Signposts To The Yellow Brick Road

Signposts To The Yellow Brick Road

The early vote of confidence for the Modi Government came from foreign investors in the stock and bond markets. They pumped in over $ 55 billion.

It may well be time to return the compliment by unshackling it from our dreaded bureaucratic embrace. This could also get the Indian numbers up in the emerging market investment basket, the MSCI, and other such. The impact could run into trillions of dollars per annum with all the bells and whistles in place, and so it is well worth doing.

The Government has proposed the creation of a financial special economic zone which will be comparable in tax and regulatory terms to what the FIIs are used to in any other international trading centre. The sooner this is implemented the better because dealing with the Indian market today is not much fun for foreign investors. 

A new index is slowly coming into play, devised by S&P, that looks at the nearly 5,000 traded stocks in the Indian bourses to provide a more comprehensive picture along with greater investment depth and choice.

Particularly since it is becoming apparent that company earnings, even in the Sensex and Nifty, may not keep up with the multiples in their stock prices in 2015 or 2016, and may need till 2017 and 2018 to better them. This, alongside the climbing GDP figures, that could go double-digit by then, mainly on the back of infrastructure development. Meanwhile, a short-term correction seems to have set in on the bourses.

It's unfortunate that a lot of this non-existent corporate growth is because there is no  domestic credit at a reasonable price to offtake. This is thanks to the RBI’s niggardly attitude to cutting interest rates, in tiny fractions at a time, ever citing inflation.

If only our RBI Governors, including current incumbent, the eminent Raghuram Rajan, worried a  little about how the constant inflation targeting affected the potential of creating employment like Janet Yellen, of the Federal Reserve Bank of the US. It is arguable too that our penchant for over regulation  has ended up killing the banking system and has stopped development in its tracks.

Ironically, the RBI, has never succeeded in controlling inflation with its tight monetary policies, in the face of the erstwhile surging oil prices, and the fact that with an import of 80% of our petroleum, we have  tended to import our inflation willy nilly.

The conservatism is nevertheless maintained in all seasons undaunted. It is the same tune, both when inflation is high, and when it is low – then, finding nothing else to cite, the RBI fears future spikes to justify keeping interest rates high!

The recent moves on the part of the Government, despite its protestations to the contrary, to clip the largely autonomous central bank’s reach and powers is therefore most welcome. It will help the cause of growth and dynamism that cannot continuously run interference from one learned Governor of the RBI after another, and an entrenched central banking bureaucracy clinging to its turf for dear life.

The Government proposes to divest the RBI of its control of the interest rate mechanism, the public debt, the power to regulate long-term bonds, and the power to regulate inflows of foreign capital.

The RBI will not be left with very much if all this goes through the legislative and administrative process, besides making cautionary noises, as always, on its favourite subject, that of inflation.

As things stand, despite some substantial reformist laws implemented by the Government lately, almost a year since it took over, there is an understandable lag effect before the benefits begin to accrue.  Net net, the real economy is not reviving with the alacrity that the bourses had hoped for.

The FIIs had expected greater speed and urgency, given Modi’s reputation for dynamism, and the sorry pass the Indian economy had sunk to in the closing year of the UPA rule.

The Modi Government’s surprising gradualism has already been much commented upon, but now, as too much time has passed since May 2014, the world is also changing. The dollar is strengthening, the rupee is getting weaker, the US is coming good, and is on the brink of raising its interest rates. India may be growing again too, but it has a lot of catching up to do, and this is blunting its appeal somewhat.

On the plus side, the large monies coming into the Government’s coffers from spectrum sale, coal block auctions, the mine and mineral rights, insurance, will all help it reduce the fiscal deficit. This, even as it has increased allocations for infrastructure development in the recent budget proposals and going forward over the next five years. The infrastructure spend will definitely grow the GDP and provide some new jobs as long as the necessary land acquisitions are not held up, ordinance or bill notwithstanding.

Hopefully, our own efforts in this regard will be amply matched by eager foreign investment into this long gestation area, given the handsome short-term consumables in construction equipment, steel, cement, vehicles and the like.

At least now, recent successes suggest the Government will have its start-up stake without having to resort to printing a huge mountain of notes.

Ergo, the fiscal deficit target of 3.9% could, once again, tend towards the 3.6% earlier chalked in. The Government will not, it is true, garner very much by way of direct taxes in any finite time frame, the tax base being terribly narrow, with just 3% of the population in the tax grid.

And there is little hope of increasing this substantially. The unorganized sector is out of it, the farmers are exempt, small business dodges, as do NGOs and Trusts, professionals as in doctors, lawyers, also routinely cheat on their tax liabilities. Given our post-independence ideological restrictions, we won’t tax agriculture, and the 60% of the population that compose our rural folk.

It is ironic that this is now thought to be socially equitable, landlords, agricultural barons et al, without distinction, even as it becomes a tax dodge for many. We may not be taxing the lowly ‘ryots’, but they were once the fundament of the tax regime, when they were far more wretched and poor, in British and Mughal times.  

The splendid ICS had, in effect, to look after just two things: law and order and  agricultural tax collections. And think of it, the absolute inflation for the whole of the gold-standard 19^th century globally, was just 4 per cent! Let us hope this does not become food for thought for the RBI afresh.

But today in India, greater tax realisations can only be expected to come from the GST with its better chances of compliance in service of an economy slated to grow in double digits soon.

But to make rapid progress, our inherent drawbacks must be uprooted, just like all the worn railway tracks, if Bibek Debroy has his way. The Indian banking system needs urgent overhauling. There are large PSU bank debts, a huge NPA over-hang, difficult to disguise, even with  extensive restructuring. Besides, all the banks are under-capitalised, and urgently need to sell 49%  of their equity, as planned, to the private sector.

Will this also go better with an RBI cut to size? Yes, definitely.  In the name of autonomy and stability, the RBI has been more of a stick in the mud to progress than a helpful agent of reform and change.

For: Swarajyamag

(1,235 words)

March 28^th 2015

Gautam Mukherjee