Is India ready for a free market? - Straight from the Hip by J Mulraj
Investing in India - Straight from the Hip by J Mulraj
Is India ready for a free market? A  A  A

25 AUGUST 2012

Despite the fresh wave of economic reforms ushered in by Manmohan Singh as Finance Minister in 1992, India still remains a far cry from being a free market.

And, as the disgraceful behaviour of the BJP, which succeeded in stalling Parliament for four days, using filibuster, a luxury India cannot afford, showed, is India really a mature democracy?

A positive way to look at all the corruption filth that is being churned is that it is the outcome of a cleansing process, and a transition from a command economy to a free one.

The latest episode of this filth is that of favours granted by the Coal Ministry, to some firms, in allocating to them captive coal mines at give-away rates, thus enriching the allottees at the cost of the exchequer. The scandal is known as coal-gate, and has nothing to do with the toothpaste, although there is little to smile about.

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The Coal industry was nationalised in 1973 and it says volumes about the inefficiencies of a command economy that, despite having one of the largest reserves of coal in India, there is an immense shortage of it. Such severe shortage that some 50,000 MW of power capacity already set up, cannot produce it for want of coal. Imagine the loss of production, and of jobs, this entails. In a mature democracy, such an obnoxious state of affairs would have been debated in Parliament and solutions found.

Yet we have the farce of democracy being played out when, instead of debating, proceedings are blocked, upon a demand for the ouster of the Prime Minister for his inability to misallocate coal blocks. In a mature democracy, the proper procedure would be to pass a motion seeking his ouster, and to then vote on it. Not by using lung power to stall proceedings.

Yet we see that in many spheres, our political leaders are unwilling to give up their levers of control and allow free market forces to function, with proper supervision. Politicians love the power, and the moolah, holding such levers fetches them. False excuses are then made to retain such levers.

Prior to coal gate the scam was about misallocation of scarce spectrum, through out-of-turn allotment of it. The Supreme Court ordered the confiscation of 122 licences, perhaps including those not improperly obtained, thereby throwing the baby out with the bathwater. The confiscated spectrum is sought to now be auctioned but at a minimum reserve price that would surely lead to higher call charges.

The net net result of all this is that the telecom sector, once showcased as the success story of liberalisation (and indeed it was) is now in dire straits, and telecom company bosses are no longer viewed as sultans of swing. The other sector which India was proud to showcase, viz. the IT sector, is also going through troubled waters. Yet another sector which was hitherto tomtommed as a success story of liberalisation, viz. civil aviation, is going through such a bad patch that it would be hard for its investors to remain civil.

The bad patches for these industries are manifestations of the reluctance of our policy makers to move over to a free market, and of their desire to hold on to the levers of control. Nothing else.

In the civil aviation space, there is absolutely no reason for the Government to retain majority control over Air India. None. It does so for the perks such holding provides to officials, in terms of ability to upgrade themselves, delay flights, divert flights and order new aircraft. The ostensible reason for retaining such control is the ubiquitous 'national security', which is balderdash. There are several nations across the world which do not have a national airline with no threat whatsoever to national security.

The only situation when concerns of national interest are paramount is when Indian nationals need to be evacuated out of distress zones. Surely the Government has enough powers to sequester civilian aircraft at such times, without needing to own a loss making one it continuously has to fund.

How does all this affect stock markets?

It does, via the banking sector, again, a sector in which the Government wants to retain the levers of control. It has a majority ownership in 21 public sector banks and is unwilling to dilute ownership to majority citing, you guessed it, 'security concerns'. Majority control enables directed lending (the Chairman of a PSU bank is reluctant to refuse a request to lend to a Kingfisher Airlines or an Air India or a discom, if asked to do so by Delhi).

As a result, the Reserve Bank of India (RBI) now says that asset quality of banks, more so of PSU banks, remains a concern.

PSU banks have a 70% share in deposits. Similarly, the Government has majority control over the Oil and gas sector, through Oil and Natural Gas Corporation Ltd. (ONGC), Gas Authority Of India Ltd. (GAIL), OIL India, Indian Oil Corporation (IOC), Bharat Petroleum Corporation Ltd. (BPCL) and Hindustan Petroleum Corporation Ltd (HPCL). The last three, which are refining companies, called OMCs, or oil marketing companies, are constantly bleeding, and it is the PSU banks that are funding these losses. One shudders to think of what will happen to NPAs when the OMCs cannot service their working capital loans.

However, it is not as if free markets are a perfect solution; as the several crises in global financial institutions show, unregulated free markets are dangerous. JP Morgan made huge losses in the derivatives maket. It has mispriced CDS (credit default swaps) which were traded in the over the counter market, and unregulated. Yet, as an article in points out, it has a far bigger exposure in another derivative market, i.e. the interest rate swap market: "Furthermore, with the objective pricing arbiter of all OTC products, MarkIt, being owned by the same banks that (ab)use it every day, the logical conclusion is that the $400+ million mismarking in JPM's CDS is orders of magnitude lower compared to what JPM is undoubtedly engaging in in other product verticals, namely IR swaps, where the bank has total exposure of $71 TRILLION in the OTC derivative market."

Fortunately our regulators, RBI and Securities and Exchange Board of India (SEBI) have not encouraged the growth of such derivative markets, the growth of which has to be commensurate with the growth in capabilities of the regulatory bodies that oversee them. If such capabilities are missing in markets such as the US, which saw the subprime mortgage crisis, and in UK, which saw the LIBOR manipulation crisis, it is a far cry to expect them to be developed in India.

Having said that, there seems no justification for the Government to hold on to a perenially sick company like Air India. There seems no justification for retaining a monopoly over coal mining. There seems no justification for retaining a majority control over 21 banks; the stability of the financial system would be assured even if the Government retained control over the largest, SBI, and one or two more.

These are the issues that BJP ought to raise, and debate, in Parliament, if it wants the electorate to consider it as a serious contender for the reins of Government.

Last week the BSE-Sensex gained 92 points to close at 17,783 and the NSE-Nifty ended at 5,386, up 20.

The market is propped up by foreign liquidity in the hope that, post the monsoon session of Parliament, the UPA would show the courage to continue with reform.

There is talk that it will allow FDI in multi brand retail. Now, if one were to go to any shopping mall one sees that they are all multi-brand retail outlets. Yet the kirana walas, or local grocers, are facing the competition, which has been there for several years. Why should local grocers not be able to face it when foreigners are also allowed to enter the space? The argument against FDI in multi brand retail that it would hurt the local grocer is, therefore, wrong, and is a red herring.

What next for the stock market?

The monetary authorities are to meet at Jackson Hole, Wyoming, and investors are waiting to see if Ben Bernanke, US Federal Reserve Chairman, would unveil a QE3. It is unlikely.

The bad news is that two of the world's large and strong economies, are floundering. Germany is likely to go into recession by the end of this year as its export demand from weaker European countries flounder and domestic demand is alos also hit by its prudent citizens who save more.

The bigger shock for global markets will be a hard landing in China. The Chinese Government too, has been fudging figures (no surprise that) and its manufacturers have been stuffing channels, i.e. producing goods, which boost GDP, but which lies unsold in trade channels. The inventory is, necessarily, financed by state owned banks and if demand does not pick up then China may have a hard landing.

So any further injection of money that may come out of Jackson Hole would temporarily boost the market, but the rally would then run into the headwinds of problems in Germany and China. And, instead of taking advantage of the turmoil in other countries, our politicians will rant and rave at each other but will not plan for the future of the country. So, selling in rallies is advisable.

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.

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.
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3 Responses to "Is India ready for a free market?"
surajit som
Aug 26, 2012
meghnad desai has made an interesting observation. that congress and bjp should form government jointly. this is likely to happen but not in near future . in 2014 (or before !!) they will not get majority.most probably a third-front will form govt. then the current policy inaction will become policy disaster.think mamata or mulayam as PM !! may be then the two parties will be forced to come together.then -and then only-we can get a decent economic policy.till then the economy-and the market- will muddle through. sometimes Nifty hitting 6000 then falling to 4700 !! Like 
Aug 25, 2012
Have been reading your musings for years ... even if I may have not agreed with your views on rare occasions, never had the urge to write ... but have to do so today ...
`... proceedings are blocked, upon a demand for the ouster of the Prime Minister for his inability to misallocate coal blocks.' What do you mean? You may not be too concerned with the open loot of resources, but as a conscientious citizen and tax-payer of the country, I find it is my right and duty to oppose this loot. I don't understand what will be settled by the debate in Parliament on this issue (I am not saying there should not be debates in Parliament.) UPA Government couldn't care less about the opposition. In fact it is out to defang all its critics by initiating vindictive actions against them, including blocking their freedom of speech in the name of maintaining communal harmony.
sunilkumar tejwani
Aug 25, 2012
very well written article. Despite grim situation of world economies at large, markets have been inching higher on the back of liquidity. So it is good to sell on rallies especially banks, metals and auto sectors. Exception some crazy sectors like FM CG, Pharma and some fancied stocks which are in a momentum driven rally. Like 
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