Riding towards a fiscal cliff on a donkey - Straight from the Hip by J Mulraj
Investing in India - Straight from the Hip by J Mulraj
Riding towards a fiscal cliff on a donkey A  A  A

10 NOVEMBER 2012

The US elections are over and, in a hard fought contest, the Democratic Party leader, President Obama, was re-elected. The symbol of the party is, of course, the donkey, and it is on this that the President would be riding towards the fiscal cliff, on Jan 1, 2013. That's when certain tax breaks are automatically cancelled, which would raise taxes by upto $ 2,000 a year for individual Americans, and when cuts have to be compulsorily made in some Government expenditure, in order to contain the fiscal deficit.

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    Both the Democratic and Republican party leaders are working to resolve issues before the donkey topples over the fiscal cliff. Given that they have been talking for a few years, but have failed to resolve it, a resolution seems difficult in the 45 days left before the cliff is reached. This means that US GDP growth would be flat for an economy which is 70% driven by consumption, as the tax hike bites in. The reduction in Government expenditure would also lead to increased unemployment and reduction in public services (some States like California which cut the police force have unsurprisingly seen a spike in crime rates, and a drop in property prices because of it).

    The Government would have to borrow, at higher rates, to bridge the gap between its revenue and expenditure, which spells trouble for the huge US T Bill market. This can witness a sharp fall.

    What about India? We are also in a similar sad situation with an out of control fiscal deficit. The Finance Minister is banking on a few things to bring in revenue, but, alas, his hopes may be shattered.

    One of the things he is banking on is to fetch Rs 30,000 crores from disinvestment of its holding in a few public sector companies. Yet, as pointed out in my previous column, a disagreement over pricing in SAIL, for example, can stymie the process. The Government has also postponed the divestment in National Aluminium Company Limited (NALCO). It is also unwilling to sell its holding in 3 hugely successful stocks, ITC, Axis Bank and L&T, held by SUUTI. The Department of Disinvestment is trying to sell Government stakes in some PSUs through a new process, by creating an exchange traded fund (ETF) to house them, and then selling units in the ETF to individuals.

    ETFs are mutual funds which are traded on an exchange and hence can be sold at any moment, through a broker, unlike mutual funds, which have to be redeemed via the fund, and the investor has to bear a one day price risk. ETFs mimic the index they are based on, without seeking to overperform (or underperform( it; since they do not do stock selection, transaction costs are much lower.

    Alas, they have not been popularised in India which has only a handful of ETFs, as against around 1500 ETFs in the USA. In fact, more ETFs on Indian stocks are created and traded on the NYSE than in India, which in effect means that our market is being exported.

    Our market for derivatives based on the Nifty has also been exported, to Singapore. The Singapore market, SGX, trades more Nifty futures, since April this year, than does the NSE. The reasons for this is 1. The STT tax (securities transaction tax) on all trades, which is not there in Singapore 2. Tax uncertainties, especially after GARR and 3. Lower tax rates in Singapore.

    Similarly we have failed to create a vibrant mutual fund industry. Mutual funds were introduced in the US in 1890 but became popular only much later; in fact the growth of the industry took off in the 1970s. Today the industry has assets of $ 13 trillion, and is larger than the banking industry. US households hold 23% of their assets in mutual funds!

    By contrast, India's mutual fund industry, which started in 1965, has grown to just $ 110b. size over 45 years. Hardly 1% of Indian households assets are in equities, so a fraction of that would be in mutual funds.

    Given that there has been no effort at promoting the growth of mutual funds, it is very doubtful that the Government would be able to entice enough investors to bet on an ETF of public sector undertaking stocks.

    The other hope for raising revenue before the fiscal year ends in March is through sale of telecom spectrum. The Supreme Court had cancelled licences allotted in some 122 circles through an incorrect process, and had ordered the Government to auction the spectrum released because of the cancellation. The Government is auctioning only a part of it, in an effort to drive up the price, and the Supreme Court is chagrined at the disregard of its order.

    The auction is to be held separately for CDMA and for GSM. For the former, Videocon withdrew and so did Tata Teleservices, this week, so this part of the auction would be cancelled. Both said there is no business case for the price of Rs 14,000 crores set as a minimum by the Government. Thus there would be no revenue from sale of spectrum for CDMA operators. For GSM, too, the auction may prove difficult at the prices set, and Sunil Mittal of Bharti opines it would be over in a day. Bharti's quarterly profits have declined for the 11th straight quarter. The mobile telephony industry, which has created over 900 m. customers (many many more than those created, over decades, by Government owned duopoly of MTNL and BSNL) is now coping with high debt, continual capex requirement and increasingly unaffordable spectrum costs.

    The Government also decided, on its own, that telcos can hold only a certain amount of spectrum, and that those holding spectrum in the more efficient 900 MHz band would have to migrate to the less efficient 1800 MHz band, on payment of market determined prices.

    The Government is expecting to fetch Rs 40,000 crores from sale of spectrum but would end up probably getting a lower figure. Combine that with the Rs 30,000 crore expected from sale through disinvestment, and we are also mulishly heading towards our own fiscal cliff.

    Which suggests that, if the fiscal deficit is not contained, the Reserve Bank of India (RBI) may well decide to postpone its cut in interest rates. The RBI, with one eye on inflation, is chary of cutting rates until the fiscal deficit situation is improved.

    Interestingly, sales of automobiles, which are interest rate sensitive, showed a remarkable 35% growth in October! Sales of utility vehicles grew a whopping 88% and of two wheelers 12%. However, loan growth for housing, another interest rate sensitive sector, has fallen, as house prices have gone up.

    Results of banks for the quarter ended Sep 2012 show stresses in the system. Andhra Bank, for example, had net profits of Rs 325 crores for the quarter, but this was after a provision of Rs 121 crores for NPAs. So had there been no extra provisioning for NPAs the profits would be nearly 40% higher. Similarly, State Bank of India (SBI's) net profits for the quarter was Rs 3,658 crores, but that was after a provision of Rs 1,837 crores for non performing assets. The question that needs to be asked here is why loans are extended, and further extensions/concessions given, for suspect project, without adequate collateral. Are we again succumbing to directed lending, directed from Delhi?

    Would the Government realise that it is because of such directed lending, in other words control over management, that its disinvestment plans run amok? Management at most public sector undertaking is good and can create a lot of value for shareholders, provided it is left to manage without interference. Since the Government is the majority owner, and stands most to gain from such value creation, is it not common sense for it to cease interfering with management, and directing lending procedures at banks, to be able to benefit the most?

    One of the loans for which provisioning had to be made is to Kingfisher Airlines, which has Rs 7,000 crores of debt. It is not known if banks have taken adequate collateral for this loan. The airline has been asked to bring in Rs 5,000 crores as additional capital by month end, failing which its licence as an airline is likely to be cancelled.

    Vijay Mallya, the promoter and major owner of the airline, has sold a 53% stake in United Breweries to Diageo for some $ 2 b. but says that the proceeds would not be used to re-capitalise the airline.

    Last week the BSE-Sensex ended with a loss of 71 points, at 18,683, and the NSE-Nifty closed at 5,686, down 11.

    So what now?

    The imminence of the US fiscal cliff, and the likely crash of the US bond market, is making global investors consider the relatively strong GDP growth of 5.5% (as expected by the Finance Minister) attractive enough to continue pouring in money. Thus more FII money will propel the Indian market. Global investors seem to be Teflon coated and unmindful of the stench of corruption. The new Chinese leader, Xi Jinping, has averred corruption to be China's biggest threat. Our leaders, in contrast, view corruption as the biggest opportunity, for themselves.

    So the rally may continue, perhaps till sensex 20,500 or nearabouts.

    Wish all my readers a Happy Divali.

    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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    8 Responses to "Riding towards a fiscal cliff on a donkey"
    dev golchha
    Nov 12, 2012
    Insightful and interesting! waiting for an article for solutions/alternatives to the issues mentioned in the article. Good going Mulraj. happy Diwali !!! Like 
    Nov 11, 2012
    Just i can say this superb &must read article,thanks for sharing. Like 
    shaheen mohmad ashraf
    Nov 11, 2012
    mulraj ji i like your column very much it always is concize and full of information relating to investors , unlike column of bill booner Like 
    Nov 10, 2012
    The 'remarkable' auto sales figures in Oct '12 is partly due to a lower base. In 2011, the festival season - when a lot of buying happens - started a month earlier. Like 
    Nov 10, 2012
    BTW, Happy Diwali to Mr. Mulraj and all readers of SFTH. Like 
    AD 3
    Nov 10, 2012
    Mutual fund industry is a big scam. They make huge fees if the mutual fund valuation goes up & they make huge fees if it goes down. Except for a few good fund managers, none of the MFs add much value.

    Its better if India concentrates on developing the ETF business.
    Nov 10, 2012
    Mr. Mulraj,

    You mention that:
    "more ETFs on Indian stocks are created and traded on the NYSE than in India, which in effect means that our market is being exported.".

    IMHO, its quite the opposite. It is importing investments. The ETFs on Indian stocks are a vehile for non Indian citizens (like myself) of investing in Indian markets.

    Secondly, the foreign ETFs you refer are US$ or other foreign currency denominated, and cannot compete with any similar Indian ETF. Non Indian Rupee denominated ETFs carry the additional currency / forex risk.

    r v iyengar
    Nov 10, 2012
    You have written that the disinvestment plan of the government has run amok. The right word here should be that it has run aground! There is no activity at all with barely 4 months left for the FY13 to end. Like 
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