Why the fiscal cliff is important - Straight from the Hip by J Mulraj
Investing in India - Straight from the Hip by J Mulraj
Why the fiscal cliff is important A  A  A

22 DECEMBER 2012

Last Sunday we went to a brunch at a midtown restaurant where I ate and drank like a glutton, and paid the price for over indulgence over the next two days. I had to compensate for my excess consumption by reducing it, and thus restoring the balance in my system.

It is the same for countries, and for the Governments running them.

The US has a debt/GDP ratio of 102% and is hitting a fiscal cliff in January, when the limit of Government borrowing hits a ceiling set by its Congress. After that, certain tax exemptions would be compulsorily withdrawn (which is estimated to raise individual taxes by some $ 2,000 per year, and, in turn, reduce consumption), and some Government expenditure will be compulsorily cut. Japan's debt is 229% of its GDP, Greece is 160%, Italy is 120% and Singapore 100%. India, at 68% looks prudent by comparision and is lower than France which is 86% or Germany, at 87%.

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Ultimately countries, like individuals, have to pay the price for gluttony by consuming less. The only difference is that they take longer to understand this, which is mainly due to the way democracy works. No Government wants to tell the people the bad news, so it keeps trying to push the can down the road, by simply printing its way out of current trouble.

But after a while, the QEs (quantitative easing) stop working. Money, being money, goes everywhere, not necessarily where politicians want to direct it by easing its supply, viz. into creating production facilities, and jobs. It goes into other assets like stock and commodity markets, and real estate. These form bubbles, which, someday, burst, and cause greater pain. Politicians, around the world, shudder to inform their electorate that the long term solution is a bit of fasting and not more feasting.

The two political parties in the US cannot agree on measures to avert the fiscal cliff. Essentially the discord is over whether, and by how much, to raise taxes, which the Democrats prefer, and by whether, or how much, to cut entitlements, which the Republicans prefer.

Social welfare schemes, subsidies, and expenditure schemes to promote a desired behaviour, may be all well intentioned. But, unless properly and continually monitored, they become wasteful. There are always scamsters able to find loopholes, and to exploit them for personal gain.

An example of this is the misuse of subsidy to encourage use of biofuels offered by the US Government. Some scamster found a way to exploit a loophole. This resulted in a freight train going several times from Michigan, in USA, to Ontario, in Canada, without once discharging its cargo, and yet earning millions of $ in bio fuel subsidies, until the fraud was discovered.

In India, too, we have similar, well intentioned but poorly monitored welfare schemes, and nimble footed scamsters able to exploit loopholes for personal gains. Sadly, corruption is far more prevalent in India than in the US, and so the monitoring of such schemes is far more lax. These rascals do not have any empathy at all and are equally willing to steal from cows as they are from small children. The Midday Meal Scheme, set up with the laudable objective to fight malnutrition, is reportedly being misused for private gain. Different state Governments have, in violation of a Supreme Court order not to issue licences for this scheme to one entity, have done so. Such as to Great Value Food, owned by the recently deceased liquor baron Ponty Chadha, by the Punjab Government, or Christy Fried Gram Industry Ltd, by the Karnataka Government. Why do Governments give monopolies to such firms, and then fail to monitor whether the food that is distributed is of a good quality?

This, sadly, is how the benefit of economic growth is eaten away by corrupt persons.

Tax revenues are good enough to sustain some of these schemes, provided the leaks are stanched. The direct transfer of cash under the unique identity scheme would thus help to reduce the impact of greedy middlemen with grubby fingers, on payment outflows. Provided, that is, that the UID is also monitored and implemented properly and is not misused by creating fake ids or other means.

So why does a high national indebtedness level matter?

After a point hugely indebted countries can't find lenders willing to give them money without strings attached, which are called austerity measures. Unable to fund growth, such countries find their levels of unemployment rising, especially of youth unemployment. Countries like Greece and Spain have youth unemployment figures of over 50%, a frighteningly high figure as it means a whole generation wasted. What happens next is looting and violence, as happened in Argentina in a prosperous ski resort.

Are we not inviting similar problems ourselves, through sheer misgovernance?

We, too, have poorly monitored different schemes and are unable to prevent misuse and leakage, which bloats the fiscal deficit. Because of the high deficit we do not spend as much as we ought to on both physical infrastructure (the roads, ports, airports, power plants that are needed to drive economic growth and thus create jobs) or social infrastructure (the schools, hospitals etc). We thus run the dual risks of not creating enough jobs and of not having people with the proper skillsets for the jobs created.

Add to that the move, for the sake of political expediency, of having reservations in promotions and it becomes an explosive mix. With fewer jobs being offered, depriving a meritorious person a chance to further his growth is going to lead to social unrest.

Now in the last three months before the fiscal year ends, our Finance Minister is working hard to raise revenue.

One source of it is by divesting Government stakes in public sector companies. He got just under Rs 6,000 crores from sale of 10% of National Mineral Development Corporation (NMDC) and hopes to be able to raise, before end March, another Rs 23,000 crores from sales of stakes in National Thermal Power Corporation (NTPC), Oil India, Steel Authority of India (SAIL) and other stocks. Government owned insurance company, LIC, which has been selling in the rally, is ready with funds to prop up any of the issues, if needed.

The Government also hopes to be able to raise another Rs 40,000 crores through sale of telecom spectrum. Its first attempt to sell spectrum failed due to an absurdly inflated reserve price, which has since been reduced by 30%. One doesn't know if this will entice buyers. The mood has certainly not been set by the latest complaint filed by the CBI, against Bharti Airtel and Vodafone, and also former telecom secretary, Shyamal Ghosh, for allegedly being allotted excess spectrum ten years ago when Pramod Mahajan was telecom minister. This would hardly put them in a frame of mind to bid for spectrum and would hardly encourage bureaucrats to take decisions for which they could be hauled up a decade later.

In interesting developments, a 12 year old energy and commodity futures exchange, ICE, has done a deal to acquire a 200 year old exchange, none other than NYSE, for $ 8.2 b. The world of exchanges is fast changing and the spoils are going to more nimble footed and tech savvy exchanges than to older ones.

Also interestingly, the $8.2 b. valuation, assiduously built up over a 200 year period by NYSE, the world's largest exchange, is a little more than the Rs 40,000 crores figure which the Government expects through a sale of auction to obtain which it hasn't had to work, and which, theoretically, be obtained in 200 seconds!

Nor, sadly, has the Government or any of its bodies, done work towards building up a large base of equity investors. Demat accounts with NSDL, one of the large depositories, number 12.5 m. which is just 0.1% of our population. Now consider that just 1% of the demat accounts are responsible for trading 90% of the volume on NSE, in the cash section, and one realises that the populace is not sharing in the economic growth of the country. The Government is now thinking of some tax incentives to promote equity investment, but that would be a very tiny measure. The growth of the mutual fund industry ought to be encouraged. The largest two fund houses in the world, Blackrock and State Street, both manage more money than India's GDP.

The BSE-Sensex fell 75 points over the week to close at 19,242, and the NSE-Nifty dropped 31, to end at 5,847. What now?

The Government needs the revenue of Rs 30,000 crores from disinvestment in order to keep rating agencies at arm's length, and is speeding up economic reforms, wherever it can, to get foreign investors in. FIIs have invested over $ 22 b. in calendar 2012 in Indian equities. The latest reform was a new Banking bill, which, among other things, will raise voting rights for foreign institutional investors (FIIs) and allow Reserve Bank of India (RBI) to issue new bank licences. Though India hardly needs more banks; it needs bigger ones that are capable of providing India Inc. with the money to fund its expansion. The Government has a controlling (over 51%) stake in some 20 public sector banks and refuses to reduce it to below 51% (why not do so barring 2 or 3 really large banks?) or to pump in money for them to grow. Other bills such as the Land Acquisition Bill have been deferred to the Budget session.

Perhaps the UPA may need to move faster. The recent victory, for the third time, by Narendra Modi, in Gujarat, has proved that the good governance is what the electorate is more concerned about. The divisive tactics on the basis of caste, cred or religion, are, thankfully, not working.

The UPA would thus, ahead of the 2014 general elections, have to deliver on the economic front and not rely on divisiveness or shibboleths. It would need to move faster with sensible economic reforms.

The Rangarajan Committee is examining a different contract for sharing of revenue in oil and gas production agreements. The existing contract leads to micro management (read: CAG audit of capex) and to a perverse incentive to inflate costs. This would be welcome but would inevitably lead to charges by opposition political parties.

Anil Agarwal of Vedanta has made a sensible suggestion for an open mining policy so we can cut imports significantly and boost the economy.

The US will try to buy its way out of its problems, but it would have to pay the price for past gluttony through slower growth and higher savings to pay off its debt. India will have to find ways to better monitor its welfare programmes so as to help the needy and not the greedy.

The sensex should hit 20,500-21,000 on the sensex before an overdue correction.

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 "Why the fiscal cliff is important"
Om Prakash Sharma
Dec 22, 2012
You have forgotten to mention the most devastating law of entitlements,The food Security Bill. Even the US is discussing the bad effect of entitlement. Who funds these schemes,The Tax Payer Like (1)
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