Investment Driven Economy to Consumption Driven

Today's ET editorial ( http://epaperbeta.timesofindia.com/Article.aspx?eid=31815&articlexml=Go-for-a-Single-GST-Rate-of-About-03102017014017 ) suggests that government should adopt a single rate of 14% for GST.

This set me thinking. India is an investment driven economy. Capital Formation with private and public investments determines the growth in the economy. For the past few years, private investments have dried up leading to lower than targetted or potential growth.

When BJP came to power, all of us had a great hope that the economy will revive. BJP's economic policies will be directed towards high growth and away from entitlement economics. However, Rahul Gandhi's "suit boot ki sarkar" jibe seems to have made BJP cautious and sympathetic towards entitlement/socialist economics. The result of this cautiousness is that BJP has wasted a golden opportunity to convert India from an investment driven economy to consumption driven economy. With the implementation of GST, BJP could have seized the initiative and set a single reasonable rate of GST. Instead, in order to cater to the socialists, it has 4 rates of GST plus luxury/sin surcharges resulting in a complicated system.

Consumption is viewed as evil by government but if you want high growth, high consumption is essential. Due to socialist mindset, goods have been divided into essential and luxury and attempt is to tax luxury at ridiculous rates. Is the government missing that people have aspirations? India is a young country and youngsters like good things in life. It would have been a stupendous opportunity for the government to cater to this young crowd, have a single rate of GST and encourage consumption of even luxury goods.

The Prime Minister has pushed through the bullet train program inspite of all opposition and lot of sarcasm/criticism. Consumption is not bad and getting the latest and best is to be encouraged. High price does not mean luxury. Quality comes at a price. So to tax a mercedes at a rate higher than maruti alto sends a message that government wants you to drive a maruti alto and not graduate to a Merc.

These are early days and government and GST council can and seize upon this opportunity by following advise given by ET editorial and set country on to high growth path and also encourage consumption of quality goods.

Theory of Votebank Politics

Indian economy has lost momentum and now even 6% growth looks doubtful. How does one explain this kind of situation arising from an expected 9-10% growth. I ascribe this to VoteBank politics and my analysis goes as follows:

Congress is anti-growth as growth will eliminate poverty. Elimination of poverty will not allow it to practice votebank politics and act as Messiah of the poor, backward and minorities. It had to put brakes on fast growing economy and also make sure that the fiscal situation worsens, surest way to keep country poor and backward.

It therefore unleashed Jairam Ramesh, an intellectual and allowed him free hand in halting all the projects that were going on. A politician would have found ways and means to let the projects continue and required compliance on a forward basis. Not the intellectual minister. For him it is either black or white or as he prefers to call it - go or no go. Once Jairam Ramesh managed to stop several large projects and created the nervousness amongst industrialists, he was moved to another ministry to carry out even more damages (though ostensible posture was he was being shifted as a punishment). And lo and behold, we had the Land Acquisition Bill unleashed on us, which required farmers to be paid 6 times the market value of land. So Jairam Ramesh first stopped all ongoing projects, then ensured no new projects can be launched since land acquisition will become impossible. Agenda 1 of putting brakes on fast growing economy achieved without people/industrialists realising what hit them.

Then comes the Agenda 2 of ruining the fiscal situation. High crude prices and refusal to let diesel prices be raised helped achieve this Agenda to a large extent. However to make sure that this Agenda is not derailed, Congress came up with the brilliant idea of Food Security Bill. This will ensure a huge burden on exchequer, offer opportunities to middlemen to pilfer the treasury of the country and the aid meant for poor will never reach the poor. Of course, we have been taught that dont give men a fish but teach him to fish. Growth will give poor the method of fishing but we cant allow that so give him fish i.e. ration or subsidised foodgrains. Never mind if the foodgrains meant for him never reach him but the politician can claim to have done his deed and claim credit.

Growth also leads to higher tax revenues and can improve the fiscal situation. Putting a brake on growth ensures fiscal situation doesnt improve.

Poor fiscal situation leads to depreciation of the currency, leads to high interest rates as govt needs to borrow, leads to high inflation as govt will print money to meet non-development led deficit and lead to erratic growth, destroying the confidence of investors. We are back to pre-1996 era of Congress rule (of 50 years). And the surest sign of this was given by the Hon'ble Finance Minister who while talking about inflation and high interest rates reminded Parliament of similar situation of 1980 and how growth rebounded back the next year. Obviously when rupee depreciates, growth will rebound for a year only to retreat back the next year. I wont be surprised if we see negative growth in some quarters over next 3 years. A -25% compression in Capital Goods sector is the first sign of things to come.

It is obvious why Congress does not like India Shining slogan.

Democracy with so-called benevolent politicians practicing votebank politics is probably the worst kind of government that people can have. Dictators/fascists/autocrats at least get criticised and dont get sympathy of people but with a democratic form of government, politicians do exactly what dictators/fascists/autocrats do and get accolades for working for betterment of lives of poor. Except for a lone crusader Anna Hazare who has shown politicians in their true colours.

Icing on cake of votebank politics is the blatant and shameless legitimisation of arsonic activities by the Govt. What i am referring to is the gift of Rs 3600 crore Indu Mills to RPI Activists who illegally occupied the mills and refused to vacate it. And of course none of the political parties dare oppose this move of the government (even a feeble or token opposition is absent) for fear of backlash.

I also believe that high corruption leads to high generation of black money sucking out legitimate liquidity from the system and leading to perpetually higher rates of interest and high inflation. This is very symptomatic of pre-96 era. Interest rates came down only post-98 and this resulted in lower inflation and led to golden period of consistent high growth.

Most of the large developmental infrastructure projects like telecom, roads, power took off in the non-Congress ruled era.

The sad part is that party which helped show India's potential is plagued by infighting and failing to seize the opportunity presented by Congress. Each leader of BJP wants to become the Prime Minister (at least that is the general public perception) and therefore we dont see a coherent strategy to counter the misgovernance of the country from India's largest opposition party.

Technical View Oct 13, 2011

Markets after hitting a bottom of 15745 have risen to 17000 levels where they face multiple resistances.

First is the double top at 17200. Then are the gaps at 17358-664 and 18005-37. It has filled one gap of 16833-17000.

Markets will require tremendous strength to overcome these resistances, possibly gap ups, which looks difficult in the current environment.

On the downside levels of 16400-600 should prove crucial.

Banks and Power Sector Exposure

Bank stock valuations have been hit due to exposure to Power sector and uncertainty related to availability of fuel and PPAs. However if one looks at the groups that are developing these projects, are these worries really justified?

Biggest capacity expansion is by NTPC, followed by RPower, Adanis, Tata Power, Lanco, Jaypee, Jindals etc. Only Lanco maybe considered weaker amongst this and could cause problems to Banks. However it is foremost in terms of capacities actually commercialised and to be commercialised.

Have any of these groups really defaulted to the banks?

Ability of analysts to swing the mood of institutional investors on the basis of some theme (i guess mainly to market their research) is really amazing. Some broking houses actually held roadshows to assess the exposure of banks to power sector and impact that it would have on their earnings and balance sheet.

And for most banks exposure to power sector is less than 5% of their total advances. Power projects typically will have annuity of 25-30 years so a couple of bad years can really be made up.

After more than 25 years, i still cant understand how and why market chooses to react so violently to issues like this and completely decimate the valuations. Maybe because i belong to the school of thought who thinks equity is for the long term and quarterly earnings are less important than the long term prospects.

Europe -- Migration to where the jobs are could be the solution

There should be a simple solution to the problems of Europe. Greece can first stop paying interest on bonds (or ask for a moratorium for 1-2 years), restructure the economy (that is the difficult part, more on it follows), get back in business. Banks which get hit due to restructuring will get support/bail out from their own governments. This way nobody pays for others' sins.

In India we had massive cleaning up of the banking system in the 90s. Restructuring of bank loans happens regularly. So this solution is implementable.

The difficult part is to restructure the economy. That means creating jobs which will pay well and therefore govt support reduces. Europe including Greece are losing competitiveness in mfg. Efforts of the developed world to globalise so that access to markets in developing economy is available seem to have backfired on them as with globalisation, mfg shifted and technology transfer became easy. This problem gets exaceberated by the lifestyle enjoyed by Europeans. I have come across several comments branding Europeans as "Lazy" and "not willing to work". These are comments from Indian companies who acquired businesses in Europe and had tough time getting people to work (meaning work longer hours beyond the official working hours). Greece reportedly has severest problem here with people retiring in 40s and most people working in govt.

Maybe one solution is to export people to where there are jobs and these expats support the local economy (like the gulf employees support Kerala's economy). Given the smallness of population of Europe, the world will have enough jobs for people willing to work. China, India, Canada, Australia, Germany, France, UK, US should allow migration from the affected countries. They can have minimum visa quota.

An unusual solution but one which will work.

And then we are back in business.

Quotes Proverbs Sayings

Only in finance can an old idea be held up as novel and hugely profitable. In

fields such as chemistry or physics, progress is cumulative. In finance, progress

is cyclical. - James Grant

Budget 2010

My takes on budget:

· I I like the cut in personal income tax. It leaves a large sum in hands of consumers. With 50% of population below 25 years of age, such a large cut will spur consumption. And the recovery last year is led by consumption with companies like Nestle, P&G, HUL, Pantaloon, Asian Paints, Castrol, Hero Honda, Bharti all showing tremendous volume growth.

·

I d I don’t think the government will achieve the non-plan expenditure number. It will be overshot by 10% or so resulting in increase in fiscal deficit by 100 bps (from 550 to 650 bps).

·

St S Structural reforms are a positive.

o Govt has set up petroleum regulator and is now setting up coal regulator.

o They have also talked about reforming the judiciary and bringing down the time to settle cases from 15 years to 3 years by FY12. This can be a big positive for attracting international investors.

o They have brought oil deficit within budget and not through oil bonds. Expect some announcement on petroleum prices deregulation. Move to increase diesel prices by Rs. 2.50 is indicative of resolve to get finances in order.

o Reduction in fertiliser subsidy.

o GST from April 2011.

o New Tax code, new companies bill and new regulations for financial sectors are some of the other things which government is focussed on in an effort to deliver better governance.

· B Budget is likely to fuel inflation. I expect margins in this quarter to fall due to higher raw material prices. Increase in excise duty and petroleum prices would add to cost push inflation. Results for march quarter will be impacted due to pressure on margins across all industry segments.

· F Focus on infrastructure through PPP continues. This should ensure GDP growth of over 10% in next 2 years (my own assessment is if we get road sector right, growth could accelerate to 12% per annum in 3 years).

o We are going to see significant addition to power capacities over next 4 years.

o Roads are already upto 9 kms per day from less than a km a day and expected to reach targeted 20kms a day by June.

o Urban infrastructure projects in many cities taking off.

· R Revenue growth, specially direct taxes, maybe much greater than forecast. I remember in Chidambaram’s time direct tax revenues were growing at 40% per annum.

FM has played to the gallery by giving a fiscal deficit number which the market was looking for (though looks extremely difficult to achieve). However I would be cautious in the markets as valuations are determined by actual profits of the companies and large cap stocks are already stretched on valuations and this quarter should see significant margin pressures.

And I expect inflation to pick up significantly leading to tightening of interest rates. So watch this factors as biggest risks to markets.

Enjoy