Their erudition and their education, would, it was felt, help them steer a coalition Government hobbled by Left parties with antediluvian ideas of economic growth, on a sensible path. For four years, it seemed things were going well, with the Indian economy growing at 8% and pouring enormous amounts of tax revenues to the Government. The triumvirate, alas, forgot what they had learnt in economics classes and succumbed to the politics of survival. We will now pay the price of neglect to plan for the future.

Poor governance matters. Look at Vietnam, till now one of the tiger economies, whose fast economic growth attracted a lot of foreign capital and created a stockmarket boom. The growth was not managed. The stockmarket has fallen 70% from its peak and every single day in April was a downtick! Look at Zimbabwe, where Robert Mugabe’s neglect has turned a country once the rice bowl of Africa, feeding other nations, into one that has to beg for food as it is bankrupt. Look at North Korea where upward of 1 m. people will die of famine as the great leader chases his nuclear nightmare.

Luckily India has democracy, and democratic institutions. But economic realities must be faced, such as rising crude oil prices unable to sustain untargeted subsidies, without fully prostrating to political compulsions. The triumverate ought to have been protected from political interference, much as Narasimha Rao did when Manmohan was the Prime Minister!

GDP growth is expected to slow down this year, though we should still be over 8%. If services, which account for 55% of the economy, continue growing at above 10%, that provides 5.5% GDP growth; industry, which accounts for 28%, growing at 7% (as in April), would provide another 2% and agriculture, accounting for 18% would, with a 3% growth, chip in with 0.5%, adding up to 8%. Or more, with higher growth in any sector.

The irony is that the resources generated during the past four years in terms of tax revenues, have not been spent in ensuring the future. Most of it has been wasted in political gestures, such as the subsidy on petroleum products. Only a small fraction, perhaps not even a tenth, goes to the truly deserving, who would need subsidised kerosene and LPG as fuel for cooking.

This population could provided the subsidy in a more effective way, using technology, without needing a blanket low price for all. The kerosene mafia, which adulterates diesel with subsidised kerosene, is a beneficiary of this largesse, as are car owners who are not discouraged from buying fuel guzzling cars. (Belatedly, the Government has woken up to its responsibility and levied a special excise of upto Rs 20,000 on fuel guzzlers; too little, too late). Contrast this with Indonesia, where the Government had the cajones to hike petrol prices by 30% last year. Demand for oil has fallen 10% since.

The BJP Government had, when in power, hiked petrol and diesel prices by an equal amount, even though the underlying crude oil price growth was much less. However, it did it in 34 small increases, without attracting public fury, instead of one large one, leading to protests. (Ironically the protestors were the very people who prevented the small hikes). So even when politics comes into economics, management of it becomes important.

Kerosene coupons, much like food coupons in America, would be one way of better targeting subsidies to reach only the intended beneficiaries. Modern day technologies like smart cards embedded with chips to distribute products can also be used. The Government could, and should, have used buoyant tax revenues to develop resources using floating turbines to generate wind power and wave power technology to generate power from waves is now advanced enough to make it equivalent to nuclear power, which would give the Government an alternative. India, with its huge coastline, would be able to develop this, had the priorities of nation building been determine by strategic thinking and economics instead of populism and accommodative politics!

Because prices of petrol and diesel have been subsidised, there is no price effect on its consumption, resulting in a ballooning import bill for crude oil. This leads to a current account deficit, taken care of by capital inflows. To attract which, and to control inflation (which in the last week of May touched a 7 year high of 8.75%), interest rates would need to be raised. RBI did just that, raising the repo rate (the one at which it lends to banks) by a quarter percentage, to 8%. The interest rate cycle is turning up, globally, which would negatively affect equity markets.

With all these untargeted, hence largely wasteful, subsidies on oil, on fertilizers, with the increase in salary after the pay commission hike and with the farm loan waiver, the Government’s fiscal position is atrocious, which is why foreign investors have been selling in spades. Which is also why the Government approved a procurement price of Rs 850/quintal for wheat, lower than the Rs 1000 recommended by CAC.

There was a lot of interesting corporate news. The promoters of Ranbaxy, India’s largest pharma company, agreed to sell their 34% stake to Japanese Dai Ichi Sankyo at a price significantly higher than market price, which consequently shot up. Dai Ichi will make an open offer for 20% at the same price, of Rs 737 per share.

Reliance Communication, which is planning a merger with MTN of South Africa which would be the largest deal from India, will have to face another complication. (The cap on foreign investment in telecom is a major complication which calls for a convoluted route to takeover). Reliance Industries has claimed that it has the right of first refusal if R Com is sold.

Idea Cellular is taking over Spice, in which Telekom Malaysia has a 39.5% stake. Post merger and preferential allotment, it would end up with 20%.

The India story is still good, largely due to the demographic dividend, with a young, well educated population who are free to pursue dreams. At a recent analyst meet of NIIT it was pointed out that India will have an addition of some 47 m. educated people in the 19-25 age group. The rest of the world (including China) will have a reduction of some 53 m. in this age group. Given proper governance, and a polity that cares for the future of the country more than for its longevity, there is no reason why the boom should not continue for years. Given good governance!

Last week the sensex fell sharply by 506 points on opening day (high oil prices, weak Dow), rallied thereafter, then fell again, to close down 382 points at 15181. The Nifty fell 110 points to end at 4517.

It is possible that the sensex can rally to over 16,000 level. One could exit if it does, for thereafter, at some point, early elections may be called. Oil prices are likely to fall, which would help control inflation. The inflationary environment would probably be most benign in Nov and Dec. An election then may probably be seen to be in the best interest of the ruling Government.

Source: Investing in India – What They Didn’t Teach Them at Harvard!

They, therefore, maintain a majority stake in 18 public sector banks, which have 70% of the business, and have kept a cap of 74% foreign holding in the telecom sector. This hurts economic growth.

At a recent analyst meet, the CMD of Punjab National Bank, was asked by this columnist why it was that, given their pedigree (it is 113 years, SBI is over 200 years old) and their finances (both have produced excellent results), their market caps are, respectively, $4 and $ 23 b., far lower than the $450 b. commanded by ICBC of China, which is far younger and doesn’t produce such impressive results. Although, given China’s earlier start down the path of economic liberalisation, ICBC has a balance sheet more than 7 times larger than SBI.

Perhaps one of the reasons could be the reluctance of Government to bring down its ownership below 51%. In a globalised world this is stupid, because you Lilliputianise your large players (if I may coin a term). Look at the top Fortune 500 list and see how many are family owned. To grow to a global size, firms have to give up stakes and it will be institutional investors who would buy them. Bill Gates would not be the richest man in the world if he had held on to his 78% stake when he first listed; it is now down in the early teens. ICICI Bank is no less Indian even though more than 70% is held by foreign investors.

Dr Chakrabarty, PNB’s ebullient and frank CMD, made a good observation. If, he said, India is to become the third largest economy in the world by 2050, as everyone now believes, there must be financial institutions from India that have become global and will be able to serve the needs of Indian companies that would also have grown. PNB is taking steps to move in that direction.

It will not, however, happen, unless Government lets go of the fear of financial Armageddon if foreigners control the financial sector in India. One should think a majority stake in SBI plus one or two other large banks would be enough; the others must be allowed to grow through organic and inorganic growth.

In telecom the cap is at 74% for foreign holding. This is making it difficult first for Bharti Airtel and now for Reliance Communications, to make a sensible merger/acquisition of MTN of South Africa. Since foreign investors already hold 13% of R Com, Anil Ambani can offer a maximum of 61% (swapping it with a 33% stake in MTN to emerge as the largest holder of the combined entity); besides MTN has to make an open offer for 20% from minority shareholders.

The reason the Government retains majority control has less, however, to do with the wolf at the door syndrome, and more to do with controlling and appropriating the profits. That is why oil and gas companies are being looted. Indian Oil Corporation, a Fortune 500 company, has reported a loss for Q4 ended Mar 08. Prices of petrol, diesel and other petro products are kept artificially subsidised and the oil marketing companies like IOCL have to bear a part of this subsidy. They have run out of money to buy petro products and there is a looming rationing of petrol and diesel. Moreover, because they are partly compensated via issuance of non marketable petro bonds, they have had to borrow heavily from SBI which, in turn, has made its largest repo borrowing of Rs 13000 crores and has had to hike deposit rates.

There was even an asinine suggestion that in order to make up for loss of revenue if excise duties are reduced (the oil sector contributes some Rs 70000 crores, the highest, to tax revenue) the Finance Ministry was thinking of levying a cess on all taxpayers. Look at the ridiculousness of this! It means that for car owners to get cheaper petrol, all tax payers must pay! And this has got support of the Left parties!?!

Look further at the insane consequences of this. Facing a liquidity crunch for no fault of its, IOCL is thinking of selling its 7.7% stake in ONGC and 2.4% stake in GAIL!

All this to save car and truck owners the pain of paying market related prices for petrol and diesel! This reduces demand elasticity which is 16% in America and so leads to artificially high demand for them, and hence for oil, pushing up its price. Is this a responsible Government?

Under insistence from its Left coalition partners, the Government is following a policy of not selling profit making PSUs. Now that IOCL, BPCL and HPCL are hurtling towards becoming loss making PSUs one supposes they will be sold at bargain basement prices. Does no one in Government see that this is sheer idiocy?

The Government has to take several steps to make India a more energy efficient nation. One of these is to improve public transportation systems and to discourage private transport. During the past few years it has had hugely buoyant tax resources to allow it to do so. These, sadly, have been frittered away, a lot in subsidies which do not serve their intended purpose. Because of poor ports and roads, it is felt that power generation target of 70,000 MW would fall short by 20%, as the equipment would not be able to reach the work sites on time.

Look at the Government’s appetite for tax in the case of a tobacco company, for instance. Granted, tobacco is harmful to health and must be taxed. In the case of ITC, for the year ended Mar 08, the Government collected Rs 15,398 crores through excise and corporate tax, leaving a profit of Rs 3120 for shareholders. The ratio of Government share to shareholders’ share is 5:1. None of this has, however, been used for providing tobacco farmers an alternative livelihood to wean them away from tobacco.

In corporate news, Tata Motors is coming out with a rights issue of Rs 7200 crores to part fund its acquisition of Jaguar Land Rover.

Last week the sensex fell 234 points to close at 16415 and the NIFTY fell 76 to close at 4870. The fiscal deficit is hugely understated by all the off balance sheet bonds given to oil and fertiliser companies; the RBI Governor has quietly stated as much. Interest rates would have to be raised as inflation is not under control, partly due to Governments fiscal incontinence and largely due to its thoughtless policies of state control over important sectors (banking, oil & gas, coal). The US is also likely to end its interest rate cut cycle and start to raise them. Rising interest rates makes debt markets relatively more attractive. So it is unlikely that the sensex would do anything dramatic this calendar year.

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The underlay of these two emotions are complacency and lethargy, respectively.

The current rally which took the sensex up from 14,700 to 17,700 may lead investor to become complacent, or sanguine, for old times sake. They ought not to. Better buying opportunities should come later.

The reason for the caution are that both domestic and global factors warrant a display of caution. General elections at the Centre are due next year, but expected to be called late this year as the ideological strains of smiling for a family picture will start telling and as a coalition Government turns into a collision Government. States like Karnataka are going to the polls shortly.

Governments, except under severe pressure as in 1991, tend to take foolish economic decisions. As elections approach, they compete even harder for foolishness, bordering asininity. Parties in Karnataka are promising things like free power, a complete waiver of farm debt and other things, in order to curry political support. This largesse, of course, comes from Government (hence tax payers) coffers and not from party coffers which, logically, it should. One way to bring a measure of sanity would be to ask political parties to bear a part of the cost (say 10%) of electoral promises from party funds!

Foolish decisions take their toll on companies and on the economy; thus on stokmarkets. The subsidy provided for petroleum products is estimated at Rs. 77,000 crores, comprising petrol (7,300), diesel (35,700) PDS kerosene (19,100) and LPG (15,500). This is borne by the Government and upstream and downstream oil & gas companies who are partly compensated for the losses through issuance of bonds. The downstream companies such as IOC, BPCL and HPCL are financially haemorrhaging and have become highly leveraged. They do not now, have money to import diesel without which road transport would come to a halt and economic growth would not be the expected 8.5% or more.

With crude oil prices relentlessly rising (they hit $ 126/b) the subsidy burden can only balloon and the foolishness of the subsidy policy only exacerbate. A rebalancing of our energy mix is needed and the main hope is gas, which, fortuitously, we have discovered in good measure. Gas, however, would remain buried under the sea until its pricing, now in dispute, is expeditiously resolved. We cannot afford the luxury of a slow moving judicial system; the issue has to be settled soon and with finality.

The foolishness of Government interference and its impact on companies is also evident in the telecom sector. In Mar 2006 BSNL, a wholly owned Government telecom company, launched a tender for some 45m lines. Being a Government entity, the tendering process was subjected to challenge by writ, and finally the tender was drastically pruned on ministerial instruction. BSNL, which then had 17.6m customers, grew to 40.7m customers two years later. Private sector Bharti Airtel, not subjected to meddling, has grown from 19. 5 to 62m customers in the same period.

Bharti is now seeking to expand overseas, by trying to acquire MTN of South Africa (not to be mistaken with MTNL, which Bharti would be reluctant to acquire, given the differences in work culture). BSNL is now opening a new tender for 93m. lines, worth some Rs. 40,000 crores, which would have equipment suppliers salivating and one hopes that the Government has learnt the errors of micromanaging and doesn’t do anything foolish to interrupt it.

Yet other examples of Government pre election actions are in its arm twist of steel companies in both public and private sector, to bring down prices, never mind higher input costs, which they have agreed to now. The prices would, naturally, play catch up once elections are over. Or in the ban on future trading in agro commodities in order to contain inflation is another. Even though a Government committee found no link between prices and futures trading, this was banned. Consequently prices of soya oil, e.g. have soared, instead of fallen!

In fact there is now an illegal market in Indore, called dabba market, which trades in commodities like soya oil and settles trades through the unofficial hawala route. The ban is completely irrational and only a gesture towards containing inflation, without success. The market for the commodity is being exported. If this is not Kafkaesque, what is?

In corporate news of interest, L&T is undertaking a restructuring which would involve hiving off of a dozen operating subsidiaries, thus unlocking a lot of value. The parent company would have a board to guide these subsidiaries and to manage the L&T brand, which is estimated to be worth $ 2b. It is one way to protect the company from takeover; perhaps the trigger was the likely sale by SUUTI (the SPV formed to take over distressed UTI 64 assets) of its 9.1% stake in L&T.

The US $ slid against the Euro and other major currencies, but, surprisingly, especially with elections around the corner, has strengthened against the rupee, which went up to over Rs. 41.5 to the dollar. Perhaps due to massive RBI intervention in buying the greenback.

Globally, too, there is need for caution. Warren Buffet has warned of further pain in the financial system, though not, thankfully, of a panic. Panic was caused by excessive fears of counter party risk having slowed credit growth and was averted by the actions of the US Fed whilst rescuing Bear Sterns. Poor quality securitised mortgages were exchanged for higher quality Government bonds. It seems to have worked in restoring confidence for now. The US Fed seems to have suggested an end to cuts in interest rates.

The sensex fell on all five days of trading last week, losing 862 points to end at 16737. Of the 30 stocks, only two, viz Tata Steel (which contributed 35 points) and HUL (1) were in the black. Major contributors to the decline were RIL (156), L&T (117) and ICICI (99). The Nifty lost 245 points to close at 4982.

It is possible that there could be another rally to take the sensex back to 17,500 levels. If and when that happens, remember the title of this column.