FM's fiscal gimmick will be dangerous

Oct 25, 2013

In this issue:
» The biggest mistake that economists have made!
» The most influential shareholder activist in the US
» Major asset bubbles in London and China...
» Is another crisis brewing in the Eurozone?
» ...and more!

Time and again, we have discussed how politics and economics are inherently conflicting. And that, political motives almost always tend to override economic priorities. With the forthcoming general elections inching closer, the murky political game has become more and more evident.

Here is the latest proof. But before we get there, let us give you a brief backdrop. As you would know, there are serious concerns about whether India will be able to reign over its bulging fiscal deficit. In simple parlance, fiscal deficit is the excess of government's expenditure over its revenues.

All this while, Finance Minister P Chidambaram seemed quite determined to limit the fiscal deficit for the ongoing fiscal 2013-14 at 4.8% of GDP. But with the swelling food, energy and fertiliser subsidies, fiscal consolidation seems like a far-fetched goal.

Economic logic would suggest that the FM should cut down expenditures, particularly subsidies. But given this is an election year, cutting down subsidies would be equal to political suicide. Further diesel price hikes until elections seem a bit unlikely.

So how can the government achieve its 4.8% fiscal deficit target without curbing subsidies? Chidambaram seems to have found out an easy way. The answer is outright accounting gimmickry. Yes, that's true!

As per an article in Reuters, the government is considering rolling over US$ 15 bn worth of subsidy costs into next year's budget. What does this mean? It means that there will be no subsidy cuts in the current fiscal. Just the subsidy payments would be delayed and accounted for in the next budget.

What a maverick scheme! The government will achieve its fiscal deficit target without having to cut down on subsidies. But what about next year's budget? It will have to bear the burden of the subsidy rollover as well as the massive food security programme.

But who really cares! At the moment, winning the upcoming general elections seems to be the only thing that matters. The reason we ought to worry is because the government seems unhesitant to jeopardise the long term economic interests of the country in its pursuit of short term political ambitions.

What are your views about the government's plan to rollover subsidy costs into the next budget? Let us know your comments or post them on our Facebook page / Google+ page

Editor's note: As your trusted source for views and opinions, we know that you expect a lot more from The 5 Minute WrapUp. We know that there are many other asset classes besides stocks that you want independent opinions on. It is to address this need that we have launched The 5 Minute Wrapup Premium. Here you can expect our views on not just asset classes like gold, fixed deposits, mutual funds and real estate...but also get a peek at how Equitymaster is viewing the global opportunities and risks in investing.Click Here for full details...

 Chart of the day
We recently showed how retail participation in Indian stock markets has been on a wane. Here is another proof that retail investors have been pulling out of the markets. An article in Business Standard has reported the findings of a study carried out by India's premier B-School Indian Institute of Management, Ahmedabad. What is a prominent feature of the shareholding pattern in India? As per the study findings, the answer is concentrated ownership and control. From 2001 to 2011 December, the controlling shareholders have further increased their stake in the Nifty domestic companies. On the other hand, non-institution retail investors have witnessed their share going down. It is worth noting that this trend is in line with the trend in the developed markets. In our view, the global financial crisis of 2008 and the following economic instability have severely eroded the confidence of retail investors. And as such, their participation and shareholding has substantially declined over the decade. Moreover, poor corporate governance and weak regulatory oversight has also dented investor sentiments.

Share of retail investors declined over the last decade
Data source: Business Standard

-- Wasn't Gold Price Bubble supposed to burst in 2011? --

In August 2011, Gold price dropped by 6% from its peak.

Many believed that the metal will drop even further and the Gold Bubble was going to burst!

But in our September 2011 editions of The 5 Minute WrapUp , we said that Gold would not only continue to be a safe haven for investors but would also witness a significant price hike.

However, as we could not give recommendations in our e-newsletter, we couldn't recommend our readers to Buy Gold...

And over the next 2 years, against everyone's opinion and exactly as our research team had predicted... the price of Gold shot up from Rs 25,400 in September 2011 to above Rs 31,200 by the end of August 2013!

Now, to ensure that you don't miss out on any such investment opportunity again... we're changing our e-newsletter.

Now, The 5 Minute WrapUp Premium will tell you all about such investment opportunities and give Actionable Investment Ideas in assets like Gold, Stock, Fixed Deposits, Bonds, and so on.

How can you upgrade to The Premium version?

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There's no question that mankind has seen its quality of life improve a great deal over the past many centuries. Just for perspective, even a commoner today has far more tools and luxuries at his disposal than say a ruler of some princely state a couple of hundred years ago. And most of the credit should go to the breakthroughs in the scientific world. Little wonder, scientists and their sciences have come to be revered as the most sought after profession. So much so that even practitioners of a non-scientific discipline like economics are hell bent on calling economics a science.

Nothing could be further from the truth though. Sciences have what are known as universal laws. Water boiling at 100 degrees Celsius will still boil at 100 degrees Celsius no matter how many times you conduct the experiment. But will an economy or say interest rates in a country obey this rule every single time. Highly unlikely! Besides, the outcome of a scientific experiment will not change no matter what we think about the experiment. But an economic experiment will fluctuate significantly based on the thoughts of its participants. For example if all participants think that the price of stock should be Rs 100, there are chances that stock price would eventually go to that level. Think it as Rs 50 and it may well come down to those levels. Thus, it is imperative that economists give up their obsession with science. The sooner they do this, the better they will be able to appreciate the strengths as well as the limitations of their discipline. And also be able to formulate much better policies we believe.

Shareholders are owners of the company. This gives them a right to air their views in critical company matters. However, shareholder activism in India is virtually absent. But there is one gentleman in US who has re-defined the term shareholder activism there. It would be an understatement to say that he has transformed the corporate practices of US. His name is John Chevedden. Though unknown to many this gentleman is currently the most influential shareholder activist in US. His strategy is simple. Bring in more transparency in business proceedings. And ensure that the interests of minority shareholders are not compromised.

Executive pay, fringe benefits and board independence are some matters where interests of minority shareholders suffer. For instance, management can pass a resolution to increase executive pay even when company is making losses. Such a move is uncalled for when business is incurring losses. And John Chevedden is taking guard against such business practices. For instance, as per Chevedden's proposal one CEO of a top bank was required to hold his stake in the bank for one year until he retires. This shall rule out any possibility of trading on material insider information. He has instituted many such steps which have brought in more transparency in corporate America. Perhaps it's high time India needs its own John Chevedden! Only then the governance standards will improve.

The interesting part about asset bubbles is that very few seem to recognize one till it bursts. The danger is that when the bubble bursts, there are losses and pain all over. The question then is why is that is there no way to recognize the bubbles when they are at early or mid stages? Well the answer is that yes there are ways. And people and legislators are well aware of these methods and ways. Then why is it that no one recognizes them? The answer is that because they don't want to.

At least this is what Societe Generale's analyst, Albert Edwards thinks. In an interview to Business Insider, he has stated that the same people who failed to see the bubbles that caused the crisis earlier; are still failing to see the bubbles now. In his opinion the major asset bubbles this time around are those in the housing markets of London and China. These are mainly caused by the cheap money that is being pumped into the global financial system. And the lack of strict regulations to control asset bubbles. We think that London and China are not the only ones that are seeing asset bubbles. The cheap money is fuelling many more assets all around the world. And when they burst, the pain for global markets and investors would be intense.

It was not until economies like Greece, Spain and Ireland went nearly bankrupt that one really understood the meaning of sovereign debt crisis. However, Europe's problems do not start and end with the sovereign debt crisis. The debt crisis in Euro zone is far more entrenched. And far more deep rooted than ECB chief Mario Draghi would like to acknowledge. Not too long back, the chief of European Central Bank (ECB), promised to do 'whatever it takes' to preserve the Euro. However, as per Economist, given the proportion of zombie firms and over indebted households, things may well be beyond Draghi's reach. For the time being Mr Draghi has scheduled an inspection of the balance-sheets of the region's 128 biggest banks. This asset quality review will let know the risks in the balance sheets of banks and which ones should be shut down. However, the too big to fail banks in Europe and not just the US have always got a preferential treatment from politicians. Hence one wonders how effective will be this quality review. As per Economist, in countries like Portugal, Spain and Italy, nearly 40% of the firms cannot even afford to pay interest on the funds borrowed, leave alone repaying them. In such a grim scenario, Mr Draghi's plans do not seem very convincing.

In the meanwhile, the Indian stock markets were trading below the dotted line. At the time of writing, the benchmark BSE-Sensex was down by 24 points (0.12%). Stocks from the capital goods and realty sectors were the leading losers, while those from the IT space were amongst the top underperformers. Major Asian equity markets were trading in the red led by Japan (down 2.8%) and China (down 1.5%). The European markets have also opened on a negative note.

 Today's investing mantra
"Investors making purchases in an overheated market need to recognize that it may often take an extended period for the value of even an outstanding company to catch up with the price they paid." - Warren Buffett

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16 Responses to "FM's fiscal gimmick will be dangerous"

Arun Draviam

Oct 26, 2013

Long term growth of the economy is bound to suffer under P. Chidambaram's regime. In 1997 he boasted of the Tax Amnesty. The quantum of gold declared by the by now familiar black market operators and tax evaders, was more than the quantum of gold that has been dug out of mother earth's womb. The nation is suffering due to the non-retrieval of the black money held with Swiss Banks. Surely Chidambaram is not going to do anything about it.


Pavan Jain

Oct 26, 2013

This is nothing but jugglery of numbers. The way Govt is hellbent to entice the voters by whatever means, fair or foul, we seem to be heading for disaster, economically and otherwise.


krishna Murthy

Oct 26, 2013

When ever policy, legislation have been formed then it must have atleast 100 years of future perspective and good control which should not give give room for manipulation or mis use. Unfortunately all the present govt had is half hearted with out any control, room for bickerings, which is the fancy of the present govt and above all they call this as democracy an new definition given by the so called nth rated PM and FM of this nation.See PC parakh,s letters .


Kuruvilla Abraham

Oct 26, 2013

If the current team comes back to power they can immediately take action to cut the subsidy of fuels like diesel and LPG. Within a six month period step by step they can absolutely get rid of the fuel subsidies. This will save a lot of money for the government which in turn can be diverted to food security, agricultural sector and tax exemptions for new small scale and medium scale industries. It is the import bill of petroleum which is draining a lion's share of the country's revenue.


Ranjit Bakshi Gupta

Oct 26, 2013

This is because the Madam wants to see his son in the throne of India.. For that if the economic conditions of India goes down to (-) GDP , kutch poroa nahin.



Oct 26, 2013

The maverick finds an easy solution to brag forever. More than achieving his target by foul play, the sadist must be deriving immense satisfaction from adding to the burden of the next government (which he is sure is not his!). Congress followed this same cheap tactic in rushing through the Food Security Bill posting the burden to torture the next government. What a well-wisher of INDIA!



Oct 25, 2013

Another clever and irresponsible attempt by FM, to through some more dirt under the carpet. Congress anyway knows they are not likely to return to power in 2014; so they do not have to clean this mess,I sincerely wish this government goes tomorrow without hurting the economy any more with long-standing liabilities. This also helps in stopping CBI to release some more criminals free and closing all the obvious cases against these anti-social elements.

Like (1)


Oct 25, 2013

Sir, In the absence of a Responsible Opposition, Thinking Electorate,Political Parties with integrity,Nationalism and clear vision, any gimmicks are bound to happen in India in election years and is justified. The Blame game,'Onion Crisis', Imaginary Scams,'CBI investigations of age-old cases' to tame the opponents are the 'Order of the Day' in election years here. Politics of hatred,opportunism,unscrupulous strategy decides the winner in Indian elections.How can we tell - one gimmick is healthy and the other is dangerous.

Like (1)


Oct 25, 2013

the roadside chanawala/hawker can manage his finances better because it his own money and not public money.

Like (1)

K N Hegde

Oct 25, 2013

Learned Friends,
In response to the note reg declining retail investors in indian equity market, I submit the following remedies.
1. Stock-exchanges should not be permitted to make profits. It should be a NO-loss NO-profit concern. Broker-companies have become necessary evils all over the universe.
Therefore exchanges must not give any leverage or the exposure to the individual trading a/c holders. The brokers exploit retail investors and traders by giving extra ordinary leverage & thereby suck the entire margin amount of customers.
Forget 2008. Restrict bro-companies. Bar exchanges from making profits.
Tell RBI that inflation management is not its concern.
Beware of P C, dangerously manipulative, misusing his brains to hoodwink public ,must be told to control inflation efficiently.

Like (1)
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