Needed - financial reengineering

27 FEBRUARY 2010

The good thing about the Union Budget was that there was no tinkering, introducing obnoxious taxes like the FBT or a tax on cash withdrawals. Stability in fiscal policy is very welcome. The bad thing about the Budget is that non plan expenditure, comprising mainly of interest payments on past debt, and subsidies given by Government, consume the larger chunk of tax revenues, and the amount left over to spend on building much needed hard assets is miniscule. Its time something was done about this; just like companies do financial reengineering, so should Government.

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The Government is to spend Rs 11.1 lac crores, a whopping 2/3rds of which, or Rs 7.3 lac crores, is non plan. Interest outgo is Rs 2.5 lac crores, eating up 22% of the total expenditure. The capital expenditure on building assets is Rs 0.58 crores, which is less than a quarter of the interest bill. The market was relieved when the target for Government borrowing was lower than it anticipated; it should not be. Instead, there must be more pressure to try and reduce this mountain of debt.

One idea this columnist has been mooting is to have a scheme under which buyers of existing Government paper (choose any series of debt) can buy it from holders, ie banks, in an auction. The buyers would then forgo both repayment and servicing obligations on this debt, in return for which they would get a weighted deduction (say 3 times the face value?). The deduction can be worked out in a manner to make the scheme attractive for people with high tax rates (eg foreign banks) to bid for. In essence, the Government is swapping its debt obligations for a reduced tax revenue.

Firms like Goldman Sachs advised the Greek Government on how to do reengineering, for which it is now being, rightly, investigated, because the advice enabled the Greek Government to hide its spending. There is, however, enough talent and ideas, for honest reengineering, should the Government seek it, as it should.

The Government is, rightly, trying to control expenditure, but its attempts are too feeble. This is due to the sheer hypocrisy of all politicians. When Finance Minister Pranab Mukherjee tried to reduce the non plan expenditure of subsidies by raising excise on petrol and diesel by Rs 1/litre and restoring the cut of 5% in customs duty on crude oil, which was cut when crude prices were much higher, the opposition drowned his voice in a flurry of fake agitation. Simply because they are in opposition. One recalls when Yashwant Sinha was Finance Minister in a BJP Government, with Congress in opposition, it was the Congress who vociferously opposed a proposed but necessary hike by Rs 1/kg in urea prices. (The subsidy was degrading soil quality by encouraging the overuse of urea and underuse of non subsidised fertiliser).

Thus politicians of all hues are not looking at national interests. Are we, then, really a mature democracy?

The opposition then staged a walk out in protest (why don't they finish their morning walks in the morning only?). It seems that the Congress opposition in Gujarat State had staged a similar walk out when the state budget was being presented. One wonders if these are the leaders who can take India forward to become a global economy.

For if we have to assume global leadership as a nation then we must be also responsive to the environment. True, the Budget seeks to provide thrusts to renewable energy, which is welcome and necessary. We must, simultaneously, discourage the overuse of depleting fossil fuels. Not only should the entire polity have welcomed the hike in petrol and diesel prices, instead of walking out, but the Government ought really to do much more.

In response to the oil shock, the US had incorporated, in 1975, fuel efficiency norms called CAFE (Corporate Average Fuel Efficiency). We have none such, even in 2010. Why? A responsible Government would encourage, through lower excise duties, the sale of smaller vehicles meeting fuel efficiency standards and discourage, through higher excise duties, the larger cars that don't. Vehicles like Hummer, which are criminally wasteful guzzlers of gas purely to provide an ego trip to the owner, should be banned, or at least discouraged through expropriatory tax levels.

Simultaneously, now that India is finding gas, the Government must mandate the larger auto companies to offer at least one model with factory fitted CNG kits. At present car owners (such as Meru cabs) fit CNG kits, but bear the risk of it not performing. Why should they? Private auto companies are not going to show leadership in this; it has to be mandated.

Gas finds are going to be a significant contributor to the reduction in fiscal deficit, which is the main cause of investor concern. Reliance Industries has announced that the value of the gas produced in its KG basin in the past 10 months was $1.5b. This is with a production level of 60 mmscmd, against its capacity of 80. So it could produce some $2b. of gas annually. As per the production sharing contract, RIL gets 95% of this value, until the capital cost it has incurred is recovered fully; its share then goes down, and the Government's share goes up until it has recovered 250% of its cost after which the Government gets 85% of the value. There are more such gas finds, including from ONGC.

Not only are the petrol subsidies creating holes in the budget but also in the ozone layer. They are also creating big holes in balance sheets of Government companies, effectively destroying their values. Indian Oil Corporation, a navratna (one of nine jewels in the Government crown) faces a bill of Rs 12,000 crores because it has been illegally foisted with sharing such a burden. It is a wonder that minority shareholders have not taken legal recourse to a trampling of their rights in ONGC, GAIL, IOC, HPCL and BPCL.

Poor planning and strategy was also nearly the undoing of the follow on offer of RECL, a well managed financial institution. On the last day of the issue, the RBI announced a reduction in risk weightage of loans to power generators, thus freeing up more resources for lending. Foreign institutional investors came in and lapped up the issue, at a price higher than the Rs 203 floor. The market was sending false signals because immediately after the issue closed, the stock price rose sharply, ending the week at Rs 244.

From this it appears that perhaps existing large holders may have sold their stock in the cash market, bringing down the price, and simultaneously bough in the futures market, and made an application at the lower floor price of Rs 203. If this is, indeed, the case, then SEBI ought to consider shutting down the futures and options window for companies going to the market, for a month prior to the issue.

The BSE-Sensex ended the week at 16429, for a weekly gain of 237 and the NSE-Nifty ended at 4922, up 77 over the week. The India story looks good, especially if the attempt to introduce the goods and services tax next April is successful. The better targeting of subsidies, using technology, is also a step in the right direction. Increased attention to improving agricultural yields, of harvesting water, of setting up cold storage chains, are all steps in the right direction.

The worry is the global toxic assets, which are still to be fully written off. Only half the estimated $3.4 trillion of toxic assets have been written off. Any failure of a large bank or financial institution, or, indeed, of a country such as Greece, could trigger panic and 'flight to safety', ironically US T bills. Our domestic pool of savings is growing, thanks to a savings rate in the low 30s. Over time, our markets will become far less dependent on foreign capital flows than they are now. Until such time, we should keep an eye on global developments and pray there is no crisis. We should also pray that our politicians grow up.

The first prayer is more likely to be answered!

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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4 Responses to "Needed - financial reengineering"


Mar 4, 2010

There is corruption at every level. In fact laws are enacted so that there is room for the bureaucrats and politicians to make money by giving a favorable interpretation of the law. In favor of the business that will offer the bribes.
To be ruthless with the politicians and corrupt officials should be India's new motto.



Mar 1, 2010

I agree that minority shareholders of MOC should take legal route for losses suffered due to subsidised prices.
Second, the attitude of Opposition parties leaving the
session as a protest is not Democratic or constructive opposition. They should abjure this practice-both Congress & BJP.



Feb 28, 2010

I liked your remarks about governance and the political landscape. They are appropriate and well received. I certainly do not agree with a reader who recently criticised you for straying from, what he argued, was your remit i.e. stocks and finance.
The more I experience India the more worried I am about the calibre and integrity of our politicians not excluding their capacity to corrupt the most talented bureaucrats and other influential people.
This is India's achilles heel and I fear the likes of China and Pakistan who view our growing influence and success with envy,are determined to take full advantage of this fact.
We therefore must be RUTHLESS with politicians, bureaucrats, judges, etc., who fall from grace, if we are to become a true global player and I sincerely hope the present Government will set the right tone.



Feb 27, 2010

Govt. has increased the excise on Petrol & Diesel which is of no help to OMCs. If they had increased the base price, it would have been some help to the beleaguered OMCs. This defies all logic. Besides penalizing the minority shareholders for no fault of theirs, this is also demotivating for the workers and officers of OMCs. Investing public seem to have lost the trust in the promotors of PSUs (read govt.) and this is primarily the reason for fiasco of recent IPOs of NTPC & REC.

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