Our Government cuts the nose to spite the face

28 MARCH 2009

Okay, so here's the deal. The whole world has gone on a liquidity driven buying spree and its biggest financial institutions have ended up with 'toxic' assets, or assets bought at inflated prices during the bubble years. Several institutions have failed; the others have been bailed out. GDP growth is likely to be negative in developed countries in calendar 09. India's GDP ought to grow around 5%. The US Government has unveiled a $1 trillion plan to work with private investors to buy toxic assets. Unemployment is rising globally and Governments of each and every country are striving to stimulate economic growth.

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It is in this backdrop that India has 3 things going for it which are capable of providing an economic boost, are popular and can transform the situation from despondent to hopeful. Our political leaders (if, indeed, that is the proper term for them) try their best to scuttle these 3 things!

One is the KG basin oil and gas discoveries. These, together with the discovery by Cairn of oil in Rajasthan, can yield oil and oil equivalent amounting to 30 m tpa, and save the country about $7b, or a third of its oil import bill. Besides, the fall in oil prices would save India another $20b. Yet, the production of KG oil has been tied up in a legal dispute and ought, in national interest, to have been much more speedily resolved. The Cairn output is ready to commence production but the Government, which is to decide it, has not decided the pricing nor the buyer/s. If this is not criminally irresponsible governance, what is? Why do we cut our nose to spite our face?

The second cause for optimism is the amazing achievement by Tata Motors of producing a car for Rs 1 lac ($ 2000). The amount of engineering, design and innovation that must have gone into this endeavour is mind blowing. How have the political leaders treated this? By sending it out of West Bengal, thus delaying its launch. Irresponsible governance, again. Why do we cut our nose to spite our face?

The third economic boosting activity was the India Premier League cricket tournament. Its popularity can be gauged by the fact that, despite the slump and the global financial crisis, the auction of top players was at higher prices. This tournament would have generated enormous economic activity in terms of air travel, stay and ticket sales, together with the boost to restaurants and other areas where matches were being held. This economic boost would not be given to South Africa at a time when, as mentioned above, Governments of each and every country are trying to boost domestic economic growth! Why do we cut our nose to spite our face?

The reason cited for sending IPL is the inability, during elections, of the Government to assure safety against terror attacks. Fair enough. However, there were no elections on Nov 26. Also, South Africa itself is going into elections 5 days after the first match. So it seems the true reason is that the Congress probably felt that should a terrorist attack happen, it may cost it the election.

Global markets rallied after the announcement by the US Treasury, of a $ 1 trillion plan to work with private investors to solve the toxic asset problem. Under the plan, a private investor can buy such toxic assets, and pay only 10% for them, with the Government, through agencies such as FDIC, guaranteeing payment of the balance 90% and giving the option to the investor to walk away, forfeiting the 10%. In other words, the US taxpayers have given private investors a call option on toxic assets. Imagine what would happen if the market for toxic assets does not develop after this plan? The Government would have bailed out the banks responsible for creating the assets, at the cost of the taxpayer, says Jeffrey Sachs in an article in FT.

The announcement of the $1tr. plan by Tim Giethner, Treasury Secretary, led to a global equity spurt, including in India, where it was aided by FII inflow. Well, at least entities registered as Foreign Institutional Investors (FIIs) but which could be Indian money seeking an alternative route now that Swiss Banks have agreed to give access to account information to any Government that asks!

The outgoing Government has not seized this wonderful opportunity to get information about Swiss Bank accounts; it is estimated that $1.5 trillion of Indian money resides there! Perhaps the next one may. In fact, it should offer an amnesty scheme which would allow the money to come in tax free if invested, say, in infrastructure bonds and held for 5 years; or on payment of a 40% tax upfront, no questions asked. Again, had our 'leaders' (sic) been more mindful of the country's interests than their own, they would have done this.

The Government is trying to give an economic boost by asking public sector banks to lend aggressively and now by asking public sector companies to accelerate their investment. ONGC, IOC, GAIL and others will incur a capex of Rs 57,000 crores this year. Capex decisions are best left to company managements, but the Government treats companies in which it has a majority ownership as if they were fully owned and shows scant respect for minority shareholders. This is foolish behaviour, for, in so doing, the price multiple minority shareholders would be willing to pay for such PSUs would decline, thereby lowering the valuations for all.

Last week the market rallied, alongwith global markets. The sBSE-Sensex rose a whopping 1081 points over the week to end at 10048 and the NSE-Nifty rose 301 to end at 3108. The 1081 score was thanks to a Sehwagian double century by RIL, which accounted for 230 of those points, and a Tendulkarian missed century by ICICI Bank, which accounted for 96. RIL has signed gas purchase agreements with a dozen fertiliser companies, and cash flow from the KG gas should start flowing in Q1 of accounting year 09-10. Use of cheaper gas compared to expensive naptha ought to result in a huge saving on fertiliser subsidy bill, which is nearly Rs 100,000 crores ($20b).

That would help reign in a spiralling, and very worrying, fiscal deficit thanks to utterly irresponsible spending splurge in the past 5 boom years. The Government will have to resort to a very high borrowing programme which has already resulted in a sharp fall in Government bonds and a rise in yields. Both are negative for stockmarkets.

Fall in Government bond prices would mean that banks would have to account for it on a mark to market basis, for those bonds which are not marked as HTM category (held to maturity). The increase in yields translates into higher borrowing costs for companies, which eats into their margins. It also means that debt becomes relatively more attractive to equity, which is a risky asset class. Ergo, the failure of Government to preserve tax resources generated during boom years, for a rainy day, is making it more difficult for it to spend at a time when spending is most needed. We cut our nose to spite our face.

On Monday 23, when the sensex rose a whopping 457 points and added some Rs 34000 crores to the sensex market cap, the purchase by FIIs and by domestic funds totalled Rs 700 crores. That's a big bang for the buck! It is indicative of the role sentiment plays in stockmarkets.

It is this sentiment that will be sought to be manipulated in the coming weeks, with increased volatility and increased noise about the possible start of a bull market. In my view, the world has far too many problems, and far too many toxic assets yet to be dealt with in a proper manner, for the bear market to have ended. Hence, such rallies ought to be taken as selling opportunities, for creating liquidity for a more opportune time, rather than buying opportunities.

Aiding in this is a recommendation by the National Advisory Council on Accounting Standards (NACAS) which has recommended that companies with foreign currency loans may be expempted, given extraordinary circumstances, from marking to market the increased liability on them by virtue of the decline in the rupee. Implicit in this recommendation is the hope that the rupee would once again start appreciating. This, in turn, would depend on whether the next Government is more responsible than the outgoing one has been. Should NACAS's recommendation be accepted, it would artificially boost profits of companies which have borrowed in foreign currencies.

The sensex has hit the upper end of the band of 8500-10500 and could conceivable correct downward. One can expect it to behave like an inebriated yo-yo in order to confuse investors and sucker them into buying, on fear of being 'left out'. Investors may be advised not to cut their nose to spite their faces; leave that to our Government!

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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