All entries for Tuesday 23 August 2005

August 23, 2005

The Bull Run Will Continue

SAAG Paper 1515, 23.08.2005

The ‘feel good’ factor in the Indian economy is back. Just a year or so ago, the National Democratic Alliance had to pay heavily in the elections for supposedly overdoing its ‘India Shining’ campaign on precisely this factor. Now, as inflation falls, agricultural output picks up, foreign investors zoom in and growth estimates are revised upwards, the shine seems to be back on the Indian economy. And this time it seems to be sustainable.

On his first trip to India, World Bank President Paul Wolfowitz said in the information technology hub of Hyderabad on 17th August, "'India is rapidly emerging as a country of global importance and we are seeing its footprints across the world now in new and exciting ways. I am here to learn from your model of development and reform in a democratic environment." Perhaps his comments should be seen within the context of recently improved US-Indian relations, but he was not really overstating his point.

Inflation, a big time worry for the government in a largely price elastic economy, is under control. On the week ending August 6, the wholesale price index fell to a two-and-a-half year low of 3.35% vis-à-vis the previous week’s 3.84%. This may seem surprising given the soaring prices of commodities like steel, and the global crude prices nearing $70/barrel. Yet, as the Finance Minister Palanippan Chidambaram said on August 20, much of the credit should go to the Reserve Bank of India’s "adroit management of money supply".

While the RBI foresees no change in interest rates in the medium term, a main reason behind the dipping inflation rate is the phenomenal monsoon. While citizens of Mumbai got an overdose of the rampant rains, in a country where 25% of the GDP is based on agriculture and where it employs over 600 million people, a good monsoon is bound to have a positive impact on growth. It is to be remembered that the 8.2% growth India achieved in 2003–04 was primarily because of a good monsoon following a severe drought in 2001–02 that led to a rocketing of agricultural output. While the 4% agricultural growth achieved in 03–04 might not be repeated, even a 2% agricultural growth will push the overall growth rate well past 7%.

Add to that the near 10% growth in services and manufacturing, the former accounting for over 50% of India’s GDP, greater than expected growth in foreign trade, increases in tax revenue owing to the nationwide value-added tax introduced in April, and soaring sectors like steel, automobiles, real estate and telecommunications- you can easily paint a rosy picture. Yet, roadblocks have emerged in the recent weeks which threaten to derail all this progress.

First, the blatant opposition of the US to the Iran-India gas pipeline is likely to delay or even stop the proposed $4 billion project. On her visit to Delhi in March, Secretary of State Condolezza Rice explicitly stated the American position- "I think that our views concerning Iran are very well known at this time. And we have communicated to the Indian government our concerns about gas pipeline cooperation between Iran and India. I think our ambassador has made statements in that regard." That is a poorly veiled ‘no’. For a country which imports 70% of its energy, this is a second blow after recent bombings in Bangladesh entailed that a natural gas pipeline via that country between India and Myanmar also seems unfeasible for a while. Despite Indian bureaucrats in South Block putting up a defiant face, it is of no mean significance that talk of the pipeline was quietly avoided during Prime Minister Manmohan Singh’s address to the nation from the Red Fort on Independence Day (August 15).

The consolation is that India’s energy companies are making new discoveries at a fair pace, and the state-owned companies have been spending around $1 billion annually to increase their stakes in foreign owned oilfields/companies. For example, Oil & Natural Gas Corporation (ONGC) has increased its tally of stakes to 16 during this fiscal year. Moreover, ONGC reported a new offshore oil discover in the Cambay Basin, along with coal bed methane gas finding in Jharkhand this week, taking its tally of discoveries this fiscal to 6. The private sector is not behind either. Earlier this month Reliance Industry struck methane gas in Madhya Pradesh, estimated to be around 3.6 trillion cubic metres.

Second, owing to continuous arm-twisting from the left parties, the Finance Minister this week ruled out "strategic sales" in profit-making state owned companies. Basic economics questions could be asked of this move. Who would buy "strategic stakes" in loss-making companies and why? Although the government has not ruled selling "small chunks" of shares in these companies, who decides what these chunks are? Most certainly the decision will lie with a bureaucrat-laden committee and not the boards of these companies. One of the main reasons behind the oversubscribing of the listing of these companies on the stock market was the expectation on investors’ part that eventually these companies will function autonomously under an independent board of directors accountable to the shareholders. That may well be a pipe dream now.

However, here too remains a ‘but’. While the media in India was vigorously debating the pros and cons of the alleged scrapping of the disinvestments process, reading between the lines, nothing of that sort has happened. Even Sitaram Yechuri, a Communist Party of India (Marxist) politburo member, recognised that the government has not changed its fundamental position- that sale of shares in profit making companies will continue, albeit the government retaining the controlling shares. Moreover, the government has re-iterated that all sales of shares will be through the markets, and not by private bidding. That may well lead to an improved accountability which may prevent debacles such as the one at the Dabhol power plant in Maharashtra. Finally, the government introduced certain new freedoms for public sector companies, which will enable some of them to freely acquire other companies worth up to $250 million. This is not a policy in vacuum- since last year the Finance Ministry has been consistent in gradually deregulating these companies. Thus, it could be argued that these companies will be de facto free and can be run efficiently. Evidently the markets think so- ONGC shares were up by 5.3% between August 16 and 19.

Third, the introduction of a dose of populism in the otherwise decent economic policy of the government has resulted in certain mind bogglingly grandeur monolithic policies. The mother of all such policies- The Employment Guarantee Act- was tabled in parliament on August 19. It pledges to give one member of a family below poverty line guaranteed employment for 100 days in a year. Typically, it raises more questions than it answers. Why exclude families just above the line? What is to be done about the rampant corruption in the state distribution system that is certain to gobble up a chunk of the massive amounts needed to fund this project? Where will such a huge investment (estimated at around Rs. 1.5 trillion) come from when the government is already struggling to meet the targets of the Fiscal Responsibility & Budgetary Management Act, 2003? Who decides the use of these public projects that would be erected to give jobs to these workers? Would it not be better to develop the rural infrastructure and provide support in the form of better quality seeds and encourage mechanisation of agriculture while letting the private sector give employment in other sectors? Would the policy result in speculation among shopkeepers about the increase in the people’s incomes and lead to a hike in local prices? The list could go on.

But for a few important reasons, this stops short of a financial disaster. First, it is only being introduced in 200 districts with a sketchy pledge of extending it to 350 districts in the future. Second, as economist Jean Dreze pointed out, there is no compulsion in the Common Minimum Programme to implement this project within a set time frame, nor is there an obligation to pay the minimum wage. Third, there is a clause in the bill which mentions that if the government is prima facie satisfied of a major corruption scandal in the scheme, it retains the right to block further funds being released. Unlike what the Marxists are seeking, there will be no "universal, unlimited and irreversible guarantee". That should be a sigh of relief for those who do not preach economics for the insane.

Despite all these hurdles, India will continue to "grow at roaring rates", to quote The Economist. That is because the macro-economic fundamentals of the country remain strong. In a rare stint of "crystal ball glazing", a senior official at the Securities & Exchange Board of India (SEBI)- the market regulator- predicted that the Sensex might cross 16,000 by the end of the 2005–06 financial year in March. That may be an overstatement, but the bull run on the stock market shows no sign of tiring, despite soaring crude prices and the recent floods in Mumbai, as it is beats its own recently set records by closing in on the magical 8,000 figure. While equities were doing well anyway, the recent comment by M Damodaran, Chairman of SEBI, advising investors to take "informed decisions", might lead to a run for mutual funds. According to Abeek Barua of ABN Amro, the current bull run is not just because of soaring corporate profit margins. The adrenalin rush in the market will continue because of a growing liquidity in the world market that is seeking returns, and given the uncertain nature of the current US growth, and a slowing European economy, India is a prime destination.

India needs better governance to raise its sustainable growth rate from 7% to 8–9%. And India expects better governance. Further tax cuts, removal of tax exemptions, more investment in infrastructure, reduction in duties and regulations to business and poverty alleviation programmes are planned in the next budget. It could be said that India’s reforms have been slow because it seeks to preserve its "human face". Yet, as Professor Jagdish Bhagwati of Columbia University has argued, the entire concept of human face could well be a mirage. India always had a human face, and continues to possess one, despite carrying on with economic reforms.

At a pace slower than expected, but still good, India will chug along. Perhaps that is better than flying high without scrutiny, and invariably running headlong into a myriad of problems, and then worry about "cooling down" or a "safe landing".


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