Reality has a nasty way of catching up - Straight from the Hip by J Mulraj
Investing in India - Straight from the Hip by J Mulraj
Reality has a nasty way of catching up A  A  A


Finance Minister P Chidambaram must be musing on the prophetic words of Sir Walter Scott when he said 'oh what a tangled web we weave, when first we practise to deceive".

For over four decades after Independence, India's policy makers stuck with the mistaken philosophy of a command and control economy. This stunted growth all round. Entrepreneurs needed a licence to manufacture anything, which were given out selectively and scroungingly, thus depriving the Indian consumer of good quality products. Waiting lines to obtain a telephone connection, or a two wheeler or a car or anything else ran into years.

Simultaneously, capital was also controlled. After nationalisation of private sector banks, the public sector banks controlled almost the entire market for working capital, and six all India financial institutions for long term loans. Directed lending (directed by politicians to their favoured nominees) resulted in bad loans. The capital market were also controlled through the mechanism of pricing new equity issuances at prices as determined by the Controller of Capital Issues (sic) based upon a formula that ought really to have been kept inside a museum.

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To make up for scarcity of desired goods, the Government set up huge public sector companies, entirely owned by it and not answerable to the scrutiny of public shareholders.

All this resulted in a misallocation of capital. One must say that misallocation of capital is not the preserve of Indians alone; virtually every country does it. Japanese politicians sanctioned and built bridges that went to nowhere, and ports that were too remote to ever be used, all in the belief that infrastructure spending would boost the economy after the meltdown starting end 1989.

Since misallocated capital did not yield the desired return on investment, the Government stepped in with all sorts of subsidies. For politicians, subsidies are magnificent because the funds being spent are not out of their own pockets. Who cares whether the subsidies actually go to the intended beneficiaries or to middlemen who salt them away. The number of such scandals are legion, the latest being the connection between politicians and contractors to fleece the Integrated Child Development Scheme.

The welfare schemes sound laudable, and may even be well intentioned, but are actually a big drain on the exchequer because the money gets siphoned off.

Ergo, the constant and unassailable fiscal deficit.

Reality, though, has a nasty way of catching up.

The fiscal deficit is now running amok, and external rating agencies are threatening a downgrade of India to junk status. Such an eventuality would significantly raise to cost of capital for India Inc. as well as for India Gov. Moreover, the Reserve Bank of India (RBI) Governor is not easing interest rates until he is convinced that the Finance Minister is doing enough to bring down the fiscal deficit. That is a right decision, though it hurts economic growth. The FM is unhappy, but it's a situation that successive Governments, intoxicated by fiscal profligacy, have brought on to themselves.

Reality has a nasty way of catching up.

It's not only, as stated before, that our Government is fiscally profligate. The US is also at the edge of a fiscal cliff, which is the result of a debt ceiling imposed by the US Congress, due to be hit in January.

Various Indian state Governments are bankrupt too. West Bengal has had to borrow $400m. from ADB, with conditionalities, which include raising taxes. Punjab is another state with high indebtedness. Most of the problems of high debt are self inflicted, the result of poor policies and poor governance.

Bur reality has a nasty way of catching up.

So now the Finance Minister, and the Government are caught between Scylla and Charybdis. With General Elections due 2014 and a shaky coalition till then, (Mulayam, Mayawati and others have wrapped their fingers around the political rug to pull it anytime) the Government is reluctant to prune subsidies for fear of losing popularity. Which is why they announced, and then rolled back, a hike in subsidised LPG gas cylinder prices.

To reduce the fiscal deficit the Government is also trying hard to raise resources. One of the ways it is doing so is by 'refarming' of spectrum, i.e. asking telcos which have already been allotted the 900 MHz spectrum, and have installed the infrastructure for it, to move over to the less efficient 1800 MHz spectrum. The telcos are asked to bid for the spectrum when they go to renew the telecom licenses, and the Government expects to raise Rs 2 lac crores from the telecom industry when this happens. The industry will also purportedly have to spend Rs 1 lac crores on capex in the switch to the new spectrum, another example of a waste of resources.

The terminology being used is creating confusion amongst analysts, who feel that sectors are being merged. The telecom sector, for example seems to be merged with agriculture, after 'refarming' of spectrum. The civil aiviation industry looks like it is being merged with the coffee industry, with so many planes being 'grounded'. The banking industry, meanwhile, seems to be integrating with the healthcare industry, after all the 'stress tests'.

Well, the refarming of spectrum, and sale of spectrum of those whose licences were cancelled by the Supreme Court, may result in revenue generation to the Government, but it will be at the cost of the industry and, of course, ultimately, the consumer. Expect mobile telephony rates to increase sharply. Those most affected by the hike in rates are the marginal users, which, of course, affects their economic inclusion.

Reality has a way of catching up.

The RBI Governor didn't oblige the Finance Minister with a cut in repo and reverse repo rates, despite the road map of fiscal rectitude displayed by the FM. The Governor wants a GPS for the road map. He will cut rates only when he sees enough serious intent to curtail the deficit. Kudos to him.

Another way to raise revenue is to sell stakes in the public sector companies built up over the years. Such stake sales ran into ideological protests, but reality has a way of catching up. The Government hopes to raise Rs 30,000 crores before March end through such sales, and is considering creation of an ETF (Exchange Traded Fund) in which to park the shares, and offload units of the ETF to investors. Globally ETFs have become very popular. These are called passive funds inasmuch as the fund does not try to beat the market, as represented by an index, but only to mimic the index. Since there is no need for sector or stock selection, as in the case of an active fund, ETFs have far lower management fees, hence their popularity.

Yet this may not work. Take the case of Steel Authority of India (SAIL), one of the companies in which the Government wants to reduce its holding to raise money. The stock quotes below its book value, and investment advisors advise the Government to sell it at or near market price. The steel ministry is holding out for getting book value. It has to listen to the market and the Government has to take a call on whether it wants the revenue badly enough to wait for the market price to exceed the desired book value, or to sell now at market prices. In a command economy, it may arm twist financial institutions to buy the stock at book value, but in a market economy, reality has a nasty way of catching up.

Thus it seems like the target for fiscal deficit set by the Finance Minister may not be met.

Adding to its woes is the fall in gas production from Reliance Industries Limited (RIL)'s KG6 basin. The new Petroleum Minister has said that pending issues would be quickly sorted out. Amongst these issues is the audit of capex by the CAG which RIL opines is a technically complex matter which needs to be audited by specialists. Perhaps such specialist would be appointed and the audit done quickly so that the matter comes to a closure. The Government has announced that it would not be reviewing gas prices before such a revision is due in 2014.

In other corporate news of interest, Wipro is hiving off its non-IT business into another company, Wipro Enterprises Ltd., in which shareholders will get 3 different options to participate. Segregating the businesses makes sense.

Last week the BSE-Sensex added 135 points to close at 18,755 and the NSE-Nifty gained 33 to end at 5,697.

The US Presidential election results will be announced next week and it is too close a race to call although the new US jobs report (171,000 created) helps President Obama, as does his handling of the hurricane which ripped through the Eastern seaboard.

The danger for investors is that, whichever candidate wins, Israel may, with active or tacit help from the US, undertake an adventure in Iran. Were that to happen, oil prices would spike, global stockmarkets crash and the world would go into a recession.

Bearing this risk in mind, the fact that Indian stock markets have been impervious to the scandal-a-day-keeping-investors-away syndrome, suggests that global investors, with filled coffers thanks to QEs, are bullish on Indian stock markets.

But it is time to be cautious.

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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1 Responses to "Reality has a nasty way of catching up"
Nov 6, 2012
Thanks for sharing your thoughts, Mr. Mulraj. The world is a better place because of people like you.
However, I don't agree that:
huge public sector companies, entirely owned by it and not answerable to the scrutiny of public shareholders.
We have numerous examples of public sector companies doing quite well and the capitalist private sector (with the scrutiny of public shareholders) bringing the world to a financial disaster (2008?) needing government largess / bailout.

Obviously, in India and many other countries, it is needed that the gov't not interfere in the management of the public sector units and put in place a mechanism (as 100% owners) of checks & balance with the aim of ensuring good management.
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