Causes of concern

PSU splurging without reforms, high rates on dollars and absence of long-term visibility on interest rates

By Mohan Sule

During a bearish phase, investors tend to sit out on the sidelines or view it as an opportunity to indulge in selective bottom fishing. Looking at the low volumes on the stock exchanges, it looks like investors are preferring to err on the side of caution. Despite attractive valuations, many stocks are getting ignored. This reflects the lack of confidence of investors that things are going to turn better any time soon. This stems from the pessimism that it would take years for the euro-zone region to revert to its role of an economic powerhouse. The slow recovery in the US is not accompanied by creation of jobs. More than global economy, investors are fretting that the current crisis is not getting the attention it should from the political class. The well-meaning prime minister is busy listening to investors’ woes. His trained mind might even know the answers to the problems. Experts are there to draw up blueprints. Foreign investors are ready to pump in capital. Yet there is hesitation to execute these plans as the solutions call for disruption of the present way of life. Take the power crisis. This has three components. One is the shortage of coal. PSU Coal India has the monopoly but hobbled by the government’s price sensitivity. Facing obstacles in tying up supply at home, companies have to shop abroad. The generation sector is bogged down by delays in permission. The users of the power, the state electricity boards, are incapable of making payments as a large portion of the power they distribute is subsidized or pilfered.

The prime minister and the bureaucrats in the power ministry know what needs to be done to offer relief. But the cure is unpalatable to the political class. Farmers and the poor form a crucial electoral block and have to be wooed with free or cheap electricity. Coal is considered a national resource, and the mining bill makes it expensive for the investor to dig it up. Natural gas to the power generators have to be distributed through quotas and nuclear power generation is stirring political controversies over safety. All these ingredients make up a perfect recipe for chaos. During the Great Depression of the 1930s, US President Franklin Roosevelt embarked on a spending spree by building a network of roadways as a means to provide employment and business to the private sector. After the dot-com bust triggered a bear phase, the NDA government led by Prime Minister Atal Bihari Vajpayee flagged off the ambitious National Highway project, which is bearing fruits now. As the fiscal deficit has overshot its target due to schemes providing employment to the rural poor and selling petrol below cost, the UPA government is no position to embark on another round of fiscal stimuli by way of tax reductions. Even the proposal to cut the securities transaction tax has been scrapped. Instead, cash-rich PSUs have been asked to splurge to boost business confidence. Perhaps the government is hoping that the capital expenditure would get better valuations for PSU shares, thus lifting market sentiment.

It would be interesting to see what answers the PSU CEOs give to the shareholders during next year’s results. These include CEOs of banks, which are offering interest rates on dollars comparable with those on domestic deposits of equivalent tenures. The measure smacks of desperation though it has started producing results: inflows have increased, boosting the rupee. The plight of companies saddled with FCCBs should have made banks cautious. The depreciation of the rupee and fall in stock prices, extinguishing the bondholders’ option of equity conversion, has saddled issuing companies with huge debt. Some of them have had to roll over or incur additional debt to redeem the bonds. With western banks busy with their own problems of staying solvent, Indian companies are in an awkward situation. RCom has turned to a consortium of Chinese banks, providing them indirect access to our telecom sector. The US$1.2-billion credit to refinance the US$ 1.8-billion FCCBs is nearly half in value of the promoters’ 68% holding. Add to this the reluctance of the Reserve Bank of India to offer a long-term view on interest rates though it has been providing estimates of inflation and GDP growth. In the October 2011 credit policy, the central bank noted the peaking of the interest rate cycle but left the reduction timetable to a number of unspecified factors. Of late, the trend is to provide guidance on interest rates at least for a year: the US Federal Reserve has announced its intention to keep the rock-bottom interest rates unchanged till end 2014. This creates a stable environment for investors. Such a courageous move by the RBI would ensure that India attracts quality money from pension funds rather than arbitrageurs.

Mohan Sule

A modest agenda

The budget should aim to create a stable environment for risk taking rather than embarking on ambitious but divisive reforms


By Mohan Sule

Which avatar will Pranab Mukherjee don when he rises to present the budget for the coming fiscal? Will he be the cautious and prudent economist, fretting over the income-expenditure imbalance, or will he be the nifty politician, eager with schemes that will bear fruits in 2014? Manmohan Singh’s appointment as finance minister during the foreign exchange crisis of the early 1990s was widely lauded as it raised the comfort level of lenders and investors. Yet, the same person as prime minister has proved to be ineffective and blamed for the “policy paralysis”. The reasons are obvious. The balance of payment crisis facing the country was so severe that there was no alternative for prime minister P V Narasimha Rao but to let Singh carry on with his work of opening the economy. In contrast, the unexpected defeat of the NDA government and the formation of the UPA government in 2004 were against the backdrop of the India Shining campaign. Its second term began amid buzz of the India Growth story, the country’s resilience during the global turmoil of 2008-09, and its capacity to overtake China in the not-so-distant future if it continued with the same growth rate. Complacency set in and so also the belief that, no matter what, foreign investors have no choice but to come to India. Instead of continuing with the reforms process and setting an example for corporate governance, domestic compulsions overrode economic wisdom. The result? Foreign investors voted with their feet, and the rupee, whose strength at the height of the 2007-2008 bull run had emboldened many professional forecasters to peg the 45 level as its fair value, sunk to below 53 a US dollar, with scary predictions about its future direction.

What does this mean? A professionally qualified finance minister is as good as his circumstances allow him to be. If the job is restricted to balancing the budget, the prime minister can appoint any of the bureaucrats manning the ministry to the post. The person presiding over North Block has necessarily to be a political animal, adept at electoral math. It will not be a big surprise if there is the tightrope walking of balancing subsidies and other non-Plan expenditure with budgeted revenue. At the same time, there is realisation of the limit to instant gratification. The ramifications of the reckless spending by Europe’s PIIGS are still being felt around the globe. The finance minister, therefore, requires sympathy and understanding. He has to be seen responding to the financially weak segments of the economy. At the same time, he understands that creating an atmosphere that encourages investors will be the best help that he can extend. In this situation, the budget maker tries to prioritise, paying attention to areas that need to be addressed on an immediate basis due to the imbalance created by the external environment or their capacity of showing quick returns. The end result is a messy affair, satisfactory to none of the constituents. The coming budget may also disappoint those purists who would want the finance minister to wield the scalpel more forcefully in discarding the fat of subsidies and dole-outs.

The political class sees the budget exercise as one of the means to fulfill some of its promises to the electorate and, during the terminal years of the tenure, to offer blandishments for a repeat from the voters. The investors watch it to gauge the returns that can be expected post the changes in rules. Eventually, for both it boils down to how much risks the budget allows them to take. Reduction in tax rates and scrapping of levies can result in deficit instead of acting a trigger for more productivity. Higher rates of imposts can sap industry rather than provide more revenue. Instead of adding to its popularity, populist schemes can boomerang by triggering inflation or plummeting of confidence in the government. On the other side of the spectrum, the new regime of regulations will be welcomed by investors if it signals a continuation of the past growth policy and not a U-turn for short-term goals. As long as both the constituencies find risk-enabling provisions the budget would seem to have met its objective, notwithstanding tallying the finer details of inflows and outflows. The Direct Taxes Code and the Goods and Services Tax bills, if passed by parliament in the budget session, will create security in the direct and indirect tax structure, which is so essential for risk-taking. The finance minister in essence has not to do much this year except focus on shepherding these legislations instead of trying to ramrod disruptive reforms in banking, insurance and retail. Stability rather than brinkmanship is the need at this juncture.

Mohan Sule