The consequence of fiscal profligacy and failure to change - Straight from the Hip by J Mulraj
Investing in India - Straight from the Hip by J Mulraj
The consequence of fiscal profligacy and failure to change A  A  A

7 JULY 2012

One wonders why political leaders do not see, and draw lessons from, the errors of others. All of them are prone, during good times, to spend lavishly, and to launch welfare schemes which they later cannot afford to sustain when times get bad, as they inevitably do.

Stockton is a town of 300,000 people in California, which, during boom years in mid '90s, when house prices soared, and tax revenues soared with them, took on more obligations towards pension and healthcare benefits for its employees. It has now filed for bankruptcy. This will hurt the bondholders who financed the town's deficits in the intervening years, and will affect the old, retired, pensioners, whose healthcare benefits will be curtailed. The town has cut down on its police force, consequently, the crime rate has soared, further bringing down property prices and, with it, bringing in lower tax revenues.

That's the story of a town. But entire countries such as Iceland and Greece, have been living beyond their means and failing to rein in fiscal deficits, borrowing the money to pay for an unaffordable lifestyle. Judgement day has come for Greece, as it will for others. What this implies is that future generations have to pay for the lifestyles of current ones.

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India is treading the same course. We have seen how welfare schemes, even the best intentioned ones, become millstones over a period of time. When an earlier Government decided that the deserving poor needed to be subsidised for kerosene and LPG, used in cooking, it did not envisage how tough it would be for subsequent Governments to unwind the scheme. And yet it must. Else our cities one day face the same fate as Stockton.

The solution to a fiscal problem is to simultaneously try and grow revenue and cut costs. The problem, as the Greek episode shows, is that its not easy. Cutting costs, called austerity, actually prevents the raising of revenue, as with austerity the economy shrinks instead of growing. The trick is to apply austerity with some common sense. Cutting costs which are frivolous, such as the unnecessary cavalcade of cars each time a politician moves about, or the army of hangers-on in the corridors of power in North and South Block, should be encouraged for cutting. But it isn't, for they enhance the 'ego' of the politicians. Instead, expenses which actually can result in inward remittances, are tarred with the same brush of austerity measures. This is both myopic and hypocritical.

The standard solution of Western Governments to fiscal problems is to throw more money at the problem, in the hope that the money will find its way into creating productive assets and jobs. This is what three Central Banks did last week including the ECB, Bank of England and China.

The ECB has cut its central rate to 0.75%. Deposit rates would be low in Europe, as they are in the US, giving little incentive to save. Neither is there much economic growth (the US economy added 80,000 jobs in June, but is much behind the regression line (see chart 1) .

The fact that China is also pump priming shows that its economy is growing weaker than expected. Its economic growth of the past few years has largely depended on a boom in the construction of houses, providing jobs and incomes for spending. However, millions of houses are lying vacant, and China has some ghost towns through which modern highways run, having tall apartment buildings which are completely empty. When the market crashes, it will drag down Chinese banks and can cause a hard landing.

Looking to all this India is better placed, with a huge demographic advantage of a young population. It can achieve consistently high economic growth rates, for which sensible policy direction is needed. One keeps hoping that this will come, and the market cheers every move towards sensible economic reforms, only to collapse when another foolish action is taken.

India is at a stage where development of new towns and cities, which will create jobs, and lead to a huge rural-urban migration, can yield tangible and sustained economic growth for decades.

In India, around 55% of the population depend on agriculture, but earn 15% of national income. This statistic reveals several things. One is that the terms of trade are manifestly unfair to farmers. Two that agriculture, as now practiced, cannot provide jobs or adequate income for youth living off it, who are thus under-productive. If this population gets jobs in newly formed urban conglomerates, through a massive rural-urban migration, which is coming, then productivity levels will rise and will sustain the economic growth.

The big IF, of course, is how policies will be made to achieve this. Given the expertise of our political class to turn gold into lead, expecting common sense to prevail in policy makers would be a triumph of hope over experience.

It is expected that, once the Presidential elections are over, a spate of reform measures would be initiated. Among them would be freeing up, in stages, the price of diesel, the subsidy on which is eating the innards of the Union Budget as well as that of 3 companies, Oil and Natural Gas Corporation Ltd. (ONGC), Gas Authority Of India Ltd. (GAIL) and Oil India, bearing the brunt of sharing it.

Consider how this subsidy sharing, which is done on a completely arbitrary basis, affects these firms. ONGC, for example, has a Vision 2030, of incurring capital expenditure of Rs 11 lac crores over the next 18 years. Had it not been forced by the Government, the majority owner of it, to share the subsidy burden, its profits, and cash flows, would have provided the bulk of this capex plan.

The ironic thing is that only a part of this subsidy on diesel goes towards the intended beneficiary. A lot of it is used in diesel vehicles, including trucks, to reduce transportation costs (which was not the intention of the subsidy scheme) or is leaked by administrative middlemen. Despite knowing this, Governments have found it impossible to reverse it.

Another expected reform is the re-introduction of FDI in multi brand retail. This was brushed aside, on the objections of Mamata Banerjee, who has, since, been brushed aside. The UPA has got the backing of Mulayam Singh Yadav, and has returned the favour by agreeing to a new financial aid package for the State.

Yet we do things in a roundabout way. Consider the banning of upfront commissions to mutual fund agents. The reason for this ban was that the commissions were coming out of the investor's pockets because the amount invested in the fund were net of these commissions. It would, perhaps, have been better, for the agents to get a written consent from the investor to the payment of upfront commission, out of the money invested by him, with the knowledge that they so were. What has happened is that, without aggressive sales by the agents, the growth of equity funds has declined. That of investing in gold has increased.

Now the Government wasts to reverse the situation. But it is loath to revoking the ban on payment of upfront commission. Instead, it has increased the expense ratio charged by mutual funds, by a quarter percent, so that the fund house can pay commission our of it. One hopes this will work. Perhaps the Indian mutual fund industry is at too nascent a stage of its growth for it to be free of practices such as upfront commission to agents, which would ultimately happen when the industry has matured enough.

The poor performance of the monsoons is a matter of concern; the deficit in North India is 71% so far. The planting of coarse cereal is down 53%, that of rice 26% and of oil seeds 17%.

Telecom policy has also got badly muddled up. Once a success story, it is now mired in corruption and policy confusion. The DoT is unsure of whether or not to permit 3G roaming by operators who have agreed to share 3G spectrum in circles where they don't have them. This is a no brainer - of course they should be allowed! Telecom, as indeed all, policy, must be for the benefit of the consumer. Barring Reliance, no operator has spectrum all over India. Would it imply that a Vodafone, or Idea, customer, would lose roaming ability if he entered an area where his operator did not have spectrum? How silly is that? Would the DoT clarify if public interest is its primary objective?

Last week the BSE-Sensex gained 90 points to end at 17512 and the NSE-Nifty added 38 to close at 5316.

One feels, and hopes, that the Government may, however belatedly, discover that it does have a spine and will initiate another round of economic reforms. The expectations are a phasing out of diesel subsidies, a renewed attempt to introduce FDI in multi brand retail and an announcement that tax laws would not be changed, and matters pursued, with retrospective effect.

Should this happen, there can be a 10% spurt in the market.

However, if the UPA does not have the, shall we say, spine for this, then the rally would start fizzling out.

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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5 Responses to "The consequence of fiscal profligacy and failure to change"
Vilas Ghadi
Jul 9, 2012
Earthworms do not have a spine i believe. Do you think this Govt. can do away with subsidies. Forget it neither this Govt. or any other Govt. India can do that including that of NDA. Thats a politicial compulsion for the idiots. What can you do when the likes of A. Raja are allowed to roam free with a heroes welcome back home in Chennai. Or a Mamata allowed to do a spoilt childs act. Do away with reservations and quotas and subsidies and we will see better days ahead

Pradeep Kumar Nair
Jul 9, 2012
The recommendation (oft repeated by you) to look at upfront commissions to MF agents (as the market is not matured) is pernicious to say the least, cos it tends to believe that agents have the goal of maturing the market and we all know what they are measured on. The suggestion you gave about the upfront commission being transparent, pray what is different from what is in force now.

I also think it contradicts the argument you are putting forth for subsidy removal, once a habit is established, we don't have the record of changing or removing it, so the current clamour of the MF industry to bring upfront commissions back is a disguised admission that we don't care for you investors
Jul 8, 2012
The article is 100% true and I hope atleast the new young generation will understand this and do the needful to rectify the mistakes.

For this we need to urgently educate the new young generation with full swing. The article is one such step towards the same.
Jul 7, 2012
I agree with surajit som that stockton is just one of the many cities in the usa going bankrupt. The entire state of California is bankrupt and indeed the usa is almost bankrupt. No one wants to face up to that fact. USA is in a complete state of denial of its impending troubles, both fiscal and social.

It will be able to drag on for several decades but its standards will erode and it will make desperate efforts to scam the countries of the world by attempting to export its bad practices over the world passing them off as proven methods of economic progress.
surajit som
Jul 7, 2012
what we are witnessing is the collapse of western capitalism particularly post-WW II type. stockton is like the appearance of AIDS.there will be hundreds or thousands of stocktons all over america and europe.

what will emerge? not necessarily something better. may be an era of bogus or rancid socialism. like we see in india today.let us remember that for majority of russians ,the post-communist russia is probably worse than communist russia. the age of affluent and glamorous west is over. welcome stockton !!
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