Dancing with the Devil. - The Honest Truth By Ajit Dayal
Investing in India - Honest Truth by Ajit Dayal
Dancing with the Devil. A  A  A
13 MARCH 2008

For 4 years now this government has been dancing with the Devil.
As has the previous government.
And while the music was playing, the dancing was joyful.

But the music has stopped now.
The dancing has stopped.
We look up to see who we were dancing with.
And we see the Devil.
The joy has given way to pain and anguish

We should be celebrating.
An economy that has grown at a rate of 6.2% each year for 27 years is a big achievement. Only China has had a rate of growth higher than that of India.
Yet, for the all the spiritual joy this growth rate should have offered us, we wanted something more.
We wanted to be seen at conferences in Tokyo, Hong Kong, London, and New York.
Our leaders wanted to be there.
Which is all fine: it is good to let the world know that India is doing well.
To attend a celebration.
But we went to meet the Devils.

For all their knowledge and all their wisdom, our wise men lost their sense of balance.
They wanted to be “modern”; they wanted India to be “accepted” so they allowed the brokers to talk them into allowing P-Notes to be issued to short term investors.
For all their understanding, they did not recognise the character of the investors whose money they have taken.
Every “ooh” and “aah” they heard after a speech on India’s achievements was mistaken to be a compliment of their India policy.
In actual fact, the “ooh” and the “aah” was the sound of pleasure these short term investors emit when they make money.
They don’t care how they make that money.
It could be profits from trading in India, China, or wheat or steel.
Profit is what matters.
Short-term, month-end profit.

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Imagine a man who wishes to get married to a wonderful lady – someone who will be a mother to their children.
What qualities would a man look for in such a woman? You would need her to be caring, to be comforting, and to be committed – for the long term.
Not someone who would head for the door at the first sign of difficulty.
Given all this, would you go out and marry the lady who rents her body to the highest bidder?
On a daily basis?

India did just that. We married someone looking for an hourly wage.
Our policies encouraged the P-Note punters.
The Reserve Bank of India said “no” to P-Notes in December 2003.
Everyone ignored that warning sign.
USD 52 billion of money flowed into India.
Over 50% of that was P-Note, mostly short term money.
The Index zoomed.
Every news channel was blowing whistles, beating the drums, and waving the India Incredible! flag as the markets hit a series of new highs.

The music has stopped.
Wake up and see who you were dancing with.

The financial policies adopted in India were designed to encourage speculation.
The Devil was in encouraging short term money flows.
The Devil was in rewarding a short term, almost speculative, attitude to investments in the Indian stock market.

Look at the great financial innovations that gave us these wonderful songs and allowed us to dance late into the night.
Leverage: the ability to borrow more, so that one could speculate more.
P-Notes: the disguised route to smuggle short term money pools into the country.

Worse, the Indian taxation regime encouraged people to shovel their money into stock market trading. The tax on profits from short term trading is less than the tax on money earned from starting a real business.
Dwell on that for a moment.
You build a business, you hire people, you try to contribute to society and the profit you make attracts a tax rate of 30%.
But if you punch a few buttons on your rented trading terminals and make a profit from speculation, the profits you made attracted a tax rate of 10%.
This short term capital gains tax is proposed to be increased to 15% in this budget.
What would most sensible people do: face the endless bureaucracy and corruption and struggle to start a new business or learn how to punch buttons on a trading terminal in an air-conditioned room?
A tax rate of 30% after a lot of hard work, or a tax rate of 15% from watching TV channels?

All this innovation and reform was justified by a need to have better liquidity.
And why is liquidity important?
Because theory has it that, the more people buy and sell, the more “correct” the price.
The more correct the price, the more accurate is the Price Discovery.
That is theory.
Practice, in a speculation driven environment, was a little different.

Liquidity only tells you how much money people are willing to throw into a game at any point in time.
It does not tell you whether the price point established is “correct”.
The price may be totally incorrect, but the people playing the game may have a different perspective on what is “correct” or not.
A BSE-30 Index level of 16,000 in September 2007 attracted USD 6 billion of foreign money flows.
The Index is now struggling to stay above 16,000 and there is no USD 6 billion of foreign money pouring in.
Money is moving out.
The “price” is still the same but there are no buyers.
Not because India has gone through some crisis.
Rather, because India has taken money from short-term investors who need to scramble their money back home.
Or need to get on that plane to Polaris to find new sources of funding.

The lady just got a better hourly rate from somewhere else.
She may not have the time to kiss the children goodbye.
Sorry about that.

The shattered husband has to reflect on what he has done wrong and redefine his criteria of a companion.
The attitude towards investing has to change.
The tax regimes have to change to punish short-term activity.
Impose a higher capital gains tax on short term gains.
Shut down the P-Note facility.
Widen – and speed up – the facility for long-term Foreign Institutional Investors.
Make India boring for the rent-me-by-the-hour crowd.
Send the senior members of the government to towns in India on delegations to discuss the potential of the Indian economy.
No more foreign trips to visit the owners of P-Notes.
Allow the Indian pensions to invest up to 40% of their assets in equity.

India is on a wonderful long-term trajectory of positive economic growth.
The stock markets have become an end – they are supposed to be a means to an end.

In the final analysis, a growing economy will result in an expanding stock market and in wealth creation.
While the policy makers figure out the true character of the woman they have married, there is some irrational “price discovery” going on in the stock market.
Use this sell off as an opportunity to buy.

But, yes, please do read the offer documents and understand why you are doing what you are doing.
Dancing with the Devils - with the unknown - can be an expensive experience.

Table 1: Suggested allocation in Quantum Mutual Funds
Quantum Long Term Equity Fund Quantum Gold ETF Quantum Liquid Fund
Why you should own it: An investment for the future and an opportunity to profit from the long term economic growth in India A hedge against a global financial crisis and an “insurance” for your portfolio Cash in hand for any emergency uses but should get better returns than a savings account in a bank
Suggested allocation 80% 15% 5%

Disclaimer: Past performance may or may not be sustained in the future. Mutual Fund investments are subject to market risks, fluctuation in NAV's and uncertainty of dividend distributions. Please read offer documents of the relevant schemes carefully before making any investments. Click here for the detailed risk factors and statutory information”

Note: Ajit Dayal, the author is a Director in Quantum Information Services Private Limited and Quantum Asset Management Company Private Limited. Views expressed in this article are entirely those of the author and may not be regarded as views of the Quantum Mutual Fund or Quantum Asset Management Company Private Limited or Quantum Information Services Private Limited.

Mutual Fund Investments are subject to market risks. Please read the offer documents of the respective schemes before making any investments.

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