Government stuck in a huge debt trap! - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster
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Government stuck in a huge debt trap! 

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In this issue:
» India staring at a full blown banking crisis
» Has Microfinance lost its lustre?
» IMF learns lessons from Greek bailout
» Will excise duty cuts boost consumption?
» ....and more!


00:00  Chart of the day
 
The much awaited Interim Budget is out now . One of the key performance indicators of the Government - fiscal deficit, has been announced at 4.6%; much below the target of 4.8%. Using the tricks like spectrum auction, PSU dividends etc, the Finance Minister has tried to create an illusion that fiscal health is in good shape. However, the semblance of order is unlikely to last. Here is why.

We all know about the Government's borrowings and use of bonds to facilitate the same. Like any other liability, this debt too needs to be serviced with interest and principal repayment once these bonds mature. As per an article in Firstpost, the quantum of interest and principal repayment liability regarding these bonds is more than the fresh borrowing by the Government. This means even if the Government uses all fresh debt, it won't be enough to repay the old one.

Government's Liability Mounting Up
*Projection

But what is the Government actually doing with this borrowed money? As per Fiscal Responsibility and Budget Management Act (FRBMA), the Government should use this money to create assets in order to spur growth. However, we all know that all this money is mainly going to unproductive expenses like subsidies for energy, fertilizer sector. A recent addition to this list is Food Security Bill.

The fiscal profligacy of the Government along with policy paralysis leaves little prospect for growth. Hence, the Government is just increasing debt without ensuring a growth in future. Needless to say, this trend cannot continue forever. Rising government debt, high inflation and slow growth will finally spoil sovereign credit profile. This will impede Government's borrowing and repayment ability, further fuelling the mess in the economy.

There is further opportunity cost related to this practice. High Government borrowing limits funds for Private sector and leads to a rise in the cost of funds required for investment. Along with slow demand and delayed project approvals, the companies are putting investment plans on hold. No wonder the economy seems to be stuck in a vicious circle.

A solution to this could be disinvestment and Privatization. The same is likely to lead to operational efficiencies and better growth prospects. However, the Government has not seen much success with it and instead resorted to tactics like special dividends from PSU companies (in which it is majority shareholder). Thus, instead of improving their prospects, the Government is stripping PSUs of their cash and future investment opportunities.

To conclude, with slowing growth, focus on vote bank politics and lack of investment activity, there seems to be no way out of the huge debt trap that Government is stuck into. The recent estimates for a lower fiscal deficit and promises in the interim budget are unlikely to be kept. Meeting targets on paper with some quick fixes will make the economic issues more chronic. It's time that the Government takes some serious measure for fiscal consolidation.

What measures do you think the Government should take to limit fiscal deficit? Let us know your comments or share your views in the Equitymaster Club.

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01:40
 
The debacle of United Bank of India is just the tip of the iceberg. As per estimates, the bad loans and restructured loans put together may lead to a total write-off of Rs 3.5 to 4 trillion for the Indian banking sector! And what is the FM's response to it? Well, in the interim budget yesterday, FM promised recapitalization of PSU banks to the tune of Rs 112 bn. Needless to say that the incremental capital will just be fraction of the total NPA burden in banks' books. And without any stringent measures to arrest further slippage in asset quality, India is staring at a full blown banking crisis. One that could not just erode shareholder wealth but also endanger depositor money. But FM Chidambaram seems oblivious to these consequences. That India's largest bank had to be bailed out by the LIC for its QIP offer should have been indicative enough of investor sentiments. The RBI has already sounded warnings about the health of the sector. However, without government support to bring the PSU banks in order, 70% of India's financial sector is at the realm of crisis.

02:20
 
What is that one concept in finance that has had the biggest fall from grace recently? There are strong chances that the honours would go to this whole idea of microfinance. At least that's the impression one gets after reading an article on the topic on a leading business portal. Of course, investors in India won't be alien to this downfall. The story of one of the leading companies in this space, SKS Microfinance, has virtually become a case study on how not to conduct a business. Experience in other parts of the world is no different. As the article claims, studies have found microfinance to have had zero impact on poverty alleviation. It isn't that the concept has been totally eliminated. There's still a lot of good that is coming out of microfinance. However, the hopes and aspirations that it once aroused seems to be no more. We are of the view that blind believers in this theory did not take into account the whole eco-system while touting the miracles of micro finance. In a world where cost of living for the poor is increasing at a fast pace, they found it hard for their earnings to keep pace with it. As a result, they were forced to dip into microfinance loans or default on interest payments. Besides, the fact that lenders entered the field with a profit motive also made matters worse. And it is the coming together of these two factors that perhaps dealt the biggest blow to microfinance. Thus, rather than a panacea for all the financial problems that the poor face, microfinance has now been relegated to just another of many financial innovations out there.

03:10
 
In the aftermath of the 2008 financial crisis we saw quite a few countries facing a sovereign debt crisis. Greece was among the first countries to seek a bailout. Now, handling such a financial crisis is a tough job. Decisions taken during such times are very critical and have long term repercussions for all stakeholders involved. Moreover, such instances set precedents and shape the response to future events.

In this context, the International Monetary Fund (IMF) has proposed a new policy to address sensitive matters in international finance. Say for instance, a country is hit by a crisis and is unable to pay up its debt obligations. How should a lender of last resort like IMF respond to such a case? What would be the best way to maintain political, economic and financial balance?

It seems the IMF has learned some tough lessons from the Greek bailout. As per an article in Bloomberg, IMF's first Greek rescue program allowed investors, including German and French banks to be paid in full. In other words, the poor lending decisions went unpunished. Moreover, there are other problems such as countries waiting too long to seek assistance and as a result increasing the size of bailout. As a result, the international lender has proposed some preconditions for financial assistance. The IMF would be the lender of last resort only if private creditors share the pain and accept losses. Will this result in better mitigation of financial crisis? While the IMF's proposal seems logical, whether it will work well in all cases remains to be seen.

04:00
 
The Finance Minister in the recent Interim Budget announced a slew of excise duty cuts. The idea behind being that these cuts would bolster consumption in an economy that has slowed down. But will these really achieve the trick? There is no doubt that the industry as such will welcome these moves. But for consumption to pick up at a really strong pace, some structural measures such as a simpler tax structure will have to be implemented. Moreover, there is no guarantee that these excise duty cuts will necessarily translate into lower prices for consumers. Most of the companies across industries have already been seeing considerable pressure on their margins. So they may not be too keen to pass on the price cuts to consumers. What more, this is ultimately an Interim Budget with not much that can be achieved in a short period of time. It seems more and more likely that it will be upto the new government to provide the direction required for the Indian economy.

04:25
 
In the meanwhile Indian stock markets are trading firm. At the time of writing, the benchmark BSE Sensex was up by 149 points (0.7%). Banking and Capital Goods stocks were the biggest gainers. Most of the Asian stock markets were trading higher led by Hong Kong and Japan. The European markets opened on a negative note.

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11 Responses to "Government stuck in a huge debt trap!"

Basavaraju

Feb 19, 2014

If it is true, our Harward return is giving false figures to the public,who will address these issues, it is very serious issue none of the political parties and even media is not addressing.
God only can save this country,when it is full of insane people who will listen to the logic?


Like 

shrikant kulkarni

Feb 19, 2014

Finance Ministry should be prosecuted for misleading the nation on real Financial Health of Country. Finance Minister as well as Finance Secretary should adhere to Accounting Principles when they expect the same from Private Industry and their Auditors. playing with figures is worst gimmick by Finmin than Satyam fraud. Reduction of Excise Duty on Vehicles and White Goods is not a correct policy. Finmin should have focused on Infrastructure and basic industry to attract Capital Investment and generate employment and then increase demand for Goods.

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U S Subramanya Maiya

Feb 19, 2014

1. Controlling the wasteful expenditure being incurred on the security of Politicians except President and PM.
2. Controlling the non productive subsidy like Food Security. (3) Proper controlling system be placed on Defence procurement, since we hear lot of corruption in Defence deals, thereby save nearly 50000 crs. (4) Tight controls on the bank loans which are being swindled by big corporates, builders, miners, etc, whereby crores of rupees can be saved. (5) Govt should immediately forfeit all the moneys being kept in foreign banks, without delay.

Like 

Sundaram

Feb 19, 2014

It was really frightening while I was reading the article.
I was wondering why our newspapers and media are not highlighting this to the public. This will definitely put more pressure on the Government to follow the right approach.

Like 

Kothandaraman

Feb 19, 2014

1. Govt. should insist the oil production companies to increase the crude oil and gas production to higher targets without any letups.
2. Govt. should stop all free of cost things.
3. If the OMCs are making losses then why they are putting up more more outlets and showing profits. There is some thing is misleading us. This has to be found out and sorted out.
4. Govt. should give high priority to alternative energy development instead of giving free items to the people.
5. Govt. should ban importing nonessential items such as toys and cosmetics.

Like 

Adolf Asir

Feb 18, 2014

To:
Equitymaster, 5 Minute Wrapup

I like to suggest the following steps for early action:

1. There is need for transparency everywhere.
2. Both in the ruling party/ clique and among the opposition party/ parties, at least a Core Group of Economists and intellectuals should be brought into existence, for doing an in-depth analysis.
3. Politicians, instead of all the time blaming the ruling group for all the economic and fiscal mess, should come forward with their own alternative plans and suggestions. EASIEST WAY IS TO BLAME OTHERS, WHAT HAS YOUR PARTY DONE AND IS DOING?
4. Investments on the Social Sector, eg. poverty alleviation (not entirely by doling out money or subsidies) should be greatly done and encouraged.
5. Politicians, all parties included, are more interested in scoring brownie points and exulting on the others' misdeeds and mistakes rather than doing any careful study of the issues involved.
6. MPs who disrupt the Parliament and prevent its functioning should be identified and handed over to the Security or Police for the right 'treatment'. Besides, they can be debarred from contesting the General Elections, as their acts cost Tax-payers' money and are entirely counter-productive.
7. Set up Youth Parliament or Child Parliament, on the lines of the US example for the new generation both individually and collectives to exercise their brains and come up with new ideas and solutions. Educationists and Corporate Houses/ Heads can also contribute much in this area. Provide an expenditure budget from the income earned and give all incentives and tax concessions for promoting such forums.
8. Revamp the Public Accounts Committee (PUC) and make it into a Public Accountability Committee, which should audit and examine, all Plan and Non-Plan expenses in order to arrest needless expenses and improve performance.
9. Panchayati Raj System should be greatly empowered and financed so that the Govt's Poverty Alleviation and other Social Sector programs do not simply waste all the funds allocated, but ensure better end use of such funds.
10. Jan Lokpal should cover all murky and grey areas and bring about the desired changes.

Adolf Asir

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rajen n parikh

Feb 18, 2014

The country's accounts must be shifted to accrual basis from the cash basis presently being followed so that the real truth stares you in the face. Then only will financial reality dawn - on everyone - and political solutions follow.

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DWARAKANATH VALLAM

Feb 18, 2014

1.See whether we can bring back black money hoarded in foreign banks.
2.See whether we can do away with income tax and implement transaction tax wherein every monetary transaction (giving & receiving), whether big or small ( of course we can fix some reasonable limit considering the worth of the transaction) done through any recognised official & legal instrument done by any type of citizen inside the country.
3.Exempt all Educational, vocational, training or human empowerment transaction involving money out of purview of the transaction tax.

Like 

Ganesh Sastri

Feb 18, 2014

Like any body else, GOI should LIVE WITHIN ITS MEANS. Instead of using ABSURD FRACTION like Deficit divided by GDP, GOI should express deficit as percentage of its NON REFUNDABLE INFLOWS. GOI is clearly living BEYOND its means. It is spending three rupees for every rupee of non refundable inflow. This is clearly NOT sustainable. GOI's profligacy has already resulted in MASSIVE inflation during last ten years so much so that while thirty years back you could buy property for one lac, thirty years from now, you can have proper tea for one lac. The high inflation and MASSIVE trade deficit are the major cause for INR to fall from 4.76 in 1966 to where it is now. A weak USD ( which fell from 250 yen to 102 in the same period) has gone up thirteen times.

Like 

M.Ganesan

Feb 18, 2014

Management of finance should be acknowledged as a specialized subject as medical science or Engineering. The finances of the Central as well as the State Governments are largely managed by Politicians and IAS officers who are not competent to understand the nuances of financial management. They see things at a macro level, but what is needed is Micro level management. Will we allow a sick person to be treated by a Politician or an IAS officer? So also the department heads of the Finance Department of the Central and all State Secretariat should be finance professionals such as Chartered Accountants, CFAs, Economists and the like.

M.Ganesan
m.ganesan@sify.com

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