»Straight from the hip by Jawahir Mulraj

Future cost of current promises
16 APRIL 2011

Parliamentary democracy is inarguably the best form of government.

Yet, like any system, it would have its weaknesses. One of the biggest weakness of democracy is that politicians are happy making electoral promises in order to get voted, and to continue making them if they are so voted, knowing full well that they won't be around to pay the bill. India is currently having elections in 5 states, and witnessing a flurry of electoral promises.

----------------------------- Get FREE: The Guide to Gold -----------------------------

Will the gold prices keep rising in the future too?

Is it better to invest in gold or stocks? ...

'Gold Bug' Bill Bonner, answers these questions for you in the exclusive publication - The Guide to Gold

Quick! Sign up for our FREE newsletter, The Daily Reckoning and get this Guide FREE!


Thus, for example, free power to farmers, an earlier electoral promise made in states like Andhra, succeeded in doing much more harm than good. The state electricity board went bankrupt. And farmers, not having to pay for power, made excessive use of pumps, depleting forever groundwater reserves.

The largest economy in the world, the USA, is also suffering from promises made to public sector employees, by its elected representatives, promising pensions based on defined benefits (DB), which are linked to the last drawn salary. Because of such promises, all 50 states are bankrupt and are not in a position to fund shortfalls in state pension plans. They have to balance their budgets.

The shortfalls arise because returns from pension assets are inadequate to cover pension liabilities.

The Governments of the developed world made these promises at a time when, because of the baby boom (children born post WWII), the support ratios (i.e. number of people working to number of retired persons) were favourable. In the US, the ratio has slipped from 5, in 1970 to4.6 in 2010 and expected to drop to 2.6 by 2050. In aging countries like Japan, which has also discouraged immigration, the ratio has fallen from 8.6 to 2.6 in 2010 and expected at an alarming 1.2 by 2050 (see Economist, April 9, 2011) The DB pension plans usually cover Government employees; most private sector firms have moved over to defined contribution (DC) plans.

Ironically, private sector employees pay taxes which are used to fund the public sector employees' entitlements, creating a future problem which would have to be tackled. Yet even in DC plans the returns on assets is moribund, thanks to slow economic growth, and insufficient to pay the liabilities. The gap has to be funded by the State Government, but cannot, as it has to balance budgets.

Governments are trying to increase the retirement age, in line with increased longevity. Yet the French people took to the streets when President Sarkozy tried doing that. They would also try and increase return on assets.

This is where emerging markets like India come in. India plans to spend $ 1 trillion on infrastructure and needs the money for it.

Domestic investors have not been too enthused about investing in infra bond issues by financially solid firms like IDFC, PFC and others; they get an equivalent return in shorter duration bank deposits. Yet pension funds would salivate at the rates offered by such bonds. The issue would then be one of currency management.

Indian Overseas Bank, for example, was able to easily sell a $ 1 b..medium term note issue, at 290 basis points over US Treasury bills, which works out to 5%. This leaves it with a healthy spread on the rates at which it lends money. The appetite for such instruments can be gauged from the fact that it got applications for $ 1.9 b. and chose to retain an additional $ 500m. And IOB is not one of the largest PSU banks in India.

The bill for past promises has to be paid some day. President Obama plans to cut US fiscal deficit by a whopping $ 4 trillion, over a period of time, and has presented a plan to start doing so. It will involve a cutback of entitlements, for sure. The point is that the promises for which the bills have to be paid were made by his predecessors, in order to be voted to, or to remain in, office. It is the same for India, and for the electorate not to get swayed by promises of future dollops but to look at the current performance of the Government. If we go by recent re-elections of Governments of Gujarat and Bihar, there is heartening evidence that, indeed, the electorate is aware of the con.

The spoils of being elected, viz. amassing of incredible wealth through corruption, are now centre stage in the media. Jagan Mohan Rao of Andhra Pradesh has, for example, revealed assets of Rs 365 crores, a 350% jump over assets declared 2 years ago. That is a return any asset management company would die for. The assets of other politicians show similar, spectacular spikes. Does anyone in the IT department ever investigate?

No. Investigation is confined to law abiding citizens who, because they are law abiding, can be arm twisted. Vodafone has been asked to pay Rs 12,000 crores, of which Rs 2500 crores by way of a deposit and the rest by way of a bank guarantee. But investigation against the UP Chief Minister was dropped.

The bill is paid in several ways. Theft of power is given a euphemistic title of 'transmission and distribution' loss, around 35%.

Thus not only do state electricity boards go bankrupt but the country has to add extra generation capacity. Since most of the generation capacity is thermal, we are running into a coal shortage. By 2017, coal demand is estimated at 1000 m. tonnes and domestic production at 800 m.

Similarly, subsidy on petrol continues, despite everyone agreeing it needs to go. (Is it because politicians and their kin own most of the petrol pumps?). Oil marketing companies viz. IOC, BPCL and HPCL are losing Rs 5/litre of petrol sold, and combined losses of the three will make all of them loss making. It is far easier to pass a law than it is to make a sensible change of it.

India's GDP growth will, according to Montek Singh Ahluwalia, Vice Chairman of Planning Commission, be less than the earlier expectation of 9% and even an 8.6% GDP growth would require industrial production to pick up, since agriculture is not likely to grow at over 3 %. IIP for the month of 3.6%, lower than expected. The Chief Economist of rating agency CARE estimates a GDP growth of 8.2 - 8.3%.

The first corporate result for 2011, from Infosys, disappointed the market, causing the stock to drop 9.6% in a day. Revenue for the year ended March was up 22% to Rs 7250 crores, and operating profit was up 17% to Rs 2102 crores. The company is also having to deal with a high profile exit of T V Mohandas Pai, a 17 year veteran and head of HR, as also with an accusation of a US senator about misuse of a short termB1 visa, as a replacement for a long term, capped, H1B visa.

T Rowe Price, the US brokerage house, is threatening to exit its recently acquired 26% stake in UTI because of the non transparent way in which the new Chairman is being appointed, after the previous chairman, UK Sinha, moved over to head SEBI. The Government has to put in place more transparent and efficient systems for its public sector companies. The largest telco, BSNL, has been without a head for a long time. In the case of ONGC, the largest oil and gas company (by marketcap) and SBI, the largest bank, also, replacements for the top guy took a while. Why should it need a prod from a foreign firm for us to do the obvious?

The BSE sensex dropped 64 points last week, to end at 19386, and the Nifty fell 17 to end at 5824.

One expects that the downtrend will continue before things start getting better. Yes, over the longer term, there would be a massive transfer of funds eastwards, because the economic growth, and the returns from it, are in countries like China and India, and politicians of the western countries have promises to keep. Our politicians should be cautious making them - the cost will have to be borne by their grandchildren.

And why am I foolish enough to think they care? Sigh.

J Mulraj is a stockmarket columnist and observer of long standing. His weekly column on stockmarkets has run for over 17 years. An MBA from IIM Kolkata, he has been a member of the BSE. He is now India Representative for Institutional Investor. 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 stockmarkets 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 has not been authenticated by any statutory authority. The authors, Quantum AMC and Quantum Advisors do not claim it to be accurate nor accept any responsibility for the same.
© Equitymaster Agora Research Private Limited