 of these banks together account for more than 70% of the country's banking sector. They employ over 7 lakh people. However, around 15% of these employees are expected to retire over the next five years. A number of vacancies are expected to arise at senior management levels. But, these banks may have trouble plugging the gaps. Getting top talent from private sector or foreign banks will be a difficult and costly affair. Thus revamping the current archaic system is critical.

As of now the pay scale for bank employees were decided through negotiations between the Indian Banks Association (IBA) and unions once in five years. Employees face delayed promotions, lack of recognition and thus become disillusioned. Attracting and retaining top talent is a major issue at these banks. As per an article in Mint, recommendations of the Khandelwal committee on revamping HR policies may soon be accepted. PSU banks may then be allowed to decide their own wage structure based on individual efficiency and the bank's performance. Plus officers may get variable pay and performance-based incentives. With new private sector banks on the anvil as well, there will soon be a real war for talent in the banking space.

It seems that the commodity dream run has come to an end. Especially for base metals whose prospects are closely linked to the economy. Fears of worsening global crisis have changed the demand-supply dynamics in the industry. After witnessing a rapid rise in last year or so majority of the base metals have corrected significantly. Copper is down by about 23% year to date. Even steel and aluminum prices have declined substantially since the beginning of the year. And this has been attributed to slowing demand particularly from the US and Europe. Further, tighter credit conditions have made inventory financing all the more difficult. This has taken a further toll on prices. Having said that, the demand from China has remained robust. And with the dragon nation accounting for almost 40% of the global demand the overall impact on price has not been that brutal. Going ahead, if the Chinese demand slows down and the credit situation fails to improve in the West we may witness further bouts of correction. And this could spell doom for the industry in general.

In the meanwhile, the Indian stock markets were trading in the red for most part of the day today. At the time of writing, the benchmark BSE Sensex was down by 104 points (0.6%). Barring consumer durables and capital goods stocks, all sectoral indices were in the red. Asian stock markets too were witnessing selling pressure with Malaysia (up by 0.3%) and Taiwan (up by 0.5%) being the only exceptions.

 Today's investing mantra
"The extravagance of any corporate office is directly proportional to management's reluctance toward shareholders." - Peter Lynch

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4 Responses to "Will the govt.'s populist thrust hurt the economy?"

Ashutosh Bose

Oct 4, 2011




Oct 4, 2011

Finally the Government has done what it should have done when we became a Republic. The Mine & Mineral Act, will reduce tension in the hinterland and give the tribal a proper compensation to his only source of income. I don't know how they arrived at a figure of 26%, but I guess even the PSU companies do not even contribute more than 2-3% of their profits, so it is not only the private sector, but even the PSU (Govt) who will get affected by this act. The long term advantage is that our children will hopefully grow in a country with fewer naxals.


Tikam Patni

Oct 4, 2011

All these schemes including NREGA (Gaddha Khodo and Gaddha Bharo Scheme)have twin purposes:

1) Garner Votes easily,
2) Syphon off lacs of crores easily.

Hell with the country and it's economy.

SBI downgrading is downgrading of India, or that is now coming.



Oct 4, 2011

The government of the day talks of the inclusive growth, but the inclusiveness seems to encompass the congress men and their coterie only and the really underprivileged are getting nothing more than lip sympathy from all hues of politicians. The government's governing culture has hit a nadir and they are at a loss as how to proceed further with internal contradictions raging every day. Therefore the present policy will not help the BPL people in an way!

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