»Straight from the hip by Jawahir Mulraj

Stockmarket euphoric in anticipation of a majority Government
10 MAY 2014

Last week the BSE sensex gained 590 points, to end the week at 22,994, and the NSE-Nifty added 164 to close at 6,853. What is interesting is that these gains were made entirely, and then some, on Friday, the final day of the week, which saw the sensex rising 650 points and the Nifty adding 198. What made the market rally so strongly on Friday? Probably it was the sight of TV images showing a strong turnout when Narendra Modi's motorcade passed through Varanasi, which investors anticipate will result in the electorate giving a majority, or near majority, to the NDA. Exit poll results will be declared on Monday evening, and if these also confirm the TV image conclusions, it could lead to a further spurt. Results will be out on May 16.

True, there will be a feel good factor if the electorate throws up a mandate that does not require a coalition of the unwilling. This could cause a mood swing in the positive direction. However, it is also true that the next Government will have huge problems that need to be addressed, and these can only be tackled firmly if they do not require the support of fickle coalition partners in so doing.

One of these problems is the effect of El Nino, with the Australian Met Department issuing a warning to India would be the most intense ever. This is important because agriculture provides some 14% of national income and supports half of India's population. If it does not grow at an anticipated 3% rate, that knocks of 0.42% off GDP growth figures.

The other major challenge is the omnipotent fiscal deficit. The UPA Government has piled up a lot of unpaid bills on various subsidies, and has transferred a part of the burden of welfare schemes to State Governments. There is little, if any, left for productive investment in physical or in social infrastructure. If, for example, the economy is to grow at above 6%, banks will need to lend more. The public sector banks do not have the capital to grow their books enough to sustain this GDP growth. The Government does not have the funds to provide that capital, estimated at around Rs 4 lac crores.

The performance of public sector banks (PSBs) is adversely affected by the instructions given (on telephone) to their Chairmen by the owners, the Government of India, to lend to crony capitalists. This directed lending inevitably results in non performing assets. As per AIBEA (All India Bank Employees Association) the non performing loans for 406 borrowers was a whopping Rs 70,300 crores. These are up 5 times in 5 years! Further, a whopping Rs 2.04 lac crores has been written off by banks as bad loans! To put it in perspective, this is half the amount the Government needs now to re capitalise banks!

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The banks are directed by RBI to make provisions for non performing loans. These provisions have reduced the net profits of PSU banks. Thus, out of the 18 banks which have so far declared results for the year 2013-14, profits after tax have grown by 5.1% over the previous year. The PAT of 9 PSU banks has fallen, in aggregate, by 37.7%, that of 7 new private sector banks has risen by 20.9%, and of 2 old private sector banks have risen by 0.4%. The reason is that provisions made by the PSUs were up 42.8% compared to 27.1% by the new private sector banks which were not subjected to directed lending pressures, but answerable to public shareholding pressure.

So providing the base capital for banks to raise further capital to ensure their ability to lend more, will be a big challenge for the new Government. Providing jobs will be another big challenge.

In order to provide jobs to the teeming youth who will be joining the workforce, the next Government will have to take several steps. The correct education and skilling needs to be provided. Our education policy is, like several of the UPA's well intentioned but misguided policies, ill fit to serve the purpose. There aren't enough schools and colleges and training institutes; those who own them have a license to collect bribes to grant admissions.

The new jobs will have to come from services (such as construction, when new cities are being built, or in the malls and shops that will be established there, or in road construction, once that gets going again) an from manufacture. There are several things inhibiting the expansion of both services and manufacture, thus impeding the kind of job growth that is not only necessary but is also crucial to avert a societal breakdown.

What are the several things? They have been written about quite a bit. Environmental issues is one of them, projects have been stuck for too long (witness Posco's struggle in Odisha) because decisions are not being made. In its overzealousness to protect religious sentiments, for example, the Supreme Court banned any mining or forest activity within a 150 km radius of Niyamgiri shrine. That translates, as per this insightful article by R N Bhaskar into a 70,000 sq. Km area, far more than the area reserved by other holy sites such as the Vatican (0.4 sq. Kms), Jerusalem (125 sq. Kms), Masjid Al-Haram (0.4 sq. Kms) or others.

To encourage more manufacturing jobs, the next Government would need to look at making labour laws more flexible and of changing the newly enacted Land Acquisition Act, which has far too many layers of permissions required to be encouraging of it. The new DIPP Secretary has also suggested that this Act needs a rethink.

Unlike many developed countries, India has a favourable demographic profile, with a young population that can, if jobs are provided, keep the economic system going. As mentioned in these columns, the US has 60 m. more people drawing money out of the system, through welfare, than putting into it, through taxes on salary and other income. One fifth of the families don't have a single earning member.

Norway had sensibly kept aside a part of the funds it earned from exploration of North Sea oil, saving for a rainy day. However, it has established a welfare state that has made its people too dependent on it, and who prefer to 'nave' (living off the benefits provided by the welfare agency, NAV). Because they get generous pension benefits, about 600,000 people who ought to be working, aren't.

It is obvious that pension funds cannot keep on paying out and will have to bite the bullet at some time. The city of Detroit has already filed for bankruptcy and other cities are to follow.

Poland, which allowed private pension managers a few years ago, has recently expropriated the assets of private pension funds! This article in Institutional Investor talks about how they simply seized these assets! The Government of Cyprus had seized bank deposits of its account holders two years ago, wiping out 40% of the deposits overnight!

Basically depositors of banks, globally, are not provided protection from folly of irresponsible lending, except to the extent that their deposits are guaranteed by the Government. Thus the way PSU banks are directed to lend, and then compelled to write off as irrecoverable, money which belongs to deposit holders, is pretty alarming.

Especially when we see the abysmal way in which our Government protects the investor saver. In the NSEL case, the EOW finally arrested Jignesh Shah, the promoter, ten months after the Rs 5,600 scam broke. The National Spot Exchange (NSEL) was unregulated, despite this issue having come up for discussion in various Government departments. This was in 2011, two years prior to the eruption of the scandal. Had the Government, being aware of an emerging problem, taken immediate steps to curb it, the problem would nary have ballooned.

Investors in equity of listed companies are not protected when the companies simply vanish, after collecting the money raised . There seems no will to chase these promoters and to bring them to justice. Chit funds like Saradha thrive sometimes, as the Supreme Court suspects, with political patronage for their misdeeds.

In the case of NSEL, instead of empathising with victims of fraud, the Finance Minister, P Chidambaram, had the temerity to blame investors, instead of his own Government, for investing in an exchange that was unregulated. How are they to wade through a maze of regulations, for Chrissake! When your own Government agencies were waffling and discussing under whose jurisdiction the exchange lay! The question any honest Prime Minister would need to ask Chidambaram is -why did you permit the establishment of an unregulated exchange? And why, knowing that, did you then inaugurate a sister exchange, MCX-SX?

Later, in Aug 2012, the Government, via a notification, gave teeth to the regulator, FMC, to recover the money, as per this article

The teeth were probably made of plasticine, for it took 9 months for the FMC to use them, and make the arrest.

Faced with a perennial fiscal deficit, Governments, across the world, are trying to grab resources wherever they can. Such as Poland expropriating private pension fund assets or Cyprus appropriating deposits. The US is thinking about ways in which to bring into the tax net profits of American companies that are lying offshore, in their subsidiaries, amounting to over $ 1 trillion. These include famous companies like GE, Microsoft, Pfizer, Apple etc.

In India the Government tries to collect money by raising tax disputes, such as the one against Vodafone. It sought to collect capital gains tax, payable by a seller, from Vodafone, the buyer. When the Supreme Court held against it, the Government made a retrospective change in its tax laws. Now Vodafone has gone in for international arbitration.

The stockmarket will be volatile next week, probably running up a bit more if exit polls, to be declared Monday evening, indicate prospects for a clear, or near, majority for an alliance. Given that the structural issues would need a long time to fix, the joy may give was to a dose of reality. Even though the sensex hit an all time high of 23,048 and the Nifty an all time high of 6,871, its sobering to read that 95% of stocks are below their previous 2008 highs. So getting a bit lighter in a further rally should be an option to be considered.

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.
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