As predicted, the Indian government has started its divestment drive. As outlined earlier, this is part of its plan. It is talking up the markets, announcing reforms that can never be developed on, and then selling its paper. It will recover Rs 40000 cr. from divestment and Rs. 30000 cr. from spectrum auctions. They say, the money will be applied towards the deficit. In reality it will be used to fund further sops and giveaways in the next budget. The deficit will be kept at 6 % of GDP and they will take their chances with the rating agencies like S and P later.
Much has been made of the “burst of reforms” unleashed by Finance
Minister Chidambaram in recent weeks. The stock market has rallied and
animal spirits it seems are back. Everybody’s babbling about how the
UPA, after eight years in power, has found religion ie “reforms”in the
last eight weeks.
The market is now at 21 times price to
earnings (trailing twelve month free float adjusted as per the National
Stock Exchange). Once more the mood swings violently. More interestingly
the India VIX , the fear index is at 3 year lows of 15. This is usually
an indicator of complacency, and historically such lows have signified a
massive sell off. The combination of the stretched price to earnings
and the VIX means the market is ripe for a big sell off. My two bit as
an Ivy educated fund manager in Bombay who has worked internationally
on some of the world’s major structural adjustment and economic reform
In reality, the reforms amount to bureaucratic
tinkerings with percentages – of a sort that only tax mavens and
accountants can comprehend. Witholding taxes go down by a percentage
point or two. FII margin percentages change. Service tax percentages for
insurance companies change. Now an attempt's been made to increase the
percentages foreigners can hold in insurance and pensions. (This last
will never pass through Parliament given the unanimous opposition to
it). Blah Blah Blah.
The Indian economy, in fact, requires
Parashurama’s ax and not the surgeon’s scalpel. The reference is to the
mythical woodcutter of Indian mythology who wields a massive axe when
needed. Wholesale violence will have to be committed on large areas of
India’s economy with Parashurama’s axe, if we are to resume a decent
The government had no choice but to unleash this
wave of tinkering and call it “reform”. It is trying to keep the capital
markets buoyant because it needs to sell or “chipkao” (i.e. stick, as
we say in the business) close to Rs 40,000 crores worth of equity. This
with spectrum auctions, hopefully plug the budget deficit a little by
March. More crucially, it will also free up resources for massive
election giveaways in next March’s budget. This is especially needed if
the Food Security Bill –Madame Sonia’s chosen strategy for reelection –
is to be passed.
Real reforms for India will not happen for a
long time. These include financial sector reform, and an end to the
financial repression signified by the statutory liquidity ratio.
Privatization of the banking system that’s put an end to the ridiculous
spectacle of 75 % of the banking system being owned by the government in
a market economy. Bankruptcy and exit laws will have to be introduced.
Labour market liberalization and the freedom to hire and fire labour
will have to be allowed.
The collapsed state of Indian cities
will have to be addressed by building 30 to 40 cities to accommodate
massive rural urban migration. Land acquisition which is impossible now
will have to be addressed. This list does not even include the sector
changes required in real estate and infrastructure and sugar, and so on
and so on. None of this is happening ever, it seems.
babbling in the media about how crucial the February budget is going to
be for the UPA because it will be packed with big ticket sops like the
Food Security Bill. Remember game theory however. It is crucial to take
your opponent’s reaction into account. The Opposition also knows that
the budget will be crucial to the UPA’s reelection chances ! Why then
will they allow the UPA to present the budget at all. Especially when
they have the numbers and the government is already on life support and
in a minority. !!!
The government therefore, will, in all
likelihood, fall in November-December, during the winter session of
Parliament. Elections will take place in March-April as India needs the
school system for a general election. This will allow the Opposition the
chance to deny the government’s attempt to pass a budget full of sops
and giveaways. The February budget will consequently be a vote on
account. This scenario will suit all parties except the Congress and
hence it will happen.
Is the market discounting the possibility
that in a few weeks, all these guys PC, Montek, etc. will be gone ? Is
it discounting the possibility that this reform drive is a sham, that
will be exposed in a few weeks when the government falls ? Looking at
the way its going up, I think not.
The logical conclusion also
is that this is the high point of the markets move this year. India has
gone from having the most incompetent FM (Pranab) to the most cunning
FM (Chidambaram). The later is deliberately doing all he can to talk up
markets to implement his plan. There is little need to oblige him and
his plans of using the stock market as a financing vehicle, by buying
high and losing one’s hard earned capital.